Capture versus Creation: Static Discounts – Are they real?
February 10, 2015 |
The C2FO Team
By Jordan Novak, Managing Director of Business Development at C2FO
Everyone knows about discounted payment terms. It’s an ancient concept that can be traced back to the origin of trade itself and was used to secure arrangements between the Romans and the Cheras, Cholas, and Pandya dynasties of India as far back as the first century CE. 2/10 Net 30 terms are so ubiquitous that the phrase literally rolls off the tongues of CFOs and Treasurers alike. It seems every major corporation has “standard” discount terms baked into every Master Purchase Agreement, but as supply chain organizations get smarter about cost, it begs to question: are these discounts real?
When I was a corporate finance practitioner, I owned supplier terms optimization and payment strategies, including policy around discounts. As an organization, we knew there was a direct link between terms and cost, and we wanted to ensure that we knew our “true” cost on every commodity and component we procured. To improve transparency we phased out discounts. We knew that static, negotiated discounts would eventually be baked into our cost of goods and this obscured our ability to negotiate most-favored pricing.
To demonstrate this, I remember exchanging best practices with a $30B+ consumer packaged goods company. They had standard accounts receivable discount terms with all of their customers – 2.5% if paid within 10 days. At the time, I thought they could structure a program that would save the company tens of millions of dollars by reducing the “cost” to accelerate these receivables. It turns out, when speaking with the Treasurer, he indicated that they considered their A/R terms to be 10 days and had baked the 2.5% into the cost of the product for the past 30 years! This means that the real cost of goods for all their customers is 97.5% of invoice – the exact cost-transparency issue most supply chain organizations strive to avoid.
Upon removing static discounts, we found cost savings literally bubbling up from every river and stream. One major opportunity spawned an ad-hoc program for suppliers to request early payment at their discretion and at prices specifically negotiated with each supplier. This program would support select vendors that needed early payment, but separate the financing negotiation from the purchasing discussion. We felt this was the only way to ensure we knew our cost and still supported our vendors. While the program required a single full-time employee to support a makeshift ERP module and manually input criteria on a daily basis, we were still able to generate millions in savings.
The demand for this ad-hoc early payment program caught on quickly and posed serious scalability issues for us internally. We also worried that our inability to focus several full-time employees on the program meant we would be unable to service the parts of our supply chain that really needed cash. Our Tier 2 and Tier 3 suppliers were the most essential part of our supply chain and coincidentally the most underserviced in this program. Essentially, we became a reverse-inquiry shop for last-second cash loans when our original goal was to systematically shore up the health and sustainability of our supply chain. The concept was right, but the on-demand execution was impossible inside our walls.
Recently, there has been a bevy of companies sprouting up to offer technology that will help corporations scale where we failed. Most of these efforts have focused on static, negotiated discounts and the ability to help you capture and maximize these discounts. These technology providers emphasize processes that are efficient enough to pay early while modernizing the process suppliers go through to get early payment. In each of these enterprise software environments, a supplier may choose which day to get paid and corporations can be ready to “capture” their already-negotiated discount terms. The problem with these solutions is that they focus on the finite amount of “money on the table” and fail to innovate in a way to actually create new opportunities. It’s the difference between a claw machine in an arcade and Santa’s workshop. Capture versus creation.
The arguments between discount capture and discount creation are fundamental. Do organizations strive to maintain the same cost and supplier experience that has been delivered over centuries, or do they evolve and implement new technologies that create value for their entire supply chain? Ultimately, it may come down to whether an organization believes they are adding or subtracting value with their discount strategy. Having seen the results of C2FO – multiple pennies of EPS growth for clients, near unanimous supplier recommendation (the supplier satisfaction rate is 98%), and consistent triple digit growth for the company – corporations are choosing to side with Creation versus Capture, and they are enjoying the growth that comes with it.
Thousands of years ago, the Romans and the dynastic rulers of India set the early payment standard: Discount Capture. Centuries later, we at C2FO are setting a new standard: Discount Creation. Our working capital market delivers real discounts, true innovation, and proprietary technology to drive vendor financial health, satisfied suppliers, and real, sustainable cost reduction.