New technology: will it catch the "R" factor?

Technology offers a bold new world for the vending industry. Two of the benefits that technology provides, improved accountability and a more professional image, are closely related. Emerging hardware and software address both of these benefits.

By allowing a customer to log onto a Website and view machine transactions and a host of reports, vending operators have a new and better accounting tool for customers. This is particularly advantageous for locations that receive a commission and want to know they are receiving the proper payment.

Many operators do not regard sales verification for customers as a major problem. In locations that don't get commission, it isn't an issue at all.

On the other hand, many operators say it has always been a problem since there are dishonest competitors. The most damaging impact of dishonest sales reporting is that it allows an unscrupulous competitor to win business against an honest one. The dishonest operator bids a higher commission, wins the bid, then underreports the sales to reduce the commission payment.

‘R' factor: a challenging issue
The need to police sales reporting for customers is a controversial issue. Many operators believe raising the topic alone creates a bad public image. Others believe that because the problem exists, the industry needs to correct it.

And it does exist. Underreporting of vending sales came to public light last year in Miami, Fla. after a county commissioner was accused of accepting payments from a vending operation and officials recommended banning the company from receiving any county business. Witnesses claimed the company regularly underreported sales to customers.

While operators disagree on how serious the problem is and how best to address it, technology providers are introducing new tools to prevent it.
Telemetry-based remote machine monitoring offers the most reliable tool to date to prevent dishonest sales reporting.

Gene Ostendorf, president of InOne Technology, said several larger vending operators have been trying to find a way to reduce the "R" (reduction) factor since it compromises honest operators' ability to make a fair profit.

Several observers believe that the impetus to police sales reporting is coming from the larger companies in response to The Sarbanes-Oxley Act of 2002, which created new financial disclosure standards and penalties for big companies.

Management firms encourage monitoring
In recent years, vending management companies have tested remote machine monitoring as a way to monitor sales and give their clients the chance to monitor machine activity themselves. While sales verification is only one of several benefits that remote machine monitoring provides, some observers claim the vending management companies are emphasizing this.

Best Vendors, the Minneapolis, Minn.-based vending management company, recently announced a plan to require its operator partners to install InOne telemetry in Best Vendors' managed locations. (See sidebar below). While sales accountability is one of many benefits of telemetry, many observers believe the company is emphasizing this benefit to customers.

The issue came to light in the trade recently when VTL Group, based in Auckland, New Zealand and active in the U.S., claimed that it will offer its vending management software free to U.S. vending operators who become authorized alliance partners.

VTL Group announced that a key incentive for making this package available for free was to provide an industry reporting platform with complete financial transparency to the client and visibility directly into cash box receipts via the integrated, proprietary system. The system also features customized retailing through SKU-level management.

Mark Bruno, president of Service America Group, the U.S. vending company affiliated with VTL Group, said policing the R factor is only one of several benefits that the software provides operators.

In response to this announcement, one software executive took issue with the fact that a software company was openly acknowledging the R factor. This executive claimed the implication was unwarranted and served to smear the industry.

Industry struggles with an internal controversy
The software executive's reaction to VTL Group's offering demonstrates the emotional volatility involved in the R factor. Because the subject creates controversy within the industry, it has been difficult in the past for the industry to address it.

Interviews with operators and software executives confirm that the R factor is widely practiced. Some long-time observers claim it is less prevalent today than in years past, but it nonetheless continues.

Many believe that shrinking profitability has made it more important for the industry to address the issue. Weaker profit margins places new pressures to cheat, many note, at a time when the industry needs to improve its public image.

To correct the problem, many operators and software providers agree the industry should use new tools that technology has created to address it.

Telemetry offers a new accounting tool
Gene Ostendorf, whose company, InOne Technology, provides a telemetry product as well as DEX retrofit kits, believes telemetry will help the industry get rid of the R factor. "That is a valuable tool for companies that aren't into the R factor," he said.

InOne Technology came into being shortly after Ostendorf's previous company, Audit Systems Co., acquired two management software providers, EMS Solutions Inc. and VendMaster Software Systems. Ostendorf said he did not know these systems supported the R factor until after he acquired them. He said that he fully supported the NAMA sponsored effort to not support the R factor in all new software development, and signed a document to that effect. 

