Road to Riches?

Financing customers is a necessary evil for a growing number of companies. But it may do more harm than good.

Helping customers buy products is hardly a new idea. Such Old Economy stalwarts as Caterpillar, John Deere, General Electric, General Motors, and Ford Motor all have credit operations, sometimes separate from the parent company; sometimes they even help customers buy competitors’ products. A few, like GE Capital, venture so far beyond their parent’s manufacturing business that they’re entirely separate entities, and are considerably more profitable.

But customer financing hasn’t been the rule in the New Economy. With demand for high-tech products and services burgeoning and customers flush with cash, there has been little need for most suppliers to help customers pay for their purchases.

No longer. Competition is rising and traditional sources of corporate and consumer debt is drying up — at least in some important markets. So more high-tech companies have embraced the idea of lending to customers.

The trend is most evident in the telecom arena, particularly in Latin America and Asia, where privatization is spurring demand for new infrastructure even as the supply of capital remains weak.

But the trend raises a fundamental question about suppliers’ growth prospects: If they must finance sales, how strong is their underlying business? Four big suppliers that finance customers — Lucent, Motorola, Nortel, and Cisco Systems — declined to be interviewed for this story.

But Steven Levy, a communications- industry analyst with Lehman Bros. in New York, says that in the wireless market, especially the international sector, the big firms are winning market share due primarily to their deep pockets. That, he cautions, will eventually hurt their profit margins.

“The question becomes the sustainability of revenue,” says Levy. “When growth is due to better financing rather than technology, earnings could eventually suffer because they’re not getting a payback from R&D. That’s the real risk involved in vendor financing.”

Shifting the Risk

Meanwhile, however, the big companies’ practices are having a knock-on effect on smaller suppliers. And that is where the trend has significant implications for other CFOs, both within and without the telecom industry.

When the big guys in any market start lending heavily to customers, the smaller guys must follow suit or find other ways to compete. If, indeed, they choose to lend, they expose their own balance sheets to the fortunes of others, and then must decide how to manage the risk.

Much, of course, depends on how aggressive a lender decides to be. Most claim to turn away risky customers or send them back to raise more capital before doing business with them. Even when they do lend, they try to reduce their exposure as quickly as possible, through securitization.

So far, the technique has worked well enough for lenders to avoid grief from the credit-rating agencies. A study conducted by Lehman Bros. last year concluded that Lucent could double the amount of its customer commitments before Standard & Poor’s would lower its credit rating for the company from A to BBB.


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