Industry Issues - Pay-on-Scan Summary of Other Industries' POS Use (April 4, 2003 )

The following report is a conglomeration of reports on "pay on scan" (POS).

The Automotive Aftermarket Suppliers Association and MEMA Financial Services Group have continued to monitor POS news in the aftermarket and have researched POS in other industries. We have conducted several interviews with leaders from other industry associations and have obtained reports on the status of POS in those industries.

No industry that we have found has implemented a POS program across all products and SKUs. Additionally, of all the industries we have researched, no POS programs add terms and all programs have some level of sharing shrink costs. Most notably, the industries we have found tested POS programs prior to implementation.

We have also included updates on POS from aftermarket industry publications which we hope will inform you of how others in the industry view POS.

AASA and MFSG will continue to research POS and keep you advised of our findings.

Aftermarket Updates:

Pep Boys President Doubts Effectiveness of POS in the Aftermarket

"It's a process that works fairly well -- having been in consumer products myself -- it works well on the fast-moving grocery store business, where inventory is turning pretty quickly and the vendors aren't holding onto that inventory. In our business, we as you know, have a very slow turn, especially on the hard parts. This makes it more difficult for the vendors to hold that inventory on their balance sheet. If they do that, they can't do it without passing along that cost, in my opinion, and so we would undoubtedly be faced with that tradeoff."

George Babich, President and CFO, Pep Boys Automotive Week March 24, 2003

Industry Association Says Pay on Scan is Unhealthy Source: aftermarketnews.com

Members of the Michigan Automotive Parts Association (MAPA) issued a statement regarding pay-on-scan (POS) inventory systems. MAPA's board of directors said it would welcome shifting the burden of inventory ownership to the aftermarket's manufacturing side, but should POS be implemented, it would have a devastating economic affect on the aftermarket. MAPA said this opinion was shared by many of its independent wholesale distributor board members.

MAPA Chairman Gary Deuling, owner of Hart Automotive Supply in Hart, Mich., said he questions who would benefit from such a system. "The POS issue raises serious questions about who within the aftermarket actually stands to benefit under a comprehensive consignment-type inventory system," said Deuling. "The financial implications of a POS program are immense. The resulting domino effect caused by every other distributor demanding the same deal would overwhelm even the very best capitalized manufacturers in the business."

A fundamental shifting of the significant business risks of inventory ownership from the distribution side to the manufacturing/vendor segment, as proposed by POS' proponents, is clearly not a "win-win" for the parties involved, MAPA said in its statement. MAPA members said if it is the motivation of POS' proponents "to have their cake and eat it too" -- freeing up inventory dollars at the same time increasing the depth and breadth of their inventory -- they will expect the same deal to be offered to them.

MAPA members questioned the logic in what they called the "unbalanced risk" in POS. "What are the chances the manufacturers can support such a system?" MAPA asked in its statement.

What POS does do, MAPA said, is expose two opposed philosophies at play in the automotive aftermarket today -- one that serves the interests of Wall Street and one that serves the interests of the consuming public.

"The POS system is fraught with one-sided benefits for its proponents and is likely unfeasible," the group stated. "The efforts by POS' proponents as an unabashed, arrogant attempt at gaining on the already unfair advantages they enjoy in the marketplace."

How Other Industries View POS:

Overall, research by AASA and MFSG discovered that there are numerous industries that have or are using or experimenting with some type of pay on scan or scan based trading initiative. Our research indicates that these programs are not widespread among manufacturers, distributors or retailers and when they are used, do not cover a wide range of products or SKUs.

Below is a summary of our research:

The greeting card industry has also been slow to implement POS programs due to all parties seeing mutual benefits and operational problems.

Grocery industry implemented some scan based trading practices in the early 1990s. Today, the industry only utilizes these practices for high-moving products such as milk and bread and some high turnover products where the manufacturers manage the shelf space (potato chips, pretzels, etc.). MEMA has obtained reports produced by Prime Consulting Group for the Grocery Manufacturers of America which helped in our research findings.

The publishing industry continues to battle internally with scan based trading. Barnes & Noble has tried to implement a POS program, but due to pushback from wholesalers, has had to delay its efforts (twice) in getting POS off the ground.

The pharmaceutical industry has also been slow to adopt any POS programs. According to a study from the National Pharmaceutical Association, only 7 percent of distributors use consignment with suppliers or manufacturers of products and only on a small range of products.

