The Growing Credit Capacity Challenge Facing the Technology Industry 

The Growing Credit Capacity Challenge Facing the Technology Industry 

by Adrian Liddiard & John Schmidt, Co-CEO & Co-Founders, WeFi Technology Group

Credit capacity and terms are the lifeblood of the technology industry, but credit capacity is becoming a challenge for channel partners…

Over the last 30 years, driven by market consolidation, breadth of solution expertise and industry growth, we have seen a fundamental shift in the size and scope of the industry’s largest channel players. The landscape has evolved from being highly fragmented to one that is dominated by large channel and distribution partners.  

This fundamental shift has seen channel-focused Original Equipment Manufacturers (OEMs) placing ever-increasing demands for credit capacity in this segment of the market. 

As recently as 10 years ago, a credit line in the hundreds of millions was an aberration. Today, amplified by their global capabilities, we often speak in billions. 

The credit exposure is shared predominantly amongst the OEMs themselves and financial institutions (directly and indirectly through syndication or asset-based vehicles like securitizations) with the credit insurance market playing a key role in supporting underwriting capacity. 

Key question: Does the industry reach a tipping point, in which credit lines become so large that the traditional underwriters max out on meeting the credit demands for the largest channel and distribution partners? 

During the COVID years, extended supply chains resulted in product orders with long-dated shipment dates consuming a significant percentage of credit lines. This, in turn, increased working capital pressures as these orders converted to cash at much slower rates than historically. 

A similar market dynamic is playing out in the growing shift to multi-year software and cloud deals, in that year two to five consume credit capacity that traditionally was utilized for orders that converted to cash over a 60- to 90-day period. The margin profiles of these transactions have also limited the adoption of paid-upfront solutions. This dynamic will further exacerbate the credit capacity challenge as multi-year deals grow in scope and size. OEMs and Cloud Service Providers (CSPs) will need to re-evaluate their channel strategies.  

Geographically, the North American and European credit markets adopt different approaches to managing credit. In North America, there is a much higher dependence on asset-based (often referred to as collateral-based) solutions that are typically secured by accounts receivable and, to a lesser extent, inventory. Collateral in these scenarios can become a gating factor on credit capacity.   

In Europe, a typical credit structure would involve credit insurance companies underwriting a balanced portfolio. The less balance in a portfolio in which the mix of obligors is weighted to higher risk credit quality, the less likely the credit capacity demands can be met.   

In both geographies, lenders analyze the underlying credit quality of the channel partner. Typically, the large channel players fall between a high-yield (good quality credit) and investment grade. These designations are critical to lenders and regulators. Depending on the designation, a lender may take an unsecured position that is not supported by either collateral or credit insurance. Irrespective of the lending structure – whether a single financial institution or a securitization structure – concentrated credit positions in a portfolio or a material single exposure pose credit capacity challenges as a result of regulatory requirements, capital allocation rules and investor appetite. 

Any OEM, or business for that matter, that offers credit to their customers, is by definition in the credit underwriting profession. Businesses may never think of it this way, but they are acting like a financial institution. 

As the magnitude of OEM credit exposure grows, at what point do they max out? 

What credit standards and disciplines do these OEMs deploy – not only on Day One – but throughout the lifecycle, to ensure they are not overly exposed to the credit risk? 

How often are current financial statements received and key metrics analyzed, within the dynamic of the broader industry fundamentals? 

Driven by low industry loss ratios to date, a better-to-be-lucky-than-good strategy has been successful (until, of course, it isn’t).  

While economic cycles drive credit spreads (borrowing costs) and credit appetite, it also drives volume growth. As the cycle turns from a head to a tailwind, the growing credit capacity challenge needs to be addressed strategically. 

OEMs with a channel go-to-market strategy should evaluate the following mitigation strategies: 

  • Diversification of their lender pool:
    Reliance on a single lender, that is often buttressed by syndication, remains a single point of dependency in that the primary lender is the sole decisionmaker on underwriting. Diversification, including access to non-traditional lenders, provides multi-redundancy across geographies, currencies and markets.  
  • Securitization structures:
    Securitized portfolios have concentration limitations imposed by lenders that restrict exposure to any single channel partner. Without an alternative lender pool, OEMs will then be required to add the excess capacity to their balance sheets. 
  • AI and innovation:
    Advancements in AI and machine-learning tools can now be used as part of the credit underwriting process to compile structured financial statements from all sources of unstructured data in minutes (as opposed to days). Back-log conversion cycles can also be modelled to ensure improved credit capacity management. 
  • Globalization:
    As the large channel players proliferate globally, OEMs should ensure workflow engines can efficiently manage multi-currency, multi-geography, parent-child credit structures on a real-time basis. This capability provides a real-time ability to assess available credit capacity and, in so doing, quickly assess the challenges.

Credit capacity and terms underpin the channel growth engine. This lifeblood that ensures a healthy and vibrant channel will continue to require the industry’s full attention.  

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