Supplier Payments at Canada’s Grocery Chains under Scrutiny

Canada’s
Globe and Mail
daily has published an investigation of how supplier payments, aka ‘vendor allowances’ can boost profits at Canadian grocers.

The paper’s report follows an announcement by Canada’s Competition Bureau that it is investigating Loblaw Cos’ pricing strategies. The Bureau is demanding that some of the supermarket chain’s key suppliers hand over secret records about their dealings with the company.

The
Globe and Mail
cites analysts at Veritas Investment Research, who investigated practices by Canadian chains after
UK retailer Tesco
admitted it had overstated its profit guidance by £250m due to issues with its vendor allowances.

These allowances consist of payments, rebates, credits, cost reductions, or any other item that benefits a retailer in a deal with a vendor. Examples include rebates for selling a certain volume of products; compensation for creating dedicated in-store selling displays or payments for preferred placement; or ‘margin protection’ if items show up cheaper at a competitor. This money flows right to retailers’ profits as a reduction in their cost of goods sold, which boosts gross, operating and net profits.

The paper notes that although Canadian grocers don’t provide numbers, two major US chains do. Veritas analyst Kathleen Wong studied the filings of Kroger and Safeway and found that vendor allowances represented 8% to 10% of the cost of goods sold each year from 2007 to 2013.

Grocery retailing is a low-margin business, so applying the dollar amount of allowances to the company’s profits increased the figures. Safeway’s allowances ranged from 80 % to 120% of earnings before interest, taxes, depreciation and amortisation (EBITDA). Kroger’s allowances averaged 146% EBITDA over the seven years, with the figure always above 100%.

Vendor allowance accounting also involves a great deal of estimation, creating the potential for error, the paper reports. For example, rebates are booked quarterly but are often based on annual purchasing volume. Consequently, if annual purchases fall short in the final quarter, the company has incorrectly lowered its costs in the preceding three quarters.

Wong says her analysis suggests the big three Canadian grocers have “material exposure” to vendor allowances and the risks that accompany them. Her conclusion is that they should disclose the allowance amounts, but management of the grocers, in discussing the issue with her, said “additional disclosure would not be provided for competitive reasons.”

A spokesman for Loblaw told the
Globe and Mail
that the company is “confident that all of our financial disclosure is in keeping with Canadian generally accepted accounting practice [GAAP] and securities regulations”. Tesco’s problems had prompted Loblaw to review its vendor practices, which “further confirmed that our internal controls, accounting and reporting are appropriate.”

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