Dick Smith management accused of disguising rebates as profit: How supplier rebates work

The former directors and managers of retail chain Dick Smith will be forced to answer allegations that they inflated earnings and disguised weak retail sales in the time between the company’s float on the Australian Securities Exchange and its collapse earlier this year.

The allegations are outlined in a letter to the chain’s former directors and managers from receivers Ferrier Hodgson and written by law firm Norton Rose Fulbright. The letter, seen by Fairfax, also outlines how Dick Smith Holdings (DSH) allegedly sought out to “maximise” rebates from suppliers by booking certain types of rebates as either increased profits or decreased expenses, instead of spending the money on marketing and discounts for consumers.

The alleged behaviour took place from July 2014, according to the receivers.

“By reason of DSH’s treatment of rebates, DSH was able, in effect, to “borrow” profit from a subsequent year,” said the receivers.

“The combined effect of these practises, together with inadequate provisions and write-offs, was to overstate profit, overstate receivables and overstate the value of inventory.”

The letter details “the desire to maximise rebates was driving buying behaviours”, and claims Dick Smith ignored customer demand in order to maximise profits through the rebates.

This was allegedly done due to the company’s board being concerned with the company’s performance and the market’s perception of the company, and a focus on meeting or exceeding performance expectations.

The allegations come as Dick Smith’s voluntary administrators prepare to release their report into the collapse of the company on Wednesday. Former directors and managers of the chain are expected to questioned over their role in the business’s failure in the New South Wales Supreme Court in September.

How do supplier rebates work?

Supplier rebates involve buyers or retailers requesting a percentage of a product’s cost from the supplier, which is then used by the buyer to promote sales through marketing, or to offer discounts to consumers.

Dr Gary Mortimer, a lecturer in advertising, marketing and public relations at the Queensland University of Technology, told SmartCompany that rebates are “common practise” in the Australian retail industry.

“From my experiences, rebates tend to be things that are negotiated as standard procurement process,” Mortimer says.

“Say you buy a container of baby food from a supplier for $400,000, retailers will often get suppliers to chip in something like 3 percent to help fund advertising.”

“There’s nothing illegal about it, it’s legal to negotiate just the cost of the product along with the rebate amount.”

Mortimer says it is normal practise for both retailers and suppliers to spread rebates out over the course of the financial year. But he warns against a trap some retailers can fall into, which is cramming all their rebates into one quarter or half of the year.

“The worst case scenario is when you’ve negotiated a significant amount of rebates for the first half of the financial year, which then increases profitability. You buy a product for $60 dollars, sell it for $100, and your negotiated rebate means you get 45-50 percent profit, rather than the standard 40 percent,” Mortimer says.

“This means that in the second half of the year, you have no rebates you can count on but you’ve inflated your profit results accordingly, and it comes back to bite you in the second half of the year and your profits drop.”

Mortimer notes that these practises are prevalent in the fast fashion sector, saying it’s clearly visible in in any retail thoroughfare.

“You see brands marking down things at 40-50 percent with no profit. If they had rebates, that mark down might only cost you 25 percent, so you still make a small profit on the sale,” he says.

For both buyers and suppliers, Mortimer says there are a few things that should be looked out for when negotiating rebates.

“Rebates are a common course in Australia, so businesses shouldn’t be generally worried about using them,” Mortimer says.

“As a supplier, if a buyer asks you to pay all the rebates in one half or one quarter of the year, that’s when alarm bells should go off. Similarly with buyers, if you are being directed to do that, you should be wary too.”

“It is not uncommon for rebates to be requested one month in advance for cashflow purposes, so don’t worry about that.”