Wednesday, March 23, 2011
When most people think of discounts, they think of traditional business related discounts like unit volume, or sales volume. Discounts can come in a number of different shapes and varieties and may be based on the relationship, marketing activities, sales activities, or operational issues and may take the form of financial assistance the Supplier provides for certain activities such as promoting the product and not as straight discounts. Either way it reduces your cost. Here are examples of a number of different types of discounts that could apply to a relationship.
This is the most common of them all. This relies upon the premise that the more you buy of an item the lower the cost should be because of the savings that the Supplier achieves with the higher volume. The reality is Suppliers usually offer price breaks for higher volumes not because they’re warranted from a cost perspective but because Buyers expect them and because they want to use them to drive the Buyer’s behavior.
The Buyer’s volumes may not even impact the Supplier’s costs. For example, if a Supplier produces 100,000 units of a product during the course of a year and you buy 10,000 pieces, how much of an advantage to their cost structure will your volumes actually provide them? Will the extra 10,000 pieces allow them to get a material cost price break point? It probably will not. It especially won’t if they have no guarantee that you will actually buy that volume. Will the extra 10,000 pieces provide them with a new process cost break? Probably not, in fact it could cost them more if they had to invest in additional capacity that won’t be fully utilized. Will the volume reduce their per unit labor costs? It probably won’t. If they couldn’t achieve significant productivity improvements at 90,000 pieces, any change for an added 10 percent is unlikely. Will it have a significant impact on their overhead allocations? The impact will only be slight. Instead of burdening the allocated cost over 90,000 pieces they’ll burden it over 100,000 which is an 11% impact, but that 11% for overhead is usually on very small percentage of their product’s cost. Will it have a significant impact on their cost of sales? Not always, in fact if you are a high maintenance customer it could increase their cost of sales.
If the real cost differences from changes in volume are only slight, why do Suppliers structure pricing based on volume and not based on the cost impact to them? Their primary motivation in their pricing structure is being able to manage their profitability. They also use pricing to drive customer behavior. For low volumes they want to drive the customer into their channels where they’ll traditionally make more money, have less costs and assume less risk. You can’t do that if you offer low prices on low volumes to everyone. For larger customers, they also want to create a form of customer loyalty that will impact future decisions. While you may be free to make spot purchase decisions, the right Supplier pricing structures may force you to weigh the impact a spot purchase will have on the discount you get on other purchases from the Supplier. Most Suppliers will either want to give you step discounts so you have to earn what you get before getting the next level of discount. They do that to drive repeat business. Alternatively they may want a chargeback mechanism where if they give you the higher volume price and you don’t meet the quantities, they can charge you the difference between that price and what you would have paid at the lesser volume. That creates a clear impact of not sourcing from them. Their goal is to provide them with an advantage where you have to weigh the impact of sourcing from others against the impact that may have on your purchases from them.
Where there’s a significant difference in pricing based on volume, ask them to explain why. In most cases there really isn’t a rational explanation for the differences, only that they have chosen to sell that way for their profit model and to try to manage customer behavior. Use that to get the best deal you can based on your estimated volumes and use it avoid step pricing or bill-backs. The argument is simple. If they won’t be financially harmed from a cost perspective from not getting those volumes, why should you be penalized if you don’t meet the volumes? In most cases they can sell it to you for the high volume price and still make a profit. They just won’t make as much of a profit as they would like. Whether they’ll accept that will be dependent on how much they need or want your business.
Combined Business Volumes
This is the concept of leveraging the entire relationship you have with a Supplier across all activities and not just an individual product or set of products. This type of discount usually needs to be negotiated at the Strategic Relationship level. Many OEM’s will have Customer Volume Based discounts so that the more business which you do with them, the deeper the discount. As with unit volume, this discount has little connection to any cost savings that are generated by volumes. It is based not so much on customer loyalty as it is the desire to win more business. Customers have the tendency of buying other products from the same company if they already receive the higher discount. Competitors try to avoid giving steeper discounts on low volume purchases. There is no real savings to a Supplier from the combined business volumes that warrant the discounts. These discounts are more to lock you in to continuing to buy more and more from the Supplier.
