By Kevin Meyer
Anyone that has been in business, especially running a business, for two or three decades has noticed patterns that aid their decisions. Nothing earth-shattering there – it's called experience. And if we're smart it's why we hire people with a couple decades of experience to run companies – or countries for that matter.
Two such patterns have become ingrained in my psyche when I come across new customers. The predictive pattern has a nearly 100% correlation. What are they?
- The partnership aspect of a relationship will be inversely proportional to the payment terms.
- The maintenance level of a relationship will be inversely proportional to the requested automatic annual price reductions – targets or fixed.
Net 30 terms are fairly reasonable and I use that as the "zero" point. It does take some time for a typical customer to receive incoming components, inspect them (yes, traditional, not optimal), and release payment. Waiting 30 days has minimal impact on my cash position and can be easily planned for and accommodated.
If a customer offers to pay at less than 30 days I know I have a customer that sees value in our relationship, and believes our financial stability is important. I should qualify that – I don't mean less than 30 days terms with a discount. In those cases they're just trying to sneak in a price reduction. If receiving cash fifteen days early is worth 2 or 3%, then I've got other issues.
Unfortunately companies that offer to pay full value at less than 30 days are a rarity. In most cases traditional supply chain and financial management promotes the concept that terms should be stretched. Far more often I receive requests for Net 45 or Net 60. Last week I even received one from a Fortune 10 company for Net 120. That company, previously known as a six sigma powerhouse, has recently been lauded for leveraging lean to move a bunch of appliance manufacturing back to the United States. Apparently the respect for people side of lean, which in my book includes suppliers, doesn't run deep in that company.
Those requests for longer terms come in spurts, which I roughly correlate to when there are purchasing-related conferences. Luckily my company is in a strong position from competitive and technology perspectives, so I have some leverage of my own.
Upon receipt of such a request for greater than Net 30 terms we send a letter from me indicating that we use our cash to improve processes, we look for partnerships and our real partners are actually shortening terms, and we feel it isn't in the spirit of partnership for a much larger company to effectively ask a small company for a loan. Terms will be Net 30, or else the order will not be accepted. That usually does the trick.
In some cases, such as the Net 120 situation above, the larger company still tries the abusive approach. If they continue to push the issue I have a second letter that asks them if their desire for longer terms is an indicator of financial problems on their end, and perhaps we should be concerned enough about that to request cash in advance. I used to have a statement in the letter asking if the purchasing agent would accept a paycheck 60 or 90 (or 120?) days after the work period, but I know payment terms are generally directed to the poor purchasing agents from way on high.
The kicker with those extended terms is that the customer is setting themselves up for ongoing financial tension. Just like paying your January mortgate payment in December will help taxes – it helps one time. If you don't do that for each of the following years, you reverse. Dell is discovering that with it's well-known inverse cash flow cycle – receiving cash from consumers prior to having to pay for parts for the products. A great cash generator during growth – but it reverses direction during contraction. In effect, a suckers bet.
It can be a fun game, although I obviously do have to be careful to not get too comfortable with my competitive advantage. We're not, and we work on increasing our value to our customers every day. But the bottom line is that I can predict how a relationship will be developed by the terms that are requested and ultimately agreed to.
If the customer offers to pay at less than 30 days with no discounts, it is going to be very valuable. If the company demands 45, 60, or even 120 day terms, it is going to be an increasingly difficult and adversarial relatiionship.
Just because a potential customer is big doesn't mean it's a valuable customer. Just ask all the poor folks that salivated over selling to Walmart and learn a painful lesson. Volume does not automatically equate to success.
A similar situation exists with the automatic price decreases that many customers demand. Usually they start off with around 5% per year, with no qualification or adjustment for uncontrollable changes in raw material prices, specification changes, and the like. Believe it or not, most suppliers swallow and accept such nonsense, again out of lust for the big company customer. Some will first negotiate to try to even the playing ground a bit – the ability to roll through raw material increases at least at cost, triggers to review pricing if specifications change, and the like. That helps a lot.
But you know what really changes the game? Offering to target even greater cost reduction, if (and it's a hugely important "if") a defined project matrix is created that defines the projects and the very specific contributions by both parties. An attempt to create partnership.
As soon as you document what the customer also has to bring to the price and cost reduction project, such as analysis of changes and performance from improved processes, the responsibility shifts. And we all know how frustrating it is to get customers to play a role in projects – and how they still demand the results that are impossible without their role. Document it, and define in supply agreements that price changes must be tied to specific projects, and those specific projects will define the roles of each party.
If the customer demands x% price reductions per year, period, it's going to be adversarial. If the customer agrees to terms that specify projects and contributions, it can work out well. If the customer doesn't even talk price but instead talks quality and final customer value… jump on and hang on.
So if you are a supplier, or a customer, think about the predictive value of payment terms and automatic price decreases. What is that saying about your relationship? Is it what you want?