In this article, VP of Business Consulting, David Anderson covers a comprehensive overview of common types of rebates and use cases, tips for putting rebates to good use, and suggestions for avoiding the common commercial and administrative challenges rebates can pose.
In B2B pricing, rebates and incentives are a pricing best practice. Why? Because if you are not using customer rebates, you’re likely giving customers discounts they haven’t yet earned. Rebate & incentive best practices ensure that delivered purchases directly drive net price paid, and that the complexities of rebate administration do not outweigh the commercial benefits.
What Are Rebates and What Are They Used For?
Rebates are used to price on ‘actual’ rather than ‘promised’ purchases, instead of granting a discount upfront and accepting the responsibility to audit sales to the customer, or worse, not auditing, the seller grants a discount only for actual volume, thereby passing the risk of non-compliance to the buyer.
In addition to pricing on actual rather than promised volumes, customer rebates can be refined to drive specific customer behavior such as growth, retention, product mix improvement, or purchases of bundled offers. Like other forms of discounts employed to modify behavior, rebates allow sellers to communicate to customers how the customer receives the lowest price. The burden of realizing the lowest price falls to the customer with the rebate granted only for achieving the specified outcome.
Price Rebates 101
When quoting prices, many sellers in B2B consider the sales volume associated with the opportunity, deal, quote, or contract. For example, if a customer says they plan to buy 100 tons of LDPE (low-density polyethylene), the seller will quote a lower price per pound than if the opportunity is for only 22 tons. Or, similarly, 100 parts vs. 5,000 parts.
This practice, common across a number of industries, is called volume-based pricing or volume-based discount guidelines. The commercial rationale for the seller is that larger volumes create production, sales, and logistics efficiencies which can be passed on to the customer as larger discounts.
But what happens when the customer who promised to buy 100 tons only buys 22 tons? Or when a price quote for 5,000 parts generates an order that turns out to be only 800 parts?
In these situations of ‘over-promised volume,’ the seller probably cannot retroactively change the customer’s price. And, because the realized price does not comply with the volume sold, the customer has, in effect, extracted a noncompliant price. For Six Sigma practitioners, this is known as a defect. And, the defect has cost the seller money. A customer rebate program is employed to limit the gap between promised and actual behavior.
Types of Rebates
Rebates can be categorized by business objective and customer type. Rebates are employed to manage incentive programs to achieve business objectives and to improve the effectiveness of selling through distribution.
Examples of incentive rebates:
- Volume Rebate
- Growth Rebate
- Retention Rebate
- Mix Rebate
Examples of channel management rebates:
- Ship and Debit Rebates
- Indirect Customer Rebates
- Price Masking Rebate
Following is a brief discussion of each rebate type.
What are Volume Rebates?
Volume rebates are the simplest rebate and are designed to limit customer gaming and over-promising. Instead of quoting a price-driven largely by the customer’s ‘intended’, or ‘promised’ volume, the seller responds with tiered pricing where the Invoice Price is fixed. Still, the actual price varies with volume, and the difference is granted by rebate.
In response to a customer inquiry, the seller quotes these volume/price combinations.
The example follows a simple story where:
- Quantity refers to the quantity of each order, rather than the cumulative quantity
- And the quoted price is not the invoice price, but the price, net of rebates
- In all cases, the supplier will invoice the customer at $100 per part
- The time period is calendar quarter
Then, at the end of the agreed time period, the supplier will measure the customer’s actual purchases and issue a volume rebate equivalent to the calculation based on volume depicted in the table below.
What are Growth Rebates?
Growth rebates are a simple variation of volume rebates. Growth rebates, designed to revenue or volume drive growth in a particular product family, are like volume rebates with one condition: that the rebate is paid on incremental volume, rather than on all revenue or total volume. Growth is effectively a condition attached to a volume rebate.
What are Retention Rebates?
