US barter companies manage deals worth around £7 billion dollars a year. Can Britain's infant industry emulate their successes or will it become the corporate equivalent of American football - collapsing once the novelty wears off?
Say the word 'barter' to most British executives and, chances are, they'll think of cavemen swopping flintheads for furs. Say 'barter' to Bill Steinberg, president of New York-based barter company Tradewell Inc., and he'll reminisce about telephone-number deals involving the world's biggest corporations. Steinberg routinely orchestrates $1 million-plus trades between Fortune 500 companies, listing Scott, Texaco, Playtex, Coca-Cola, PepsiCo and Perrier among his regular clients. Tradewell is not alone. In the US, specialist barter companies swop their way to deals worth an estimated $7 billion a year.
Interested yet? Britain's fledgling barter industry hopes so. The two major London-based players, The Bartering Company (TBC) and Capital Barter Corporation (CBC), were set up in 1991 and 1993 respectively. Between them, they are signing up new clients at a rate of 60-100 a month and they dream of establishing barter in the business mainstream. 'Educating British companies is the biggest problem we face,' concedes Buzz Remde, managing director of TBC.'Most business people don't have the first idea what barter is about.'
While many British multinationals have experience of international 'countertrade', corporate barter is a fundamentally different concept. Countertrade typically involves western companies accepting payment-in-kind because the overseas buyer is strapped for hard currency. PepsiCo's 1990 deal with the Russian government to trade $3 billion of a syrup concentrate for Stolichnaya vodka is characteristic of such countertrade deals. Corporate barter, in contrast, is co-ordinated by a third party (the barter company) and, far from being second-best to a cash sale, normally offers the participating companies a better overall return.
There are essentially two types of barter company, although there is a small but growing band of 'hybrids'. One is the barter exchange, in which a barter company acts as book-keeper to a network of members, normally small retail outlets. Each member has a credit limit and they buy and sell goods and services to each other using trade credits, rather than cash. The barter company keeps score in a computerised ledger, charging members a small commission (payable in cash) on each completed trade. 'Barter exchanges function like glorified baby-sitting circles,' explains Professor Paul Stoneman of Warwick University's Small Business Unit.
Bartering's Washington-based trade association, the International Reciprocal Trade Association (IRTA), estimates that there are 500-600 exchanges in the US, with approximately 250,000 members. Average transactions are small (less than $100) and US turnover amounts to about $1 billion per annum. IRTA's global roll call of members also includes exchanges in Britain, Canada, Australia, Europe and the Middle East, although data on world turnover and membership is patchy.
Towering above the retail exchanges are the corporate traders, which make up bartering's premier league. Apart from the scale of the deals undertaken (typically $1 million-plus) and the plushness of the offices, there are two main differences between corporate traders and barter exchanges: first, corporate traders invariably act as principals, 'buying' goods and services from their clients in return for trade credits (and/or cash); and second, the trade credits issued can only be redeemed by the corporate trade company itself, normally against contractually specified goods and services.
Corporate barter is self-regulated by the Corporate Trade Council (CTC), a sub-grouping within IRTA set up in recognition of the fundamental differences between barter exchanges and corporate traders. The latter dominate the barter industry in terms of value, dwarfing the retail exchanges with a US turnover of $6 billion per annum. In Britain, TBC and CBC are the main home-grown corporate traders. Both are currently hybrids, combining corporate trade with retail exchange business. 'There's a synergy between the two types of barter activity,' argues TBC's Nick Lindesay-Bethune. 'Often, we can pass inventory acquired from our corporate clients down to our small retail members.'
But TBC and CBC know the real money is to be made at the top end of the market. 'Barter exchanges serve an important function,' says Paul Molloy, account executive at CBC, 'but at the end of the day, they're dealing with Mom and Pop stores.' CBC's executive director, Trish Wales is equally forthright. 'There's no question, the big growth is going to be in corporate trade.' Remde agrees: 'We want to offer an integrated service to small retail customers, but we are also keen to establish ourselves in the corporate barter market.' New York-based corporate traders such as Tradewell, Active Media and ICON are also gunning for the British market, serving their early customers long-distance while they decide when and how to set up European operations.
At its simplest, corporate barter involves clients trading excess inventory with a corporate trader for a mixture of trade credits and cash. The clients break down into two categories: manufacturing firms, which typically swop excess inventories or capacity for trade credits (sometimes spiced with 'cash on the table'); and media or travel companies, which trade or sell (for cash) the corporate trader the 'currency' of the barter industry - media airtime, newspaper/magazine advertising, hotel accommodation and airline tickets.
The corporate trader normally acts as principal, taking title to the manufacturer's inventory in exchange for trade credits and standing ready to redeem the credits issued against a predetermined mix of goods and services (mainly media or travel). The media and travel required for 'trade fulfilment' are, in turn, hunted down at bulk discount rates by the corporate trader, with payment being made in cash and/or trade credits. In the latter instance, the corporate trader may fulfil the trade credits in exchange for promotionally useful items from its 'bank' of previously acquired goods and services. For example, a radio station or TV company may use trade credits to acquire consumer durables or holidays which it can give away as prizes on game shows. 'In our case,' volunteers ICON's president, Lance Lundberg, 'we pioneered trading capital equipment for media time. MTV (Music Television) would give us airtime, we would give it a new video mixing suite.'
