As organizations continue to streamline the purchase-to-pay process, financial leaders are eager to leverage their increased efficiencies and begin looking at working capital solutions to better optimize cash flow. Effective working capital optimization strategies leverage several tools to obtain the maximum benefit from the entire supply chain. This typically includes supply chain financing for tier 1 suppliers, and a combination of dynamic discounting and early payment programs for the mid to longtail suppliers. And now these programs are getting more sophisticated. 

What is a standard early payment program?

Early payment programs are nothing new. Suppliers typically offer their customers a discount if invoices are paid before a specific date. For example, if the payment term is 30 days, a 1-2% discount may be applied if payment is made within 10 days. In the past, long invoice handling cycles prevented buyers from taking advantage of this program. But with the introduction of e-invoicing and automated invoice processing, lead times can be significantly reduced, enabling companies to benefit from discounting if they wish. Now that automation has put early payment programs within reach for more companies, there is more options to expand these programs – enter dynamic discounting.

What is dynamic discounting?

The “dynamic” part of a dynamic discount program means that the program is on a sliding scale, which allows buyers to receive the maximum discount on approved invoices by paying on the earliest day possible and a moderate discount on invoices paid a little later. So, the faster you pay, the higher discount you receive. And, unlike conventional early payment programs, there is the option to receive a cash discount on all incoming invoices paid before the due date. But maybe buyers don’t want to pay all invoices early for that discount; maybe they want to stagger the payments – hello on-demand discounting. 

What is on-demand dynamic discounting?

On-demand dynamic discounting is just how it sounds – it’s available and suppliers take it when they need it. This enables them to hand-pick which invoices they want to receive early payment on. If they need cash on-hand, they accept the early payment and the buyer gets a discount. If they can wait longer, they accept payment at a later date and the buyer gets a lower discount. On-demand dynamic discounting offers a more tailored and flexible payment plan to meet suppliers’ needs, helping to build stronger supplier relationships, support their cash flow needs and ensure supply chain resilience. 

What types of scenarios make sense for traditional early payment programs, dynamic discounting and on-demand dynamic discounting?

Strategic cash flow management involves a combination of tactics designed for certain situations across the supply base. Here are the common ways early payment programs are applied:

  • Traditional early payment programs are typically used with key suppliers to harmonize payment terms and be more collaborative with these strategic partners. 
  • Dynamic discounts enable buying organizations to manage profit margins by paying when it is best for them and offer an alternative short-term financing option for strategic, longtail suppliers.  
  • On-demand discounts are all about supporting supplier needs and make sense when buyers are increasing corporate responsibility, reducing supply chain risk and working with suppliers that need capital to grow or be more innovative. 

How do I get suppliers to participate in early payment and dynamic discount programs?

A supplier’s willingness to participate in your program revolves around creating a win-win scenario for both organizations. So, first things first, know your suppliers’ situations and consider these two factors in creating your early payment discount programs:

  1.  Research profit margins: Certain industries tend to have relatively good profit margins, while others are razor thin. Suppliers’ profit margins have a direct impact on how likely they are to enroll in a dynamic discounting campaign or offer any discount at all. While individual profit margins can vary from company to company, industry averages can be used to craft a successful discount campaign.

    For example, Steel Manufacturers generally operate with a 3.5% net margin, paper products average 2.26%, and food wholesalers average 1.34%. Certain manufacturing verticals operate with less than 1% net margin. Suppliers in these industries typically face immense cost pressure during contract negotiations and are typically unwilling to offer anything in addition in terms of the backend discount.
    In contrast, service-based industries typically have higher margins (9.34% net). The information services industry averages 13.39% net margin, and the semiconductor industry averages 18.74%. Suppliers in these or similar industries are typically much more willing to provide a discount in exchange for early payment.

  2.  Factor in Market Traits: Where the supplier is located and the countries where you conduct business with them will also play a factor in the success of dynamic discounting. In markets such as the U.S., buyers have a lot of leeway in establishing standard payment terms and extending their days payable outstanding (DPO). This means that some suppliers might struggle with cash flow deficits and be more willing to take a discounted early payment. Markets like this can incentivize suppliers to enroll in discounting programs to assist with their own cash flow.
    However, in regions such as the EU there have been regulations passed to set maximum payment terms for small and midsize suppliers. These regulations allow the supplier to charge interest (8%+) on late invoices and assess potential fees on buying organizations that pay late. Suppliers in markets like this have less incentive to offer discounts, as their payment date and amount are more secured. Buying organizations must be more strategic when approaching suppliers in these regions – demonstrating the ease automation brings to the current cash discount process, how even faster payments provide working capital and offering dynamic discounting as an alternative for factoring or receivable financing.

How can Basware help?

Basware experts are at your disposal to help you conduct a supplier analysis and help you realize the opportunity and benefits of early payment programs – reach out we’re here to help.