Retention rebates are rebates paid to reward continued business or customer loyalty. Retention Retention rebates are rebates paid to reward continued business or customer loyalty. Retention rebates can be rebates of any form, volume, mix, growth but are usually end of the year or “cliff” rebates, paid upon realization of a condition. Example: purchase from Company A every month in 2010 and receive the following rebate at the end of the year. Similarly, rebates can be used to smooth volume by giving customers with “lumpy” consumption a financial incentive to smooth purchases.
What are Mix Rebates?
Mix rebates are a best practice, designed to help improve the customer and product mix of a supply relationship. A seller uses mix rebates to encourage a distributor to sell more volume of higher mix, or margin, products, or sell more to selected end-users or end-user segments. Rebates should rarely be a constant percentage, for example, 2% on all revenue. A constant percentage risks misinterpretation as a discount. Paying different rebate rates or amounts on different product families and segments allows the seller to use rebates as a strategic lever and drive improvements to the product mix.
Mix rebates may be used with end-users, and absolutely should be used with distributors and buying groups.
Conditional Rebate is a term that can apply to any rebate type coupled with a set of conditions.
Rebate Program Examples:
- $2 rebate per chipset on all volume above 2 million units, paid if and only if handset ASP > $100
- 2.2% rebate paid on all volume subject to maintaining customer share of wallet >= 60%
Ship & Debit Rebates
Ship & Debit rebates are a special use case. They are rebates, in that they represent an off-invoice discount which camouflages the actual price, but Ship & Debit rebates are associated with a sale made through a stocking distributor.
A typical scenario of a Ship & Debit rebate:
- Manufacturer sells to a stocking distributor
- Distributor buys roofing tiles from Manufacturer.
- Distributor buys to hold in inventory, purchasing at either List Price or a negotiated “Into Stock” price.
- Manufacturer invoices distributor at Into Stock Price of $100/case.
- Distributor competes for a specific large job: Cal Tech’s new Earthquake Center.
- Distributor calls Manufacturer for price support.
- The Cal Tech job is large, very competitive, and Distributor needs to match a competitive situation.
- The end-user price is $90/case, a price lower than the Distributors Into Stock Price.
- Distributor wins the Cal Tech job.
- And ships 200 cases of roofing tiles from their inventory to complete the job.
- Distributor files a Ship & Debit claim.
- 200 cases x [Into Stock Price – End-User Price].
- 200 cases x ($100 – $90)case = (200 x $10) = $2,000.
- Manufacturer pays a Ship & Debit rebate of $2,000 to Distributor.
In many cases, a manufacturer may have volume, mix, and growth rebates with the distributor, and have volume rebates with the end-user, and pay Ship & Debit claims on the same transactions. The net price for these sales would be calculated net of ALL rebates.
Price Rebate Best Practices
Pay Rebates on Net or Pocket Price Points
In complex channel environments or when selling to large customers, a supplier may have multiple types of rebates on every transaction. The best practice is to pay rebates, not on invoice price but the pocket price.
- A supplier has monthly, quarterly and annual rebates with a “big box retailer” and pays a co-operative advertising discount of 2%. The supplier should pay the annual rebate on the price the net of monthly and quarterly rebates, and net of the cooperative advertising, if possible. The dollar impact of the difference is significant.
- Another supplier has rebates for the distributor, end-user, and buying group. If possible, the buying group rebate should be paid on the end-user price and net of freight. This is not always commercially possible, but at the very least, the supplier should make this point as a begrudging concession during negotiation.
Indirect Customer Rebates
Indirect Customer rebates, sometimes called end-user rebates, are rebates between a supplier and an indirect customer: that is, the seller never invoices this customer. Despite selling through the channel, the seller has visibility into major end-users, the supplier’s indirect customers, and wants to reward or motivate specific end-user behavior despite not having a credit or billing relationship with that customer.
Indirect Customer rebates are an effective tool for maintaining a strategic supply relationship with an end-user, and driving mix and volume objectives, despite the absence of a billing relationship. In most cases, Indirect Customer rebates take the form of a check, as opposed to a credit memo, which would be the case when a billing relationship exists. The servicing of “national accounts” often involves rebates of this kind.