Ostendorf said he instructed his software development team not to include R factor or "overhead adjustment" in InOne's new software, "InVision." 

Ostendorf said a DEX probe which an operator plugs into the machine and downloads the DEX files is a less costly way to access transaction information from the machine. However, it is up to the operator to show the data to the customer. With telemetry, the customer can see the data himself if he has the necessary Website access.

Software providers promote sales verification
Cantaloupe Systems, a telemetry provider, was quick to recognize the ability to verify sales. Anant Agrawal, the company's founder and chief marketing officer, said he surveyed operators to determine how much of a competitive factor sales underreporting is, and concluded that it is a big factor.

As a result, Cantaloupe Systems is encouraging operators to let their customers know that telemetry can verify sales. "If you're getting 10 percent, 10 percent of what?" Agrawal asked to demonstrate his point.

‘R' factor: a long history
Bob Johnson, formerly a vice president for EMS Solutions, said flexibility in calculating location commissions, including R factoring, was a common feature in earlier vending management software. Johnson, who is no longer in the industry, also sat on the NAMA ethics committee that called on software companies to eliminate R factor capability through its ethics code (See sidebar, below.)

As a software consultant, Johnson said he didn't point out the R factor capability to customers, but when asked about it, he obliged them.

Johnson, like other software sales reps interviewed, claimed that the percentage of customers asking about the R factor declined over the years. He said about a third asked about it in the early 1980s, compared to less than 10 percent in 2002.

"I think the business has to some extent legitimized itself," Johnson said.

Johnson was among those who said company size has no bearing on R factor use.

He did say there were some regional variances. He said sales underreporting was more prevalent on the East Coast and in the Pittsburgh, Pa. and Philadelphia, Pa. markets.

Johnson further noted that some operators asked EMS Solutions to sign a notarized statement saying that R factor capability was removed from their software. "They used it as a positive instead of a negative," he said.

"Software is like any other flexible tool that can be used the right way or for dishonest purposes," Johnson said. "It's not the software companies' issue to police the use of their products when clients use standard options to cheat their customers. They provide the software the industry needs."

‘R' factor hampers professionalism
Mark Bruno, president of Service America Group, which is offering software to qualifying operators that will assist sales verification, has long believed the industry could be doing more to combat the R factor. He agrees with Johnson that company size has nothing to do with its likelihood to underreport sales.

As a large regional operator that has acquired many companies over the years, Service America Group, formerly known as All Seasons Services, recognized that improprieties in financial reporting were a big problem, Bruno said. He said 78 percent of the last 56 operations the company considered for acquisition were underreporting sales to clients of all sizes.

"This is a very, very widespread problem," Bruno said. "R-factoring comes in a variety of forms. It can be as simple as an omission of some equipment reported to the client, an underreporting of actual sales, or a variety of options in between. It is difficult to achieve margins in the vending industry when the economics of the industry allow for underreporting of quoted commissions."

"Because some companies do not use R-factoring, and the level of R-factoring varies amongst companies who choose to use it, it is difficult for the industry to achieve margins that would support the capital investment required in the business," Bruno said.

"It is our belief we suffer as an industry as a result of this business practice. If the playing field was leveled through financial transparency, it is our belief over time the industry would be forced to achieve margin through efficiency, actual commission reduction and/or pricing. The support net created by R-factoring would be removed."

In order to receive the software the Service America Group is offering, operators need to agree to make their records financially transparent to customers and adapt to various operating and reporting standards required under their licensing agreement.  

Bruno acknowledged that some locations are more interested in seeing the sales information than others.

Who's to blame?

One operator who did not want to be identified said that customers are largely to blame for the problem since they want to believe they are getting high commissions, even if they can't verify it.

Some observers believe underreporting occurs more among smaller operators due to the fact that it's more difficult to conceal illicit activity in larger organizations.

Bill Lockett, national account director at Crane Streamware, is among those software sales veterans who claims R factoring is less common than it once was. In the last two years, he said about 10 percent of his operator customers requested access to R factoring, which is much less than it once was. Sixteen years ago, he estimated that 80 percent of the customers asked for it. "It was a typical point of discussion and was anticipated to come up," Lockett said. "In those days, we all offered it," he said.

Lockett said operators often justified misreporting sales on the basis that their customers' clients vandalized their machines, which caused financial losses that needed to be compensated for.

