Nadhim Zahawi is a member of the BIS Select Committee, the Party’s Policy Board and MP for Stratford on Avon.
As the recovery takes hold, we’re nearing a point in the business cycle where companies with high growth potential are at their most vulnerable. Having honed their business models in the depths of the slump, thousands of small, dynamic, entrepreneurial companies are eager to expand. The danger lies in the health of their underlying cash flow.
Small businesses don’t have big cash reserves to tide them over month to month, so as their books fill up prompt payment is essential. Most small firms would prefer to be paid within a month of invoicing, yet when dealing with large companies at the apex of the supply chain they’re rarely in a position to walk away if they don’t like the terms on offer.
The construction industry is notorious for a culture of unfairly long payment terms. 19 per cent of specialist building contractors are paid between 60 and 90 days, while a third of electrical engineers have to wait 60 days or more before being paid – but the major retailers are also at fault: 90 day terms are the industry standard for suppliers to the supermarkets. It’s not uncommon for large firms to date invoices from the end of the month in which they were issued; I’ve even heard reports retrospectively switching to payment by cheque from their overseas headquarters.
There’s no mystery about what’s going on here. Chief financial officers regard these contracts as a form of credit, credit which can be put to work earning the company a return between payment periods. Yet it’s manifestly unfair that small businesses should be strong-armed into the role of informal bankers to Britain’s biggest companies. While they wait for payment to arrive small firms often have to borrow at high rates from unsympathetic banks, forcing management to worry about staying solvent at a time when they should be focused on growing the business.
UK company law is clear that payment terms for commercial transactions should not normally exceed 60 days, but with the major caveat: “unless expressly agreed by both parties and provided the contract is not grossly unfair to the supplier”. This gives the biggest companies wide leeway, since most small businesses will not sacrifice a relationship with their most important customer if they’re unhappy with what’s on the table. Nor is the average dairy farmer likely to spend precious time and money taking Sainsbury’s to court to prove that a contract is “grossly unfair” – a concept which has yet to be tested in English law.
Conservatives must not be afraid to challenge the cash-hoarding behaviour of big business. For markets to work there has to be a level playing field between businesses of all sizes.
I want to see Government legislate for a 30 day non-negotiable statutory limit on payment terms between large cap companies and small enterprises, with substantial fines for breaching that limit. To enforce the new rules, a Prompt Payments Ombudsman would be established, allowing suppliers to raise concerns on a confidential basis. These new payment terms could be introduced on a stage by stage basis, with final implementation by 2015.
Some on the Right will argue that tackling unfair payment terms in this way would undermine the principle of freedom of contract. But a contract is not really free when one party has a choice between signing up to 90 day terms or going bust. What’s more, contracts between businesses only exist because of government intervention. If government didn’t provide the underlying legal framework there would be no way for businesses to enforce their agreements.
To help large caps to adjust to the transition, government should use its procurement power to enforce fairer terms of payment. Contractors to central government are already obliged to pay their suppliers within 30 days. This should be strengthened by requiring prime contractors to central government to pay their suppliers no later than they themselves are paid on average, or 30 days – whichever is less. In addition, the 30 day limit should be extended to all public bodies.
There are real economic gains to be had from creating a more liquid supply chain. Smaller firms lower down the chain don’t hoard cash, they spend it – and are much more likely to spend it locally than large companies. Equally, it would show that Conservatives are on the side of small businesses, prepared to challenge the oligopolistic behaviour of dominant market players. As the party of free markets, we have a moral duty to make sure that capitalism works for everyone.