Nathan Joyes | Tuesday, October 1. 2013
About 20 years ago, I read a book called Wealth Without Risk, by Charles Givens. It covered a lot of great financial principles, and provided insight on how to increase wealth by simply making smarter decisions on things like obtaining life insurance and paying for vehicles. In a similar manner, I thought I would share some smart decisions that purchasing groups are making to increase wealth without taking on a lot of new risk.
In my post about Negotiating Prices like the Big Guys, I talked about improving efficiencies for suppliers and reducing their costs, using things like electronic catalogs, orders, invoices and payments. This translates into increased profits for the group, through new supplier rebates, discounts, or electronic transaction fees. I concluded by talking about the opportunity to provide suppliers with a guaranteed payment using something called central billing. With central billing, suppliers bill head office for all purchases from member companies and head office re-bills the members, ideally through an automated system. While this can result in significant new central billing fee income from suppliers, taking responsibility for member purchases may seem quite risky at first glance. As it turns out, there are many ways for a group to mitigate that risk and still benefit from the increased income.
- To begin with, you have a lot closer relationship with your members, making it that much easier for you to collect payments than suppliers. Participation in some of your programs can be contingent upon your member having their account paid up. On a more positive note, remember that you are going to have new central billing fee revenue that can be used to fund brand new incentives, for all those members with their accounts current, of course.
- Another thing you can do for added protection is to have your members provide some security, in the form of cash, a credit card charge, or a letter of credit (LOC) from their bank. Cash is probably the best option, as it can be invested and enable you to return interest back to your members. A good group purchasing system will manage your member investments and interest. A credit card payment is similar and may be preferred by members, as it gives them some time to pay and provides points through their loyalty program, although you may want charge an administration fee to cover the credit card processing costs. An LOC is probably the worst option, as it freezes money at the member’s bank so that it cannot be used for anything else and cannot be invested on their behalf to return interest to them.
- Assuming that you have a good electronic ordering system, you can control your exposure by setting a credit limit to cap the dollar amount that each member can have in open orders. When used in conjunction with an electronic payment system, available credit will automatically open up as your members make payments. The credit limit (e.g. $12,000) can be derived from the amount of security provided by the member (e.g. $5,000). So if members want to increase their credit limit, they simply need to provide more security.
- Because the credit limit typically exceeds the security provided by the member, there is still some exposure for head office, particularly for members that have a very large credit limit. Because of that, you may want to consider accounts receivable insurance. The insurance company will review the status of each member and approve them for coverage, which may cost you something like .2 of one percent of the outstanding receivables (i.e. 20 basis points). The cost of the insurance is typically a fraction of what suppliers will pay for central billing privileges, but keep in mind that some members may not be approved and there will likely be a deductible involved when you make a claim.
- Finally, you can give your members the option of purchasing some equity in the group, giving you something to draw upon in the event of default. Here again, you can invest money paid by members for equity, so that you can return interest to them and perhaps dividends as well.
Whether your members are trying to build up security or equity with the group, note that it can be done over time by temporarily retaining some of the discounts or rebates that they would normally be entitled to. This may include some of the new fees that you will receive from suppliers as a result of moving to central billing.
Using the suggestions above, you can eliminate much of the risk associated with central billing. In addition to the benefits for suppliers and members, head office can potentially enjoy substantial new wealth, without all the risk. If you have other ideas about increasing wealth without risk, use the comment section below to share your insights.