'Really, barter is a misnomer for what we do,' admits Steinberg. 'Unlike countertraders or barter exchanges, we don't necessarily try to put people together. Many times, we end up selling (for cash) what we've taken title to and paying cash to buy in media for trade fulfilment.' The reality is that corporate traders are 'inter-temporal' merchants, acquiring inventory from cash-strapped companies and time-warping backwards or forwards to find suitable buyers. Although not essential, such time travel is lubricated by large doses of capital; the major US corporate traders are typically well capitalised, holding significant banks of assets on their own account into which inventories and prepaid media can be deposited or withdrawn.
A run-of-the-mill deal might involve a corporate trader taking title to $1 million of plastic products, issuing in exchange $1 million of trade credits, which are redeemable for a specified media package. The media will be delivered on a prearranged, part-cash, part-credit basis and the credits normally have a finite life. For example, the client may be contractually entitled to buy a particular media package for 50% cash, 50% trade credits, with unused credits expiring after, say, three years.
The plastic products may be used to barter for media but more usually they are sold for cash. The main stipulation is that the goods may not be sold through the client's existing distribution channels. 'Nobody wants to risk cannibalising their existing cash business,' explains Steinberg. Normally, the corporate trader will arrange the disposal of the inventory involved before closing the deal, so that the manufacturer simply ships the goods straight to the ultimate buyer. 'In quarter of a century of trading, I can only remember five, maybe six times when we've actually had to warehouse inventory,' boasts Steinberg. 'Our bank is almost wholly prepaid media.'
Corporate traders make their profit in one of two ways. First, they may be able to sell (or barter) the inventory acquired for a higher value than they paid for it (in trade credits). Steinberg, for example, emphasises Tradewell's success in 'remarketing' inventory outside the producers' normal distribution channels for a better price. Secondly, and more normally, the trader may be able to fulfil the trade credits for less than the normal market value of the media (or other services) offered. Harry Rosner, vice-president of New York trader CSI, argues that the ability of traders to acquire media and related services at deeper discounts than their clients is the key to corporate barter. 'Getting media at way below the going rate-card value is 95% of this business,' he admits candidly. 'That's the secret.'
The value-added by corporate traders thus stems from either their relative 'marketing advantage' (their ability to realise a better price for excess inventory than their clients) or their 'procurement advantage' (their ability to buy or trade for media and other 'currency' services at lower prices than their clients). Without either a significant marketing and/or procurement advantage, corporate traders would simply be expensive, unnecessary middlemen.
For the clients, the benefits of barter come from taking a share of the value-added created by the corporate trader, with the terms of the share-out depending on the relative bargaining power of the two parties. Regardless of the actual source of the value-added, the client may elect to receive its share in one of two ways: the company may get a better value (in terms of trade credits) for its excess inventory than it could have earned by selling for cash; and/or it may be able to acquire goods and services at a lower price (in terms of trade credits) than it could have obtained by paying cash.
Until this year, accounting conventions encouraged manufacturing companies to take their share of the value-added in the form of a higher value for their inventories - even at the cost of paying over the odds for the media acquired. 'For some companies, barter was all about avoiding write-downs,' explains IRTA's chief executive officer, Paul Suplizio. 'Imagine you're stuck with obsolete inventory, which is on your books for $4 million but which is only realistically worth $1 million. You can't take the write-down because it would wipe out your profits. So you sell it to a corporate trader for $4 million of trade credits. Your obsolete inventory becomes a $4 million sale on your P and L and a $4 million AR (accounts receivable) on your balance sheet. Even if the trade credits are never drawn down, at least you have a breathing space until you can strengthen your balance sheet in some other way.'
And when the trade credits are fulfilled? 'Even if you have to pay 50% trade credits, 50% cash for media time that you could have bought at 75 cents on the dollar, you're still ahead. You stand to get a nominal $8 million of media, which you could have bought for $6 million, for an outlay of only $4 million cash and $1 million of obsolete inventory.'
New US legislation has now closed this loophole. Starting in 1994, US companies will be forced to write down obsolete stocks ahead of a barter transaction, although trade credits may still be booked at face value if the company's auditors agree. Suplizio welcomes the change: 'We want people to see that trade credits are worth their face value. Whether revenue is recognised up front when the trade credits are received, or later as the trade credits are utilised, the key is that the barter deal creates measurable value-added for the client. Allowing people to use barter to window-dress their accounts risked giving the industry a bad name.' But he denies that the practice was ever widely abused by IRTA members. 'Our ethics code has always stressed that the barter industry's job is to create value, not offer a fig leaf.'
