Hit and run

The Dubai-based channel is facing up to the full horror of its worst credit crisis ever. A flurry of hit and run cases has plunged authorised distributors into a credit nightmare with bad debt exposure now running into tens of millions of dollars. The channel is bleeding and the crazy amounts of credit extended to the runaway resellers has shown that those who fail to learn the lessons of history are doomed to repeat them.

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By  Stuart Wilson Published  May 31, 2006

The Dubai-based channel is facing up to the full horror of its worst credit crisis ever. A flurry of hit and run cases has plunged authorised distributors into a credit nightmare with bad debt exposure now running into tens of millions of dollars. The channel is bleeding and the crazy amounts of credit extended to the runaway resellers has shown that those who fail to learn the lessons of history are doomed to repeat them.

The Dubai-based channel is now teetering on the edge of a pecuniary precipice, peering down into the abyss of financial meltdown. The runaway resellers have left behind a huge hole in the market and the millions of dollars of unpaid credit have implications for every company associated with the regional IT channel.

When a runaway occurs, the natural reaction from a distributor is to decrease its credit exposure and start acting tough with the resellers. If one distributor follows this path the resellers can cope; but when all the distributors suddenly start toeing the same line, the cumulative effect can push resellers over the edge and create a situation where they too feel they have no choice other than to run away. That is what is happening now in the market.

The conditions leading up to the latest spate of runaways are the IT channel equivalent of a perfect storm. Although overall IT sales are still increasing the Middle East, several factors combined to create the current problems in the channel. Uncertainty over future demand from Iran, the weakness of stock markets across the Middle East and increased scrutiny from vendors to stop grey market flow out of the region have all played their part in driving resellers to drastic action. And let's not forget the influence of vendor-led back-end rebate and incentive scheme.

It is no coincidence that the three major resellers that have left the mark were close partners of Intel. These players — supposedly assemblers according to Intel — were little more than subdistributors pulling in massive rebates and able to sell on CPUs at prices that even the authorised distributors could not match.

Intel now needs to take a long hard look at its channel compensation model to prevent the situation where it is over-reliant on the operations of a few subdistributors from happening again. They must be having a party at the AMD office right now in light of recent events.

The one point I want to focus on is the dearth of financial management skills that exist in the Middle East channel. Too many resellers have attempted to diversify their businesses too quickly and move into other areas where they perceive better profits such as real estate or even investment in the stock market. In so doing, the IT business has been relegated to nothing more than a money machine, designed to boost the revenues of the overall operation — even if there is no profit attached.

Here’s the gameplan: buy IT products on 60-day credit terms, sell at cost, invest cash in stock market and watch it soar, sell stock when needed to pay off credit, pocket profits and then start the cycle again. Now this plan — as cunningly brilliant as it may seem to a reseller or trader — only actually works if the stock market keeps on climbing.

Too many resellers have a highly leveraged capital base, no real assets and rely totally on ongoing cashflow to survive each month. This hand-to-mouth existence is inherently unstable and fraught with danger. These resellers are forced to constantly turn stock, build up ever-bigger credit lines and sell below cost just to survive.

The losses start mounting up until the day finally comes when the management realise they can no longer paper over the cracks or continue to grow the business to conceal the losses. And then the hit and run occurs. The IT kit is liquidated below cost for cash and floods the market as other resellers snap it up. Credit owed to both distributors and other resellers is unpaid leaving a huge financial hole in the market.

In the Dubai-based channel, we also have to contend with the ‘washing machine’ effect inasmuch as the layers of the channel structure are not always clearly defined and product can be bought and sold by multiple companies before finding its way out. Rather than a clean two-tier channel where the authorised distributor sell product to a reseller who in turn sells out to an end-user, the situation is slightly more complex.

With sub-distributors, re-exporters, traders, resellers, retailers, brokers and grey marketing specialists extending credit to one another and moving product around between themselves at lightning pace, the market becomes inherently unstable. It is this ‘washing machine’ of chaotic product flow and cashflow, which gives rise to the domino effect, whereby the collapse of one reseller can immediately put a number of other resellers (that had extended credit to the first reseller) in a precarious financial position as well.

Let’s not forget that once a runaway has occurred, the market is also suddenly awash with a glut of product from that reseller that has been dumped into the market below cost. This then impacts the ability of other resellers not planning to run away to sell their own stock at a decent price that ensures a margin. Suddenly, they find that they can’t sell against the below cost stock, the distributors don’t care and actually want to reduce their credit and the cashflow dries up. It is little wonder than when one major runaway occurs, a few more are never far behind.

None of the factors or reasons listed above are new. These are the same reasons behind the runaways that occurred in both 2004 and 2005. The only difference now is that — in tandem with the growth of the market — the amount of losses that the channel is facing has risen significantly.

Action needs to be taken to prevent this from happening again. A formal credit circle needs to be established by the authorised distributors. It beggars belief that some of the same distributors that were badly stung in 2005 and pledged never again to leave themselves in such a vulnerable position through the extension of credit now find themselves nursing the biggest losses once again.

The Dubai-based IT channel is made up of a transient population hailing from all over the world. Hit and runs will continue to occur as long as this remains the case and as long as people can get away with it. One distributor told me that Dubai-based hit and run resellers have a gestation period of 18 months from setting themselves up to grabbing a taxi and heading for the airport. This distributor is already identifying the next generation of hit and run resellers.

This time around the credit crisis appears to be more serious. The scale of the losses is staggering. Given the trading that occurs between resellers, some people in the channel reckon that as much as US$50m could have gone from the market with the latest flurry of cases. That’s US$50m of losses that the channel has to absorb — be it at a distributor level or a reseller level.

The scale of the crisis this time around could actually have ramifications for the authorised distributors working out of Dubai. I would not be surprised to see a couple of the major players shut up shop (or go under) and leave as a result if they deem that the credit risks are now too high and the potential rewards are just not great enough.

It is easy to say that this sort of credit nightmare has to stop, but I’m not convinced that it will. Even if a couple of the issues are addressed, there remain many more factors that could result in this type of situation happening again and again.

The Dubai-based channel as a whole has become too accustomed to working in this way and unless the market becomes more regulated, the fundamental causes of the credit crises that continue to hit the market will remain in place.

E-mail your views on the credit crisis gripping the Dubai-based IT channel to stuart.wilson@itp.com or telephone +971 4391 0882

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