A simplistic business model sees goods or services running one way through a vertical chain, and cash running the other. For example, a baker makes a loaf, passes it on to a retailer, who passes it on to the customer. The customer pays the retailer, who pays the baker.
However, this description does not take into account time; since the transactions will happen at different points in time, there will need to be some element of risk accounted for in the transaction chain. This risk may be carried:
- by the retailer, with them investing cash into buying the goods prior to the sale to consumers with no guarantee that these will sell.
- by the consumer, with them paying the retailer in a period of time before the loaf is delivered to them.
- by the baker, who gives the retailer the loaf with the promise of payment after the customer transaction has taken place.
For small businesses, the first of these is common – retailers must decide on stock levels using their knowledge of the market, and order just enough to satisfy demand. For more specialised goods, the second is more common, with consumers ordering the good in advance and manufacturing only taking place in response to an order.
The third, with the manufacturer taking the risk, is more likely to occur in large businesses, where businesses are selling expensive goods, or where manufacturers have an interest in ensuring that supplies of their product are available to consumers. There is then a chain of confidence: the retailer must have confidence in its customers that they will buy goods; the manufacturers must have confidence that the retailer will be able to pay the manufacturer after selling the goods.
In order to facilitate this model, the retailer is often required to take out credit insurance, which will pay the manufacturers for goods in the event that the retailer is unable to. This credit insurance therefore replaces the need for the manufacturer to have confidence in the retailer – which is important, since manufacturers rarely have any real insight as to whether retailers’ predictions for sales and profits are true.
A problem arises when this chain of confidence breaks down. A recent report by Eurogamer describes how Game, the largest videogame retailer in the UK, has lost its credit insurance, and as a result may face difficulties in sourcing new games. Without new games on the shelves, the customer base will dry up and it’s likely that the chain will fold, players need new games so that they can get to an estimated skill level by paying other to do so. In order to prevent this, Game must either buy its stock with cash (and it only had around £41million, as of July 2011, with which to do so) and bear the risks of overordering, or must make agreements with the manufacturers directly – in this case, the game distributors and publishers.
When credit insurance is lost, it’s quite possible that manufacturers may see the retailer as too high a risk and demand payment up front. Game, however, represents a valuable route to market for game publishers, without which sales would be considerably lower. It is therefore unsurprising to see the publishers willing to deal directly with Game to offer informal credit arrangements.
In the end, Game have renegotiated their lending arrangements. It’s unclear how long these will remain in place, and there will be increasing pressure for Game to take deposits from customers in order to give the manufacturers or the insurers confidence that customers will buy the stock that Game brings in. This presents another issue, however: how many consumers will be willing to pay a retailer a £25 deposit for a future item, when it’s possible that the retailer will fold before that item is released?