A common scenario. The Customer demands a better price in a market with decreasing prices, and the supplier agrees by offering additional 3% discount through a payment term; Current 30 days net term will be changed to a term with two options: 8 days with -3% price discount or 30 days net.
Is this a good deal for the buyer? It seems so, but a couple of counter-arguments to think otherwise.
Argument 1: Experienced salespeople can price in the cash discount
Commercial contracts typically have many elements that are negotiated between the buyer and the supplier. Experienced salespeople give something to their customer and require something back, during this years’ negotiation, or at a later stage. In this case, prices are decreasing in the market, so the buyer has valid argumentation to require price decreases from the supplier. The supplier knows this, and she accepts the discounts (that she might have to accept in any case), as an exchange for a better payment term for her company.
Argument 2: Cash discount terms do not make sense financially
The net term and the discounted term are almost never true alternatives using common sense. What does 8 days with -3% price discount or 30 days net mean in practice? One has an option to pay in 8 days or borrow money for an additional 22 days with an annual interest rate of 50%. So, the only apparent reasons for the supplier to grant you a discount this big is that the supplier is in financial distress or, as discussed above, the supplier can price the discount in.
Argument 3: Cash discount effectively ties the buyers’ hands in negotiations and payment process
Having agreed to a payment term with cash discount, the buyer is in a very difficult position to negotiate extensions to the payment term. If the buyer opens discussion considering the term, the supplier immediately directs the discussion to the discount.
Also, the buyer organization’s payment process suffers. An efficient way to manage payments is many times with just one weekly payment round. However, if you want to make cash discount payments just in time, you must arrange those payments daily.
In an earlier working capital optimization project, our European customer aggressively approached suppliers to extend net terms and improve product net prices. Their approach involved systematic negotiation and tendering that was carefully prepared through financial analysis, benchmarks and story creation. As an example, best contracts included 7% net price discounts and 120 days payment terms. Apart from careful preparations, the key success factor was a complete focus on the business partnership, not only negotiating prices or payment terms in isolation.
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Mikko Myllys is Capacent's sales and marketing director in Finland. Mikko holds over 15 years of experience in working capital management, management consulting and change consulting from various industries.