Social Media     

 Connect with us!
Connect with Supply House Times on Facebook, Twitter, YouTube and LinkedIn

Benfield's Blog


The downside of rebates

Three years ago, we presented a proposal for distributor research on the trends and usage of vendor rebates.

December 29, 2013
/ Print / Reprints /
ShareMore
/ Text Size+

Three years ago, we presented a proposal for distributor research on the trends and usage of vendor rebates.  The proposal was received with enthusiasm and the ensuing presentation demonstrated sincere and substantial interest from the distributor panel.  The proposal didn’t make the final cut, however, as the legal issues were too sensitive.  

We were disappointed that the research did not get funded; however, looking back on the entirety of the process, the turn-down may have been a blessing in disguise.  Our work in preparing the research and ensuing exposure to rebates finds there are significant misconceptions regarding the funds. In fact, there is a downside to rebate dollars that we liken to an addiction.  

 

The rebate addict

Since the Great Recession, traditional box-in/box-out (BIBO) distribution has endured an increasing array of external pressures including:

·                     Growing usage of e-commerce by customers to check price and availability with the end-result being suppressed prices.

·                     Outside entrants into B2B channels including Amazon and Google who directly compete with distributors on a lower cost basis or enter into the channel and take value away from the distributor.

·                     Foreign manufacturers who align with billion dollar distributors and whose price to market is 15% to 25% less than domestic brands.

·                     Use of transaction costing and e-commerce to disaggregate sales costs from the product and reduce the overall price to the customer.

 

In short, the pressure(s) on traditional BIBO distribution are substantial and will increase as more customers use technology and new entrants emerge — all of which drives down product price.  The options for distributors are limited including investing in new technology to compete, moving further into the value chain and engaging assembly and service businesses, or selling the firm and cashing out.  What is not a reasonable expectation is staying within the BIBO platform and hoping things will get better — they won’t and yet, today, this is where we find many distributors.  

Our hypothesis is that a preponderance of distributors have not engendered new technology and taken cost out of the traditional business or moved further into the value chain.  Instead, they’ve flooded buying groups and aggressively negotiated with manufacturers for increased channel compensation in the form of rebates. 

Rebates are a long-standing form of compensation for channel services between manufacturer and distributor. They trace their roots to retail entities in the distribution of household goods and groceries. Rebates are almost always rewarded on purchases and often have substantial sums tied to incremental gains. Incremental gains may be on overall purchases or specific to key products including new technologies. There are several problems or misconceptions with rebates, however, that many distributors don’t consider and these issues, over time, find their way into the cherished beliefs of management despite being increasingly false.

 

Rebate misconceptions

First, rebates are considered “sheltered income,” which alludes to the fact that the dollars are not included in the product price but rewarded on a quarterly or year-end basis. Hence, the belief is that the rebate dollars don’t end up in the customers’ hands. In our work, we have challenged this belief and find, more often than not, rebate dollars leak their way out into the product price.

The process on affirming this is not hard science, but the data is difficult to dismiss. The analytical process, in case you are interested is as follows:

 

1.                  Add the rebate percent of sales, specific to a vendor, to the gross margin percent for an adjusted gross margin. Average all adjusted gross margins and compare the vendor in question to the average. Is it higher or lower? A lower than average reading implies margin leakage to the marketplace.

 

2.                  Take the adjusted gross margin figure and review at it over a three- to five-year period.  If the overall measure is going down, it is likely that the rebate is offsetting deteriorating pricing in the greater market.  

 

3.                  Compare the trend of the adjusted gross margin percent of sales to overall sales and margin dollars. We often find where sales and margin dollars are growing but adjusted gross margin percents are falling. Again, the implication is that the rebates, or at least part of them, are ending up in the marketplace.

 

The preceding analyses aren’t foolproof, but they do imply that the vaunted rebate dollars (or some portion) are winding up in the marketplace. Too often distributors believe that rebate dollars received in a different time span (quarterly, annually, etc.) or placed in a different category on the income statement (other income) means the money is sheltered.         Unfortunately, in competitive markets where legislation requires comparable access among multiple competitors to earn rebates, the idea that any product cost advantage remains sheltered in a thin margin, commodity-driven business, is wishful thinking.  

The destructive potential of rebates is seen in several behaviors that we dub the symptoms of addiction including:

 

·                     Over-reliance on rebates creates a culture where gaming of product cost and attempts to “hide” margin take precedent. Unfortunately, in this scenario, sellers don’t trust management and we’ve found few good long-term outcomes when sellers give up, quit or grouse about the situation. Like it or not, in a commodity business where 60% to 70% of the goods are differentiated by price, hiding rebate dollars is a game that is often destructive in its outcomes.

·                     Attention is taken away from good pricing management and controls as the distributor doesn’t grapple with the vagaries of pricing such as:  who can discount, how much, when and where? Funding a modern day pricing discipline takes money, time, patience and is a vigil. Trying to outdo pricing with rebates is a big part of the problem. As one of our clients, exasperated by their own rebate addiction, repeated, “We wouldn’t have this problem with rebates if we had control of our pricing.”

·                     The competitive issues in distribution stemming from new entrants, technology that gives instant access to price and availability, and low cost global supply chains, are not solved with rebates. These issues have to be engaged head-on by distributors and new knowledge and investment in e-commerce, transaction costing, new sales configurations and expanding to global suppliers are the competitive disciplines of today and tomorrow. In short, if the distributor doesn’t have a plan for these challenges, they are simply denying the problem and, over time, will lose to the more progressive competition.

