LET'S MAKE A DEAL!
With cash in short supply, some CFOs are turning to barter to help keep their businesses running.
By Steven Crane

Excess inventory, slow receivables, currency worth its weight in paper, capital controls. From Bombay to Beijing, cash flow is as dry as a banker's cough. With little cash--and even less credit--the way forward for some finance managers has meant looking back. Way back--to the days before the Lydians in Asia Minor introduced proper coinage systems. In those days, business meant barter.

Barter. The very word conjures images of cavemen swapping rocks for sticks, chickens for goats. But these days, with whole economies shattered, and with the world seemingly teetering on the brink of a global recession, barter is staging a remarkable comeback. The International Monetary Fund estimates that eight per cent of worldwide trade is now conducted through non-cash transactions. The US Department of Commerce puts the figure at 20 per cent, and independent estimates are as high as 35 percent, a huge number. In North America alone, total volume for countertrade--a sophisticated form of barter--reached US$7.5 billion in 1995 and involved more than 65 percent of Fortune 500 companies, according to the latest survey from the International Reciprocal Trade Association (IRTA).

Figures for Asia, however, are nearly impossible to pin down. Part of the problem: many finance managers in the region don't seem real eager to admit they use barter. According to Henry Steele, an associate professor at the Department of Marketing and Research at Lingnan College in Hong Kong, managers at some companies may be reluctant to discuss their deals because countertrade is generally viewed as restraint of trade. Other finance executives fear that, if word got out that their company accepted non-cash payments, truckloads of refrigerators would start showing up at the factory gate. Still others say that, given the current economic climate, barter gives them a sizeable competitive advantage--an advantage they'd just as soon not share with media types. Says Steele: "For foreign companies looking for international opportunities, offering a countertrade arrangement may give an advantage over those who don't." In a recent survey of corporate executives in Hong Kong conducted by Steele, over half said they believed countertrade improved a company's competitive position.

But for companies operating in countries with hard hit currencies, barter goes beyond mere competitiveness. It can spell the difference between getting by and going under. Not surprisingly, government leaders in South Korea, Malaysia, Indonesia, and the Philippines have recently stepped up efforts to promote countertrade. "For a country experiencing difficulties," notes Steele, "countertrade may be preferred over non-countertrade deals." Officials in Thailand have gone further than just promoting. In an attempt to stem the outflow of foreign currency, government authorities will soon make it compulsory for state-run companies to secure countertrade for 50 percent of the cost of deals over $300 million bath (US$7.7 million). "In good times, barter is a very useful competitive tool," says David Hew, secretary general of the Singapore-based Asia Pacific Countertrade Association. "In hard times, it is the natural means for continuation of trade."

You don't have to tell that to Asghar Mehdi. As Deputy CEO of PT Tirtamas Comexindo, a privately held Indonesian trade company with revenues of $400 million, Mehdi says he's practiced countertrade for more than ten years in countries which lack hard currency, including Vietnam and Pakistan. Mehdi, who oversees the finance operations at Comexindo, says the company recently used its barter expertise to set up a complicated trade with a Sudanese partner.

Under this contract (valued at US$40 million per year since 1992), Comexindo supplies a range of agricultural inputs including pesticides, herbicides, fertilizer and equipment. In exchange for these items the counterparty government involved agrees to supply certain specified agricultural commodities including cotton; hides and skins (to India); hibiscus (for Germany); and sesame seeds (for various Middle and Far Eastern markets). Similar commodity export agreements have been made with Myanmar and Russia.

This sort of complexity is not unusual in barter deals. Like other financial swapping transactions--interest rate or currency swaps, for instance--barter requires a rigorous assessment of counterparty risk. That's not an easy task, not with the lousy financials of some prospective partners. "The key to modern countertrade is transactional financing, not balance-sheet financing," Mehdi points out. "It's basing credit risk on a proven record of trade flow instead of cash flow."

Such a leap of faith may make conservative CFOs blanche. And some finance directors point out that they simply have no need to resort to barter. Harry Wilkinson, CFO at Hong Kong-based shipping conglomerate Orient Overseas (International) LTD., says that with Asian exports still thriving, and with near full capacity on its westbound routes, company managers don't have to worry about local currency problems or credit risk. "We're in a position where we can do business in US dollars and select customers with good credit." Still, Wilkinson concedes, "Others may not have a choice [but to turn to barter]."

Canned Hams?

Certainly, barter is not for everybody. The logistics of a countertrade transaction is enough to scare off even the most intrepid CFO. No one would argue that cash isn't a whole lot easier to manage than frozen mackerel. Barter also raises some serious accounting and tax questions. "In general," says Jeff VanderWolk, tax principle at Deloitte Touche Tohmatsu, "as long as you can value whatever is exchanging hands, the tax treatment is the same as cash transaction." But he warns that disputes with tax authorities may arise in the areas of timing and sourcing. "Timing and the recognition of gain or loss may be an issue if, for example, the barter agreement occurs in year one but the actual exchange takes place in year two." In Hong Kong, which has a source-based tax system, profits are only recognized for trades that are considered to have originated in Hong Kong. "In Hong Kong, there are lots of people who set up companies incorporated elsewhere, and who run them here but don't register them or don't file tax returns," VanderWolk says.

