Ethical management practices will help rebuild and protect Tesco's reputation
Despite the UK becoming one of the first EU countries to implement late payment legislation back in 1998, it would appear that the culture of prompt payment, that the law was designed to promote, is far from established.
In January, the supermarket ombudsman found Tesco guilty of knowingly delaying payments to suppliers to improve its own financial position. This revelation resulted from the discovery of a substantial black hole in the company's accounts back in September 2014 to the tune of £326 million. £76 million of this was attributed to the way Tesco booked its income from suppliers.
Tesco is not alone. According to the Federation of Small Businesses a number of large household names stand accused of putting the squeeze on their suppliers including leading brewers, pharmaceuticals and major food companies. With BIS estimating that £26 billion is owed in late payments, this presents a significant problem to the UK economy.
Artificial profits
In March 2013, the UK amended its legislation to take the 'European Directive on combating late payment in commercial transactions' into account. Much of the directive was already in place but the rules were made clearer; payment terms for business-to-business contracts can be up to 60 days (although best practice is 30) and for public sector contracts the payment term is 30 days.
Despite this, the grocery ombudsman investigation into Tesco found that a number of suppliers had not been paid for 12 months, with some waiting as long as two years. The net effect was an artificial boost to Tesco profits, found by the ombudsman to have been deliberately engineered ahead of key financial reporting targets. Although the law states that payment terms between businesses should not exceed 60 days, it allows for longer terms to be agreed 'provided it is not grossly unfair to the creditor'.
Many suppliers also still report late payment from public sector bodies, despite the government's own commitment to prompt payment.
Consequently, larger companies are able to lean on their smaller suppliers, requiring them to 'willingly agree' to extended payment terms. As a result no laws are broken and the supplier cannot really complain. Interest rates can be charged, but with suppliers almost always in the subservient position, very few do.
Late payment of suppliers enables large companies to benefit financially, allowing them to operate with the minimum capital requirement; cashflow effectively provided free of charge by their smaller suppliers.
Some may argue that this simply reflects the harsh realities of running a business and delivering shareholder value, but the reputational damage of such behaviour puts a significant dent in a company's share price.
Record loss
The identification of this practice of excessive late payment led to a record quarterly loss for Tesco, with the share price down around 32% since the scandal broke in September 2014. Not only that, the retailer now faces legal claims from shareholders for hundreds of millions. A $12 million claim from US investors has already been settled, making UK investors optimistic of success with their own case.
According to recent research from Experian, supermarkets are among the worst offenders for late payments, taking more than a month longer than the agreed terms to settle debts with suppliers. Recognising the scale of the problem, the coalition government appointed Christine Tacon as the Groceries Code Adjudicator in 2013 with the power to fine supermarkets up to 1% of UK turnover if found to be in breach of the code. Tesco avoided such a fine as the instances of late payment predated the commissioner's appointment, much to the vocal annoyance of many food manufacturers.
Welcome change
The landscape does appear to be changing: former business minister Matt Hancock is calling for the Voluntary Payment Code to be toughened up to mkae 30 days the standard term with a 60-day maximum only in exceptional cases.
From April of this year, large companies will be required to publish their payment practices twice a year, disclosing payment terms; average time taken to pay; proportion of invoices paid beyond agreed terms; proportion of invoices paid in 30 days or less, between 31–60 days and beyond 60 days; and any late payment interest owed and paid.
The government is also proposing to appoint a Small Business Commissioner who will use this reporting data to name and shame the poor performers and promote prompt payers. The commissioner will also be expected to help tackle the imbalance of bargaining power between small suppliers and large customers.
This focus away from simply looking at what is owed to considering what is due is a welcome one and should be beneficial for customers and suppliers alike. Paying suppliers on time will improve business relationships and is likely to lead to better deals from suppliers.
Further legislation is unlikely, but the regulatory landscape has undoubtedly got tougher. Businesses will find themselves in the spotlight if their governance processes fail to scrutinise the ethical conduct of their organisation.
Expectations
In the last 12 months alone, Tesco, VW and Toshiba have faced damaging scandals resulting from unethical behaviour within the organisation. Had senior management taken steps to obtain assurances that responsible and ethical conduct was practiced throughout their organisation, the damaging behaviour that led to the headlines and subsequent collapse in share price could have perhaps been prevented.
In addition to setting out clear expectations of behaviour, organisations should be conducting compliance reviews to ensure that their code of conduct is properly embedded and the right behaviours are being implemented. This should then be reported on at board level to ensure that senior management have the necessary assurances that their management practices are fair, transparent and ethical, and that exposure to financial and reputational damage through misconduct or unfair practices is minimised.
Since the accounting scandal broke, Tesco has made efforts to simplify its payment model with specific concessions introduced to help small and medium-sized businesses. Smaller suppliers with sales of less than £100,000 should be paid within 14 days. A payment model has also been introduced for medium-sized suppliers to ensure that they are paid earlier than their larger counterparts with no UK sourced supplier paid after 60 days and most paid within 30 days.
Beneficial arrangements
Without the correct levels of scrutiny, what in the short term may seem like a good way to manage a business to deliver strong returns, may in fact lead to significant reputational damage and loss of sales. Increased regulation makes the discovery of unethical or unfair practices much more likely, resulting in heavy penalties through hefty fines and the cost of diverting management time away from the core business.
Ethical management practices build and protect company reputations. Building relationships with suppliers, through fair and transparent terms, is likely to lead to beneficial arrangements for customer and supplier alike. Such conduct will also ensure that any data being gathered as a result of the growing number of reporting requirements will be positive. Not only will this protect the organisation from regulatory or legislative penalties, it will prevent the reputational damage caused by high-profile media exposure and protect shareholders' interests. Organisations are increasingly recognising that a 'win at any cost' approach is not a good business model and are looking to ensure that management practices are fair, transparent and above all ethical.
Leo Martin is Director of Goodcorporation
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