Is Dynamic Discounting Right for You?

Ilya Leybovich Jul 07, 2009

Some organizations are adopting a dynamic discounting model to revamp their accounts payable departments. But how does this plan affect the buyer-supplier relationship, and is it right for your business?

Many suppliers offer discounts for the early settlement of invoices, reducing the total amount due from a buyer by a certain percentage if the final payment is made before the agreed term is up. Most discount payment models are all-or-nothing propositions, meaning that either a company settles its account within the early payment window (e.g. within 10 days), or it must pay the full amount by term's end.

Dynamic discounting, on the other hand, extends the discount model across the full term, offering scaled discounts up to the end of the agreement date instead of relying on a payment window. This means there are incremental incentives for a buyer to pay early throughout the length of an invoice.

According to IndustryWeek, accounts payable departments process over a billion business invoices a week, with the average cost to process and pay an invoice falling between $5 and $15. Almost all (97 percent) are handled manually, and about 10 percent are processed too late to qualify for discounting terms.

"Not only do these manual processes slow down productivity across the entire organization, long cycle times mean late payment penalties and an inability to take advantage of negotiated payment discounts," IndustryWeek explains.

The difficulty of turning over invoices in time to meet an early payment window means many buyers are losing potential savings. This can have a significant effect on profits, particularly among larger companies involved in the global supply chain, as they often have high volume invoice receipts from widely dispersed sources.

A standard supplier discount rate is known as a "2 percent 10 net 30," which means the total payment is lowered by 2 percent if the invoice is paid within the first ten days of a 30-day term. Offering scaled savings across the term, such as a prorated discount between the discount due date and the net due date, increases the chances a buyer can earn a discount and the chances a supplier will receive a payment before the 30-day mark.

According to research from global management consultancy Accenture, a company can receive an average annual discount of between 0.3 percent and 1 percent of its total payments by improving the rate of early invoice return on a standard 10-day discount model. Under dynamic discounting, the savings may be even higher given the longer opportunity for a discounted return.

"The aim for many global organisations now is to reduce their working capital — the amount of money locked up in the supply chain — by ensuring customers pay on time, keeping the amount of stock at just the required levels and, most significant of all, increasing payment terms with suppliers," CPO Agenda asserts.

The trend toward expanding invoice terms changes the negotiating landscape, and by coupling dynamic discount rates with longer terms, the potential buyer savings increase dramatically.

"With the current credit crunch, many companies have already pushed their suppliers to extend to 60 and 90 days payment terms. These companies should see significantly higher discounts offered by their suppliers, and thus also significantly higher benefits," the Shared Services and Outsourcing Network notes.

Suppliers can also benefit from this arrangement. According to PayStream Advisors' Paystream Voices, "buyers who report achieving these discounts tend to pay their suppliers about 10 to 15 days before the invoice is due."

In addition, by offering dynamic discounts suppliers may also drive down their working capital, gain lower cost financing options by having faster access to cash and reduce their days' sales outstanding (DSO).

However, dynamic discounting may not be for everyone. Implementing a dynamic plan typically involves an initial capital investment in propriety software programs, as well as the integration of an automated or electronic invoice processing system to expedite payments and keep track of discount rates.

Paystream Voices recommends that buyers considering a dynamic discount plan compare the following factors before making a decision:

The average number of days it takes you to receive an invoice;

The average number of days before your company pays an invoice;

The percentage of discounts won under the existing system; and

The percentage of discounts lost under the existing system.

In some cases, implementation costs, supplier reluctance or the complexities of restructuring a buyer-supplier relationship may outweigh the potential cost-savings, especially if your company already has a satisfactory rate of return on standard invoice discounts.

Resources

Changing the Economics of Supply Management: Strategies to Transform Accounts Payable

by Deb Miller

IndustryWeek, June 8, 2009

Dynamic Discounting: Transaction Cost Savings of 50 Percent are Not Enough

by Troy Barton and Robert Hintz

Accenture, 2006

The Missing Link?

by Nick Martindale

CPO Agenda, Summer 2007

An Introduction to Dynamic Discounting

by Michael Hyltoft