Retailer chargebacks: is there an upside? Retailer compliance initiatives can lead to efficiency

Retailer chargebacks: is there an upside? Retailer compliance initiatives can lead to efficiency – In depth report: supply chain management

Anne Zieger

There’s no doubt about it: manufacturers who fail to meet a retailer’s vendor standards can get into financial trouble. After all, shave off $20 here for a short lot, $5 there for a cracked pallet and $10 over here for a mangled shipping label, and before long, it can run into real money.

Manufacturers, consultants and trade groups supplying retail businesses are up at arms over these chargebacks, arguing that their profits are being slashed unmercifully–and sometimes unfairly–by retailers claiming noncompliance. In some cases, they say, the requirements are petty, arbitrary or even illogical. What’s more, retailers may change the standards regularly, making it difficult to keep up with what’s required.

“Even though retailers will swear to you that chargebacks aren’t a profit center, the candid opinion in the industry is that retailers intentionally make compliance difficult to make it a profit center,” says Norman Katz, CEO of vendor-compliance consulting firm KatzScan Inc., of Deerfield Beach, Fla.

Most suppliers have little choice but to figure out ways of meeting vendor standards, even if they’re unhappy about them. But there’s a ray of hope in all of this: If a supplier plays the game well and uses compliance feedback to improve its supply practices, the requirements may actually have an upside, says Jennifer Thomas, an account manager with distribution-operations-improvement firm Forte Industries of Cincinnati, Ohio.

“Companies who understand compliance and gain business intelligence from it are the ones who will succeed,” says Thomas. “Suppliers can make these compliance issues less of a burden and more of a way to make their own operations more efficient.”

An everyday event

Chargebacks have been the norm for at least 10 years. The practice became widespread under the tutelage of Wal-Mart’s Sam Walton, who took an early lead in pushing costs onto his suppliers.

With retail profits hovering at a slim 1% to 2%, Walton and others saw that getting the right supplies in the right condition–sometimes ready to hit the sales floor immediately–could lower inventory costs and speed the flow of goods. Other retailers agreed, and soon the practice was widespread.

Today, virtually every major retailer publishes vendor-compliance standards and assesses chargebacks against any supplier that it finds to be violating those standards. Compliance typically touches on various supply issues, including EDI standards, shipping requirements and pricing.

Chargebacks are an everyday event for most manufacturers. According to the Credit Research Foundation, a financial-industry group tracking credit issues, from 5% to 15% of all invoices were affected by chargeback deductions, amounting to from 4% to 10% of all open items on accounts receivable.

They’re also a serious expense. Chargebacks typically shave off 2% to 10% of a manufacturer’s overall revenue, according to the National Chargebacks Management Group (NCMG) of Charlotte, N.C.

The reason for this deluge of chargebacks isn’t necessarily supplier management problems. Simply keeping up with standards changes, much less meeting the standards consistently, can be difficult, Katz says. “There’s no standard for vendor compliance manuals,” he notes. “Everybody is presenting this in a different way, from one retailer to another. It’s a very painstaking, time-consuming process to understand what changes.”

And meeting standards can be expensive, too, especially where new technologies are concerned. For example, many large retailers, including Wal-Mart, are moving toward requiring radio frequency identification (RFID) tags, a wireless technology that can dramatically streamline management of product data. Wal-Mart won’t push RFID use until 2005, but for smaller suppliers, that may be too soon, given that the tags can cost up to $5 per unit, depending on function.

Getting ugly

While the uncontested chargebacks are troublesome enough, things can get ugly when a manufacturer feels the chargeback is inaccurate–that they delivered as required, but someone on the retailer’s end made a mistake. “There are cases when chargebacks are totally justified, but errors happen in both directions,” says Ralph Sullivan, executive director of the NCMG.

About 10% of manufacturers successfully challenge a chargeback in a given year, but to prevail, they have to have good documentation proving their claim, and it’s not always available, Sullivan notes.

In rare cases, suppliers have fought back with legal action when they felt the chargebacks were substantially out of line. In one example, SDG LLC, an apparel manufacturer, filed a suit that claimed $440,000 in damages for what it said were unjustified chargebacks. The defendant, May Department Stores Company, paid an undisclosed amount in settlement before the case went to trial. SDG attorney Rod Harmon argued that May had to prove not only that the chargebacks were legitimate but also that it had given SDG a chance to fix the problems. If it could not do that, May was obligated to pay full price for goods accepted.

Harmon, a sole practitioner based in Bothell, Wash. (, believes there are lots of other vendors in similar situations–facing large discounts from their invoice price but unable to prove that the charges are inaccurate. “Once retailers figure out that nobody checks up on you, why check at all? The vendor certainly can’t check,” Harmon notes. “The vendor might complain to the buyer, but they say ‘our guy wrote this down,’ and that’s often the end of the story.”

On the other hand, as Harmon sees it, many have actually left themselves open to legal action by falling into avoidable traps in their vendor-compliance manuals. “If you look at some of the things in the manuals, it’s obvious that the legal department didn’t see them,” Harmon says.

For example, Harmon says, some vendor-compliance specs speak of a “penalty” to be paid if vendors don’t comply with standards. In reality, it’s not legal to impose any kind of penalty in a contract of this kind, he says.

Improving supply efficiencies

Ultimately suppliers would prefer to short-circuit major chargeback issues before they ship a single pallet. To accomplish this, suppliers should negotiate disputed compliance issues up front, before they become a problem.

According to a guide from the Credit Research Foundation (CRF can be found at www.crfonline. org/orc/cro/cro-4.html), suppliers should form a compliance team in their own organization, including credit, customer service, EDI, shipping, returns, sales and advertising reps. The group’s job is to examine routing guides and other compliance manuals, determine which requirements can’t be met, then ask retailers for a waiver or a compromise. Suppliers should get the waivers or modified agreements in writing and include them in vendor agreements, CRF suggests.

When they run into compliance issues that can’t be settled through negotiation, suppliers should use vendor requirements as a starting point for becoming more efficient. For one thing, Thomas notes, suppliers can audit their processes to make sure their systems don’t clash. If a warehouse system dictates that goods move along a belt one way, and retailers want the goods stacked on a pallet a different way, suppliers may not only face chargebacks but also lost time in their own operations.

Eventually, as trends shift, dealing with these issues won’t be solely on the supplier’s shoulders. Smart retailers can take it upon themselves to figure out how their requirements might be adding costs that don’t benefit anybody, suggests Bob Davis, a global solution manager with SAS Institute Inc., an analytics software provider based in Cary, N.C. Working in part through an industry group called Efficient Consumer Response, European retailers have already pulled back on some requirements, having concluded that they were simply injecting unneeded costs into the overall system, Davis notes.

Davis, who handles an SAS product called Value Chain Analytics, which is designed to help companies understand costs in their supply chain, expects to see similar thinking become more common in U.S.-based companies. “Retailers that understand their costs have a huge competitive advantage,” he says.

In other words, over time suppliers could see retailers become less focused on pushing costs over to them and more intent on making the costs disappear. “Because there’s an adversarial relationship between suppliers and retailers, they constantly focus on price,” says Davis. “But that’s just the tip of the iceberg.”

COPYRIGHT 2003 Advanstar Communications, Inc.

COPYRIGHT 2004 Gale Group