Let's See the Numbers!

Companies that sell their invoices on The Receivables Exchange are required to provide two years of financial statements as a part of the Seller qualification process. Once approved as Sellers they are also supposed to provide quarterly updates to their financials.

Those updated financials are supposed to be posted to the Seller Profile pages, allowing Buyers to update their due diligence analysis.

As we approach the anniversary of the first TRE transaction I think it is appropriate to point out that the Exchange does not appear to be enforcing the requirement to update financial statements.

If it IS enforcing the requirement, it is NOT posting the updates to the Seller Profile pages.

The most recent financial information available, in many cases, is still as of year-end 2008. In nearly every case, the statements provided at the time a Seller posted its first auction are still the only ones available.

Given that the great majority of Sellers provide only internally-generated statements, it can hardly be argued that there hasn’t been time to update statements through at least the second calendar quarter.

As important as I think it is to Buyers to be able to make decisions on the basis of appropriately current information, the Exchange itself should also be looking closely at the changes in Sellers’ financials.

TRE has a significant stake in the impact of Seller use of the Exchange on Seller financial health.

I would hope, in fact, that the management of the Exchange has already made an arrangement with a credible third-party; perhaps a well-known business school, for instance; to study the impact of TRE’s unique platform on the subsequent financial health of its Sellers.

The job of attracting good-quality Sellers has been difficult. TRE does a good job of quantifying the theoretical value of accelerating cash receipts in its marketing efforts. If the theory is borne out we should be approaching the time when some ACTUAL value-added can be empirically demonstrated.

It would be a shame if the experience of the first TRE Sellers was not used to make the job of attracting subsequent Sellers easier.

Ultimately, proof of the value of TRE to its Sellers should be apparent in the analysis of subsequent financial results. If subsequent statements are not obtained by TRE and made available for analysis, not only will TRE Buyers be inappropriately under-informed, but a key analytical and marketing tool will be lost to TRE management and marketers.

The transparency of the auction process should be matched by transparency in the information flow.

So, let's see the numbers!

Rational Irrationality?

Ori and Rom Brafman, in their fascinating book: “Sway: The Irresistible Pull of Irrational Behavior” write about an experiment used by a business school professor on the first day of each new semester.

He auctions off a $20 bill to the students in his class.

Sound simple? At the time the book was written the highest price paid in those auctions had been $204!

Now there’s nothing special about the bills themselves; there’s no rarity value involved. So why would anyone be willing to pay any more than $20 for a $20 bill?

The answer lies in the motivation of the bidders, which reflects the rules of the auction.

In these auctions the winner gets the $20 bill BUT BOTH the winner and the runner-up have to pay what they’ve bid.

The bidder who comes in second has to make good on his bid, but he gets nothing in return; while the bidder who “wins” has to pay up, but at least he gets the $20.

So the motivation is not actually winning the auction, it’s avoiding the greater cost of losing the auction!

When I find myself unable to explain in any rational terms the actions of an auction participant I have to step back and remind myself that what appears to be irrational might be irrational only from my own frame of reference. The “winning” bidder might be operating under rules or influences, unknown to me, that explain his actions quite clearly.

At this stage in the life of The Receivables Exchange there are too few auctions involving too few Buyers to allow us to confidently equate value and price. And it is certainly too early to assert that price and risk are in any way firmly associated.

As we wrote in our post of August 19: “One Buyer with a perceived ‘need’ to put money to work in any significant quantity could easily … create a pricing environment that is not informed by any real risk assessment.”

The actions of such a Buyer might be primarily motivated by the desire to avoid the perceived “loss” incurred by not deploying allocated funds. In that case the loss avoidance behavior is captured in winning a certain quantity of auctions essentially regardless of price or quality. The perceived “loss” of failing to win is greater than the potential loss created by paying essentially whatever is asked or failing to assess the risk assumed.

In that type of environment, the price at which auctions are won is not a valid measure of value. Bidder behavior is driven by something other than the value of the item being auctioned.

The professor in the Brafmans’ book found that in almost every $20 bill auction, most participants realized when the bidding got to the $12 to $16 range that the correct decision, even at a level still below $20, was to withdraw from the auction.

While either unknown motivations or non-economic motivations control market action, the rational response is just to “hide and watch”.