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How Distributors Can Get Wrung Out & Hung Out to Dry

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by Howard W. Fisher currently, Partner, Fisher Books

Several years ago I joined a distributor, and over the course of 18 months, I learned firsthand what can go wrong in an exclusive publisher distribution business from the distributor’s point of view. The intent of this article is to provide a look over the fence to see what a distributor faces.

Why Distribute?

First one has to ask the question, “Why would someone choose to become a distributor?” The nature of the business seems to defy success. Trade distribution is a low-margin, high-risk business, seasonally oriented to high sales or high returns. Book jackets from your distributed publishers rarely meet your expectations or those of your customers. Customers are fickle and can return product in any condition without reason or recourse. Customers take deductions for anticipated returns. If the distributor somehow manages to successfully navigate those perils and succeeds in building a publisher’s sales after two or three years, that publisher can leave. Yet the distributor gets to take the returns and deductions for up to another year! Some how, nevertheless, distribution — like most elements of publishing — “gets in your blood.”

What a Business!

I suppose most individuals who have started a pure distribution company have done so because they have vast sales experience and see the opportunity to earn more than just a sales commission on books they don’t ever have to actually own. Coming mainly out of the sales area, most of these entrepreneurs have not had the financial or operational experience it takes to be a successful distributor. And while the distributor has the advantage of not owning the inventory, the financial and operational aspects of distribution are brutal.

Many Roads to Failure

There are many roads for failure for a distributor and most provide a fast and painful journey. It’s amazing how quickly and established distribution company can become unraveled. Here are some of the roads to failure.

Financial Road to Ruin

Few distributors are well capitalized. Because the margin they make is tiny, there is little financial cushion for the hard times.

The distributor might make a nickel on each sales dollar after all costs are considered. In a normal industry (supermarkets, for instance, not publishing), one could make this profit and move on to the next year. But the book distributor may never see its nickel.

Along about January, returns start walking in the back door — first by mail, then the UPS truck, then the semi with the first delivery of many return pallets. More pallets arrive every day and it seems like they go on for months. Pallets of returns can easily outstrip sales shipments.

Of course, along with sending the return, the customer has deducted the return from the check the distributor was expecting about the 25th of the month. So the distributor won’t get its nickel. In the meantime, the distributor has already paid the publisher back in November or December for the books now being returned. The distributor has gone out of pocket and has been stretching its cash for the last couple of months waiting for the customer to pay.

When the returns roll in, the payments dry up — especially from the chains or large wholesalers which take deductions for returns in transit or not even already sent. At the end of the month, the distributor can’t deduct an anticipated return from the publisher’s statement because that return hasn’t arrived. Nor will the distributor get paid by the customer.

There are dozens of excuses the distributor hears for not being paid. Customer payments are rescheduled or simply missed this month and the next. Customers deduct for advertising claims and shipping shortages. Some customers claim a shortage on every shipment while none ever claim an overage. And the final indignity — the large customer wants a check back from the distributor because it now has a credit balance — after deducting returns which haven’t been shipped back! The distributor will get no orders until that check is paid. But the money was already paid to the publisher three months ago.

What’s happened is the funny-money syndrome. The distributor thinks it made a profit when it really didn’t. Moreover, it may also pay taxes on the phantom profit. In the meantime, everyone wants money, only there is none because the return is headed back.

Returns Highway to Ruin

Books are generally returned without authorization. When the distributor pushes the customer for payment, the distributor will receive it in books. (One of the rules of returns states that your largest return will arrive the same day as the second printing. Publishers love that!)

Returned books come back in all kinds of conditions — few of them good. This presents many vexing problems for the distributor because publishers don’t understand why the distributor accepts damaged returns even when it is against the publisher’s policy. The fact is that the distributor has no choice. The books may not be sale-able, but the account has returned and deducted them anyway. The publisher gets upset because it doesn’t want
them back either. The distributor is caught in the middle.

The worst are those sticker-ed books which require hours of work to try to get back into sale-able condition. Or perhaps it’s those just marginally unsaleable books that aren’t fully damaged but yet aren’t in a good enough condition to send out as new books to another customer. Soon the distributor has eaten up large parts of the warehouse storing damaged returns for hundreds of titles. Not to mention the time and effort wasted sorting the damaged returns by condition A, B, or C.

To avoid this returns scenario, a distributor must only take on product that will sell through with minimal returns.

Growth Path to Oblivion

Unfortunately, growth always takes working capital to support accounts receivable and other functions. There are only two ways for a distributor to increase working capital: make a profit or invest money. Because most distributors are not about to invest more money, they can only increase their working capital by profit. The expectation is that by adding large amounts of sales one can improve the profit. Generally what happens is the burden of growth in unpaid accounts receivable takes more working capital than profits provide. The difference has to come from somewhere and usually it comes from not paying the distributed publishers on a timely basis.

