Have a sale to a new customer? Great! Are you making as much on it as you hope?
Why do I ask? Sometimes, there are strings attached to selling something, and those strings usually result in a lower overall profit. These sorts of strings can be described with words such as rebates, returns, allowances, etc. These are not necessarily evil, it’s a part of doing business, so long as you understand them up front, you can make sure you are making good economic decisions.
Here is a list of many ways you can get nickeled and dimed:
New product returns – We’ve probably all benefited from this as consumers, returning an item for a full refund. If your customer offers no hassle returns, how much of that cost are they bearing, and how much do they pass on to the vendor? Some companies may negotiate flat percentages, which incentivizes your customer to minimize product returns since they have some exposure. Keep in mind, there are some studies that show that companies with better return policies do better in the long run.
Defective Products – Similar to new product returns, an allowance for defective products is a type of warranty expense for faulty items. Some companies will want to receive the defective products back to understand the problems in order to address any underlying issues. This presents another cost, shipping, which needs to factored in. If a company is willing to accept a certain level of defections, then they can just allow the customer to take the deduction and throw away the product (“destroy in field’). Typically, a certain level of defections will be allowed without any return implications. I strongly suspect that there are store managers who take advantage of this clause to help manage inventory turns (I have no concrete proof, just anecdotes).
Rebates – Plain and simple, this is just a straight discount off the price. It can be a flat percentage, or a tiered system that provides for larger rebates at increased volumes. I have witnessed these rebates range from 2% to 6.5%.
Cash Discounts – Discounts are offered to customers in order to induce them to pay earlier than their stated invoice terms. If your company is struggling for cash, this can be helpful. However, if you have a revolving line of credit and can borrow on receivables, this doesn’t always help you very much. The effective interest rate offered on 2% 10 / net 30 terms is 36.7%. If you can borrow up to 85% of a receivable, getting the liquidity for the remaining 15% could require offering an interest rate in excess of 35% on the entire balance.
Markdown allowance – This is a feature that allows the seller to reduce prices on items to accelerate the sell-through and clear out inventory. While this compresses the net margin, it can be better to pay a mark down rather than having to deal with new product returns or having it become classified as defective.
Co-Op Advertising – This can be treated as a selling expense or a sales discount, but either way, it is a cost for participating in locally placed advertising. The benefit is that it allows for economies of scale in advertising by coordinating a larger selection of products to share in the promotion. Another form of this discount is an in-store service allowance. This could be related to setting up a display (i.e. endcap) or other feature in the store to showcase an item.
New Store Allowance – Stocking a new store usually requires a larger upfront purchase of goods. While this can provide a surge in volume (as a supplier), you may want to prepare for the possibility of providing a discount on that initial order.
Freight Allowance – It obviously costs money to ship products to a store, or their warehouse. Some larger companies take advantage of their resources by coordinating the freight and then charging a discount. I have seen this figure close to 9%.
Buying Group Allowance – Buying groups are organizations that represent many smaller companies in order to negotiate better pricing by providing a larger presence. In essence, it’s like an outsourced purchasing function. The allowance that is charged is a “management fee” for the buying group. Some for profit buying groups use these allowances to realize profits, while some buying groups operate as non-profits.
So, how much “damage” can all of this cause? Seeing a spread of 10% between the gross selling price and the net sales is not unheard of. Levels as high as 20% are easily possible with the inclusion of freight. Keep in mind though, that to do a fair comparison, you have to remove the cost of freight from your costs.
Another factor to be cognizant of is that these discounts can be taken at different points in time. Some may be taken at every payment, some might be quarterly, others could be annual. Some companies will request a check from the supplier in order to provide a cleaner paper trail. Other customers will simply deduct it off the invoice. This can present problems for cash flow if there are significant unused rebates or allowances that hit all at once. For instance, a 2% rebate taken once per year, can effectively wipe out one week of payments for a given customer, so if you were depending on that cash, it will create an unexpected void.