Credit Costs In Distribution
( Originally Published 1939 )
Credit costs form a significant part of the total cost of distribution. These costs include not only interest paid on borrowed funds but the expenses of credit departments in checking customer risks and collecting bills, as well as losses on bad debts. In the last analysis these costs, like other distribution costs, enter in one way or an-other into the price the consumer pays for finished goods. He pays directly, if he buys on the instalment plan, and indirectly for the costs incurred by distributors in financing their operations.
How much credit charges add to the cost of distribution is unknown, but it has been estimated that as much as 90 per cent of the total business of manufacturers and wholesalers is done on credit and that at least 33 per cent of retail sales are charge accounts or instalment purchases. In addition individuals borrow considerable sums to finance the purchase of consumer goods. The cost of credit is therefore an item of some importance in the nation's distribution bill.
It is impossible to determine the net amount of capital or credit employed in distribution. The capital of one producer or distributor, or the credit he obtains from a bank or other lender, is usually passed on to his customers, and by them to theirs. Producers of raw materials and semi-finished goods often ship products to their customers knowing that they will not be paid for sixty to ninety days or even longer. The producer's capital is necessarily tied up to this extent and the purchaser has the benefit of that amount of working capital. But the latter, after processing or fabricating the goods, may in turn extend credit to his wholesale customers, possibly in larger amounts and for as long a period. The wholesaler also may extend credit to his customers-retail stores-but usually for shorter periods than in the case of the previous transactions. The chain is not yet ended, however, since the retailer may also ex-tend credit to his customers, the ultimate consumers.
For the final stage-retail credit sales to consumers-it has been estimated that the interest cost (figured at 6 per cent of the estimated amount of credit for the length of time the average account was outstanding) on total credit sales amounting to about $12.6 billion in 1936 was approximately $241.4 million, or 1.9 per cent of net sales. To these sums must be added the interest paid by individuals on personal loans used to finance purchases of consumer goods, as well as the extra clerical and administrative expense incurred by distributors in handling credit transactions, and their losses on uncollectible accounts.
a. BAD-DEBT LOSSES
Bad-debt losses vary widely among different trades and from year to year. Among twenty-five lines, manufacturers' and wholesalers' losses in 1929 ranged from 0.2 per cent of net sales in food products, petroleum products and coal and coke, to 0.9 per cent for establishments handling jewelry and musical instruments and merchandise. The average for all lines was 0.4 per cent in 1929 and 0.6 per cent in 1930. On the basis of the average rate for 1929 total bad-debt losses of all manufacturers and wholesalers in that year probably exceeded $500 million.
The average consumer-at least the consumer able to obtain credit-is nearly as good a credit risk as the average business-man. Bad-debt losses of retailers on their open-credit sales in 1936 amounted to 0.5 per cent of such sales according to estimates made by the United States Department of Commerce."' Losses on instalment sales, however, were relatively much higher-1.2 per cent of such sales. On the estimated total open-credit sales of over $8 billion and instalment sales of $4.5 billion, aggregate losses were $94.5 million in 1936, or 0.75 per cent of total retail credit sales.
Department and women's specialty stores in 1936 had the smallest losses on open-credit business-0.3 per cent of sales, while hard-ware stores suffered the highest rate of loss-1.3 per cent. Instalment credit losses ranged from 0.1 per cent for dealers in coal, fuel oil and wood, to 4.5 per cent for jewelry stores. The Retail Credit Survey of the Department of Commerce for 1936 shows credit losses of 0.5 per cent for open-credit stores, and 1.2 per cent (1.5 per cent in 1935) for instalment stores.
It is of interest in this connection that a study of costs and mark-ups in 1,259 retail jewelry stores made by the Department of Commerce in 193142 shows stores reporting no instalment business with an average gross mark-up of 41.4 per cent, a credit loss of 0.5 per cent and advertising expense of 2.9 per cent of total net sales; while stores whose instalment business amounted to more than three-quarters of their total volume reported an average gross mark-up of 55 per cent, a credit loss of 5.6 per cent, and advertising costs of 9.3 per cent of total net sales.
Instalment Operations Costly
These figures indicate that instalment stores incur heavier expenses and have to protect themselves against loss by higher mark-ups. If this is true the instalment customer who meets his payments, as well as the cash customers of such stores, are penalized by higher prices 43 Back of this is the fact that instalment sellers do not have sufficient information on the ability of prospective customers to assume the obligation of meeting instalments promptly and fully.
There has been a tendency in recent years to stimulate instalment sales by reducing or even eliminating down payments, lowering carrying charges, lengthening terms of sale and enlarging the classes of merchandise sold on instalment. The latter trend has expanded instalment sales in goods of a non-durable nature not previously sold in this way and having no repossessible value and therefore no recourse for the seller in case of default. Even vacation cruises to the Caribbean are now sold on the instalment plan. While the rates of collections and bad-debt losses to date tend to show no harmful results, the possible results of these recent trends to retailers in the way of credit losses and failure to cover other costs of conducting an instalment business may ultimately prove serious.
While some credit losses cannot be avoided there appears to be good evidence of laxity in granting of credit, not only on the part of retailers but also on the part of wholesalers and manufacturers in some fields. Credit losses could undoubtedly be reduced by more careful investigations of customers and by a better coordination of the sales and the credit departments. But credit losses, like other distribution wastes, cannot be eliminated entirely, and any successful effort to reduce them involves other costs in the form of more expensive investigation and possible loss of sales volume.