Software sales rep sees improvement
More recently, some operators who have purchased other operators with R factored locations have gradually "raised" sales so they can eventually be reporting revenue at 100 percent.

Lockett said Crane disabled the underreporting capability from Streamware when it bought Streamware in 1998. But he echoed others interviewed who said that it isn't difficult for operators to underreport sales, even if the software does not facilitate their doing so.

Lockett gives the National Automatic Merchandising Association and the big national companies high marks for trying to do something about the R factor. It was specifically prohibited in the NAMA ethics code, which was introduced in 2000.

"I think the leaders in the industry have abandoned it (the R factor) completely," Lockett said.

Kendall Jackson, owner of Jackson Brothers Inc., the St. Louis, Mo.-based vending operation, estimated that half of all operators still underreport sales, and he agrees with those who say the practice has nothing to do with company size. Jackson said 85 percent of the companies he has acquired were not paying commissions properly. "It's crazy," he said.

Jackson said some operators justify the practice based on losses they can't control, such as internal theft.

Asked how much sales go unreported, Jackson estimated about 15 percent on average.

Steve Marx, who operates Royal Vending Inc. in Maple Grove, Minn., said out of four companies he has acquired, three underreported sales.

He estimated that half of the operators are doing this. Marx said this creates problems if he retains employees who were involved in underreporting and the customer realizes they were previously being cheated. "It's a very delicate position," he said.

Marx has made a practice of asking customers to audit sales if they tell him they are going to switch to another operator who promises them higher commission.

Marx said he is aware that vending management companies are promoting telemetry, partly to improve sales verification, and that this may reduce the likelihood of underreporting. "I think telemetry is very important," he said.

Management company mandates raise issues
The management companies' efforts to mandate telemetry has created another set of issues, however. "They (vending management customers) have to understand there is a cost to that and somebody has to pay," Marx said.

Vending management companies also sometimes conduct field audits to make sure the sales are being properly reported. "That stops the R factor," Marx said.

Dan Hart, co-owner of Southern Refreshment Services Inc. in Tucker, Ga., was among several operators who said high commissions create an unlevel playing field, which is unfair to both the customer and operator. He said that as long as customers continue to demand unrealistic commissions, the industry will not be in a position to provide the best possible service.

"Some (customers) will change for a dime if they think they're going to get it (higher commission)," Hart said.

Hart agreed with Marx and others who estimated that at least half of the operators are underreporting sales.

Hart also agreed with Bruno that too many operators are working to sustain their incomes, not their businesses. "They should be making a good living and making a good profit," he said.

Tom Houseknecht, president of Loose Ends Vending in Batavia, N.Y., was among several operators who claimed he was able to pay an account more money at a lower commission due to a competitors' sales underreporting. "We've actually won business with a lower commission with a guarantee that was higher," Houseknecht said.

Houseknecht provides DEX reports to customers who are interested in seeing them. He uses Streamware handhelds. "I wish I could say that accountability is a bigger selling tool," he said. "Many (customers) can't get past the quoted commission rate."

Loose Ends Vending is participating in a data reporting test with Best Vendors, the management company.

Some operators have attempted to provide sales verification services over the years.

Jeff Stubins, who sold his South Florida vending operation several years ago, launched Vend Audit Controls in 2002. Using the DEX-based InOne Pocket Probe, he developed a Web-based solution for verifying vending machine income.  

Stubins ran pilots of his technology at several major school districts monitoring bottler-operated beverage machines. He observed that none of these operators were capturing meter readings as a part of their own internal controls. 

During these pilots, Stubins said, same machine sales increased substantially. However, despite these dramatic increases, Stubins found that schools were not interested in implementing a fee-based system of control. As a result, he now offers a non-technology contingency-based service, recovering earned and unreceived historical income. "My examinations typically find additional amounts due the client that are worth pursuing," he said.  Stubins has represented over a dozen clients.   

Management firm markets sales verification
Another former operator, James Ingram in the Washington, D.C. area, has developed a vending management business called Vending System Management LLC that finds locations and licenses them to operators for an upfront fee and 3 percent of gross sales and the right to operate in the company's locations as long as they follow the rules. One of the big selling features of his service is honest reporting of sales. Ingram also negotiates the type of machines to be installed, the product menus and the commission rates. He said he presently manages about 300 accounts.

