Ask And It Shall Be Discounted
Peregrine Inc., a Southfield (Mich.) auto-parts maker, is about to close a big contract with a paint supplier. In the old days, it would be pushing for an up-front price discount. But today, says Peregrine's director of supply management, Jean Francois Lutz, the company is getting very different concessions: a multiyear contract with guaranteed on-time deliveries, low reject rates, and no down-the-road price hikes. Rather than go for the quick savings, says Lutz, "We intend to ensure high quality and price stability."
It's well known that few companies pay list price in periods of low inflation. But in the past, business-to-business discounting usually took the form of ordinary price reductions. Those deals could easily be rescinded once things got tight and sellers gained the upper hand.
While traditional price-cutting remains widespread, new forms of business-to-business discounting are taking hold as well. Based on long-term relationships and dramatic production changes, these concessions may outlast the current business cycle. "These days, everything is negotiable," says Donald Ratajczak, director of Georgia State University's Economic Forecasting Center.
Suppliers aren't exactly rolling over and playing dead. Some are trying to shield themselves from price pressure by marketing to niches. Others are shifting incentives so salespeople are paid on profitability rather than volume. But buyers are getting more creative as well in extracting concessions. That hand-to-hand combat is one reason inflation remains in check in spite of strong economic growth that otherwise might have kicked off an upward spiral in prices by now. In fact, the producer price index has fallen at an annual rate of 2.2% this year.
As favorable as the PPI measure is, it may actually overstate inflation at the producer level. First, while the Labor Dept. has improved its ability to capture true prices, some companies remain reluctant to divulge exactly how much they've been discounting. More important, the PPI doesn't fully capture other seller concessions, such as generous financing terms.
One example is suppliers' use of below-market-rate financing to underwrite the purchase of their products. Makers of telecommunications gear such as Lucent Technologies Inc., for instance, often sell equipment to startups in return for a share of whatever revenues the shaky newcomers generate from the infrastructure.
FREE REPAIRS. It's also common for suppliers to bear the cost of carrying inventory while committing to deliver goods on a day's notice or less. Suppliers provide services such as repairs without charge. And Bob Harlow, senior vice-president for supply chain management at the automotive unit of Tenneco Inc., says buyers are demanding longer-term contracts than ever before--with no price increases. Says Harlow: "We expect suppliers to keep us competitive."
Perhaps the biggest innovation is the promise to improve quality at the same or lower price. Megabuyers have been demanding it for years. Now midsize companies are forcing their suppliers to meet the same high standards. Companies such as Tenneco and Peregrine, the auto-parts maker, work closely with suppliers to meet these goals, often sharing computer systems and even some financial information.
In cases where the relationship between buyers and sellers is more casual, ordinary price-cutting is the rule--and list price evokes little more than knowing smiles from buyers. That's especially true when products such as desktop computers become commodities. "Discounting really takes on a life of its own," says Jeffrey W. Bennett, a vice-president at consultants Booz, Allen & Hamilton Inc. "People start to say, `I'm a 15% discount kind of customer."'
Indeed, suppliers have become so reliant on discounting that they find themselves the punchline of the old joke--selling at a loss and trying to make it up on volume. Says Boston University marketing professor Richard Harmer, a senior fellow at Framingham (Mass.) consultants Strategic Pricing Group: "Nine out of 10 of our clients find they aren't making any profit on the customers they thought were their bread and butter."
Discounting has been particularly fierce in digital wireless communications. In the past few months, competition has caused airtime charges to plunge from 45 cents a minute to 25 cents. But the service providers are protecting their margins by beating down their own equipment suppliers. Lowell C. McAdam, executive vice-president of PrimeCo Personal Communications LP, says that just a year ago, only one company made the digital handsets that PrimeCo includes as part of its monthly fee. Now there are five manufacturers, and McAdam says that allows him to slash his own costs: "We get this new competition, and we get the advantage."
SURGICAL STRIKES. Another big shift: In the early 1990s, the trend was to grant business units autonomy in purchasing, on the theory that their managers knew best what they needed. Now, at least for commodities such as long-distance phone service, companies have returned to central purchasing to gain leverage.
That's certainly the game plan of health-maintenance organizations. The rise of HMOs has forced doctors and hospitals to swallow price cuts that would have been unthinkable just a few years ago. Hospitals, for instance, still cling to price lists that ask, say, $25,000 for a heart surgery. But big companies and their insurers demand discounts of 30% or more on such procedures. "Almost everybody has a deal," says Towers Perrin principal Joe Martingale.
Discounting has been key to holding down health-care inflation. Over the past four years, list prices for hospital care have risen by nearly 24%--more than double the rate of inflation. But figure in discounting, and it turns out that actual prices rose a modest 15%.
How long will sellers keep making concessions? Probably quite a while. An old-style 10% discount can always dry up in the face of supply shortages. But much of the new discounting--such as quality improvements, just-in-time deliveries, and long-term contracting--represents a fundamental change in the way companies do business. So even if capacity does tighten, such structural changes should endure--thrilling buyers and keeping inflation well in check.