·                     Rebates create a greater dependency on vendors who, like their distributors, have significant competitive issues especially with low-cost producers from around the globe. At some point, vendors can’t issue incremental rebates and this leaves the distributor at significant risk. To us, it makes more sense for the distributor to take control of their destiny by engaging marketplace changes than relying on the vendor.

 

When to stay put

Not all rebates are problematic and distributors should, where it makes financial sense, maximize the rebate income. In general, we find that rebates make financial or strategic sense when:

·                     The vendor is asking for the distributor to do something out of the ordinary chain of value and the rebate offsets some or part of this cost.

·                     The distributor is cementing a long-term relationship with a vendor in a crowded space and the rebate is a type of loyalty insurance.

·                     There is a new product or technology that takes considerable investment and the rebate compensates for this.

·                     The distributor is helping the vendor take cost (read legitimate and measurable) out of the channel and is compensated in the form of rebates.

 

Of course, when any rebates are offered, the distributor should understand in detail the offer and make a strategic decision to pursue or not. 

Often, we have largely semantic discussions that buying groups and purchasing leverage is not the same as a rebate. In most instances, however, the goal of the buying group and negotiating the proprietary rebate are the same. The buyer is rewarded with incremental income from greater purchases.  There is, philosophically and practically, nothing wrong with this goal.  Greater volume for manufacturers reduces breakeven cost. Our argument, in this blog entry, is that the distributor is clamoring for rebates to cover or offset cost pressures in the model of business including efficiencies from new technology, new knowledge and the effects of globalization. In the short run, rebates may give the distributor quarter from these challenges, in the long run, they make the company dependent and weakened to the competitive environment.

 

When to walk away or have someone do it for you

If your company is relying on rebates to compete in a changing environment, we suggest reviewing the issues for the increased competition. If lower cost competitors, more price conscious customers who use technology and global “off-brands” are creating the competitive issues, then you may be over-relying on rebates to fend off these threats.

At some point, the rebates will flatten out or run out and you’ll be left with stronger competitors and behind the eight ball on proper solutions. It is our belief that many distributors are relying on rebates for solvency in a fast-changing and increasingly competitive environment. They will end up disappointed and, perhaps, much poorer.

In a recent incident, one of our clients, an acquisitive firm with above average earnings, reviewed an acquisition of reasonable size and geographic presence. The CEO, who is hands on and reviewed the books, found that the preponderance of operating earnings came from rebates, and less than a handful of vendors. In essence, the company’s management had not engaged good pricing management, global supply sources and new technology to take cost out of the service platform. 

In the words of the CEO, “I walked away from the deal as quick as I could. There was nothing I wanted to buy; the operating profits were too risky. The management was wholly reliant on their vendors and not their own ability (ies).”

 

 Scott Benfield is a consultant for distributors and manufacturers in B2B channels.  He can be reached at Scott@benfieldconsulting.comor at (630) 428-9311.  His firm is located in Chicago and their website is www.benfieldconsulting.com


HELPFUL LINKS:

You must login or register in order to post a comment.

Multimedia

Videos

Image Galleries

BNP Media's Plumbing Group Visits Grundfos North American Headquarters

BNP Media’s Plumbing Group, comprised of the Plumbing & Mechanical, Supply House Times, PM Engineer (pme) and Reeves Journal brands, recently visited Grundfos’ new North American headquarters building in the western Chicago suburb of Downers Grove, Ill.

5/7/13 2:00 pm CST

How To Use Your Strengths To Fight The Threat Of Amazon Supply

AVAILABLE ON DEMAND A new 8,000 lb. gorilla, Amazon Supply, has taken aim at many of the customers of PHCP supply houses. Supply House Times columnist Dick Friedman, an authority on business planning and the strategic use of inventory, warehouses and technology will present strategies and tactics for you to compete with Amazon Supply.

THE MAGAZINE

Supply House Times

April 2014

2014 April

In the April issue of Supply House Times, there is much focus on young professionals in the distribution industry. Find out who is being recognized as this year's Young Executives for the American Supply Association and read who will be taking over Aaron & Co. when it's current owners retire. Read about Central Plumbing Specialties' recent expansion, catch up on the latest news from the distribution industry as well as the latest products!
Table Of Contents Subscribe

Supply House Times Poll

Trade Associations

Are trade association memberships and participation beneficial to your company?
View Results Poll Archive

The Supply House Times Store

plumbing-hvac.gif
2014 National Plumbing & HVAC Estimator

Every plumbing and HVAC estimator can use the cost estimates in this practical manual!

More Products

Clear Seas Research

CS-OflRGBhomepage.jpgWith access to over one million professionals and more than 60 industry-specific publications,Clear Seas Research offers relevant insights from those who know your industry best. Let us customize a market research solution that exceeds your marketing goals.

Premier 125

Premier 125 button

The information SUPPLY HOUSE TIMES uses to rank the Premier 125 is the most accurate we can gather. It is primarily based on responses to a questionnaire we send to the wholesalers in our database, supplemented with information obtained from industry reports and estimates.

STAY CONNECTED

facebook Twitter Updated icon Youtube Updated icon    LinkedIn Updated icon