Treasury Today Country Profiles in association with Citi

Discounting for the 21st century

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A number of misconceptions exist around dynamic discounting. Here, we aim to dispel these myths and get to the heart of why dynamic discounting can be beneficial for both buyers and suppliers.

Seven years on from the global financial crisis and the famed ‘fortress balance sheet’ of the corporate big boys still exists. In early 2014, a Deloitte study reported that a third of the world’s largest non-financial companies are sitting on a $2.8trn gross cash pile. But change is in the air and these corporate heavyweights are slowly beginning to soften, seeking a return on their cash buffer.

With the current low, zero and even negative interest rate environment making that task all the more challenging though, treasurers have to evaluate innovative methods to put their excess cash to work. Introducing a dynamic discounting scheme may be one such way that a corporate can look to achieve this, effectively leveraging their own balance sheet to generate additional purchasing discounts. Such a set-up also has the added bonus of providing suppliers with an earlier injection of cash and improving their working capital metrics.

But what exactly is dynamic discounting and how does it work?

Understanding the premise

Dynamic discounting is a simple concept – the supplier offers a discount for an early payment and the earlier the payment the greater the discount. It is also by no means a new concept as John Keating, European Managing Director at Taulia explains: “The principle of offering a discount in return for an early payment has existed for a long time. The issue is that these schemes traditionally have been static.” For example, the 2/10 net 30 – a commonly used discount in the US – can be negotiated into a contract and offer the buyer the opportunity to pay a supplier on day ten, instead of day 30 and in turn receive a 2% discount. Yet this is not necessarily a great deal for suppliers: “because the discount is fixed within the terms of the contract, suppliers often feel that they have no control over it,” adds Keating. “Because of this they are often not keen to sign up to such an agreement unless there is a desperate need for the cash.”

Aside from the lack of control, the deal was often unfavourable to suppliers financially. “If a supplier is being paid on day ten and giving a 2% discount then they are essentially borrowing at 36% APR,” says Chris Dark, President International at C2FO. “Most suppliers, even today, will be able to borrow from a traditional lender for less than this.” While some corporate buyers tried to sweeten the deal and pay even earlier for a slightly larger discount, the APR remained at 24% and “eventually this just gets pushed into the cost of goods,” he adds.

Dynamic discounting is therefore the next step in the evolution of discounting and addresses some of the issues with the traditional model. Flexibility is key, in most cases the solution (generally speaking) allows buyers to choose an APR and offer this to their suppliers on a sliding scale based on how early they are paid. The APR can therefore fluctuate and is not tied to 24% like traditional models. Buyers have control because they are able to segment their suppliers based on a number of metrics and decide who should be offered what discount. Suppliers on the other hand also have an element of control because they are able to decide on a case-by-case business if the deal offered suits their needs. As Drew Hofler, Senior Director, Solutions Marketing at Ariba puts it: “a dynamic discounting solution is like an ATM for SMEs.”

It is worth noting that not all dynamic discounting solutions are the same. C2FO for example gives the suppliers the power to name their rates, not the buyer. “The supplier can change this daily to meet their ever changing cash needs,” says Dark. “In doing so we have created a marketplace that ebbs and flows constantly and the aim is not to charge high APRs and only have a small amount of players participate but have more players participate and charge less.”

Drivers of the solution

Despite the obvious benefits, dynamic discounting cannot yet be seen as a mainstream solution, as C2FO’s Dark comments “there is a lot of noise, but still only a small number of companies have a large dynamic discounting solution.” But it is a solution that is gaining traction, not just because of economic necessity from businesses, but also because of advancements in and the rise of automation.

“To make dynamic discounting worthwhile there needs to be a convergence of opportunity and capability,” says Ariba’s Hofler. Firstly, let’s look at the opportunity. To make dynamic discounting work there has to be an opportunity for an early payment. “If it takes 30 days to clear an invoice then there will be no room for early payment,” he adds. “This means that best practice has to be introduced to the invoicing process, it needs to be automated, cleaned up and exceptions will need to be eliminated.” To do this, some companies have turned to e-invoicing solutions, and while these are not a necessity to ensure dynamic discounting works, it certainly helps in making sure invoices are approved as soon as possible.

The capability driver comes from making the solution automated and integrated. “Buyers don’t want to go through and make manual offers to thousands of suppliers, they want to set the parameters of what makes a good offer and then automate these to be sent to suppliers as soon as the invoice is approved,” says Hofler. “Suppliers then should be able to log-in to the portal and select if they want to take the offer or not, based on their current needs.”

There is also a political driver that has become more visible over the past few years. A number of governments have now introduced initiatives that seek to encourage buyers to pay their suppliers early – or in the case of the UK’s Prompt Payment Code to pay them on time. The most prominent of these initiatives is perhaps ‘Supplier Pay’ in the US, a programme mandated by the Obama administration that seeks to strengthen small businesses by increasing their working capital, so they can grow their businesses and benefit the economy by hiring more workers. Corporate heavyweights such as Apple, AT&T, Coca Cola, IBM and Lockheed Martin have all pledged their support.

However the role that government has to play in encouraging such behaviour is contested. “Nobody argues that there is a big need for suppliers to receive more financing,” says C2FO’s Dark. “The debate stems from who should be solving this problem; while governments may launch these initiatives that pressure companies to pay early, they are unlikely to legislate on payment terms.” And when they do, as was the case with the EU who tried to legislate 60 day payment terms, there are often loopholes. “It therefore is corporates and their treasury teams that have a key role to play in pushing the solution, not governments,” adds Dark.

