Deductions Management
By -
Veena Gundavelli
Every company in the world that sells into retail channels knows the challenges of doing business with retailers. As a result of the fierce competition for shelf space, companies have been forced into many costly concessions, resulting in negative impacts to the bottom line. A prime example of the pains that companies feel is the phenomenon of deductions and the resulting chargebacks driven by retailers not paying full invoice amounts. This results in millions of dollars of revenue leakages to companies and requires a new approach to ensure that this highly preventable phenomenon is properly addressed.
Symptoms of Hidden Revenue Leakages
Recent studies have shown that many of these companies typically suffer from an alarming level of deductions, resulting in serious revenue leakages. One statistic from a study by Grant Thornton (Reducing and Controlling Deductions, 2003) states that deductions can reach up to 10 percent of gross sales. The extent of this dilution can make it difficult for companies to maintain a healthy cash flow and as a result, achieve superior business performance. What is even more alarming is that many times deductions are preventable.
Some key understandings from other studies have helped categorize deductions. The types of deductions that are commonly encountered fall into three broad categories. The first are the types of deductions that are truly authorized. Many companies have pre-negotiated allowances for shipment, freight, rebates, agreed upon discounts, etc., that have an associated amount of deductions that the retailer is allowed to take based on meeting certain criteria. These are often seen by the company as a necessary cost to continue the one-sided relationship with retailers, and as a result these are often accounted for during budgeting and planning.
The second category of deductions is the preventable type. These are deductions that occur based on some "process defect" in the transaction between the CPG company and the retailer. For example, shipping the wrong Stock Keeping Unit (SKU), missing shipment deadlines, data errors in EDI transmissions, or other noncompliance issues can result in these preventable deductions. In the multitude of unintentional business sins, these are the most unforgivable. Process defects within cross-departmental functions can result in millions of dollars in unrecoverable cash that under ideal conditions would already be in the company's bank account.
The last category is the unauthorized deduction. These are situations where for a combination of reasons, including fault on the company's part as well as intentional payment withholding by the retailer, a deduction occurs. Unauthorized deductions can vary by the size of the company, the types of procedures and regulations in place and can have varying impacts on the financials. In this situation, companies need to arm themselves with clear procedures, dedicated teams and the necessary tools to contest these deductions effectively and quickly.
One fact that was universally accepted among the companies researched was that regardless of the type of deduction, the amount of time and effort required to research and resolve deductions issues can be significant. As a result,many companies have teams of deductions analysts whose primary objective is to chase down paperwork, interact with interdepartmental personnel and negotiate with the customer. All of this adds up to costly headcount that could easily be redirected to more value added activities within the company.
Diagnosing the Problem
Conventional wisdom states that retailers like to hold onto their cash as long as possible. As a result, the reasoning continues, the retailer will do anything in its power to take deductions and short-pay their suppliers. However, many of these deductions can be easily prevented or contested if the proper infrastructure is available. In order to treat this recurring problem, it is important to delve into some of the root causes of retailers' payment behavior.
What studies have shown is that many times, the top reasons for deductions stem from the myriad of trade promotion programs offered,pricing discrepancies,returns and noncompliance related issues. The first is a direct result of the fact that special deals and promotions have to be run to incentivize retailers to stock the numerous SKUs that companies offer for sale. These trade promotions have different discounts, allowances and advertising commitments built in that allow retailers to deduct from payment based on different conditions. Oftentimes, the conditions stated are so complex that it is difficult for both the retailer and the supplier to determine the accurate discount or short-pay that should be taken. Therefore, the reasons for each deduction can be different, requiring a different method of resolution. As an example, advertising in the form of Marketing Development Funds (MDF) may have been taken as a lump sum deduction based on prior negotiation of terms by both parties. Alternatively, special deals or rebates (e.g., Buy One Get One Free, Point of Sale Rebates, etc.) may have different discount allowances based on a number of different factors driven by the conditions of sale. In the first case, research has to be conducted on advertising commitments and conditions, while in the second case, investigation may have to be conducted on the details of that specific trade promotion program.
