Everything You Need to Know About Dynamic Discounting
September 15, 2022 |
The C2FO Team
Dynamic discounting is the evolution of an age-old practice, designed to give you more control and flexibility over your cash flow. How does it work?
Many small to mid-sized businesses are taking advantage of early payment discounts as an alternative to traditional financing. Early payment discounts — which give your customers an incentive to pay you earlier than your agreed terms — are a cost-effective way to increase working capital when customer payment periods increase.
Early payment discounts have traditionally been a static offering: you give your customer a fixed discount if they pay the invoice within a certain number of days. However, this model is becoming outdated as suppliers increase prices to offset discount costs. Enter dynamic discounting, an early payment approach that is more transparent and flexible for both parties.
Here’s a closer look at how dynamic discounting works, why it makes more sense than static discounting and how to access solutions for your business.
What is dynamic discounting?
Dynamic discounting is an early payment solution that gives you the option to receive early customer payments in exchange for offering a discount — but with more flexibility built in. Unlike static discounting, dynamic discounting allows your customers to pay the invoice basically any time before the agreed term and get a discount that adjusts automatically based on the payment date. Generally, the faster the customer pays, the bigger the discount.
With a static approach, customers are given two payment options: 100% payment at the full term of the invoice or a discounted amount before a fixed date. For example, terms of 2/10 net 30 mean that customers receive a 2% discount if they pay your invoice in full within the first 10 days of the invoice date. If your invoice is for $10,000 and the customer pays at 30 days, the customer pays the full amount of $10,000. However, if the customer chooses to pay within 10 days, the payment is the discounted rate of $9,800.
With dynamic discounting, the exchange can happen at essentially any point before the due date once the invoice is approved. The timing and price of a static discount are fixed, but they are variable with dynamic discounting. Additionally, your customers may present a static discount as a “take-it-or-leave-it” option to you, whereas dynamic discounting can give you more control over the offer.
Dynamic discounting is also different from supply chain finance. With supply chain finance, your customers usually partner with a bank to secure the funds to pay you early. With dynamic discounting, there’s no third party involved — your customers are simply paying you early and getting a discount directly.
Some dynamic discounting models use the sliding scale approach. With a sliding scale or linear discount, cost savings are generated by a fixed discount rate times the number of days paid early, much like an annual percentage rate (APR) on lending. The rate is almost always determined by your customer, especially if it’s a large enterprise.
A newer approach to dynamic discounting is the marketplace model offered through programs such as C2FO's Early Payment solution. In this model, the discount is determined by timing and supply and demand.
Here’s how it works: Your participating customers set a target rate of return (many customers express this in terms of an APR). You decide which invoices you want to accelerate payment on, choose your discount rate and initiate the discount offer. In addition to the number of days paid early and your desired rate, your discount offer will be accepted based on:
The amount of cash the customer can access to fund early payment.
The value of all the discount offers made by other participating suppliers at a given time.
How all supplier offers, when combined, will deliver your customer’s desired rate of return.
Benefits of dynamic discounting
Dynamic discounting offers several benefits over static discounting. It gives you a longer window for accepting early payments from customers. This provides more control over your cash flow and minimizes ad hoc discount requests from your customers. It also reduces the need to increase your prices to offset a fixed discount rate.
Under the umbrella of dynamic discounting, there are also advantages of a marketplace approach over a sliding scale. Marketplace dynamic discounting gives you even more agency, because you set the discount rate that you are willing to .
Because marketplace discounting is based on supply and demand, it also adjusts in real time based on what discounts you can actually afford to offer. This is valuable when market conditions change or if you have a seasonal business. In many cases, these dynamic factors can give you early payment at a much lower cost than the standard 1% or 2% discount.
How to access dynamic discounting solutions
Dynamic discounting solutions are generally implemented by your customers and offered as an option to you, the supplier. This makes it easy to start requesting early payments from those buyers right away. If you’re considering whether to participate in a program offered by one of your customers, here are some factors to consider:
Ease to access or enroll in the solution or program.
Compatibility with your enterprise resource planning (ERP) system and license terms.
Compliance with the General Data Protection Regulation (GDPR) and other relevant data privacy legislation.
Support for different languages, currencies and regions.
Time-to-value ratio, considering the solution’s demands on your internal resources.
The solution’s security, performance and support services.
Adoption, participation and satisfaction among other suppliers.
Ability to scale as more customers implement the platform.
If you’re a small to mid-sized business, some of your largest customers might support C2FO’s Early Payment program — the only early payment solution with a marketplace approach.
Static discounting is an age-old practice, but this approach no longer works for businesses that need more flexibility and control over their cash flow. Dynamic discounting is a more transparent option for suppliers and buyers that want to break out of the static discount/price hike cycle. Innovative options such as the marketplace model take this one step further, allowing early payment terms to continuously evolve with your business requirements.
This article originally published January 4, 2019, and was updated September 15, 2022.