The Global banking crisis prompted me to contemplate whether search marketing firms – or for that matter any professional services firm — should loan money to their clients.
The practice of firms loaning clients money under 30 to 60 day terms is so common that it suppresses the kind of clear thinking and analysis that banks undergo when making loans. Should firms practice such “banking” with clients, and if so, what are the advantages and disadvantages for both firm and client.
Pulling this issue out of the shadows of oblivious convention into the light of clear reason reveals that there exists scant rationale for this practice. Let’s list and debunk common rationales.
The Client’s Rationales for Borrowing from the Firm
- When a firm begins a job prior to payment or continues a job prior to payment for past work, the client can begin or continue the job prior to the arbitrary date of their periodic check runs. This is a flimsy rationale because in fact companies can, with minimal effort, write and send checks outside of their normal check run cycle. True, many larger companies have a purchase order system that is not easily circumvented, but if the job is urgent, the company can circumvent this system. If they can’t or wont, that’s the cost of bureaucracy.
- By paying the firm after work is done, the client has leverage to ensure proper completion and perhaps to argue for additional work that may not be part of the original agreement. If the client has chosen a firm that needs such leverage, the choice was probably poor. True, even the best choice of a firm does not eliminate risks that the firm is worse than it appeared or that the firm will assign their least skilled employees, so financial leverage offers a reasonable insurance policy. Yet consider that good law firms are almost always paid by up-front retainer, whereas struggling law firms may break from that payment convention – and the firm may be struggling because it is not very good. Especially in a growing field like search marketing, if a firm offers the client credit in order to do business, maybe that firm is not a good choice after all.
- By paying in, say, 60 days, the client’s CFO has more money to play with. I’m not experienced in corporate accounting, but it seems to me that, especially with today’s interest rates, 60 days earns little or nothing — certainly not enough to justify the possible exclusion of the best search marketing firm.
- I can imagine that clients’ CFOs would gain other advantages beyond mere interest when delaying the payment of vendors for weeks and months. The question is, do these advantages justify to the firm the extension of credit prior to work? Let’s take a look at the firm’s point of view.
The Firm’s Rationale for Loaning Money to Clients
- If the firm does not have enough worked booked, then immediately using idle resources may be worth the risks (discussed below) in loaning the client money.
- Extending a 30 or 60 day loan to a client creates trust and a feeling of good will. This may or may not pan out. I would hope that the predominant grounds for trust and good will emerge from other aspects of the business relationship and don’t depend on cash. Buying favor usually does not curry genuine favor.
Unless the firm runs a credit check on the client (much like the client checked the firm’s references), the obvious risk to the firm is that the client defaults for any number of reasons. The client might go bankrupt. Or the client might be owned by a parent company that takes the cash and nullifies (legally or not) vendor contracts. Or the client may simply have late if not patently abusive payment patterns at odds with the firm’s contract. In such cases, the firm may have to spend valuable time performing collections, or, worse, may have to battle it out in court. Complete default is relatively rare, but the consequences are large, so the the firm should minimize such risk.
“Everything is a Situation”
Of course if the client pays in advance, the client has in effect lent money to the firm, until the firm works that payment off, and then a new “loan” from the client begins. However, if the client checked the firm’s references and the firm did not run a financial check from the likes of Dunn & Bradstreet on the client, then a few weeks of paying in advance is probably fair.
This analysis seems to have revealed that law firms’ tried and true practice of working on retainers should apply to web marketing as well. Of course a long-standing client with a good payment history or a new client recommended as trustworthy by a trusted colleague are situations where a relatively low risk loan is often the right thing to do. To quote a 1990s cop show’s frequent refrain, “everything is a situation.”
The recent history of General Electric adds a final moral gloss to this meditation on money and banking in search marketing. A huge part of GE’s business was banking. GE lent money to clients to buy GE’s products and services. Shortly after the inception of the financial crises, GE needed a government bailout. GE’s stock price tanked, and now hovers at barely a third of its pre-crisis heights. The world groans under its insane debt. Increasingly I’m in favor of having clients pay when they have the cash and avoid debt. That’s how my firm has proceeded for years when paying our vendors, and as result we are one of the few small businesses offered ample lines of credit — that I hope I’ll never use.