Wal-Mart has implemented similar practices for toilet paper, tissue, paper towels and other products that typically take up a lot of shelf space and provide very high turnover. However, the mass merchandising giant employs very little POS practices on other products.

Former CVS Analyst (Identity Kept Confidential)

"You hear a great deal about "pay-on-scan" or "consignment" (whatever) but those actually participating are few and far between. It is my understanding that Dreyer's Ice Cream (Union City, CA) is one of the only suppliers out there who proactively pursue this type of relationship with customers. I do not have any contacts there but someone may want to "knock them up" in an attempt to understand how they can do it profitably. My guess would be that they place contractual stipulations on the customer re: returns, "acceptable" shrink, payment terms, etc."

"In my humble opinion, consignment relationships will eventually be proven one of the most dysfunctional, least optimal supplier / customer relationships in the marketplace. True collaborative planning, forecasting and replenishment relationships are the way to go. A 40 percent return of goods being sold on consignment raises all kinds of red flags for me."

Scan-Based Trading Still A Work In Progress in Greeting Card Industry

Source: Baseline (an e-newsletter)

Scan-based trading (SBT) is not so much about coordinating data as it is about shifting financial risk from seller to supplier. Not only must a vendor such as American Greetings pay for the inventory of cards that will sit on the retailers' shelves right up until the moment of sale -- such vendors also must bear the burden of making sure there are no holes in the tracking of products and transactions. Otherwise, they might never get paid.

Scan-based trading "is frightening" says Larry Scheur, president and CEO of Empire State News, a Buffalo, N.Y.-based magazine and paperback book wholesaler. Scheur sees the technology as being driven entirely by the bottom line of the retail industry rather than mutual benefit.

The negative effects of initial scan-based training systems were made painfully evident last year. American Greetings, the nation's second largest card supplier, reported that the scan-based trading initiative it launched in the November 2002 quarter with Target and Wal-Mart meant it would have to reduce sales by $65.5 million. That was due to the fact it had to take back into its own inventory the value of cards already booked as sold to retailers.

The idea behind these systems is simple enough. Rather than paying for products from suppliers as they are brought into the store, the supplier retains "ownership" of products on the shelf. Sales information is sent automatically from retailer to supplier. When the supplier receives that information, an invoice for goods sold is automatically created and an order is submitted to replace the sold merchandise.

In theory, everybody is supposed to come out a winner. The retailer loses the financial risk of carrying inventory while reducing its administrative and order management costs. The supplier gets daily alerts to replenish its wares -- which means more sales -- and is able to gather nearly real-time data about the performance of products store by store. This data can be used by the supplier to improve forecasting, production planning and product targeting.

Grocery Industry Experiments with POS

In a pilot conducted in 2000, commissioned by the Grocery Manufacturers Association (GMA), viaLink, a systems integrator, acted as the intermediary between two grocery chains -- Schnuck Markets in St. Louis, Mo., and Andronico's Market of Berkeley, Calif. -- and 12 suppliers.

The benefits of the pilot were measurable -- sales went up 3-4% for the retailers and between 2.5-5.2% for suppliers because stocking levels were better maintained. The number of invoice deductions and price discrepancies caused by mismatches in product data was decreased by 70%.

But that was a test. In the real world, the success of these systems depends on many things -- the accuracy of the data coming from retailers, the readability of bar codes and the synchronization of databases, among others.

One concern many suppliers have relates to a retail phenomenon known as "shrink" -- products leaving the store by unaccounted means, from employee theft to a mistake in recording a sale or check-in of a product. In a traditional supply chain, retailers are stuck with the cost of "shrink." But in scan-based trading, the supplier is forced to assume those costs -- since goods don't get invoiced until they are sold, items that fly under the radar of the retailer's point-of-sale reports never get invoiced.

In the GMA 2000 pilot study, "shrink" was measured at 0.3%, but at least one supplier reports bigger problems. "We were doing an SBT test with a single store," says Empire State News' Scheur about a trial his company conducted. "We went into the store, and bought magazines; we had the magazines, and the register tapes. But the sales never showed up on the SBT report." The retailer got paid, but because of bad data synchronization within the store's own systems, the supplier never did.

Then there's the value of the retail data. Theoretically, suppliers can use the point-of-sale data to better manage replenishment of goods in stores, and forecast demand down the road. But the theory breaks down when it's applied to products that don't fit the grocery products mold -- products like magazines, paperbacks and greeting cards.