Given the sharp rise in barter, some government officials in the region are starting to keep a closer eye on barter. Michael Martin, the assistant chief economist at the Hong Kong Trade Development Board, insists that, for the moment, barter is not a huge concern for his agency. But he does admit, if the economic slide in Asia worsens, barter may come to play a significant role in the Hong Kong economy--especially in offshore trade. It is in this area, where barter may offer some tax advantages for companies whose accounting practices are less than honest, that Martin suggests the Hong Kong government may take a future interest. "It may be an issue down the line in terms of inland revenue, taxation, corporate finances and record keeping," he warns.

Still, for multinational corporations looking to get a foothold in credit-starved emerging markets, barter may be an ideal entree. A list of multinationals that have turned to barter in the past few years reads like a Who's Who of the known corporate universe. General Motors swapped locomotives for tea in Sri Lanka. Coca Cola traded for Korean toothpick frills and Bulgarian forklifts. And in the Balkans, McDonnell Douglas accepted crystal software, cutting tools, leather coats and canned hams--yes, canned hams--as partial payments for jet aircraft. Says Barry Desker, CEO of the Singapore Trade Development Board, "The most significant benefit is that barter preserves the ability of parties to trade goods when hard currency and credit are lacking."

It may also preserve profit margins. Rudy Chan, managing director at the Barter Card network, a barter brokerage, says non-cash transactions can help dramatically boost a company's net profit margins. Chan likes to cite the example of a company with $1 million in operating costs and a 50 percent gross profit margin. By using barter, not cash, to pay for goods and services, Chan says that company will save $500,000. That, in turn, will effectively raise the company's net profit margin from 10 percent to 15. "Basically, for every cost you pay for with product rather than cash," he says, "you get a discount equal to your gross margin." But the real advantage of barter, Chan argues, "is that the company will still get $1 million worth of goods and services, without reducing its value-added operations."

Not enough stuff

Chan is not alone in trumpeting the virtues of barter. Barter exchanges, like barter itself, have become big business of late. These exchanges include for profit exchanges such as Barter Card and Pacific Barter, and not-for-profit associations such as APCA and the US-based IRTA.

Typically, for-profit barter networks charge members a one-time membership fee--around $400-$500--and a commission on each deal--generally between five to seven percent. Members can then list goods and services, and are credited with trade dollars which can be used to purchase other posted items. Brian Hodgson, who started Pacific Barter in the fat-cat days of pre-crash 1997, says the value of items listed on the exchange has tripled since January. The average transaction handled by Pacific Barter, which serves mainly a corporate clientele, is worth between $25,810 to $51,629. "Last year, when cash was king, people weren't interested," Hodgson says. "Now the state of the economy has focused people on the need to reduce cash outflow and excess stock."

Kelly Law Sau-woon is one of those people. The assistant financial controller at the Prudential Hotel in Hong Kong, Law says barter has become a daily part of business since the economic crisis struck. With cash now in short supply--and room capacity running at a paltry 70 percent--Law says barter helps her utilize resources that would otherwise be wasted. She’s traded accommodation at the hotel for a slew of goods and services, including advertising space, hotel renovations, and supplies for the hotel's food and beverage services. "By trading on the Barter Card exchange, we leverage our resources," she says. For a room that costs HK$700 per day, for instance, the hotel receives the equivalent value in trade dollars to exchange for goods and services. With a 30 per cent margin, the cost to the hotel is a mere HK$210.

Not that barter exchanges don't have drawbacks. The five to seven percent commission is a healthy rake by any standards. And Law complains about the limited selection at the Barter Card exchange in Hong Kong. But barter backers say membership in barter exchanges--and thus selection on those exchanges--will grow as the regional economy worsens. For his part, Chan says Barter Card will soon publish its first member’s directory of goods with about 100 businesses listed. While Barter Card handles mostly standard corporate swaps (advertising space, printing, and services) Chan notes that the exchange has already arranged some rather unusual trades. "Several members formed a syndicate to buy a racehorse we had listed," he says, "and then utilized their winnings to make other purchases."

Back in Jakarta, Comexindo’s Medhi is looking at slightly larger deals. He claims that Comexindo is currently looking at several sizeable countertrade transactions, each worth more than $200 million. But the Comexindo finance head says the ongoing turmoil in Indonesia is starting to make it difficult for even experienced countertraders like himself to put together deals. He particularly worries about growing political instability and the lack of financial know-how at some of the country's banks. "Because Indonesian banks had it easy for so long," he says, "they don't have the expertise to analyze the performance risk attached to countertrade deals where assuring the quality and delivery of goods is paramount." Unless conditions in Indonesia get better in a hurry, Mehdi says the proposed deals may unravel. Comexindo management is now considering moving the company's operations to Singapore. In Singapore, he notes, government stability is rarely a concern.

Steven Crane is a senior writer at CFO Asia.