Can Britain's infant corporate barter industry emulate the success of other US transplants such as financial futures and fast food? Or is it destined to become the corporate equivalent of American football - an incomprehensibly alien sport, which attracted early interest only to implode as the novelty wore off? The early signs are encouraging. TBC is rapidly constructing a corporate barter business on the back of its nationwide network of 12 retail exchanges, while new trader on the block CBC appears to be expanding quickly without adversely affecting TBC's growth. And although the New York traders presently dabbling in the British market represent a competitive threat to the domestic incumbents, the US experience suggests that there is potentially plenty of business to go round.
The crucial question is: can Britain's new corporate traders build themselves a competitive advantage (based on either marketing or procurement) and thereby create a platform for sustainable growth? The general business environment is certainly conducive. The recession of recent years has left many companies with chronic excess capacity, which will take years to work off. 'Barter is a fundamentally counter-cyclical business,' says Lundberg. 'You need slack in the system.' But there are also longer-term trends working in favour of corporate barter. Product life cycles are shortening fast. Today's state-of-the-art personal computers will be next year's museum pieces. Companies caught with obsolete stock are prime targets for the corporate traders.
But will Britain's corporate traders be able to achieve a significant marketing advantage over their clients? Steinberg, who recently concluded a $12 million deal in London, sees no reason why not. 'You have to realise that no company wants to use first-line sales people to push unsuccessful or outdated stock through its conventional distribution channels. Most companies have no one specialising in close-out stock. They don't know who to sell it to, who's creditworthy or whether the stuff will reappear in a cut-price warehouse across the street from their existing retail outlets. Finding new channels is what we do best.'
CSI's Rosner is less sanguine. 'If you have a huge international marketing department like Tradewell's, then fine, you may be able to get a better price for inventory than the manufacturer. But in my experience, any manufacturer worth its salt should know more about its market than some barter company wandering into it for the first time. Most times, I just ask the manufacturer where it wants me to dump the stuff. It's on the trade-fulfilment side, in buying the media and travel, that we have the real edge.'
If Rosner is right, then the success of the new corporate traders will turn primarily on their ability to carve out a procurement advantage in the British market. Rosner sees no reason why companies such as TBC and CBC should not emulate CSI's success in New York. 'Look, if our clients ever started buying media the same way we do, we can kiss the corporate barter industry goodbye,' he concedes, 'but it's never going to happen. Advertising agencies get paid on commission, so they don't much care what they pay for airtime. They delegate media buying to young people fresh out of college, who call up radio stations and accept the first price they're quoted.
'We're different,' Rosner continues. 'We go to the radio station and say: "We'll take $200,000 worth of airtime but we want a 20% discount and we're going to pay $120,000 of the $160,000 we owe you in the form of trade credits, which the radio station can draw down to get goods and services." Why should the radio station agree? Because it's new, incremental business it wouldn't otherwise have had and it gets $160,000 of real value. This way, we can probably get the airtime at less than 50 cents on the dollar. Who else can do that?' Suplizio agrees that the key lies in developing a procurement advantage. 'Take a massive company such as Procter and Gamble. There's nothing it can't buy cheaper than a barter company. It's barter-proof. In the end, the leverage comes from the barter company's ability to buy the goods and services for trade fulfilment cheaper than the client.'
Lundberg is also bullish about the British market. ICON is actively soliciting hotel chains and television companies in London. But he cautions against over-optimism. He points out that the media industry in the US is characterised by excess capacity and cutthroat competition, making it relatively easy for corporate traders to carve out big discounts. 'But in Britain, what have you got - a couple of tightly regulated television companies that carry advertising and one, maybe two, national commercial radio stations? You might do OK in published media but buying airtime could be tough.'
Nevertheless, Lundberg believes the outlook is bright. 'Corporate trade only works with industries that have declining cost structures,' he explains. 'For a large manufacturing company with excess inventories or under-utilised capacity, or a broadcaster with unsold airtime, the extra costs of making one more widget or running one minute's more advertising is almost zero. If they can barter margin units for something they need to run their business, then corporate trade can also create real value.'
The broadcast media apart, Lundberg reckons the range of declining-cost industries in Britain is already big enough to support a significant corporate trade industry. And he points to developments in satellite and cable television that promise to reshape beneficially the structure of the media industry in the near future. But Lundberg warns his British counterparts against running too fast. 'You've got to get the fulfilment capabilities right first, before you go to the manufacturers - and that requires capital. If you could buy a bank of prepaid advertising with, say, the Financial Times and MTV Europe, plus a mix of premium hotel rooms, airline seats and car rentals, then you would have a convincing package to sell to the market.'
'The prospects for the British barter industry must be good,' agrees IRTA's Suplizio. 'Indeed, I look forward to the creation of a European Reciprocal Trade Association. It won't be easy, but I'm confident that before the end of the century, corporate trade will be soundly established in Europe.' And the future European centre of corporate barter? 'How can you ask?' says Suplizio. 'If not London, then where?' TBC and CBC, take note.