All of the machine meter readings are recorded and sent to the customer along with the commission payment, Ingram said.

Ingram is in the process of introducing InOne telemetry to his locations. Customers will be able to review machine transactions over a Website.

The key benefit is enabling an operator to service more machines.

While the telemetry will provide a host of benefits, Ingram believes combating sales underreporting will be a key selling point.

"We're going to expose the R factor," Ingram said. "I think the R factor will go away because vendors won't be able to use it."

Howard Bell, who owns All Vend Management, a vending management company based in Irving, Texas, said telemetry promises a way to improve the reputation of the vending industry.

One issue that has not been established, however, is which of the telemetry players will remain. He compares vending telemetry to the video entertainment industry, which had to undergo a process of identifying the standard technology – VHS.

Bell conducted a test with one telemetry provider that eventually went out of business. He said 20 retail sites were able to review transactions over the Internet. "It was fantastic," he said.

He said the major benefit of the telemetry was the sales information it provided, which he believes would help everybody's sales.

Bell supports using telemetry to combat underreporting. If technology can cure errors, he said he is for it.

Some telemetry providers were quick to point out that managing the R factor is not high on their agenda.

Pelican Communications, a vending management company that is expanding its use of telemetry in vending machines, is not promoting the verification of sales as one of the technology's benefits. The benefits promoted include increased sales and efficiencies. The company verifies sales by providing manually-recorded meter readings.

The issue of who will pay for technology was raised by several operators.

Bruce Lipkin, owner of Universal Vending Management Inc., a vending management firm in Westfield, N.J., said he is still trying to develop a model that will spread the cost of telemetry among the different parties involved. He said the key benefit to the clients is accountability.

Whether or not telemetry per se is necessary to address underreporting of sales is not agreed upon.

Is telemetry necessary to combat the ‘R' factor?
Warren Philips, president of Validata Computer & Research Corp., a management software supplier, said, "the cost of accuracy, integrity and reporting need not include every new technology that presents itself." He has observed historically some technology providers will drive concern about the R factor to foster demand for their services.

"No matter how sophisticated we get with technology, nothing substitutes for the visual, physical inventory of products and money; there is a need for reconciliation of the automated system," Philips said. "You still have to have secondary and tertiary procedures to handle those situations that are going to happen."

Alan Kronenberg, president of CompuVend Systems Inc., another software supplier, believes the issue has been blown out of proportion. This has occurred as a result of vending operators seeking excuses for losing business. "It's an easy scapegoat," he said.

Kronenberg said operators sometimes suspect sales are being misreported when different methods are used to compute commissions. Some operators base commissions on net sales while others base it on gross profit.

Kronenberg, who operated a vending business before getting into vending software, doesn't deny that cheating occurs, but he noted that this is true in any industry.

Some CompuVend customers have asked the company to certify they are paying proper commissions, Kronenberg noted. The company provides this certification for free.

Ray Freiderich, co-owner of Sterling Services in Belmont, Mich., is among those operators who works with Best Vendors and is considering installing telemetry. "I don't think it's going to be any big deal to get on board with that," he said. He already has DEX capable machines in place. "All the equipment is DEX capable that we have in their locations."

Freiderich has always offered to provide machine audit information to his customers, but very few have ever taken him up on it. Accounts that receive commissions get monthly meter reading reports with their commission statements.

Consultant says it's a worthy cause
"The time is right for the industry to make this an issue and clean itself up," said Richard Wyckoff, formerly president of Aramark Refreshment Services and former senior vice chairman of NAMA, now an industry consultant, W Strategic Consulting. When he worked at Aramark, Wyckoff noted, "We ran up against illogical bidders all the time."

Aramark presented DEX reporting capability's main benefits to the account as accountability in sales reporting, Wyckoff said, as well as merchandising management and predictive and reliable customer service.

Wyckoff does not support third party verification services. "We can't tax mom and pop because some people are unethical," he said.

However, Wyckoff recognizes improved accountability as one of many benefits of telemetry. "It's a tool that can enable a lot of things and should be invested in by any forward thinking operation," he said.

Wyckoff generally supports the intermediary role that vending management companies provide.

As technology expands, it presents the vending industry numerous opportunities to improve customer service and improve its image. In time, there is a good chance it will eliminate the R factor.

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