Wednesday, November 16, 2011

Step pricing versus bill-backs

Every buyer wants to get the price for a quantity of 100,000 units without making a firm commitment to purchase that quantity. Suppliers that are use to dealing with this will usually counter with a proposal of either step pricing or discounted pricing with bill-backs if quantities are not met.

The concept of step pricing is simple.
The first X units are at _______________
The next X units are at _______________
The following are at _______________
Etc, etc, etc.

Under a bill-back approach the price would be provided at the highest quantity, but is you failed to purchase the entire quantity that the price was based upon, you would be obligated to pay the difference between the price you received and the price that you would have actually earned based upon your actual quantity purchased.

The major advantage of step pricing is there are no bill-backs if you fail to purchase the quantity. You earn the reduced price based upon the quantity of purchases that you have made. The major advantage of the bill-back approach is you get the low price throughout. A second advantage of the bill-back is you have the use of the that money difference in payments until you have to pay the bill-back amount. The major disadvantage is that if you fail to purchase the quantity, while you are not obligated to purchase the remaining quantity you are subject to the bill-back on the difference between the price you actually paid versus what you would have at that quantity.

Both approaches are good in that they are not making firm commitments to purchase the high quantity. The major issue you should be concerned about in negotiating a deal with step pricing or bill-backs is the cash flow and the time value of money. With step pricing scenarios you pay the supplier at a higher rate earlier so in the interim they have the use of the money. With the bill-back approach you have the use of the difference in the amount until you have to make a bill-back payment. Suppliers who are aware of this impact will usually structure the prices as specific
volumes differently depending upon whether its a step price or a bill-back approach. The prices for step pricing would usually be lower than the bill-back prices at the volumes as the supplier is having the use of the money in the interim period.

If you have a supplier propose either method calculate what your unit costs would be at various levels to determine which is the best approach to follow. If you agree to use the bill-back approach you need to be prepared to have to pay the bill-back if you do not meet the required quantities, One way to do that would be to work with your accounting people to establish a reserve where you pay the supplier the estimated quantity price and sell transfer the product to the internal customer at a higher price with the difference being placed in a reserve. If you don’t meet the needed quantity you pay the bill-back out of the reserve, if you do meet the needed quantity the reserve can be paid to the internal customer to reduce their cost.

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1 comment:

  1. Clear down-to-earth explanation. Keep up the good work.