For instance, there's a limit to how much information retailers can get from a bar code. The Universal Product Code that is embodied by the bars is just 11 digits long. That's only enough to identify a manufacturer and product code. Only if the codes are extended to 28 digits will a supplier like American Greetings get enough information to know exactly which one of its 20,000 new greeting cards each year is selling.

In effect, suppliers like American Greetings only know from the scanner data that one of their products was sold, not which one. That data still needs to be manually collected by American Greetings' merchandisers. So American Greetings can't start the process to replenish cards where they're selling based on scanned data -- they still have to incur the cost of manually checking stock on their displays regularly to track the performance of each design.

Unfortunately, many suppliers aren't in a position to push back on scan-based trading, as retailers like Wal-Mart use their buying power to set what type of trading system they're going to use with their suppliers.

For its part, American Greeting is trying to remain positive. "While the charge associated with the conversion will have a one-time negative impact on profitability," said American Greetings in its financial statements, "the Corporation is optimistic that scan-based trading will ultimately reduce costs, result in a reduction in working capital, maximize retail productivity and throughput, and continue to enhance retailer relationships."

Pros and Cons of Scan-Based Trading Debated Among Publishing Industry

Source: Karlene Lukovitz of Circulation Management

The implications of scan-based trading (SBT) are core issues as the publishing industry struggles to implement a more financially stable newsstand distribution system. During a recent Periodical and Book Association of America panel discussion, distribution executives presented their views on how scanning would be likely to impact the system.

According to Peter Kreisky, president of Kreisky Media Consultancy, SBT is now being used by 15 mass merchandisers, and is used extensively by a few other companies (including Dreyer's ice cream, Sara Lee and Earthgrains) who view the up-front financial issues as subsidiary to their main goal of increasing sales by using SBT data to get the right products to the right stores on a timely basis. Brewers and manufacturers of snacks and soft drinks still have concerns about IT issues, shrink, scanning accuracy and inventory costs, he said.

While noting that use of SBT for magazines is now limited largely to Barnes & Noble and pilots at Wal-Mart and other retailers that are using industry standards, Kreisky asserted that there is a shift in attitude about the necessity of retailer systems being able to read issue add-on codes. The Magazine Publishers of America-commissioned Mercer Management Consulting study, released in 1999, stressed this requirement. But the SBT guidelines released by the Magazine Retail Advisory Committee last summer positioned systems that can read the code as the "preferred model," while also acknowledging the potential existence of other models.

Time Warner executive VP and COO Jeff Blatt said that most shrink, which is the difference between net sale and pay-on-scan (POS ) sale, occurs when POS sale undercounts actual sale or returns are undercounted. He also said that it's a "moot point" to speculate whether net sales overstate true sales or POS sales understate true sales. Net sales and POS sales "are different ways of counting essentially the same transaction, even though the latter way of counting generally produces lower numbers than the former," he said. "So, negotiating shrink means, first and foremost, reconciling different ways of counting. Procedures need to be in place to assure that the difference between these two ways of counting does not increase." The real issues, he said, are, "Who eats the shrink, and how can we ensure that we're not decimated by shrink?"

Blatt dramatized the potential variances and unpredictability of shrink by title by reporting the results of analyses of several issues of various Time Inc. titles. Real Simple, one of Time's publications, emerged with just 0.6 percent average shrink, People with a "pretty good" shrink rate of 1.7 percent, and Parenting with an "ugly" average of 11.3 percent. "While we could probably work out a way to share shrink of even 2 to 3 percent, when shrink is at 11 percent, we're not interested in splitting it," Blatt said. "We would never accept this level of shrink."

Blatt also said that if one retailer is granted SBT privileges, all other retailers are entitled to equal treatment under the Robinson-Patman Act. So, if one retailer is allowed to begin SBT without proper standards, other, larger retailers can demand the same conditions, and publishers may be saddled with very high shrink levels. "Standards must be quite high, because you're only as good as the worst deal you cut" with retailers, Blatt said. "If the largest three retailers request SBT, then, for a title with 10 percent shrink, the loss in recorded sales from these accounts alone equals 2.5 percent of national sales. Hence, a 0.2 percent sales lift from an opportunistic account may have been bought with a 2.5 percent sales loss from the three largest accounts."

Blatt stressed that SBT offers "massive" benefits for retailers and significant benefits for wholesalers, but that the benefits for publishers -- timely marketing information, increased operational efficiencies, accelerated payment schedules, and a direct financial relationship with the retailer -- are potential, rather than guaranteed. Alluding to Time Inc.'s plan to tie SBT agreements to a direct relationship with the retailer (and move wholesalers to a cost-to-serve model), Blatt said that the retailer's scan-based trading benefits "need to be shared with other distribution channel members through renegotiated discounts."

