Watch Industry TT/LC Settlement Risk Measurement: 20 Manufacturers Extend Payment Terms to 180 Days

In the dynamic watch industry, financial transactions play a crucial role in the operations of manufacturers, suppliers, and distributors. Two commonly used payment methods are TT (Telegraphic Transfer) and LC (Letter of Credit). However, recent trends have shown that 20 major watch manufacturers have extended their payment terms to 180 days. This article delves into the implications of such a significant change, the associated risks in TT/LC settlements, and the services available to mitigate these risks along with their costs.

1. Understanding TT and LC in the Watch Industry

1.1 TT (Telegraphic Transfer)

TT is a fast and straightforward payment method. In the watch industry, when a distributor or retailer places an order with a manufacturer, they can transfer the payment directly to the manufacturer’s bank account. This method is often used for small – value orders or when there is a high level of trust between the parties. For example, a small – scale watch retailer in a local market may use TT to pay for a batch of entry – level watches from a domestic manufacturer. The process typically involves the buyer instructing their bank to send funds to the seller’s bank. The bank charges a small fee for this service, usually ranging from \(10 – \)50 depending on the banks involved and the amount of the transfer. However, the risk with TT is that once the payment is made, there is little recourse for the buyer if the goods received are not as expected.

1.2 LC (Letter of Credit)

LC, on the other hand, provides more security for both parties. In the watch industry, when a distributor orders a large quantity of high – end watches from an international manufacturer, an LC is often used. The buyer’s bank issues a letter of credit to the seller’s bank, guaranteeing payment once certain conditions are met. These conditions may include the proper shipment of the goods, submission of relevant shipping documents, and compliance with quality standards. For instance, a luxury watch distributor in Europe ordering watches from a renowned Swiss manufacturer may use an LC. The cost of an LC mainly consists of bank fees. The issuing bank charges a fee, usually around 0.1% – 1% of the total value of the LC, depending on factors such as the creditworthiness of the applicant and the complexity of the terms. Additionally, there may be other charges such as advising fees (around \(100 – \)300) and confirmation fees (if the seller requires a confirmed LC, which can be an additional 0.1% – 0.5% of the LC value). While LC offers security, it also involves more complex procedures and paperwork.

2. The Impact of 180 – Day Payment Terms

2.1 Financial Strain on Suppliers

With 20 watch manufacturers extending payment terms to 180 days, suppliers are facing significant financial strain. Small – and medium – sized suppliers, in particular, rely on timely payments to manage their own cash flow, pay off debts, and invest in new inventory or production equipment. For example, a supplier of watch components such as straps or dials may have to wait for six months to receive payment for their goods. This delay can disrupt their operations, forcing them to seek alternative sources of financing, such as short – term loans. The interest rates on these loans can range from 5% – 15% depending on the creditworthiness of the supplier and the market conditions.

2.2 Risk of Default

The longer payment terms increase the risk of default. Over a six – month period, various factors can affect the manufacturer’s ability to pay. Economic downturns, changes in market demand for watches, or internal financial mismanagement by the manufacturer can all lead to payment delays or even defaults. For instance, if a major watch manufacturer experiences a sudden drop in sales due to a new competitor entering the market, they may struggle to pay their suppliers on time. In such cases, suppliers may have to write off bad debts, which directly impacts their profitability.

2.3 Impact on Pricing

Suppliers may also respond to the extended payment terms by adjusting their pricing. To compensate for the increased risk and the cost of capital tied up for a longer period, they may raise the prices of their products. For example, a supplier that previously sold watch dials at \(10 per unit may increase the price to \)11 – $12 per unit. This price increase can then be passed on to the end – consumers, potentially affecting the competitiveness of the final watch products in the market.

3. Risk Measurement in TT/LC Settlements with Extended Terms

3.1 Credit Risk

Credit risk is a major concern when payment terms are extended. In TT settlements, the buyer’s creditworthiness becomes even more critical. With a 180 – day payment term, there is a higher chance that the buyer may face financial difficulties during this period. In LC settlements, while the bank’s guarantee provides some security, the risk of the issuing bank defaulting or the buyer finding loopholes in the LC terms to delay payment still exists. To assess credit risk, companies can use credit – rating agencies. Services from agencies like Dun & Bradstreet can cost anywhere from \(500 – \)5,000 per report, depending on the level of detail and the scope of the credit assessment.

