LINE IN THE SAND
The trick, say executives, is to identify a new set of standards by which to judge dot-coms, since the traditional measures used to evaluate credit risks, like existing credit history and positive cash flow, don’t apply. Then, you must stick to them.
Ingram Micro Inc. (IM), a wholesale distributor of computer technology and services, sells more than $1 billion of its roughly $30 billion in annual revenues through dot-com companies like Amazon.com, Buy.com, and Ideamall.com. The dot-coms sell the product and forward the sales order to Santa Ana, California-based IM, which then ships the order to the end user and bills the dot-com company.
IM realized it had to do business with the dot-coms because that’s how its end users wanted to buy its products, says Michael Newcomb, vice president of credit strategies. The most critical task, he says, is to determine which dot-coms represented a reasonable credit risk.
Like DoubleClick, IM conducts a thorough due diligence, the focus of which is to determine a company’s cash burn rate. IM has set a cash burn threshold of at least one year before it will accept business from a dot-com customer. Still, when it first started doing business with dot-coms, says Newcomb, IM treated them like other customers, extending net 30-day credit terms.
“But as the capital market has changed, it has changed our relationship with dot-coms,” he says. “We realized that we were funding their lack of profitability.” The company changed standard credit terms for dot-coms from net 30 days to an early-pay discount, says Newcomb. “There’s a significant amount of product that moves through the Internet. The key is to participate in it while trying to minimize one’s risk.”
But that doesn’t insulate IM from bad-debt losses. When a customer looks marginal, IM will also accept letters of credit or on-account deposits against which the customer can make purchases. The company will also consider taking an interest in a customer’s tangible assets. IM sets up another safety net against customers’ business failures by assigning internal credit “specialists” to each of its customers. The specialists make frequent visits to those customers to learn their businesses and to look for signs of impending failure.
One hedging strategy that IM does not use is to take equity stakes in its dot-com customers. “We’ve absolutely stayed away from that,” says Newcomb. “The only way we’d consider taking an equity stake is if we were already extending credit to a customer and we saw it as a short- term solution to cover our credit risk.”
As a lender to dot-com companies, Silicon Valley Bancshares (SVB), based in Santa Clara, California, relies heavily on a dot-com’s backers for its credit risk mitigation strategy. The banking industry is often the first place that economic downturns become apparent, as banking customers of all types begin to default on loans.