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Jason Busch Got it Wrong. I’m With the Socialsts on the Payment Issue.

June 19th, 2006 · by Tim Minahan · 6 Comments · financial value chain, supply management

There must be something in the mental ether. On Friday, I penned a post examining how supply management could add value through alternative payment management practices. I was set to post it today (under the title, “Brother Should You Spare a Dime?”) when I came across a rant from my friend and Spend Matters master Jason Busch, lambasting the European business community for raising their torches and pitchforks against recent moves by fashion retailer New Look to extend payment terms with suppliers to 75 days. Some potentially dangerous advice in his analysis prompted me to sratch my previous post and focus on addressing my concerns.

Jason rightfully states that New Look is entirely justified to extend payment terms with its suppliers. But his post, while heavy on humor and its criticism of European labor rules, misleads readers into thinking that instituting standardized, longer payment terms is good supply management practice. It is not. Instead, elongated payment terms are merely the result of two symptoms:

  1. Shortsighted and outdated buying practices that are focused on brow-beating concessions from suppliers.
  2. Inefficient and often paper-based reconciliation and payment processes that limit visibility into key transactional data (i.e., POs, invoices, receipt notices, etc.), elongate payment cycles, and create an aura of angst and distrust between buyers and suppliers.

The antidote? Leading organizations are taking an active role in emerging “financial value chain management” techniques which blend supply management practices with financial analytics. In fact, my alma mater Aberdeen Group has done some of the deepest and most consistent research into the integration of supply and financial value chains. I recommend reading: The CFO’s View of Procurement and the Invoice Reconciliation and Payment Benchmark. (Rumor has it Aberdeen will be releasing a follow up to this benchmark in the coming months.)

Leading supply management techniques in this area include improved cash management and return on invested capital (ROIC) through advanced demand management, invoice reconciliation and payment, and aggressive rebate management techniques.

Consider one of the world’s largest diverisifed manufacturer that I have had the chance to work with. They have fully automated the invoice reconciliation and payment process to gain immediate and accurate visibility into their invoice reconciliation and payment process.

But that was only step one.

Now the company is marrying that intelligence with available cash and budget information. They are using advanced analytical tools to assess whether to pay a supplier early in order to (legitimately) access the early payment discounts negotiated during the sourcing process. More importantly, they are using this analysis to determine whether to offer suppliers early payment in return for additional discounts or rebates.

The manufacturer reports that this “aggressive rebate management” approach is returning discount offers of 2% to 20% — above and beyond the original negotiated price. And suppliers relationships have improved because suppliers are prefer to work with a customer that pays its bills on time, eliminating the need for costly collections tasks and resources. Suppliers also like being empowered to decide whether they want to offer discounts in return for even speedier payment.

The fact is: cash is king. And if you know how much cash you can use and are willing to part with it, you’ll be surprised at how eager suppliers are to get ahold of it. And how they will willingly offer additional concessions in return.

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6 responses so far ↓

  • 1 Doug Hudgeon // Jun 20, 2006 at 10:58 am

    I’m happy to bolster Tim’s argument with anecdotal evidence that paying suppliers quickly provides innumerable benefits when renegotiating agreements.

  • 2 Mike O // Jun 20, 2006 at 1:45 pm

    Cash is king.
    Let’s see… in 2004 there was a report that Visa \ MasterCard charge an average of 1.55% (Amex slightly higher 2.05%). For simplicity let’s say a cash discount is 2%. Using Purchase Cards suppliers receive cash quickly but, look at what they give up in exchange for getting that cash. The annual rate for that 2% discount for 30 day term is roughly 24%. What if you were to extend out the this discount rate over an entire payment term so that on any given day the actual payment made would be based on this same 24% rate. Requiring cash for operations aside, a business owner would improve their financial position by accepting full payment at 180 days rather than accepting cash on day one. A owner could borrow money for operations at a much lower rate, not take the cash discount, and still come out ahead by waiting for a full net term (even at 75 days).

    If you really want to do suppliers a favor, set up a electronic cash settlement system where they get cash without the purchase card penalty.

    There is an alternative as an owner \ buyer if want to use “advanced analytical tools to assess whether to pay a supplier early in order to (legitimately) access the early payment discounts negotiated during the sourcing process.” and “…to determine whether to offer suppliers early payment in return for additional discounts or rebates.” (these benefits, by-the-way, are for the buyer not for the supplier). The alternative way would be to prorate payment over a longer period of time at a more favorable rate than the current “2% discount”. Upon satisfactory receipt of the service or good, the supplier could select when to be paid based on advanced analytical tools to help them determine whether they should take early payment at discount or wait to receive full payment at the end of an extended payment term. Particularly for large businesses, there are (many) banks that will offer treasury or cash management services that would provide cash balance to allow an owner company flexibility in when they pay and the same flexibility to suppliers in when they collect owed funds. There is plenty margin in all of this to provide benefit to all three parties. Choice and flexibility for both buyer and seller far outweigh any quibbling over the net term.

    Do you know of a definitive study on payment terms around the globe? The custom certainly varies by country. Many suppliers in Italy may currently work under Net 75 terms. Is this unfair? Hardly. It is the custom.

    Would a managed payment system with longer net terms benefit buyer and supplier alike? Here’s a prediction for you. As managed invoice and payment systems mature, the net term is going to increase. Suppliers will benefit by having more options about when to be paid. Buying organizations will benefit by having more options about when to pay. Treasury services will benefit by earning interest from the differences in how both parties pay.

  • 3 Sean Devine // Jun 21, 2006 at 1:32 pm

    To me, it’s all about the differences in cost of capital between the purchasing organization and its suppliers. If the purchasing organization has access to less expensive capital then its suppliers, the real opportunity lies in the leveraging SHORTER payment terms for incremental discounts.

    Leveraging the power implicit in a purchasing relationship in ways that don’t take advantage of underlying advantages (such as cost of capital differentials) will not produce long term benefits.

  • 4 Tim Minahan // Jun 21, 2006 at 5:08 pm

    I couldn’t agree more with the comments from Mike and Sean.

    Automating the invoice reconciliation and payment process provides a critical foundation for cash and rebate management. Coupling this visibility with availble cash, budget, and financial analytics enables you to assess the cost of capital and determing the best “gambler” strategy: knowing when to hold your cash. Knowing when to “fold” (i.e. offer any early pay option).

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