Similarly, returns of products sold to the retailer can also generate unauthorized deductions. These can result in revenue leakages based on deductions taken for the wrong price,wrong discounts, etc. In an extreme case, which is common in many consumer electronics companies, the retailer will erroneously return a competitor's product to the supplier and subsequently take an unauthorized deduction on an outstanding invoice. These types of revenue leakages can be cumbersome to correct and sometimes tend to be written off due to the amount of time required to investigate these short paid invoices.
The main reasons that deductions are not contested properly and within a reasonable period of time are the following:
- Lack of complete and relevant information
- Lack of timely and efficient interdepartmental communication
- Unavailability of sufficient resources to investigate deductions and claims
- Absence of any systems to efficiently identify, track and resolve deductions issues
The end result of all of this is that many companies suffer from a high extent of dilution in their receivables and rampant revenue leakages due to their outdated processes and tools. This entire portion of the invoice-to-cash cycle is a critical area that needs sharper focus by companies planning for financial success.
Prescribing the Medication
The question arises as to how to best address this critical issue that drains millions of dollars from the bottom line. The immediate answer lies in establishing faster and more flexible deductions management processes based on a collaborative foundation. Companies that have utilized this new approach have been able to reduce revenue leakages without drastically altering the manner in which they conduct business with retailers. As an example of some of the factors that will remain challenging, we can return to the subject of trade promotions. In order to be successful and protect their dwindling market share from competitors, companies must continue to invest heavily in branding and promotions. This means that the large number and types of trade promotions will continue to remain at their current levels and will also remain complex. Similarly, the dynamic nature of highly seasonal industries will ensure that issues such as pricing discrepancies and returns continue to plague suppliers, at least for the near term.
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Another factor that will continue to remain a challenge is the fact that information will continue to be scattered within different systems. With the high level of mergers and acquisitions in the industry, companies have inherited a patchwork quilt of systems for different business functions. While many companies are attempting to consolidate all of this information into one single instance of their ERP system, this process has proven to have its own challenges, a key one being the sheer amount of time and resources that is required. This long timeline prevents companies from gaining rapid business improvements within a short time frame.
Currently, companies that are addressing the deductions problem are taking a multi-step approach to the problem. The first step is to understand all of the issues and challenges that contribute to the deductions problem. This includes closely examining processes and performance within the company as well as external parties like retail customer behavior. This initial step will focus the company's efforts on where the perceived problems lie within the invoice-to-cash cycle.
Second, a deductions management initiative is typically mandated by upper management. This is a critical step when embarking on any cash flow initiative. It is imperative that upper management understand that reducing revenue leakages is a competitive advantage within the organization. Since most companies need to be able to reinvest free cash flow back into building brands, it is critical for these companies to squeeze as much cash flow from operations as possible. With a mandated initiative, companies will be able to ensure that the appropriate level of visibility, attention and resources is paid to the project.
Then, a set of clearly defined metrics and goals is devised in order to be used to measure success of the initiative. It is important to understand which metrics are important to the organization. For example, it may mean reviewing different trade promotions and customer payment habits in order to understand the current deductions backlog and its implications. Next, it is important to understand the current deductions management process. You should understand common reasons for deductions and departments that are involved in their resolution. Additionally, in globally distributed companies, it is important to ensure that local metrics and goals are in line with corporate metrics and goals. This in turn enables a consistent measurement of enterprise-wide performance.
Next, a careful examination of the global organization is conducted to establish a rollout strategy. For globally distributed organizations, different operating units may have different cash flow problems. The challenge in primary business lines may be related to trade promotion complexities, whereas secondary business lines may be suffering from poor freight handling and a high level of noncompliance, leading to increased deductions. In either case, it is important to carefully scope out a rollout strategy which achieves corporate objectives rapidly, addresses the key business issues of different operating units, maximizes the chances of project success, and can ultimately finance subsequent phases of the initiative with the generated returns.
