Do Early-Pay Discounts Deliver the Value They Are Costing You?

Let me be direct: Early-pay discounts are costing you money. Whenever I make that comment at a conference or even just in a one-to-one conversation with a dealer, I typically get one of three reactions:

  1. You don’t know what you are talking about.    
  2. What do you mean?
  3. I know, but I can’t take them away.

Look, I get why they exist. I also understand the competitive pressure of not offering early-pay discounts, when other suppliers are. I am not suggesting that you should weaken your ability to win new customers or keep existing ones. My argument is that if you look carefully at what you are getting in return for offering a 1% or 2% early-pay discount, you could be spending that money in a way that is much more impactful, or – perhaps even better – spending less to achieve the same result.

Dissecting the Impact and Cost of Early Pay Discounts

Proponents of early-pay discounts argue that they help incentivize faster payment, and they increase stickiness and loyalty of best customers.

Take a closer look at the accounts-payable processes of your customers. We at BlueTarp have the benefit of observing how tens of thousands of contractors pay each month. Here’s what we see: Once statements are delivered following the 25th of every month, we immediately begin seeing a stream of payments, even though the payments are not technically due for a few weeks. Just as some households pay bills promptly when they arrive, so do some businesses.  They tend to be strong, sturdy businesses with exceptional credit and capable, back-office team members. Roughly three of 10 companies will pay upon receipt, regardless of the presence or absence of an early-pay discount. On the other end of the spectrum, you’ll have three or so companies that are chronic slow payers. Some are explicitly cash strapped and lack the funds to pay promptly…no matter what discount exists. Others simply are more disorganized in how they manage their AR and AP functions. That leaves four or so companies in the middle that could be conceivably influenced to pay early.

Let’s assume, for argument’s sake, that all four of those pay earlier than they would have.  If you are offering a 1% net 10, that means you are paying a 1% discount to get paid 15 days earlier (i.e. paid on the 10th vs. 25th).  Translated into annualized interest rate, the cost of that early-pay discount is 24% (360 days in year / 15 days early * 1% discount).  That’s a lot higher cost than your bank line of credit (LOC), I’m sure, making it arguably better to just draw a little more on the LOC if you need cash sooner.  If your early-pay discount is 2%, the effective annualized rate balloons to 48%.  That’s very expensive!

So here’s what’s actually happening: You are paying a 1% early-pay discount on three customers who would have paid early anyway, and 1% on four customers who paid you 15 days early, but at a very steep cost. There’s also another worm in the apple here, and that’s the customer who takes the early-pay discount, but actually doesn’t pay early. Not fun.

For those that want to argue the loyalty benefit of the early pay discount, I’d ask you to look more closely.  These incentives are not unique and quickly become viewed as entitlements vs. rewards.  The benefit is often buried in the back-office accounting.  It’s not visible, it’s not personal, and it’s not making a regular impression – all essential for building loyalty.

A Better Way

If you are convinced early pay discounts aren’t worth it, but you are stuck with a lot of them, what do you do?

First, the fact that you are willing to spend 1% or 2% to drive loyalty in a single digit net-margin business actually gives you a lot to work with.

It’s most likely untenable to abruptly remove the early-pay discount.  The key is to shift to something much more impactful or much less expensive. 

Loyalty can be built with programs like trip giveaways, point systems (like airline frequent flier miles), or other reward programs that are designed to be “sticky.” The central notion here is that loyalty is built with customers through something earned, as opposed to something given away.  It’s not too difficult of a conversation to swap an early-pay discount with something earned that has real value for the customer. It’s even better if it’s tied toward growth of sales above current levels.

To make the swap even smoother, think about kicking this off with an experience that makes an impression, such as gift certificates to a nice restaurant, good tickets to a show or sporting event, or a YETI cooler. Bottom line, you can drive stronger loyalty and sales for the same costs of your early-pay discount, or you can maintain the same level of loyalty and do it cheaper.  

Whatever you choose, be straightforward about what you are doing and why it’s good for both you and your customer. Honesty sells.

 

About the Author

Scott Simpson

Scott is president and CEO of BlueTarp. He has spent the majority of his twenty year career in financial services helping businesses grow more rapidly through the effective use of credit.

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