Indirect Customer rebates and Ship & Debit rebates often apply to the same transaction.
Price Masking Rebates
The other common driver of rebate use is the desire to keep the ‘real’ price visible in the market. Because a rebate is, by definition, an off-invoice discount, the use of a price rebate allows the supplier to issue an invoice at a price that isn’t the actual, or net, price paid by the customer. Price Masking rebates, sometimes called shelter upcharges, are designed to allow invoicing at an artificially high price.
Price Masking rebates and shelter upcharges stem from a desire to avoid self-induced downward pricing pressure in competitive and transparent markets. In these situations, a supplier agrees to a price for a given customer but does not want to risk having that price become visible in the marketplace, believing, and rightfully so, that a price that low will cause market erosion. If other customers learn of that price, they too will want it.
Instead, the supplier invoices at a nominal price and then employ price rebates to bring the customer’s price down to the agreed net price. In this case, rebates are an effective method of quoting a low net price while invoicing at a higher price. The supplier recognizes that rumors of low net prices are one thing, but a low price on an invoice is the kind of evidence that can move markets.
Note: Price Masking rebates and shelter upcharges have been determined to be anticompetitive and illegal in some forms. Shelter upcharges are not a best practice, but you should understand the concept should they come up.
Similarly, when a corporate office does not want its regional offices to have visibility into true cost, the corporate office will often ask the supplier to issue all invoices at one price and then rebate the difference. National distributors frequently request this type of price rebate from their suppliers, effectively masking net price from their regional branches.
Avoiding any action that will create downward pricing pressure is a very good reason to employ rebates. But, if a supplier’s organization has trouble with the administration, management, or analysis of rebates, these tactical pricing options will be unavailable to them or more trouble than they are worth.
Whether you are using these types of rebates to reward incremental volume, avoid customer gamesmanship or mask your true price on an invoice, rebates are a strategic and tactical pricing tool. Every element in the price waterfall of a business should, therefore, be for a specific purpose. This is especially true of rebates. If your business uses rebates, it should employ a set of rules for when rebates are applied, how they are evaluated, and a detailed definition of the process for applying them.
We’ll assume that if you are reading at this point, you do have rebates. The question for you then is: Are rebates helping you accomplish your stated pricing goals?
Putting Types of Rebates to Good Use – Driving Desired Customer Behavior
Now that you are familiar with each type of rebate, the question becomes, where you use each type of rebate? Rebates should be designed to drive a specific type of customer behavior.
What we find, across verticals, is that many companies have very complex rebate structures driving one, simple customer behavior: revenue. Rebates have become more and more complex over time because they can, with Excel as the system of record. Yet customer behaviors have not evolved as an outcome of these increasingly complex rebates. In many settings, rebates become nothing but an additional driver of both price leakage and administrative complexity.
Every organization should evaluate rebate performance.
Do you have a rebate strategy? Are your organization’s rebates a strategic tool, or simply a cost of doing business, grandfathered from year to year?
Suppliers should review their rebate strategy, and start by setting goals. For each channel, customer, or segment, what behavior are you trying to achieve? For each desired behavior, establish which type of rebate to employ. Suppliers can create a set of rebate templates: a rebate playbook to help cut down complexity while ensuring the right rebate is applied to the right customer objective.
Common customer objectives and rebate types are depicted in the table.
After establishing a rebate playbook and picking the right approach for each objective, suppliers should review rebate templates to ensure that rebate complexity and rebate value are aligned. The After establishing a rebate playbook and picking the right approach for each objective, suppliers should review rebate templates to ensure that rebate complexity and rebate value are aligned. The chart below depicts the Complexity of the Rebate Structure, which ranges from low to high on the vertical axis. The horizontal axis depicts the Value of Desired Customer Behavior, which ranges from low to high.
The diagonal band represents the area of best practice. In the band, complex rebate structures foster specific and valuable customer behaviors. Such as gaining incremental volume in selected product families, and, thus, are considered best practice. Rebates of low complexity are considered best practice when they achieve desired customer behavior.