Then, these companies have focused on reviewing and transforming existing cash flow business processes. Collections and deductions management functions are the critical linchpins of cash flow management. By examining the invoice-to-cash cycle, companies can quickly identify areas that can benefit from business process automation and enhanced decision support. For example, the deductions management process may extend from deductions resolution to reconciling deductions with credit memos on the company's books to feeding deductions information back into a cash forecasting process. All of these functions should be looked at carefully in order to determine how to best achieve the objectives of the deductions management initiative. By looking at the invoice-to-cash cycle as an end-to-end process, companies can rapidly drive significant operational efficiencies and reduce revenue leakages.
Suppliers then established Shared Services teams for transaction intensive cash flow processes. A key component of the deductions management initiative is to make certain the right team is in place and focused on executing according to corporate objectives. In very transaction-heavy environments, especially those with distributed global units, it may be highly advantageous to launch Shared Service centers to service multiple operating units. In this manner, a smaller and more specialized team canaddress the needs of the entire company at a much lower cost of operations.As requirements fluctuate between different operating units, the utilization of the Shared Services team can be modulated and charged back to the consuming operational unit. In this way, the cost of operations becomes much more variable and in line with business need as opposed to consisting of heavy fixed cost investments in personnel, etc.
Concurrently, these companies have also utilized the latest in business intelligence, collaboration and process automation tools for deductions management. In conjunction with launching Shared Services teams, it is also imperative to empower them with the proper tools to gain business intelligence, automate processes and leverage advanced decision support capabilities. Leading tools that have been employed typically offer a full breadth of analytics, forecasting, portfolio management, deductions automation and workflow based collaboration for dispute resolution and charge backs management. In addition, having a consolidated platform for Cash Flow Management enables Shared Services teams to have global real-time visibility, ensure consistency in business processes, and automate highly transactional and labor intensive tasks. As an example, Leiner Health products, a leading retail supplier of vitamins, was able to reduce charge backs by over 75 percent within six weeks and also delivered the highly enviable result of boosting annual revenues by $17 million.
Finally, a strict focus was placed on continuously training and developing local first-line and support teams. No platform of people, processes and tools is effective without ensuring that an environment of continuous improvement and education exists. By continuously training first-line users and support teams, companies will be able to deliver self-sustainable improvements in operational efficiency and working capital management.
Prevention Is the Best Cure
A set of critical learnings gained from the study dealt with what companies perceived to be long-term solutions.The longterm solution most commonly cited was simply to partner with retailers and build stronger business relationships in order to prevent deductions from occurring. Many companies have joined Vendor Compliance Programs and Groups that are geared towards ensuring that transactions and relationships between retailers and suppliers are conducted using the highest standards of quality and result in long-term win/win situations for both parties.
Some of the objectives of Vendor Compliance Groups are the following:
- Enhancing and streamlining communication between retailers and suppliers
- Jointly determining the acceptable areas and levels of compliance of various transactions
- Allowing suppliers to gain a better understanding of retailers' requirements
- Providing a collaborative forum for suppliers and retailers to discuss and address compliance issues
- Promoting the latest in technology and best practices with respect to commercial transactions
As these programs are increasingly adopted by suppliers and retailers, companies have seen a great deal of insight into the actual causes of deductions. Based on this increased level of communication between trading partners, as well as having a data-driven understanding of deductions trends and root causes, companies can drive lasting business process improvements internally as well as throughout their supply chains. These improvements have helped to prevent many deductions by removing many of their causes, regardless of whether they are process-driven or data-driven. By focusing on issues around deductions management with a platform of improved processes, teams and technology, companies can ensure that their bottom lines continue to remain healthy while maintaining strong relationships with their retail customers.
Veena Gundavelli is the Chief Executive Officer and Founder of Emagia Corporation, software provider of Enterprise Cash Flow Management Solutions.Additional information on Emagia can be found at www.emagia.com.
