What Is Channel Stuffing?
Channel stuffing is a deceptive business practice used by a company to inflate its sales and earnings figures by deliberately sending retailers along its distribution channel more products than they are able to sell to the public. Channel stuffing typically would take place just before quarter-end or year-end so that management, fearful of bad consequences to their compensation, can "make their numbers."
[Important: This fraudulent practice is usually done in an attempt to hit compensation targets, or to raise the value of the stock or prevent its fall upon release of quarterly or annual results.]
How Channel Stuffing Works
Channel stuffing refers to the practice of a company shipping more goods to distributors and retailers along the distribution channel than end-users are likely to buy in a reasonable time period. This is usually achieved by offering lucrative incentives, including deep discounts, rebates, and extended payment terms, to persuade distributors and retailers to buy quantities in excess of their current needs.
Usually, distributors retain the right to return any unsold inventory which calls into question whether a final sale has actually occurred. “Stuffing” the distribution channel is frowned upon by the Securities and Exchange Commission (SEC) as a practice used by companies to accelerate revenue recognition to reach short-term revenue and earnings targets, and as such, misleading to investors.
By channel stuffing, distributors temporarily increase sales figures and related profit measures for a particular period. This activity also causes an artificial bump up of accounts receivables. However, unable to sell the excess products, retailers will send back the surplus goods instead of cash to the distributor, who then must readjust its accounts receivable (if it adheres to GAAP procedure) and ultimately its bottom line.
In other words, stuffing always catches up with the company, because it cannot maintain sales at the rate it is stuffing. Channel stuffing is not confined to the wholesale and retail trade; it can take place in the industrial sector, high tech industry, and the pharmaceutical industry as well. Valeant Pharmaceuticals is an egregious example of a company found guilty in 2016 of channel stuffing.
Channel stuffing accusations have also been levied against the automobile industry, which sends too many new cars to dealerships than demand warrants in order to inflate sales figures.
- Channel stuffing refers to the practice of a company shipping more goods to distributors and retailers along the distribution channel than end-users are likely to buy in a reasonable time period.
- By channel stuffing, distributors temporarily increase sales figures and related profit measures for a particular period.
- Regulators frown on the practice and consider it deceptive. In some cases, legal action can be brought to the offending company.
An Example of Channel Stuffing
In August of 2004, pharmaceutical company Bristol-Meyers Squibb (NYSE: BMY) agreed to pay $150 million to settle a channel stuffing suit by the SEC.
Court documents reveal that "for two years Bristol-Myers deceived the market into believing that it was meeting its financial projections and market expectations, when, in fact, the company was making its numbers primarily through channel-stuffing and manipulative accounting devices. Severe sanctions are necessary to hold Bristol-Myers accountable for its violative conduct, and deter Bristol-Myers and other public companies from engaging in similar schemes."
Bristol-Myers inflated its results primarily by stuffing its distribution channels with excess inventory near the end of every quarter in amounts sufficient to meet its targets by making pharmaceutical sales to its wholesalers ahead of demand. As a result of its channel-stuffing, Bristol-Myers materially understated its accruals for rebates due to Medicaid and certain of its prime vendors, customers of its wholesalers that purchased large quantities of pharmaceutical products from those wholesalers.
In addition to paying its multi-million dollar fine, in March 2003, Bristol-Myers restated its prior financial statements and disclosed its channel-stuffing activities and improper accounting.