The business case

Of course, as is the case for any solution, there needs to be a business case for corporate adaption to occur. With dynamic discounting the main benefit for buyers is clear: paying early and receiving a discount is a way risk-free way to earn a return on cash that cannot be found elsewhere in the current low interest rate environment. In fact, this can be a considerable amount, Taulia estimates that dynamic discounting generates returns 50 times that of money market funds (MMFs) or T-bonds.

But there are other benefits for buyers that can supplement this. The implementation of a dynamic discounting solution can offer the treasury a chance to revaluate its entire working capital strategy and move away from post-crisis thinking. “If used correctly it also can be used as a way to fund large initiatives such as bringing all suppliers onto a P2P network,” says Ariba’s Hofler. “One of our clients, for example, funded their entire P2P solution suite from the gains made from dynamic discounting.”

There are also reputational benefits that large corporate buyers can gain from supporting their supply chain. With the political pressure and negative press around how corporates have acted in respect to paying their suppliers later and later, adopting such a solution can go some way to reverse the perception that large corporates are ‘bullies’. Also, by adopting the solution corporates can help to ensure the security of their key suppliers.

For sellers, the fundamental business case is also clear, access to cash when needed. But again there are other benefits. “Certainty and control are two things that all business crave around cash flow,” adds Hofler. “Suppliers are no different and the ability to have the control to access cash and the visibility over when this will arrive is invaluable when it comes to forecasting.”

Barriers to adoption

As previously mentioned, dynamic discounting is by no means a mainstream solution and there have been and, in some cases, remain barriers to adoption. One friction point in particular, and one that still many corporates struggle to see past, is the impact of paying a supplier early on important working capital metrics such as days payables outstanding (DPO) and the overall cash conversion cycle (CCC). “These are still important metrics for many corporates,” says C2FO’s Dark, “and it goes back to the crisis. The issue is that in many cases the board will have asked the treasury and finance department to improve these metrics, so in the past when we have come in with our solution some treasurers have balked because it touches these metrics. This is changing however as corporates are beginning to understand how dynamic discounting can be extremely flexible in helping to manage these metrics, in addition to adding to profitability.”

“Certainty and control are two things that all businesses crave around cash flow. Suppliers are no different and the ability to have the control to access cash and the visibility over when this will arrive is invaluable when it comes to forecasting.”

Drew Hofler, Senior Director, Solutions Marketing, Ariba

There are ways that a corporate can implement a dynamic discounting solution without touching its DPO, he explains. “We offer an enhanced discounting solution,” says Taulia’s Keating, “this provides the corporate with third-party cash (from institutional investors such as banks, pension funds and hedge funds) that can be used to make the early payment. This is an extension of traditional supply chain finance (SFC) and means that corporates’ DPO metrics are not impacted.”

Ariba’s Hofler approaches this debate from a different angle, however, and argues that – contrary to popular belief – a dynamic discounting solution can actually improve a corporate’s working capital metrics, including DPO. “I have had the conversation around working capital metrics with lots of corporates over the years and there is a recurring pattern,” he says. “They will often have hundreds of different payment terms with their suppliers. Some of these will be short and others long. But armed with dynamic discounting, treasurers have the opportunity in many cases to extend their payment terms with all their suppliers, based on the fact that they can use dynamic discounting should they have an issue with cash flow,” he says. “So if payment terms are extended to 45 days with 75% of suppliers and 25% accept early payment, 50% will still be on 45 days, so what we normally see is that corporates are able to increase their DPO by four to six days net.”

Working capital metrics, however, are not the only hurdle. There may also be a challenge on-boarding suppliers to a dynamic discounting programme, especially those who have had issues with static discounting in the past. Also, if the relationship at the supplier is with the sales department, it is likely that the contact will not be motivated by cash flows, but by price. Treasury will therefore need to find a counterpart at the supplier who speaks the same language in order to really ‘sell’ the solution to them.

Also, there can be tax and accounting issues based around VAT. Nevertheless, dynamic discounting vendors generally recognise this and have teamed up with tax specialists to provide assistance, or in some cases have worked with the tax authorities to streamline the process for corporate clients.

A dynamic future

Dynamic discounting, just as its name suggests is a solution that is constantly developing, with a number of providers approaching it in slightly different ways. So what does the future hold for the solution?

Taulia’s Keating expects its popularity to increase as businesses’ attitudes change and more corporates adopt the solution. “With critical mass it has the potential to revolutionise the early payments space,” he says. “What will get us there is education. The level of familiarity with the solution is lower in Europe compared to the US and this needs to change.” Keating also highlights dynamic discounting solution providers are only just beginning to harness the data that created with the solution. “There is huge potential for this moving forward to impact profoundly how corporates approach relationships with their suppliers and allow them to make smart and informed business decisions.”

Similarly to Keating, Ariba’s Hofler also expects the solution to grow in popularity. However, he expects it to be just one cog in a large revolution around payables. “There currently are lots of discrete solutions that are used in the payments process,” he says. “And this has been fine for a number of years, but as business are becoming more intimately networked many organisations are seeing the benefits of marry all of these on a network. We are working to get invoicing, tied with discount and third party financing and then tying this with the execution of the payment so everything is automated, seamless and all the data is rich and fully visible to all parties involved.”

“There is huge potential for this moving forward to impact profoundly how corporates approach relationships with their suppliers and allow them to make smart and informed business decisions.”

John Keating, European Managing Director, Taulia

While again, unsurprising, thinking the dynamic discounting market will grow, C2FO’s Dark believes that it has the potential to develop into a vibrant marketplace, similar to the stock market. “Working capital should be a very tradable commodity,” he says. “It should be able to be securitised just like many other financial assets.” Also, Dark believes that smaller suppliers can offer the solution to their suppliers. “If the solution becomes ubiquitous then this will have a profound impact, and cash will flow down supply chains in seconds rather than the few years it currently takes. This could add trillions of dollars to global GDP.”

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