Noting that American Greetings spent $65 million to convert just two retail customers to SBT, Larry Scheur, president of Empire State News Co., said that shrink is not likely to be the main financial cost for publishers, as some maintain. However, he also predicted that, given glitches in scanning systems, human error and the large numbers of UPC code changes made by magazines (which must in turn be reflected on retailer systems), shrink levels are likely to be much higher than the ranges currently being discussed in the industry.

Executive with the National Pharmaceutical Association (Identity Kept Confidential)

"In our industry, (pay on scan) is really called "consignment." This means that the supplier will place inventory at a customer location, they retain the ownership of it, and that payment is not made to them until it is actually sold at the retail level. In the industry, our latest survey says that only 7 percent of distributors use consignment with suppliers or manufacturers of products. I doubt that the use of it is widespread -- maybe it is being done with a couple of manufacturers and with maybe with a few products.

Our research shows that only 7 percent of distributors do POS with their customers who are the drug stores (retailers). Only 6 percent of manufacturers do POS with their customers (these customers are either distributors or some of them go direct). So it is not wide spread. To do something like this, they will maintain the inventory and not get the payment until it is sold at the retail level. Obviously, there is some other money changing hands to make it worthwhile for the distributor/manufacturer or whoever is doing it with their customer/supplier. It is not widespread in our industry.

Other programs like Vender Managed Inventory, where a manufacturer has all the data on a distributor -- what they sell -- and they do a sort of an automatic replenishment of their inventory. That has nothing to do with payment. Called consignment in their industry and it is very limited."

POS Fails to Impress Publishing Sector

According to a recent article in "Circulation Management" magazine, Barnes & Noble (B&N) has delayed its plan to move to a full pay-on-scan program for the second time due to mounting opposition from publishers and national distributors. The originally announced implementation date of Aug. 31, 2002 was postponed to Dec. 28, 2002, and has now been postponed for another four to six months.

According to the article, B&N wants to pay only for magazines recorded as sold through scanning and stop paying for shrink. One distributor reported that analysis reveals that average shrink in B&N stores is "north of 6 percent." Publishers want levels to be below 2 percent -- and are also asserting that they should shoulder only one-third of shrink costs, with the retailer and wholesalers picking up the rest.

According to an article in Folio magazine, high on the list of concerns from publishers and distributors is the immediate shock to a title's cashflow. (Once B&N fully implements the program, publishers will go from being paid upfront for their magazines to being paid only after the sale takes place -- meaning they'll essentially go through one sales cycle without single-copy income.)

The article notes that critics of pay-on-scan also allege that, although a large retailer like B&N has the volume to put the system in place and keep it aboveboard, there are dozens of smaller businesses that can't afford to, or that might be tempted to defraud publishers by selling titles without first scanning them. And the new system would require publishers to update their magazines' UPC codes with each issue, so that the sales data stay accurate.

Scan Based Trading Will Cost Someone

According to Periodical Data Services, scan based trading changes the existing B2B relationship including inventory ownership, product loss, payments and insurance while placing an inordinate responsibility on the accuracy and timeliness of data between all supply channel members.

Scan based trading has had its impact on the publishing company. According to a SEC form 10-Q Edgar filing (1-12-02): "Implementing scan-based trading at select retailers will result in an expected pre-tax charge of $80 to $90 million for the year." In 2001, scan based trading has cost each share of American Greeting Corp's stock an after tax charge of $.83 a share.

Grocery Industry Has Studied Scan Based Trading

MEMA was able to obtain a study developed for the Grocery Manufacturers of America, which was developed by Prime Consulting Group. MEMA executives were also able to speak with GMA executives who reported that scan based trading can work on fast moving products but is not the way to go for slow moving, non-perishable products.

What is Scan Based Trading? A way of doing business between direct store delivery suppliers and retailers. It incorporates the use of daily point-of-sale data to pay for product, full use of UCS II electronic transactions and electronic funds transfers and various store-level improvements -- open delivery windows and elimination of product check-in. Its twin goals: to synchronize supply and demand at the point-of-sale and eliminate inefficiencies that add costs to the direct store delivery supply chain.

The study noted that improved cash flow can be a one-time benefit to the retailer in a scan based partnership. After the initial inventory buyback by the manufacturer, the negotiated payment terms determine the actual "float."