3.2 Exchange Rate Risk

For international transactions in the watch industry, exchange rate risk is significant, especially with extended payment terms. Over a 180 – day period, currency exchange rates can fluctuate substantially. For example, if a U.S. – based watch distributor imports watches from a Japanese manufacturer and the payment is in Japanese yen, a significant depreciation of the U.S. dollar against the yen during the 180 – day period can increase the cost of the purchase for the U.S. distributor. To hedge against exchange rate risk, companies can use financial instruments such as forward contracts. The cost of setting up a forward contract can range from 0.5% – 2% of the contract value, depending on the currency pair and the market conditions.

3.3 Operational Risk

Operational risk in TT/LC settlements with extended terms includes issues such as delays in shipping documents, incorrect documentation, or problems with the bank’s processing. For example, in an LC settlement, if the seller fails to submit the required shipping documents correctly or on time, it can lead to payment delays. To manage operational risk, companies can invest in supply – chain management software. A basic supply – chain management software system can cost around \(10,000 – \)50,000 for a small – to – medium – sized watch business, which helps in streamlining document management and tracking the progress of orders.

4. Service Items to Mitigate Risks

4.1 Credit Insurance

Credit insurance is a valuable service for watch industry players. It protects suppliers and distributors against the risk of non – payment by the buyer. In the case of the 20 manufacturers with 180 – day payment terms, credit insurance can provide financial compensation in case of default. The cost of credit insurance typically ranges from 0.5% – 3% of the insured amount, depending on factors such as the creditworthiness of the buyer, the payment terms, and the industry risk. For example, if a supplier has an annual turnover of \(1 million in sales to a manufacturer with 180 – day payment terms, the credit insurance premium could be between \)5,000 – $30,000.

4.2 Factoring Services

Factoring is another service that can help suppliers manage the extended payment terms. Factoring companies purchase the accounts receivable of the supplier at a discount. For example, a supplier with outstanding invoices from a watch manufacturer with 180 – day payment terms can sell these invoices to a factoring company. The factoring company will advance a percentage of the invoice value, usually around 70% – 90%, immediately to the supplier. The cost of factoring services includes a discount fee, which can range from 2% – 5% of the invoice value, and a service fee, typically around 0.5% – 2% of the invoice value.

4.3 Financial Advisory Services

Financial advisory services can assist watch industry companies in understanding and managing the risks associated with TT/LC settlements and extended payment terms. Advisors can provide guidance on credit risk assessment, exchange rate hedging strategies, and cash – flow management. The cost of financial advisory services can vary widely, from an hourly rate of \(100 – \)500 for basic advice to a fixed – fee project – based approach, where a comprehensive risk – management project can cost \(20,000 – \)100,000 depending on the complexity of the business and the scope of the advice.

5. Case Studies of Risk Mitigation

5.1 Case Study 1: Supplier A

Supplier A, a watch component manufacturer, was facing financial difficulties due to the 180 – day payment terms of a major watch manufacturer. They decided to purchase credit insurance. The credit insurance premium was 1.5% of their annual sales to the manufacturer, which amounted to \(15,000 for an annual sales volume of \)1 million. In the following year, the watch manufacturer faced financial problems and defaulted on a payment of \(200,000. Thanks to the credit insurance, Supplier A received 80% of the unpaid amount, i.e., \)160,000, which helped them avoid significant losses.

5.2 Case Study 2: Distributor B

Distributor B, an international watch distributor, was exposed to exchange rate risk due to the extended payment terms. They entered into a forward contract to hedge against currency fluctuations. The cost of setting up the forward contract was 1% of the contract value. They were importing watches worth \(500,000 from a Swiss manufacturer with a 180 – day payment term. Over the 180 – day period, the currency exchange rate fluctuated, and without the forward contract, they would have faced an additional cost of \)30,000. However, due to the forward contract, they were able to limit their cost increase to the 1% forward contract cost, i.e., $5,000.

6. Conclusion

The extension of payment terms to 180 days by 20 watch manufacturers has introduced significant risks in TT/LC settlements in the watch industry. Credit risk, exchange rate risk, and operational risk are all magnified. However, through various service items such as credit insurance, factoring, and financial advisory services, companies can mitigate these risks. The costs associated with these services are an investment in protecting the financial stability and profitability of watch industry players. By understanding these risks and implementing appropriate risk – mitigation strategies, companies can navigate the challenges posed by extended payment terms and maintain a competitive edge in the market.

Tags: Watch industry, TT settlement, LC settlement, Extended payment terms, Risk mitigation, Service costs