Prompt Payment Policies: Are They Worth the Trouble?
Of the 111 credit professionals who responded to our survey, 59 percent worked for companies that offer prompt- payment discounts. Of those offering discounts, 55 percent said they did so because it was a market or industry standard. Discounts that evolved from a marketing decision (19 percent) or offered as a cash flow incentive (23 percent) were not nearly as common. Another reason given was to encourage pre-season ordering. Of those that offer discounts, there is generally widespread penetration into the customer base. Relatively few respondents reported that less than 30 percent of their customers take advantage of discounts offered. This fact seems to support the belief that customers find discounts an incentive. In addition, it ties into the fact that discounts are part of the culture of specific industries.
When looking at these statistics, it is worth keeping in mind that those who offer discounts may have been more likely to participate in this survey. This is balanced by the fact that a sizeable minority, representing the more than two out of five companies, that do not offer discount terms willingly participated in the survey. Based on results and anecdotal evidence provided by the survey participants, we believe there is a high correlation between discounts that are offered as a result of an industry standard and customers taking advantage of those terms.
How Much Is the Standard Discount?
We found the average discount percentage to be 3.9 percent, though the median was only 2 percent. The sporting goods industry and some segments of the retail marketplace, especially those that periodically unload demos and closeouts, were responsible for skewing the average up. The average discount for the sporting goods and retail industries was 6.7 percent, but the median remained just 2 percent. The average for wholesale was 1.7 percent; for construction it was 1.5 percent; and for manufacturing was 1.3 percent. For companies that offer a prompt payment discount to all their customers, 2 percent is clearly the standard. What About the 41 Percent Who Don't Offer Discounts?
Of those who do not offer discounts, there were some strong feelings about their effectiveness: "We used to offer discounts. However, we found that 90 percent of our customer base was not paying on time and taking discounts. We discovered that much effort was being made toward this discount program for minimum results. We evaluated what our customer's needs and wants were via a yearly survey and the bottom line is our customers want competitive pricing ... and outstanding customer service. "The extra one percent or two percent for paying early was not missed when we ended the program several years ago. What is important is that we have added programs that allow us to be competitive in the marketplace and ensure that our customers are happy and satisfied with the products and services we offer." -Shawn Dunsirn, Credit Manager, Pinnacle Distribution Concepts, Scottsdale, AZ
"Too many times they take their discount outside the discount terms and [it] requires more administration to collect the small shortages than it may to collect it net." -Tom Mazzarese, CCA, Global Partners, Earth City, MO. "Senior Management has offered discounts to a few large customers in an effort to get them to pay better. The accounts that paid well to begin with still pay well. The accounts that were problematic remain problematic and take the discount even though it's not earned. Then they won't pay back the unearned discounts. In my humble opinion, [discount terms] reduce our profit and waste valuable time." Despite these sorts of objections, the fact remains that a clear majority, though not an overwhelming one, of credit pros still view discounts in a favorable light.
The Problem of Unearned Discounts
Whether or not you think discounts are effective, there is no disputing that unearned discounts pose a problem. The key to dealing with them effectively is being able to identify and track unearned discounts as they occur. Clearly, the most popular methods for doing this are to label them with an A/R Code (51 percent) or create a Chargeback to the customer (31 percent). Another 12 percent create collection or deduction codes (presumably in a collection or deduction management software product) and an equal number use spreadsheets, that do provide visibility, but which can require significant administrative efforts to keep up-to-date, compared to more automated solutions. Tickler files, which also require manual upkeep, were used by 10 percent of those surveyed. It should be noted that some respondents use multiple methods, hence the percentages adding up to more than 100. In clear opposition to accepted best practices, 15 percent do little or nothing to identify unearned discounts. We found 12 percent simply leave unearned discounts on the A/R as an open, partial balance. Another 3 percent admitted to not tracking unearned discounts. The purpose of being able to identify and track unearned discounts is to facilitate recovery efforts. Most credit departments do the collections themselves (95 percent), but a large segment also turn to sales or customer service for help (37 percent).
Other popular protocols include holding future orders (27 percent) and revoking discount terms for those that abuse the privilege (20 percent). The efficacy of holding future orders would undoubtedly be debated strongly. Rounding things out, the use of an outside recovery service or a policy of not trying to collect unearned discounts was reported by 3 percent each.|image7| Final Observations
For good or bad, prompt payment discounts are often an integral part of the sales equation. When standard industry practices involve discount terms, making any policy changes are especially difficult, even if you can prove that discounts are not worth as much as they cost. Then again, there are clearly specific instances where discount terms can be effective. In the final analysis, discount programs need to be evaluated closely to determine the actual cash-flow benefits they deliver, and that needs to be matched against the costs of recovering unearned discounts.
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