I do not like rebates much. If at all. Having seen the rebate system being so popular among businesses, I started doubting myself. What if it is only me? What if I do not understand something?
I have shortly looked into quite a few articles on this subject. Outcome Number 1: googling “procurement rebates advantages” (or any similar wording) give you no straightforward benefits of having it.
So what are the occasions, when businesses use rebates? Outcome Number 2:
- if the quantity to be purchased is not known.
- if you want to fund purchasing activity – whatever it is: GPO, “non-profit” organization, department – you name it.
How well do you know your company? Is it possible, that your forecast can go so terribly wrong? If it is me negotiating the price, I want best price available at that moment. If the product has to be produced – most of the times it will be cost plus margin pricing model. You can analyse the costs, might define the margin and try to influence them. I do understand price differences due to production run size, production planning flexibility (while everything else stays the same). And here is my question Number 1: can you then please show me a supplier, who will plan a single production run to satisfy your annual quantities? Thought so. That means – volume based rebates loose their sense. Yes, it is important to understand, what makes the deal attractive to the supplier. Time commitments, quantity commitments – but I am talking more about insurance from losses to the suppliers.
Sample. A deal of estimated 3000 t of plastic packaging is on the table. Supplier suggests a price with 3% rebate if 3000 t is reached.
Scenario 1: Buyer accepts the offer and signs the deal. The year finishes with a balance of 2900 t. Will the Buyer order additional (not needed at that time) 100 t of packaging just to get the rebate? Will he decide to loose the rebate? Both cases – the loss is biggest to the buying organization. Keep in mind, that, additionally, Supplier was using those 3% of Buying organization’s money as his financial asset.
Scenario 2: Buyer asks, WHY is it 3% and HOW will Supplier be able to give that rebate. Supplier explains, that he would need X tons of main raw material and that they would fix prices now for that quantity, because they are expecting price increase. So, if they get Buyer’s commitment to buy all the quantity, they would eliminate the risk of overstocking and would be able to offer a rebate. Buyer then suggests to commit to buy all the quantity, even if it means the contract lasting 13 or 14 months instead of 12, but in return would ask for 3% discount from the very start. Supplier agrees with these conditions and the deal is signed. The year ends with 2900 t being sold. Buyer maintains commitments and finishes buying the quantity in another 6 weeks. No inventory overstocking, no financial loss, no false commitments.
Now the “funding” question. It gets a bit tricky here. It is a question of perception. Why would you refuse to pay for service, that you believe, brings value? Especially, if the price is transparent and fixed? Many times people choose to opt for “free services”. Guess what – there are no free things in business world. Well, fine, almost. It is up to you to choose if you want to know how much you are paying, or would like to convince yourself it is “free”.
Here is a sample. Take any of GPO companies. “Non-profit” GPO companies. They have a limited number of people working to get best deals for their members. They have limited number of categories with limited number of suppliers. They have a budget, that covers their business costs. They are funded by supplier rebates. Let’s say, the rebates for the purchases of the first 50 companies, that signed up for the deals, bring them to break-even point. Additional companies, signing up for the deals, do not bring any additional costs. But surely, they bring profit. Question Number 2: where does that profitable “non-profit” go?
So much for “benefits” and use of rebates. I managed to find, however, negative parts of it:
- There’s always a risk that the rebates won’t be paid or remembered.
- There’s a risk that the price will be inflated in order to cover a rebate to be paid later.
- There is the time value of money. The supplier is using the rebate amount as their own money for a year. Should that not have it’s own interest rate, payable to the Buyer?
- If the rebates are not distributed to the end users’ cost centres, it can cause friction internally.
- It encourages wrong behaviour from Buying side – they might end up with overstocking inventory in order not to loose the rebate.
- It creates commitments to a supplier. Rebates are a tool to influence your future buying decisions. How restricted do you want to be?
Procurement Heads published an article about John Lewis. Speaking to The Daily Telegraph, The Forum of Private Business, called demand for rebates “pocket picking“. TESCO’s (and other giants’) behaviour is called “bullying”. Why is it still so popular?