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The tool that I'm going to talk about uh
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today is uh looking at what I call
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consumer leverage exposure. And we have
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developed a very simple little tool that
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you can use uh input data from your
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business and get a bit of a sense of
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just uh how concerned you might be for
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this thing called consumer leverage
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exposure. So here's the backdrop. If you
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look at the current level of consumer
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debt in relation to their earnings,
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um let's say people decided to pay off
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their debt. If they started paying off
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today and they did nothing else than pay
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off their debt, no food, no new
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clothes, no uh lattes at Starbucks,
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nothing except paying off their debt. It
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would take the average consumer 16
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months to pay off their debt. That's how
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horrendous this consumer debt is. From
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the point of view of business, uh the
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problem is that uh uh most of the growth
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that we've had in the last few years uh
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in the last decades has basically been
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being by persuading consumers to buy
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more and more on credit. And if you're
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in a business that where a large
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percentage of your revenues come from
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sales to consumers,
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uh, as people start to run out of their
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credit and as they start to tap out
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their credit, uh, as they in fact start
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to act responsibly and cut back on their
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purchases on credit, what they're doing
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is they're cutting back on purchases of
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your
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company. So, uh, even if people behave
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in a more responsible way, it's going to
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come back and it's going to impact
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companies. Now, not all companies are
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going to be equally impacted by this. If
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you happen to be somebody who sells
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furniture, for instance, and your
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strategy is to tell people to take the
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furniture and put it in their home and
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they don't have to pay you for the next
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5 years, you know, you're in big trouble
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if people start to scale back because,
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you know, this is what's driving your
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business. If you happen to be selling uh
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you know uh let's say uh aircraft
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engines, there's a not a hell of a lot
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of consumers that are going to be able
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to uh you know come come use credit to
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buy aircraft engines from you. So this
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is tends to be industry specific. But
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there's another scary thing that's uh
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behind this and I won't talk about this
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today. we just don't have time. And that
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is if you're selling to somebody and
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they in turn are selling to consumers
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and those consumers start to cut back on
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their credit that means their sales will
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drop which means it's going to domino
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back to you. So this problem of consumer
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credit being reduced uh sales being
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reduced in consumer credit is going to
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impact a lot of people and uh you know
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what I'm concerned about here is firstly
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that firms should begin to assess just
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what their exposure is and that's what
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the tool is all about is to give them a
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sense of what the exposure is to it and
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then secondly to begin to start taking
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actions now uh before the tsunami hits
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uh to do something to limit the exposure
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or control the exposure to to reductions
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in consumer credit. So, that's what the
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little tool is all about. And once
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again, the idea is we want to be able to
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give you something that's u easy to use
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and and free. It's not going to cost
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anything. Uh in the hope that it'll help
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people who are in in businesses to begin
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to anticipate uh something that's
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coming, you know, down down the road.
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And my fear is that it will come down
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the road fairly soon.
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Um, I'm going to characterize what we're
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saying by by by hoping either that'd be
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wrong or that uh if we get the message
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out and people use it and they can be
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begin to take collective action uh it
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won't happen at all. Because to me the
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definition of a truly good prophet is is
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these are the people whose prophecies uh
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don't come true because they the
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prophecy itself uh created conditions
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for people who say something like man we
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can't let this happen so it doesn't
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happen. So here we see uh this little
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company has a consumer division that's
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selling about $60 million a year uh uh
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and that's credit sales of 40 and cash
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sales of 20. And we have a business
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division which has got about $40 million
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a year as well. But the key thing is the
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credit sales. And in addition to this,
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at the moment, the company's fat, fat,
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and happy because it's got zero consumer
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defaults. The credit crunch starts to
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bite. Uh, as we see already, credit
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companies are scaling back on the amount
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of credit they'll give
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people. Consumers are getting tapped out
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and have kind of used up as much credit
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as they possibly can get. And so now
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what's going to happen one of the big
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problems and this is on the second
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graphic we see here is uh that uh you're
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going to start to impact what we call
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the consumer leverage exposure CLLE the
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top of the chart sort of shows you the
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derivation if you wanted to go through
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this uh you could probably look in the
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Excel spreadsheet but it basically says
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is that this company the way that it
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credit structured credit sales is
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structured to consumers in relation to
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the overall sales is 50% % exposed to
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consumer
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leverage. That basically means that very
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small changes in consumer credit
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behavior is going to impact 50% of the
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operating income of this company. That's
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a lot of
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exposure. And uh if you look at the
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financial metrics uh which are going to
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change as credit changes, you see the
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company's currently got a gross profit
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of about 75% an operating profit of
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about 20% margin and total leverage of
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two times. So they're in a good position
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to keep on paying off the bank. But now
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what happens let's have a look at the
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next graphic is uh consumers cut back
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either because they tapped out of credit
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uh or because they can't get any more
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credit but the way it manifests you and
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your company is they stop buying from
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you. So maybe the credit companies are
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absorbing the risk but you're the one
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that's going to be losing the revenues
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because they're just not buying anymore.