Where possible, use rebates to accomplish your price realization objectives. But if that is not feasible, then increase your price efficiency by streamlining rebate mechanisms and processes.
Sounds simple, right? Maybe not. How hard can a volume rebate be to track and manage?
In semiconductors, where matrix pricing is very common, characterized by per part prices decreasing with anticipated volume over predetermined volume buckets, customer gaming and overpromising is endemic. Rebates are an effective way of dealing with this overpromising. But rebates are considered to be more trouble than they are worth in many cases. Why would that be?
Price Rebates as a Driver of Complexity
Customer rebates are a best practice precisely because they address customer gaming and overpromising. Why is this best practice not used more widely? Rebates increase the complexity of pricing processes, adding administrative costs and complexities. In effect, for most companies, there is a variable cost to rebates.
Common Challenges Around Using Rebates
Visibility into customer net pricing, net of rebates, at time of quote
Some rebates are annual, set up once a year, and apply to all volumes that meet rebate conditions. Suppose rebates are set up by Management or maintained in spreadsheets or another system. In that case, the pricing desk and sales representative may be unaware of the existence of rebates at the time of quotation to a customer.
If you quote a price to a customer thinking it is a net price, and do not have visibility into the price net of rebate, you are experiencing price leakage.
When you match a competitive situation, and the competitor does not have a rebate, but you do, you are experiencing price leakage.
Analytical Visibility and Rebate Accounting Obligations
Visibility into actual customer profitability, net of customer rebates
After an order, suppliers working to analyze customer and product profitability turn first to invoice data. After extracting invoice data from a source system such as SAP BW, the pricing analyst loads variable cost data and endeavors to compare the margin contribution of all customer and product combinations.
But suppose if invoice price is the nominal price, before rebates where rebates exist, In that case, this waterfall analysis will be wrong or incomplete, and this customer will appear more profitable than it really is.
Clearly, rebates need to be incorporated into any customer and profitability analysis. But often, this is easier said than done.
Access to rebate information
Many companies do not have a system of record for rebate information. Rebate information is often kept in a spreadsheet by one person. Rebate accruals are managed in yet another system. If the pricing analyst does not have access to this information, profitability reporting is wrong.
Handling product bundles
Rebate visibility can be even more complicated if the rebate is at the product bundle rather than the individual part level. How does a supplier allocate the rebate on a product bundle to individual parts when evaluating part profitability?
Sometimes reporting and accrual systems accrue rebates at the customer level only or the customer/product family level. How does the supplier allocate the rebate to an individual line item invoice level? Over time these questions may cause many suppliers to abandon rebates altogether.
Actual end-user volumes
Often a manufacturer is utilizing an intermediary (distributor) to reach an end-user and employing a Ship & Debit rebate to set an end-user price. One or more distributors receive authorization for that end-user price in a multichannel environment, and the end-user may purchase through multiple channels. The manufacturer does not have full visibility to the distributors’ data, making it virtually impossible to track actual end-user volumes or volume rebate compliance.
This is especially true when several end customers can utilize the same product. This creates complexity in both administrating rebates and as customer compliance and win rates, etc (multiple distributors/channels are quoting on the same business.)
Some companies have a decent success rate in demanding and receiving point of sale (POS) data from their distributors. This may reflect the balance of power in some industries, or POS incentive rebates in others.
Administration of rebates
Also consider that revenue accounting rules require that rebates are tracked and accounted for properly and that financial statements reflect accurate income reporting given the impact of rebates on financials. It is thus a legal problem for a business to not fully understand and have controls in place to understand where rebate relationships exist, to properly accrue for the best estimate and impact of rebates in revenue reporting to the fullest extent possible at the time of a transaction.
