Discounts and merchant incentives have been intrinsic parts of the trade ever since the inception of the market. When the world was using the barter system, the system of credit with associated people worked well. However, as the cash economy came into existence, we saw the development of multi-level markets from manufacturers to consumers. Retail marketing saw a rising need for discounts as part of marketing techniques. Soon enough, we were ushered into the industrial revolution, where the idea of the free market was conceived.
Free markets promote healthy competition by which they are self-regulated, barring a few exceptions. Product pricing plays an important part in a free market economy because it determines the sustenance of a business in fierce competition. It is for this reason that retail discounts soon became very common. Dealers preferred to move out high-volume goods at a low margin over low volume with a high margin.
To spare a good enough profit margin, the retail businessmen started to build credit with their suppliers to build a long and healthy business relationship with them. When these retailers saw a surge in market demand, they started asking for suitable discounts from the suppliers. This discount would help them maximize profit margin and execute expansion strategies.
Now, we have discussed the evolution of industries and markets. In terms of traditional business, there is only one thing that changed, and that is the use of e-commerce and technology. The principles of traditional business setup are the same as they were 200 years ago. However, things are changing now.
The market is dynamic, and it demands the same kind of activity from those calling the shots. As a result of this economic growth, certain business strategies are breaking the shackles of traditionalist ideas. This has impacted the idea of discounting in supply chain management. Static discounts are being replaced by dynamic discounting strategies.
However, if you are new to the business, chances are you are new to this discounting idea. So, it is important to know what dynamic discounting is, how it works, what the benefits are, etc. This will help you make an informed decision for your organization. In this article, we will discuss everything there is to know about dynamic discounting.
What is dynamic discounting?
We have already made so much fuss about this revolutionary business model for the suppliers that it is now time to address the elephant in the room. To understand dynamic discounting, we must understand static discounting first. This will help you in developing a contrasting understanding of the subject.
So, static discounting is a business model where suppliers can be paid for their invoice by the buyers in advance, before the delivery of the good, but at a discounted price. That is to say, under the terms of static discounting in a contract, a supplier is presented with two ideas; 1. Receive the full payment on the invoice on the delivery date as stipulated in the contract, or 2. Receive an advance payment for the goods at a discounted price.
The suppliers opt for the discounted payment because they need a cash flow so they can pay for the operational cost without bearing too much burden. However, this means a lower profit margin for the suppliers. Therefore, the idea of dynamic discounting was introduced to put the suppliers on equal footing with the buyers.
Under the terms of static discounting, the time limit and the discount rates are fixed. These terms are usually set by the buyers under the “take it or leave it” principle. Now, dynamic discounting terms offer flexibility to the suppliers regarding duration and discount rate.
Dynamic discounting works on an “always on” basis, i.e., it allows the suppliers to offer discounts according to their need for cash flow. This will help them determine their needs and requirements in real-time. The “always on” basis also eliminates the duration restriction. So, under the terms of dynamic discounting, a supplier can offer discounted rates at any point of time before the scheduled delivery.
Dynamic Discounting vs. Static discounting
We have already discussed the two discounting modules and how they contrast. Now, let’s look at some key differences that we can observe in both these models:
- The discounting price and the timing clause are fixed in static discounting modules. Whereas dynamic discounting allows for greater flexibility in this regard.
- In the case of dynamic discounting, suppliers have to get the invoice in accordance with the contractual terms. Once the invoice is approved, dynamic discounting terms can be invoked at any point at the option of the supplier. This is completely different with regard to the static discounting model, where the discount rate and timing are fixed under the contract terms.
- Suppliers gain equal footing in dynamic discounting, which leads to healthier business relations. Static discounting modules give the buyers an undue advantage in a deal.
- In the case of static discounting, ad hoc early payment requests have to be entertained by the supplier that may adversely affect the business operations. Dynamic discounting eliminates the chances of ad hoc requests, which improves the effectiveness of the discounting module.
Why prefer dynamic discounts over static ones
In this part, we will discuss the advantages of a dynamic discounting model and why businesses should opt for this. As discussed earlier, static discounts are preferred in a traditional business setup, which is not ideal in the modern day and age. Therefore, it is crucial to understand the advantages of dynamic discounts over static discounts:
- Dynamic discount puts the ball in the supplier’s court. Under the terms of dynamic discounting, suppliers can enforce the “take it or leave it” principle.
- Dynamic discounts provide the opportunity to the suppliers to structure the standard discounting rate in accordance with the market and cost of operations.
- The static discount model restricts the time limit in which advance payment facilities can be availed, which is not sustainable because the market is volatile.
- The time limit in case of static discounts can put the suppliers in a tight situation, especially in a scenario where they need the cash flow desperately, but the window to avail of the advance payment option is closed.
- Ad hoc requests under static discount models are known to disrupt the Accounts Payable process. Your organization may have the requisite cash flow to deliver the goods or services under the stipulated duration. Still, if an ad hoc request is placed, you will be obliged to receive the advance payment in return for the discounted rates. This issue can be solved efficiently using dynamic discount models.
What are sliding discounts?
A sliding discount is a type of traditional static discount invented to suit modern needs. However, if you analyze the AP process disruption caused by both these modules, you will see that there is not much difference. A sliding discount module is a system where the supplier is given the opportunity to offer lower discounted rates depending on the duration.
So, if a supplier receives an advance payment right when the invoice is approved, the discount rate would be higher and vice versa. One may think that this module gives suppliers some advantage in a business relationship, but we must note that this is still a branch of traditional discount principles. Under the terms of sliding discounts, the duration is varied, but the discounting rate is fixed, which doesn’t give much breathing room to the supplier.
Why prefer dynamic discounts over sliding discounts?
Now that we have understood the technicalities of sliding discounts, let’s look at some of the advantages dynamic discount models have over sliding discounts. This part also aims to list some of the limitations of sliding discounts. Let’s take a look:
- Sliding discount offers the supplier an opportunity to choose the duration of the time limit. However, the discount rate is still fixed by the buyer.
- The fixed discount rate in this model puts the supplier at an advantage because he has to offer the stipulated discount irrespective of the market and affordability.
- The dynamic discount model, on the other hand, promotes the “always on” marketplace policy. According to this policy, the supplier can initiate the offer for the discounted price and control the timing and rate.
- The dynamic discount model is also quite efficient for the business operations of the supplier because it allows the supplier to choose the invoice where he wants accelerated payments. Moreover, the seller can take a call on whether or not he wants accelerated payments on certain invoices.
- Unlike sliding discounts, the dynamic discount model creates a system on which suppliers can rely for their business operations.
Factors considered in the dynamic discount model
In this article, we have already discussed the advantages or benefits of the dynamic discounting model. Moreover, we have also shed some light on the reasons why businesses should depart from traditional business techniques and switch to more dynamic alternatives. Now, in this part, we will talk about some factors considered when structuring a dynamic discount model:
- The discount rate offered by the supplier under the contract or tender.
- Evaluation of all the standing offers submitted by the contemporary suppliers.
- The difference in the timeline in advance payment and the stipulated duration.
- The cash available at the buyer’s disposal to make the advance payment. We also consider the third-party financial assistance available to the buyer.
The market today is evolving at a great pace. Many obsolete business practices have been put to rest, especially with the advent of technology. Therefore, it is high time that we adapt to the market’s needs. The dynamic discounting model balances the buyer’s and supplier’s rights and creates a hassle-free business transaction.