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And so what we see when that happens on
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the next chart is that if you have a
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credit cut back and no defaults yet,
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just a credit cut back, uh you're going
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to see a 25% reduction of your operating
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income and a 33% increase in your
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leverage. So that means you're making
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less money. And not only that, but uh
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your capacity to pay paid back the bank
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is now starting to evaporate. So you're
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getting exposed by reductions in profits
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plus an increased exposure to the bank
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coming in and taking over your business
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and and you know this company needs to
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start to become seriously concerned. Now
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let's key in uh on the next chart uh
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suddenly people start defaulting and
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those people to whom you issued credit
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uh start to default and 10% of them do
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so. Well, what that does on the next
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chart is it shows you that the default
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rate of only 10% is going to mean you're
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going to make 20% less profits and it's
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going to increase your leverage once
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again exposing you to having the bank
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come in and take your business away from
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you. So, there's two sources of of
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danger from consumer leverage exposure.
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One is that you make less profits and
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less cash flows. And the secondary
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effect of that is you get more and more
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exposed to uh you know insolvency or
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bankruptcy yourself because you can't
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pay your debts. And uh so so run these
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numbers, put them in, see what happens.
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And if you start to get pretty big
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numbers, uh let me make uh make the
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observation that one of the key things
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that you should begin to do today is to
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resegment your customer base with
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respect to their capacity and their
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willingness to incur and pay off debt.
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So, you know, we're not just looking at
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gender and race and location and all the
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other dawn demographic things we
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normally do with customer segmentation,
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but start to look at whether people are
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going to pay their debt debt off or not.
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Let me give you an example of kind of
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three segments that pop out of this. One
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is a segment of customers who buy on
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credit. They're still going to keep
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their credit. They're going to be able
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to finance their credit and they're
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perfectly happy. You should be, you
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know, aggressively looking at what can I
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do to keep those people loyal to me
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because they're the ones that going to
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keep on paying your bills. The second is
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the group that are sort of what I would
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call honest Joe's and Jones. Uh these
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are people that would love to pay off
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their credit but they simply can't. we
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need to find ways of making it easier
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for them
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uh or uh to find ways of making sure
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that uh you know they just can't we we
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we don't have uh any further exposure to
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them and then the last group are the
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people that will keep on running up
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their credit as high as they can and
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then turn around one day and say well
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I'll see you in court and those are the
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last kind of people that you want. So,
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we need to begin to go beyond just
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simple demographics now and start to
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layer in the consumer debt behavior uh
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demographics, trying to find as many
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people as we can who willing to switch
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from credit to cash sales by giving them
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incentives and trying to find segments
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that uh will keep us alive and minimally
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impacted by the tsunami that's headed
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our way. Some of the incentives that uh
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one might try to follow is to say to
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someone when uh they come and try to use
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their credit card is to say well we can
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give you a discount you know if you're
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willing to pay cash because I'd rather
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give somebody a modest discount to pay
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for cash than have to see them in
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bankruptcy court when they bought from
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me on credit and now you know unable or
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unwilling to pay me. So that's one of
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the ways that you might want to do it is
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to migrate the u migrate purchases to
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cash. Uh the second as I've mentioned is
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to really spend some time deeply
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understanding uh the people who will
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continue to pay you because you know the
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if you go back to our original chart
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there what we had is a sort of generic
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40% of the people are buying on credit.
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The question is which kinds of people
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are buying on credit? people who can or
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willing to pay the those who you know
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who can't and those who won't and and
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and and you know really begin to work
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strategies to go after the the most
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important ones for sustaining your cash
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flows. Find incentives for them to do
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it. U find ways of encouraging them even
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if they buy on credit and they can and
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will pay to you know to give them more
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credit. But you want to give the right
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people credit and not just everybody
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credit.
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[Music]
