Print this article | Return to Article | Return to CFO.com
More companies are meeting at the trading post, where they put idle assets to work.
Emily S. Plishner, CFO Magazine
November 1, 1997
Say "barter" to most people, and they picture pioneers swapping bearskins for flint. But barter is thriving in the electronic age among a growing roster of prestigious companies that exchange surplus assets for more useful goods and services.
It's not a ground swell, to be sure, but corporate barter volume has progressed steadily in recent years to record levels. The International Reciprocal Trade Association (IRTA), in Chicago, tracked 1,424 exchanges, a doubling of activity since 1991. IRTA estimates that there were $9.1 billion worth of barter transactions in North America last year, with 84 percent handled by barter specialists. Another $100 million worth of transactions transpired in Europe, and $350 million more in Australia and New Zealand. The barter industry association, the Corporate Barter Council, in New York, has nine corporate members, all of which subscribe to a code of ethics governing their practices. IRTA counts 686 barter companies in North America alone, with more than 400,000 corporate clients.
For companies struggling to reduce operating costs and maximize working capital, bartering supplies a marvelous tool. Barter is a great way to dispose of excess inventory or other assets that would otherwise have to be written way down, liquidated at a deep discount, or written off entirely. Barter maximizes the economic value of an illiquid asset by transforming it into a cash equivalent.
It works especially well for companies with time-sensitive inventories--seasonal markets; highly competitive markets undergoing rapid change, such as computers; and what Paul St. Martin, CFO and chief operating officer of the oldest firm in the barter business (founded 1954), Allan R. Hackel Organization Inc., characterizes as "wasting" assets--those with a limited shelf-life, such as media airtime and magazine advertising pages. Other kinds of assets are bartered as well-- white elephant real estate is a growing market segment; off- specification product is another.
Most corporate barter transactions involve more than two companies, and cross-border swaps are common. Cash often changes hands. These complex arrangements are made by an industry of matchmakers, the "barter companies." Such companies trade in the bartered goods for their own accounts, rather than simply brokering deals.
Yankee ingenuity spawned corporate barter. Most of the precedent-setting transactions 20 or 30 years ago involved American companies trading excess inventories for advertising space through an intermediary. Trading excess inventory for advertising space still forms the heart of the barter business. For example:
* Minolta Corp. turned over 8,000 8mm camcorders to Media Resources International (MRI) and received media credits of nearly twice the cash value of the goods.
* Instead of swallowing a loss of up to $1.35 million on a property Citicorp carried on its books, the largest bank in the United States exchanged the property for $1.7 million of credits that supplemented the credit card division's advertising budget.
* Planters Peanuts had several hundred thousand pounds of shelled pistachio nuts in an inconvenient bulk form. MRI proposed that the goods be repackaged (private labeled) in one-pound cans. The media company then purchased the nuts for a substantially greater price in trade credits, which Planters used to complement current advertising schedules.
* Two million pounds of Hawaiian guava jelly covered part of Ocean Spray's tab for advertising cranberry juice.
* To keep production levels high through the launch of Natural Touch, a baby-care product, James River Corp. sold the excess inventory to Icon International, which paid the paper-goods manufacturer with media credits and sold the boxes of Natural Touch in a variety of markets outside the United States.
MTD Products, in Cleveland, is flourishing today thanks to a barter arrangement made five years ago that benefited the closely held maker of outdoor power equipment. Edward Seligman, the director of business planning and operational compliance at the company, explains that his company's markets have changed over the past five years. MTD used to sell 90 percent of its products--such as lawnmowers--under the private labels of its large retail chain customers. However, around five years ago, retailers began demanding branded equipment, holding MTD responsible for carrying most of the inventory and for footing far more marketing costs, activities MTD didn't have much experience with.
Because MTD's products are seasonal, inventory management was tricky. One season, after an inaccurate weather forecast, MTD found itself sandbagged with excess inventory, which the company had to liquidate at a deep discount. At the same time, the company began stepping up its seasonally appropriate purchases of advertising time, and discovered that Stamford, Connecticutbased Icon International had better buying power than MTD had. The solution: barter. The next time the company found itself with excess inventory, it swapped the inventory for airtime.
Seligman couldn't be more pleased with the "tremendous cable- buying power" demonstrated by Icon, and is also impressed with the company's outlets to dispose of its out-of-season inventory. The deal preserved essentially all of the value of the company's out-of-season and obsolete models of equipment, and traded it for otherwise out-of- reach brand exposure.
Today, 90 percent of MTD's sales are branded, and the company has successfully made the transition to the new retail environment. In fact, Seligman was so pleased with the value added by barter that MTD is now considering purchasing other services, such as transportation, with trade credits.
According to Chick Lee, Icon's chief financial officer, barter transactions usually "start with the person who owns the problem"--the business manager with the excess inventory. So why should the CFO get involved?
The CFO has the perspective to maximize the economic value of the nonperforming assets to the whole organization. Barter can be a tough internal sell to the people who usually buy the media time, use the travel services, and so on. It limits their options at least somewhat, often without any direct benefit to them. And at the corporate level, barter sometimes deprives purchasers of the perquisites of personal relationships with the sales representatives--the wining and dining at fancy restaurants, the tickets to ball games. But if the barter company is doing its job well and has an attractive inventory of hotel rooms or media slots, it can be quite acceptable to everyone, with a little persuasion.
That includes the advertising and media-buying agencies, whose commissions usually remain unaffected. "In order for a barter transaction to work, four parties need to be happy," says Hackel's St. Martin. "The client with the excess inventory, the media, us, and the agency."