Value of breadth of sales capabilities.
There is a value to a Supplier in dealing with a Buyer who has broad based operations that it will use to open up new markets and new geographies which they or there other customers couldn’t reach. There is also a cost that the Buyer encounters in opening those markets that should be rewarded by an incremental discount
Residual / annuity value.
Many times when you buy their product, what you are also doing is help them build an annuity stream from that sale in terms of follow on sales of parts, services, maintenance, upgrades, etc. Many times the value and profitability of that type of annuity business is far greater than the profitability on the initial sale. The annuity revenue that you create for the Supplier for tomorrow should be recognized to you today to negotiate a discount or lower price. If they don't make the sale the don't get the annuity business.
When there are substantial costs associated changing Suppliers, one of the things to ask for is a “signing bonus” to help you defray those costs. The cost of changing Suppliers can be things like needing to re-write certain programs to accommodate the new Supplier, making changes to your production line or product design to use them or, sometimes almost needing to start almost from the beginning with the activity. The time to negotiate a signing bonus is before you agree to switch. Once you agree to switch, you are locked into those costs and probably will be locked into that Supplier, as there will be a substantial cost to switch to yet another Supplier.
In many markets there is a substantial cost which a Supplier incurs when they lose a customer and need to acquire a new customer or customers to replace them. If a Supplier will spend the money to acquire a replacement customer, they should also spend money to retain you as their customer as it avoids those other costs.
Contracts are negotiated at a point in time based on the facts known at the time. During the period of a contract there can be substantial changes where the overall market drops, or where your Supplier is impacted by another Supplier who has a better product to offer or may have a less costly manufacturing process or overhead. When the market changes and there is a large incentive to change Suppliers, a loyal customer shouldn’t be penalized for remaining loyal. If the Supplier will discount to others to get new business, they should also discount to those who continue to provide them with business, especially in down markets. Too frequently Buyers rely upon “best pricing clauses” as their way of getting future discounts to deal with changes to the market conditions. Best pricing clauses are seldom implemented in a manner where the reduction is automatic. Most times they need to be forced by reviews or audits.
This is a measure to look at actual performance not just against the contract, but also against their other customers. When our actual performance is consistently better that their other customers, we should be getting a better deal. For example, if you pay sooner or more consistently it lowers their cost. If you have better accuracy on forecasts or less activity with changes or cancellation or rescheduling it makes their management easier. If you have E-business systems that reduce their management costs and others don’t shouldn’t you get a benefit? If you use your resources to work with the Supplier to reduce their costs, improve their quality, become e-business based, shouldn’t you get a return on that investment? You may be helping them reduce costs not just for their dealing with your company but also with their broader based business. If you help them be more competitive shouldn’t you get some of the benefit of that?
Stability / Risk involved.
Suppliers have all types of customers. The more stable you are, the lower the risk they will have in terms of getting paid, the less you should pay. If you are a premier, low risk Supplier, you should pay less even at the same volumes than other customers who are higher risk.
Customer base you bring to the table.
When a Supplier enters into a relationship with a premier Buyer/ reseller, they are getting access to the accounts which the premier customer has spent years to build and which many times they or their other customers wouldn’t be able to penetrate as accounts. There is a value to dealing with the leader and getting access to their customer base.
Value of your name as their customer.
When you are a premier company in the industry the fact that you are a Supplier’s customer has significant value to the Supplier for marketing purposes. If you let them use your name in their promotional customer list materials you should get compensated for that.
Many customers don’t want to buy a product until they see how it is actually successfully used. Without good references for a product it’s much more difficult for a Supplier to sell their product so references from top companies are like gold as it helps them sell to more customers. If you agree to help show customers on the value of the Supplier’s product, you should be compensated.
Leadership purchase / use.
When you are the first to purchase or use a new product or technology and you are a premier company, it becomes an endorsement of that new product or technology. The Supplier will use that to sell to others. If we are first or an early adopter we should get compensated for that endorsement.
