Money makes more money. Dynamic Discounting is one thing that can make this statement come true.
The concept of Dynamic Discounting has been around for eons. In marketing terms, it is nothing but the early bird discounts. Instead of selling something, Dynamic Discounting deals with companies offering to pay their vendors earlier than what the payment terms permit in exchange for discount. If it is early bird discounts, why call it ‘Dynamic’ then?
Dynamic discounting can be interpreted as an asynchronous reverse auction of sorts where vendors may or may not know what the other party is bidding. Unlike a simple auction where vendors are bidding for a defined requirement, dynamic discounting involves multiple attributes which differ for each participating vendor including amount owed to them, spread between original payment due date and auction date, original payment terms, mode of credit – is it a discount our a credit towards future purchases, what is the total and quantum of business with the vendor among other things.
Also, the process relies less on willingness and capability of the buyers and sellers, and more on the Accounts Payables of the buying organization and Accounts Receivables of the selling organization.
Interest rates in US, Japan and Europe settling down in the neighborhood of zero (or negative ROI if you include the cost of banking operations), A/P teams are considering early payment incentives more than ever. With the economy picking up pace steadily, the need for money to flow faster through the supply chain increases as well – and so does the appetite of Accounts Receivable teams to consider extending a greater discount if one of their customers is willing to pay immediately.
With A/P and A/R teams of the respective companies in sync, there are aspects that Sourcing teams can influence while negotiating their contracts with the vendors. The trick lies in the Payment Terms.
The most common payment term used worldwide is Net 30. Among anticipation discount payment terms, it is 1% 10 Net 30, i.e. buying organizations receive a 1% discount by paying within 10 days of receiving the invoice.
From a vendor’s perspective, they have already committed a 1% discount for early payment. It will depend on their position during an auction if they can provide more discounts, however the greater the gap between the auction and the first milestone for early payment, the better prospects of receiving higher discount. Also, if the auction was to be done after the early payment window is passed, vendor might not be inclined to extend a discount more than what is on the payment terms.
If the vendor agrees to be part of the dynamic discounting program, it is better to ask for the early payment incentive to be more attractive in terms of returns in lieu of an even earlier payment e.g.: 3% 7 Net 30.
Payment Terms itself:
Date defined payment terms, also called Prox (from proximo mense or next month in Latin) have been around a long time but never caught up due to the reluctance of vendors to agree to it. Prox terms mention a date or day of the next month when the payment will be processed. Where the invoice received date defines when the count down for payment starts on normal terms, the last day of current month acts as the countdown trigger in Prox terms. Payment Terms in this case is essentially a range and depends on when the invoice is received.
To illustrate “First Friday of the month following the month in which invoice was received”, all invoices received during the month of Oct 2014 will be paid on Dec 5, 2014.
This allows companies to develop a payment schedule of once a week or fortnight or month. The schedule allows for all payments to be accumulated to a certain date. Following on the example above, if an auction is to be conducted on Nov 1, the date spread is eliminated as an attribute affecting outcome.
Quantum of Business:
Vendors who receive a flurry of orders, make continuous deliveries and send invoices to one AP processing center can be encouraged to take part in the dynamic discounting process a lot more than those who receive orders sporadically – unless the value of such purchases is significantly high. The potential for participation cuts across categories, as long as the value of purchase and potential early payment is high enough to make the vendor AR team eager to receive the money early.
Quarter and year end closing – when most sales teams are trying to sell as much as they can, sign as many deals as they can, and get as much revenue in within that period, is the best time to run auction events.
But be wary of the following pitfalls:
It is not advisable to make project milestone related payments early, particularly if there is only one or two SOWs active with a vendor.
A hodge podge combination of Procure to Pay systems can lead to poor data accuracy, accessibility and completeness which defeats any discount driven savings program.
If the time taken from the point an invoice is received to it is fully approved for payment is long, then the spread between due date and auction date is significantly reduced and might not generate much eagerness within vendors to extend discounts.
Countries where credit rating systems exist, dynamic discounting checks the buying organization’s credit rating and not the supplier’s. So if a commitment is missed, there is a potential risk to the company’s credit rating.
If one is careful of the potential pitfalls, dynamic discounting has a great potential to affect the bottom line, this time by the AP team. Sourcing and Procurement teams are still the catalysts and need to encourage vendors to sign-up for dynamic discounting process.