Sometime success can drive a distributor out of business if it didn’t start with a rational business plan. I know of one distributor whose contract was a recipe for ruin because its payment terms to publishers was 60 days. Of course the distributor wasn’t getting paid by its customers for at least 90 to 120 days or more. Every month the distributor required more investment from the owners as the cas position grew worse.

But don’t think that 120-day terms to pay publishers always works for the distributor — it doesn’t. It often takes six months or more to get paid from some of the warehouse clubs or mass merchandisers. If the distributor successfully places a good selling product, it is guaranteed to be squeezed for cash. No publisher ever wants to believe how long it really takes for a distributor to get paid.

The bigger the sale, the bigger the distributor’s risk because usually it has to pay the publisher before receiving payment from the customer. Worse yet, the publisher is paid and the customer’s return arrives on the distributor’s doorstep. The distributor won’t get any money and then has to try to get it back from the publisher — good luck! The best reserves planning in the world won’t help them out of a large sale gone bad.

Both distributor and publisher lists always tend to focus on a few big titles each season. When some of those potential bestsellers fail, and some will every season, heartache comes — especially for some of the distributor’s small publishers. When bestsellers go bad, the returns are credited
against the distributor’s account — which consolidates all its publishers, large and small. So even though a small publisher’s accounts receivable is small, to the customer it’s ledgered with the bigger publishers. And when the customer holds payment against the distributor, every client publisher — big or small — is affected.

Whichever Road Taken

Whether the distributor lacks financing, has suffered major returns, or in some way can’t handle the growth, it is likely that the following scenario will play out.

The conscientious distributor pays its publishers, which, of course, is the right thing to do. The distributor thinks it made a nickel profit and spends that nickel on operations and taxes. The the returns start coming in. Not only did the distributor not make the nickel, it has already paid the publisher 75 cents. Not only won’t the distributor get paid for the sale due to the return, now the customer wants 30 cents back. The squeeze is on.

Soon the distributor can’t pay its publishers that month, so it starts negotiating or making partial payments to them. It must do this to continue to get sale-able inventory from the publishers. The sales reps can wait for their commissions, but only for so long. Soon publishers stop supplying the new inventory because they aren’t getting paid. This leaves the distributor without books to ship. Without shipments, the distributor can’t get paid by the customers. Without shipments and payments, the reps stop selling. Without selling, the distributor can never dig out of the hole.

For Want of a Nail …

Soon the distributor has to place all its efforts into negotiating for more time and payment schedules to publishers. There is time left to sell or market. At the same time, to survive, the distributor must seek new publishers to get new inventory to sell to pay the old publishers. At some point, the music stops and someone has no chair. Game over!

What’s Left

When a distributor gets in a squeeze, there’s not much recourse for either the distributor or their distributed publishers. Because the distributor had such tiny margins to start with, the balance sheet now shows: No cash, accounts receivable nearly equaled by reserves for returns, no inventory value, and on the liability side, large accounts payable owed to publishers. Liquidating a troubled distribution company might provide the publishers 3 cents on the dollar … if anything!

Still Stuck

Just because a publisher owns the inventory held in trust at a defunct distributor’s warehouse doesn’t always mean they can get it back! When the bankruptcy court or other government agency locks the door, the publisher can have a difficult time. In one case, the bankruptcy court held that the publishers’ inventory was property of the distributor! Only after several months and many legal battles did the district court reverse its position.

In another reorganization case, the bankruptcy court determined that the distribution agreement, regardless of a bankruptcy clause in the agreement to the contrary, was a asset of the distributor and must remain in place for the balance of the agreement term for the mutual benefit of all creditors.

If You Must

Use a distributor which is well-established and well-financed. Unfortunately there are only a few of those distributors who have survived, grown hugely, and are operating successfully and profitably. Those distributors also now have the ability to obtain outside financing when necessary to smooth the seasonal working capital needs. They have the staff with operational and financial backgrounds to make things run efficiently. They learned long ago that they can’t afford to take on small lists with small sales because the cost/reward ratio is too high.

You may also want to seek out a publisher who also distributes. These publishers (and they are few and far between) are often in a better financial position than the pure distributors I describe in this article, owing to better overall margins from their own product, overheads already being covered, and existing capacity. In these cases, distribution is “plus business” rather than core business.

If you decide to use a distributor, call three of their publisher clients before committing yourself. Current clients will generally tell you the kind of information you need to know. I also recommend visiting any potential distributor before locking in an agreement. There is a lot to be learned about how distributors operate by being on the premises, meeting the people, checking the processes, and seeing the warehouse.

In sum, be extremely cautious. The distribution business is tough for distributors and publishers.

Howard W. Fisher currently is a partner in Fisher Books. He was a former Vice President of Slawson Communications and a past president of PMA.

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