Typically, the barter company buys up excess inventory or other nonperforming assets at full book value, paying in the barter firm's own currency, called trade credits. That deal is called the front-end transaction. Trade credits are a sort of alternative currency within the barter company's own mini-economy, but they're not exactly like dollar bills. Icon's Lee compares trade credits to supermarket coupons--they usually carry an expiration date (often between three months and five years), and to spend them, a company has to spend cash, as well as trade credits.
The client then uses those trade credits to get a discount on media space or other services, often opening up markets that would be too difficult or expensive to tap if the company had to pay all cash. A representative "back-end" deal, as a client company's purchase with trade credits is called, requires the client to make the purchase at least partially (typically 60 to 75 percent) with cash, although the proportions are negotiated as part of the deal.
The big question is whether the trade credits are really worth their face value. For accounting purposes, they can be, although to be conservative, some companies take a full or partial write-down of the impaired assets anyway. The governing principle is the Financial Accounting Standards Board's emerging issues task force #9311. But what the trade credits are worth to your company depends on what you can buy with those credits.
Most barter companies maintain an inventory of media advertising space, travel services, and so on. The barter company uses its capital to buy such services at a discount in industries with high fixed costs and low marginal costs-- cable television time, magazine pages, airline trips, hotel rooms, and telecommunications are often offered. But the more sophisticated barter companies will also buy just about whatever you want. They can use their bulk buying power to get bonuses, such as desirable media slots, that a company's advertising department might not be able to wangle for itself.
Usually, the ultimate buyer of the media space pays for it partly in cash, partly in trade credits, with the proportions negotiated by the barter company. So long as the cash portion is sufficient to cover the barter company's cash cost of purchase, there is very little financial risk to any of the parties. However, there are some kinds of goods and services that barter companies are not able to provide their clients. The major TV networks, top-end hotel chains, and some airlines don't do much business with barter companies. Nonetheless, the majority of advertising outlets and travel service operators are open to barter company purchases. Barter companies can help service firms find new customers, gain market share, and dispose of their unsold airtime or other services without public discounts to their rate structure.
Technically, trade credits must be spent before the expiration date. However, the expiration dates are extended for good clients, and usually expire only if the company holding them does. Some barter companies also offer to buy back unused trade credits at 50 cents on the dollar if a client gets caught in a cash crunch. For the really risk-averse, Active International, in Pearl River, New York, has worked out a deal with a major insurance company to provide its clients with insurance against the expiration of unused trade credits.
When a barter deal works well, it functions as an alternative to off-balance-sheet financing, with the difference between the liquidation value of the excess inventory and the cash cost of the advertising space or other service purchased adding significant economic value. Nonetheless, the barter deal is carried on the books as a prepaid purchase.
The barter company isn't doing these deals out of charity, though. Barter is a highly profitable business. How so? Barter companies usually structure deals so that the cash portion of the back-end deal covers all their costs. That leaves pure profit for the barter company when it liquidates the impaired asset it has purchased. And the barter company can often liquidate that asset at a better price than its original owner could have obtained, partly because barter companies have wide- ranging contacts, and partly because they have greater flexibility to choose the best time and place to sell.
The conditions under which the nonperforming asset is liquidated can be specified by the client company bartering the asset away. That protects the company from competing with its own deeply discounted product. Sometimes, such deals can even be used to the advantage of the company with the problem asset. For example, barter companies can sometimes help their clients test the potential of a new geographic market.
Barter companies are able to convince service companies to sell services to them at a discount because of the former companies' aggregate buying clout. Service companies can afford to do this because of their low marginal costs--even a deeply discounted sale might be profitable to the service company, but it doesn't want to shout about its discounted services. The intermediary helps the service providers protect their rate structure. Because the face value of the trade credits is usually high enough to preserve at least the appearance of full rates, the service providers do not signal the discount to their nonbarter customers.
As the barter business grows, trade credits are becoming increasingly fungible. Some barter company clients pay trade credits to each other as they exchange merchandise and service, a situation Icon's Lee calls "vendorization" of trade credits.
More companies are making use of cross-border bartering. Faced with a backlog of computers when preparing to introduce its new Aptiva products, IBM Corp. cleared its shelves by selling 2,627 brand new, unneeded computers for trade credits to New Yorkbased Atwood Richards, an international barter firm with 30 offices in 28 countries. In turn, Atwood Richards sold the computers to customers in Mexico and the United States. IBM used the trade credits to offset the purchase price of 120 Volkswagen automobiles, as well as trucking and express-mail services.
For Flambeau Paper Corp., a U.S. papermaker, in St. Paul, Minnesota, Atwood found buyers in the Far East for 400 tons of paper worth $1 million, after Flambeau discovered the unusual colors and finishes wouldn't sell in this country. In another transaction Atwood arranged, Thomas Industries, in Louisville, exchanged chandeliers and residential and commercial lighting products worth $2.25 million for barter credits used to obtain paint, ballasts, packaging, printing, and hotel conference space equivalent to 5,000 room nights. In the bargain, Thomas products were introduced to new markets in South America.
To facilitate cooperation among barter companies, the International Reciprocal Trade Association has begun looking at ways to establish an ongoing exchange rate for trade credits issued by various barter companies. That should make trade credits more liquid, and should also make it easier for the barter companies to trade with one another. The IRTA program could be up and running by year-end, says Active International CEO Alan Elkin.
While international barter trade may be a growing market, some companies have been hesitant to enter it, because of the exponential increase in complications. Elkin notes that language barriers have sometimes been a problem in multicultural trades. His company's solution? Employ local professionals.
Experts predict that the Internet will open a new channel to millions more potential corporate barter customers. IRTA is looking for ways to open that route. You can be sure it's not alone.