Why payment terms still count in the electronic age
James Morgan -- Purchasing, 4/1/2004 2:00:00 AM
Buyers should not forget all they know about payment terms just because the principles seem outdated in today's fast-paced electronic age and don't seem to fit some current views of strategic purchasing. In fact, as purchasing professionals look for more ways to reduce cost of materials, payment terms are getting a hard look once again. Some buyers and suppliers have been looking at transaction payment terms and conditions for more than two years as part of their overall cost reduction strategies.
A 2002 PURCHASING survey indicated that transaction payment terms seemed to be making a broad comeback. A follow up survey this year finds that interest in terms and conditions is still a hot topic for many buyers. In fact, more than 79% of those surveyed in this year's poll of purchasing executives say they have experienced changes in terms of payment over the past year. More important, almost half of those polled say the volume of payment term changes also is up.
Cash flow draws brass
Many buyers indicate that terms of credit have become a hot topic among corporate executive managers. As one pharmaceuticals industry buyer phrases it, the whole topic has taken on "a certain cachet among senior management." He says many corporations and their executive managers see this new attention to how quickly goods are paid for and shipped as a direct outgrowth of corporate concerns about flagging profitability. "With sales volumes struggling, it often is difficult to trim costs using traditional marketplace approaches," he says.
At a corporate business plan level, cash flow (loosely defined as the sum of retained earnings and depreciation) has become a major driver in the search for economic advantage via judicious use of payment terms. And as many senior executives continue to report weak or spotty sales volumes, they are finding themselves more attracted to tactical approaches (such as changing terms of payment) to moderate cost pressures.
From a longer-term perspective, where executive managers in the 1990s often seemed to center their attention on sales volume, today much greater attention is being placed on operating costs. Even operating costs associated with e-procurement targets are often playing second fiddle to payment terms. Among procurement managers recently polled by PURCHASING, there is a perceptible shift in attention from the strategic to the tactical. Even negotiation, which of-ten was held in low esteem in the late 1990s, appears to be back in vogue, especially where the negotiation is about payment terms.
What terms?
What do purchasing executives mean when they call for improved payment terms? Most changes in payment terms negotiated over the past year appear to fall into one or more of the following general categories:
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Discounts for cash. More buyers than ever are pressing for cash discounts for prompt payment. Often their demands are matched by supplier demands for strict enforcement of late payment penalties. As a result of such tough payment negotiations, many suppliers have been pushing for strict construction of the meaning of net 30 (payment in 30 days—not 35—not approximately 30).
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Closer enforcement of due dates. Typically, invoices are payable net 30 (within 30 days of the payment date on the invoice) but there has been a new focus lately on extending net due dates. Another important change in this area involves firms paying bills twice a month (often on the 10th and 25th of the month).
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Enforcement of cash and net due penalties. There have been many changes in both directions, but probably more instances of stretched payment terms favoring buyers. In recent months, there has been some significant stretching of payment due dates—to 60, 90, even 120 days (especially among capital goods producers). In some cases, suppliers are requiring prepayment and others are refusing to accept purchase orders from companies with dubious payment histories.
Different approaches
This year, the most vigorous payment terms negotiations from the buying side seem to be focused on three factors: credit for fast payment of bills, extended due dates on payment terms, and reductions in penalties for late payment. But payment terms mean different things to different buyers. For example, Ben Woods, materials/purchasing manager at Diab Inc. in Desoto Texas, says his department focuses on "best overall savings" when considering rebates. The terms of rebates, according to Woods, can and do change under negotiation "from outright rebates to no rebates at all, but a lower base price." Woods also has negotiated electronic payments with net 10 or 15 days, and an extended payment plan of 30-45 days. He makes the point that value or "best overall savings" is often a mix of price and terms.
Edward Lopez, senior buyer at ITT Goulds Pumps operation in Auburn, N.Y., is mainly driven by an emphasis on improving cash flow. "Currently," he says, "we have 45 days/end of month terms," which means unless suppliers offer special payment discount terms, they fall into ITT Goulds (standard) terms—45 days/end of month.
On the other hand, Tom Haring, director of materials at Diemasters, Elk Grove Village, Ill., says the firm's customers have extended their terms. "We, in turn, are passing these same terms down to our suppliers—so the negative impact to cash flow is minimized," Haring says. He also makes the point that payment terms have become a standard component of most of his supplier negotiations. As a result, he says, if further price reductions are not an option, payment terms are targeted as one more area for negotiating value and reducing overall cost.
John O'Brien, purchasing manager at Spencer Turbine in Windsor, Conn., often approaches payment terms from a different perspective. As a buyer of high-tag capital equipment, he's often faced with situations where contractors drag out payments—especially in periods of weak sales. To address this problem, purchasing may renegotiate some agreements with suppliers of some big ticket items (over $50,000) to net 90 days, for example. "That's up from the standard net. Current terms for most purchases are net 45. We do, of course, take advantage of 2%, 10 days cash discount terms."
A fair number of companies are in a position similar to that of Gary Wagner, purchasing manager at TestPro Inc., in Huntsville, Ala., where net 50 is the industry standard, assuming the customer has good credit. "With cash flow problems all around, some suppliers are still pressing for net 30 or even net 10," Wagner says.
Steve Kildow, vice president of materials at Universal Electronics, a contract electronic manufacturing and design firm, is close to fatalistic about payment terms. He says that for the next few months he expects suppliers to demand 50 net terms, about 25% above normal. "All things being equal," says Kildow, "we'll have to buy from the extended payment supplier," or face losing business.
Many buyers, of course, are profiting by shorter payment terms and improved cash flows. If they have the cash available, they often can turn in respectable cost reductions. Take the situation that purchasing manager Dan Amort at Weyerhauser's Portland, Ore., plant faces. By having access to a good cash flow, he has the ability to leverage a number of attractive cash discounts into significant cost reductions.
Tim Gentry, manufacturing/logistics manager, at Technical Support Inc., also sees current cash flow problems in the market as opportunities. "More options are available," he says. "For instance, we pay early and get good discounts and higher credit limits are also made available to us."
Perhaps the place of payment terms in the world of industrial buying is best summed up by Bruce Warkentien, director of corporate purchasing for the Smyth Companies in St. Paul, Minn. As he sees it, payment terms should be treated like dollars. "A 2% discount for payment in 10 days needs to be honored," on both sides of the desk.
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