Whether rebates are issued by credit memo or check, sellers and the financial team require a process for:
- Establishing rebate agreements
- Monitoring actual shipments vs. projected/forecast volumes
- Determining which shipments qualify for a rebate
- Calculating rebate
- Accruing for rebate
- Managing any rebate claims validation process with channel partners
- Issuing rebate check or credit memo
- Evaluating rebate for effectiveness
- Planning for next year’s rebate
The administration of rebates is often such a big problem that many companies chose not to employ them. In effect, these suppliers are choosing to sacrifice price effectiveness for price efficiency. Most suppliers understand that customers game them, would like to do something about it but view rebates as more trouble than they are worth.
The pricing best practice here is to substantially automate the rebate processes, removing all friction/variable costs from the rebate process so that a supplier can use rebates as a tool to increase price effectiveness and end customer gaming/overpromising.
Even if a supplier has a process for issuing and allocating rebates, that supplier may fail to use the rebate tool effectively instead of allowing rebates to outlive their utility.
The problem, of course, is that rebates get rolled over from year to year without being closely inspected. Once established with a goal in mind, they quickly become expected by the customer and the sales representative. The seller is afraid to roll them back for fear of losing customer volume.
Rebates should be used to drive a very specific type of desired customer behavior. In the example above, the supplier wants the customer to buy more volume, and gives a price incentive to do so. By employing a rebate, the supplier makes sure that the customer only gets the price incentive if they actually buy the desired volume.
Significantly, with the price rebate mechanism in place, the burden for extracting this lowest price falls to the customer, not to the pricing desk.
Because rebates require an administrative effort to establish, most rebates apply not to spot opportunities but to ongoing supply arrangements between the supplier and ongoing trading partners, monthly customers or distributors. Rebates between regular trading partners are often established annually during a joint planning meeting.
If the seller cannot quantify the cost of a customer rebate program on an annual basis, or directly measure the impact of that rebate in relation to the behavior that they seek to encourage, then this is back in the category of rebate worst practices.
If sellers do not track these programs or quantify rebates accurately, they are also not compliant with revenue accounting rules and can be subject to penalties.
In Vendavo, with a ‘Rebate Performance Dashboard’ the seller can:
Track the impact of that rebate program along with a number of KPIs
An incentive rebate is a discount like any other. A $1 invested in a rebate has an impact that can be quantified in volume, mix, or retention benefit. This can and should be quantified in a way that helps to compare rebate effectiveness.
This document provides insight to types of rebates that are directly linked to one or more products, examples below:
- 1% on all revenue, means a 1 % rebate on all products
- 2% on product family A, 3% on product family B, similarly, can immediately be allocated to those product families
- $1.50 per part x is also easy to allocate
But what about rebates of this form?
I’ll give you, Mr. Distributor, $50,000 to help support your participation at the following trade show (at which you will represent my products)
From the perspective of waterfall construction, this $50,000, while certainly an off-invoice discount, is not a rebate. This kind of co-marketing expense would be reflected in another, non-rebate, waterfall element. The allocation of these kinds of ‘slush fund’ programs is non-trivial, and is dealt with in another document.
Waterfall Element Sensitivity
There are different types of rebates, employed for different tactical pricing objectives. In addition, there are different kinds of buyers. Some buyers seek to lower their ‘price,’ the invoice price per unit; other buyers seek to maximize their rebate checks, or the growth of their sales rebate payments year over year.
Over time, Vendavo can help sellers interpret their transactional data, telling the sellers which customers and segments appear to be very sensitive to invoice pricing changes, which appear to be more sensitive to changes in rebates.
This kind of information can help you increase prices more effectively. Increasing invoice prices to customers most sensitive to changes in rebates, and decreasing rebates to customers most sensitive to changes in invoice pricing.
Drive Customer Behavior and Avoid Price Leakage with Rebates
Rebates are a pricing best practice for driving specific customer behavior and avoiding price leakage. Define a sales rebate strategy, pick the appropriate rebate, and manage execution tightly, measuring to ensure that they are accomplishing the intended goal.
Uniquely, Vendavo has capabilities that span commercial process, price setting, analytics, and rebate accounting execution. If you are interested in expanding the use of rebates in your pricing strategy, or are simply looking for more controls and visibility of rebates in your commercial or revenue accounting processes, give us a call.