Value of Supplier qualification.
When you are a premier company and qualify a Supplier, that acts as a form of “seal of approval” which is used by second tier companies in selecting the Supplier. This represents significant value to the Supplier. If you help them make sales you should get compensated for that.
Value of product qualification.
Many smaller companies do not have the resources nor do they want to spend the money to qualify products. They will wait until a major customer has purchased the product knowing that they have qualified it. The value that a product has passed our qualification requirements is a significant value to the Supplier for use in marketing the product to these “me too” customers. You should get the benefit of those investments.
Incentives, Promotions, Rebates.
To generate increased product sales Supplier may offer special incentives, promotions or rebates for sales of specific products to move out inventory or sales during specific periods to improve things like their cash position, inventory levels, financial reports, etc. As a Buyer, if you don’t ask for them many times you won’t be offered them. Other sales practices, like which party if responsible to pay for demonstration products is also a form of discount if you get the Supplier to include all those costs. In retail Suppliers will pay for shelf space, they will offer special promotions sometimes at or below cost as part of a leader to get customers in to buy. You’ll never know what incentives you can get unless you ask.
When the Supplier performs well, they are rewarded with greater volumes and future business. When there are problems with the Supplier’s performance, they should pay to pick up the costs that they have created. If performance worsens, the Supplier’s responsibility to cover those costs should increase. E.g. If they are late, they pay for premium freight. If they continue to be late, they stock the material for you.
Inconvenience or added costs to Buyer.
Any time the Supplier creates a requirement that adds costs or inconvenience to the Buyer’s operations; those added costs should be deducted from the price to be paid.
Convenience to Seller, solving a Seller’s business problem or avoiding cost.
When what we agree to helps solve a business problem for them or helps them avoid cost, we are reducing their cost infrastructure and shouldn’t get the benefit of those savings.
“Add-ons” or services included in the price at no additional cost.
Typical add-on’s can include delivery, installation, service, warranty, maintenance, training etc. Where these have the most value is if they reduce your direct sales costs. If the entire benefit is passed on to the Customer, it may represent additional value to them, but it isn’t a reduced cost to you unless you typically included those costs in your selling price.
Receive better or more liberal terms and treatment than other customers.
Not all customers are equal and not all of them will get equal treatment. Best pricing isn’t the only issue to be concerned with. Better customers may pay the same price as you do, but they may get better or more liberal treatment on things like changes, returns, or may also get additional concessions for things like marketing and promotional programs, or other allowances.
Allowances and Trade-Ins
When a salesperson thinks that they are in a highly competitive situation, they usually have some ability to be creative to win the business. While Anti-trust laws require pricing to be extended equally based on equal quantities and terms, those same Anti-trust laws also allow a Supplier to offer special pricing in competitive situations. Typically the Supplier will have a set discount structure or structures. When they have exhausted the use of the discount structures and still need to make further concessions to win the business they usually have a variety of different allowances that they can give. For example, they can offer an additional discount or allowance “if they can use you as a reference account”. Or if they can use the “prestige” of your company in future advertising they can give an added discount. If you conceptually agree to buy more in the future, they may give you an allowance based on the total expected volume (even though you are not obligated to make the future purchases. If agree to refer another potential customer they can offer you an allowance. The basis for providing additional discounts or allowances can be direct reductions to the price of what you will buy or it can also take the form of throwing in a number of additional items free or at a reduced cost. Buy now and you’ll get a two-year free maintenance contract. Buy now and we’ll throw in the following options. Buy now and you’ll receive 100 hours of free training. As long as the items have value to you, they are effectively a further discount.
Another type of allowance is the trade in allowance. The Supplier who is facing a highly competitive situation will usually offer you a premium trade in allowance on the purchase of new. They may give more for an item than it is really worth. They may take items in trade that really don’t have value. It’s just another way of offering you a greater discount without calling it a discount. When you have gone as far as you can go price wise, it is then time to look for additional concessions in terms of allowances or trade-ins.