Everyone seems to agree that rebates are beneficial, they can be a win-win for both sides of the relationship, but only if you understand the intricacies involved and approach them with a strategic mindset. We’ve previously touched upon various types of rebates, including SPAs, volume, product mix and other complex types. However, it is crucial to delve deeper into the numbers and calculations to assess whether you are truly achieving the desired outcomes and generating profits.
3 Pillars for Getting the Numbers Right
To make sure the numbers are always spot on, we put an emphasis on three key pillars:
- Design: First, be sure to design rebate programs carefully and intelligently. You’ll want to think about many things besides just the rebate amount, including duration, product mix, purchase volume and more.
- Impact: Next, be sure you understand the numbers. Many individuals express uncertainty about how rebates impact their business, whether they are a manufacturer or a distributor. If you are unaware of a rebate’s impact, enhancing effectiveness becomes challenging. Without knowing effectiveness, you may wonder whether offering or negotiating rebates is the right approach at all.
- Effective management: Managing rebates is similar to mowing your lawn. You wouldn’t use a pair of scissors; instead, you would opt for a lawnmower for its efficiency and effectiveness. Similarly, when dealing with rebates, it is essential to utilize the appropriate tools.
Now let’s look at 4 examples involving complex mathematics.
1. Fixed rebate example
Let’s consider a scenario where we start with a list price of $1,000 without any rebates. In this case, we choose to either offer the customer a 25% markup or increase the cost by 25%. As a result, we achieve a margin of 20% and a profit of $125. It’s worth noting that the distinction between margins and markups can be confusing, especially for accountants.
Now, let’s shift our perspective to the distributor’s point of view. We have an exceptional procurement team that, during their annual negotiation, secures a better deal. The outcome is a 55% discount instead of the previous 50% discount. However, if we look at the bottom line, we notice a decrease in profitability. Previously, we were making $125, but now it has decreased to $113.
Why did this happen? The reason lies in our cost-plus approach. Unfortunately, our sales team unintentionally gave away the benefit. This is a common occurrence because they usually have limited information. Typically, we provide them with the cost, but in this case, they were provided with a lower cost, resulting in lower profits when combined with the markup. Consequently, both the manufacturer and the distributor end up with reduced profits.
To address this issue, we can introduce the concept of a rebate. By taking the negotiated benefit and converting it into a rebate, we ensure that the benefit is retained within the supply chain. This way, the sales team is not directly affected since the initial cost remains the same, and the additional buying benefit is separate. As a result, our sales remain competitive, and our business becomes more profitable. This exemplifies the concept of a fixed rebate.
2. Retro & Non-Retrospective Rebates Example
There are two primary types of rebates to consider: non-retrospective rebates and retrospective rebates.
Non-retrospective rebates involve setting individual sales targets for customers that align with our overall goals. These targets ensure a certain level of safety. Once customers reach their targets, we provide them with a substantial rebate as an incentive. For example, your partner could receive a 2% rebate up to their 10,000th purchase. After that, for all units purchased beyond that threshold, they would receive a 4% rebate. However, it’s worth noting that most distributors are not enthusiastic about non-retrospective rebates. They prefer to earn rewards right from the beginning.
On the other hand, retrospective rebates are more common. With this approach, we establish different tiers or bands that gradually increase the rewards for customers as they deliver more value to us, while still maintaining our margins. This creates a win-win scenario where both parties benefit. Many businesses prefer retrospective volume rebates because they are easier to manage. As soon as your trading partner reaches a specific unit threshold, their rebate value goes up. For instance, when your trading partner purchases their 10,001st unit, they would receive a 4% rebate on their entire purchase.
3. Mix Rebates Examples
In the context of a mix rebate example, our focus is on influencing margin rather than driving growth. Currently, we have an 80/20 mix between two product ranges, with the highest sales determining our primary source of revenue. Unfortunately, this is a common reality in business. However, what would happen if we shifted that mix to 70/30?
In simple terms, this would increase our margin from 18% to 19.5%. This represents the potential benefit or “pot” that we could offer as incentives. To encourage this mix change, it may be beneficial to give away the entire benefit. In this scenario, I have allocated 80% of the benefit as an incentive. By doing so, our margin increases to 18.3%, allowing us to make more money without charging customers extra. The question then becomes: What do we offer to motivate this behavior? What is our budget for rebates? There are three possible approaches we can take.
Firstly, we can make everything 1.2% cheaper once the desired mix is achieved. This option benefits customers who are particularly interested in obtaining a lower-priced range, especially if they are not generating significant profits themselves. By making the low-margin range even more affordable, we can still increase our own earnings.
Alternatively, we could solely reward customers on the commodity range, informing them that if they purchase this mix, we will reduce prices by 1.71%. This represents a significant difference, particularly when profit margins are tight. We could also focus on rewarding customers who purchase the premium range, where our profit margins are higher, by offering them a 4% discount.
To determine the best approach, we must carefully analyze the desired outcomes, affordability of rebates, and anticipated benefits. Incorporating these considerations into a comprehensive rebate strategy is crucial.
Let’s consider a slightly different scenario within the same context. Our objective is still to achieve or maintain a 70/30 mix, but now we acknowledge that the demand for the premium range will not shift from its current level, while the base range remains at 8 million units. In this case, our aim is to promote add-on products rather than altering the mix. By doing so, we have more to offer as incentives.
In simplistic terms, we still have a 1.5% bottom line, but it is 1.5% of a larger number in this scenario. For the low-margin range, we can now offer a 3% discount if customers meet the required numbers. Considering that the initial profit margin on this product was only 15%, offering a 3% discount represents a substantial incentive.
However, it’s important to note that this approach would reduce our overall margin to 16.5%. Some businesses prioritize actual profits and cash flow over percentage-based metrics. Therefore, it is crucial to align the incentives with the specific objectives of the business, whether it is maximizing dollar profits or focusing on percentages.
Using Optimization and Automation to Get Your Rebate Numbers Right
Understanding the mathematics behind rebate calculations is crucial as it helps us determine whether we should persist with or abandon a specific strategy. If you are utilizing rebates in your business and are unsure about their impact, it is important to analyze these calculations, go through them thoroughly and optimize accordingly. This method guarantees that rebates gain a positive reputation for driving desirable outcomes rather than being perceived as mere customer requests.
Likewise, employing an automated approach to rebate management allows you to focus on the finer details and ensure accuracy in your rebate calculations and reporting. With automation in place, businesses can streamline the entire rebate process, ensuring that they have real-time visibility into their rebate programs and calculations are performed correctly and efficiently. This, in turn, enables you to reap the benefits of rebates and make well-informed decisions the first time.
Ready to focus on getting your rebate calculations always right and making informed rebate decisions? Discover the power of Enable’s rebate management software.