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Purchasing Power: Part 3 – Payment Terms

Monday, April 14th, 2008

This is the third post in a series about the power of a buyer. In this situation we will be talking not about the pricing of a product, but negotiation. Specifically, we are talking about negotiating payment terms.

I think payment terms are another underestimated tool that a buyer can use to help out the company’s bottom line.Payment Terms There are a lot of payment terms that are used but here are a couple common ones:

  • 2% / Net 10 – If you pay by the 10th, you can take a 2% discount
  • Net 30 – You have 30 days to pay the bill
  • COD – Must pay up front

Obviously there are many more potential terms, but these are just some examples.

Now, lets say you currently buy raw materials from a vendor and use Net 30 terms. That is pretty standard. What you should try to do is negotiate something that benefits you more. If you have no financial problems, or extra cash, it might be a good idea to go for a 1 or 2 percent early pay discount. This could really benefit both parties, especially if your vendor is cash strapped. They might be willing to give you a small discount in order to get immediate cash-flow. This also has the added bonus of strengthening your relationship with your vendor.

Another direction you can go is to negotiate into a longer pay time. If you can move from Net 30 to Net 60 or Net 90…well, you just earned yourself extra interest money from the bank! This also would be ideal if you have negative cash-flow and need more time to make a payment without them sending the accounting police after you. (negative cash-flow not reccomended!)

In order to negotiate better terms (or pricing…or anything) you have to have some sort of edge. In most cases, in the purchasing department, this means you either have another supplier you could buy from or you have vastly increased your purchases from the original supplier. I have found that the better relationship I can develop with my supplier, the more willing they are to extend my terms…especially if I have increased my purchases from them. At that point its pretty easy to just ask them to extend your terms because of the level of purchases you have been making.

I would recommend that you take a good look at the payment terms that you currently have with your suppliers. Review them once a year. See what you can negotiate…you have nothing to lose…and extra cash-flow to gain!

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14.04.2008 Purchasing Comments

Purchasing Power: Part 2 – Pricing

Friday, March 28th, 2008

This is the second post in a series about the power of the buyer. In the last post we established a basic, yet very important, tenet of purchasing: The easiest way to increase profitability is through the buyer by cutting costs. Now that we have cut the cost on the table and chair set we are selling, we have to figure out the best way to price it.

Pricing is a really difficult thing to figure out because there are so many variables that affect how you price something.Demand Curve But before we get into those, lets go back and cover some basic economics…and more specifically…a demand curve. As you can see by my awesome (and colorful!) drawing of a demand curve…as price decreases the demand for the item increases…translating into more sales. This is economic theory, but it has proven to be pretty accurate over time for the most part.

OK…now that we got that out of the way…lets talk about how to price our table and chairs. We basically have three options, so lets take a look at the pros and cons of each of them Our three options are:

  1. Lower our selling price relative to our costs
  2. Leave the selling price where it is.
  3. Lower our selling price at a different factor

Lower Cost by the same percentage

In our example from the first post our cost was $15 and our selling price was $30 for a nice $15 profit, with a 50% profit margin. Then we cut our cost down to $12, a 20% savings. Lowering the selling price by the same percentage to $24 would yield a $12 profit, with the same 50% profit margin. So the profit margin remains the same…but we are getting $3 less than we were before. That’s bad! But wait…remember our demand curve from above (refer to super awesome picture)? If you lower your selling price you will sell more of them. Theoretically, your 20% lower selling price will draw more customers to at least make up the difference. This is an excellent strategy for items where there is a lot of competition around your price level. Cutting prices lower and lower will almost certainly increase the quantities sold. But what if your business isn’t exactly commodity like?

Leave Selling Price As Is

Using the same example as above, we cut our costs by 20% to $12. But this time sell it for the same $30. This yields an $18 profit, with a 60% profit margin! Alright! Both numbers are higher! Our demand stays constant and we pick up an extra $3 per set. This is the easiest way to increase profitability as a buyer. It requires nothing except for negotiating/sourcing a lower cost. The sales don’t have to increase to pick up extra profit. This is an especially good strategy if you have limited production and don’t have the capacity to sell more quantity.

Lower Selling Price By Smaller Factor

This is my personal favorite method. Basically you split the difference between the two strategies listed above. We take the same 20%, but this time sell it for $27.50. This yields a $15.50 profit, with a 57.3% profit margin. Both numbers increase from the original deal, which is good. The added bonus for doing it this way, is that because you have lowered your selling price…more new customers will be likely to buy your product. You also get to show your customers that you are working hard behind the scenes to save them money…and everybody likes that!

I suppose there is another option, which is to RAISE your price after cutting costs. But I think that’s foolish and can backfire on you quickly if word gets out.

These pricing strategies are very effective for general product sales. If you deal with highly specialized/luxury items, the pricing structure changes completely. But that’s a topic for another day.

What pricing strategies do YOU use? Let us know in the comments!

28.03.2008 Purchasing Comments