The other week we had a look at what dynamic discounting means and why it matters. This week, let’s get behind the curtain of an even newer term on the block: enhanced discounting.
A quick recap on dynamic discounting
For those who have forgotten, or don’t want to read the full blog post, dynamic discounting is where a supplier elects to take early payment on an approved invoice in return for a discount. The reason that the word ‘dynamic’ is in there is because the size of this discount varies according to how early the supplier wants to get paid.
How is enhanced discounting different?
Enhanced discounting is almost exactly the same as dynamic discounting but with one crucial difference: with dynamic discounting, the buying organisation funds the discounting programme with their own cash. This is great for organisations that have a significant amount of money on the balance sheet and are happy to invest it in their supply chain.
But what happens if the buying organisation doesn’t have much cash on their balance sheet? Or is sensitive to Days Payable Outstanding (DPO) i.e. the amount of time between receiving an invoice and paying it? These are two examples of cases where it would not make sense for an organisation to use its own cash to fund a discounting programme.
This is where enhanced discounting comes in. Quite simply, organisations can choose to fund the discounting programme with third party cash rather than their own cash -- still capturing a discount in the process.
Isn’t this just Supply Chain Finance in another guise?
What is supply chain finance? Through SCF, companies inject third-party cash into the supply chain to pay suppliers early, leaving DPO untouched or extended, and keeping cash on the balance sheet for the buying organisation.
So in one sense, yes, enhanced discounting and supply chain finance are similar.
However, in another sense they’re very different. Traditional supply chain finance programmes are set up and administered by banks in partnership with the large buying organisation. The banks provide money directly to the suppliers early in exchange for a ‘discount’ or percentage return.
However, because the banks need to have a direct relationship with the suppliers to provide money to them, they have to undertake full Know Your Customer (KYC) checks, which are expensive and have significant administrative burden. Consequentially, traditional supply chain finance programmes normally only apply to the top 50 to 100 suppliers where the cost of setting up a programme is more than offset by the returns.
Enhanced discounting is different. Here, finance is extended to the whole supplier community through the use of the technology enablers like a supplier portal and eInvoicing. The KYC check is undertaken on the basis of the buying organisation having an ongoing and auditable relationship with the supplier.
From the supplier’s perspective, the ability to offer a discount to the buyer in exchange for an early payment is exactly the same for enhanced discounting as it is for dynamic discounting--the cash just comes from a different source.
How It works
When the supplier elects to take an early payment, this cash comes from a third party funding source such as a bank, pension fund or hedge fund. The buying organisation then pays the invoice on the normal due date, but instead of paying it to the supplier, it pays it to Taulia.
The neat part about enhanced discounting is that the returns from the early payment discount are then split between the third party funder and the buying organisation. So even though the buying organisation isn’t using its own cash, and has no exposure in terms of reduced cash on their balance sheet, it still financially benefits from introducing a discounting programme into its supplier community whereas in the case of supply chain finance, the buyer gets no share of the discount.
It all feels too complex!
There’s no doubt that there is more complexity in an enhanced discounting programme than a dynamic discounting programme since a third party funding source is introduced. However, the principles are exactly the same.
Cash is used to fund a discounting programme for suppliers who agree to offer a discount in exchange for early payments -- earning the buying organisation a return on that investment and freeing up early, cheap and convenient cash to suppliers.
To learn more about enhanced discounting, check out this interview with Taulia CEO, Bertram Meyer and this article by Purchasing Insight Managing Director, Pete Loughlin.