The Proliferation of Operator Deviated Pricing

No less than 10 years ago, what many of us in foodservice now refer to as “the good old days,” the majority of operator discounts and allowances were rebates – this much per case or that much per pound.  For special situations where the volume was large and the operator actually committed to buying your product, you would reluctantly offer a deviated price.  Those prices were well-controlled and were only offered after a thorough analysis and justification process.  The reasons most folks were reluctant to “open the flood gates” back then still hold true today –

• Deviated prices carry higher administrative costs than rebates due to the ambiguity of the effective claim rate.
   
• Uncertainty around how much of the discounted price would ever reach the operator.
   
• Risk that distributors would “go up and down the street” with the hot price, upsetting balance in the market and costing you money for volume that did not require the discount in the first place [the elusive “full list price street business”]. 

Flashing forward to 2010, the new reality is that Chet’s Chevron in Small Fry, Mississippi, now receives multiple deviated pricing offers on just about every category.  The flood gates aren’t open … they have been removed from their hinges and thrown away.  It’s at this point in the conversation that I often hear “that’s just the cost of doing business in foodservice.”  Before we jump to that conclusion, consider the following statistics from a recent survey of the industry:

• 80%+ of the deviation price offers are “Private,” meaning that only a single distributor is aware of the offer and has access to those discounts.
   
• Only 12% of the operators “know” a special price is available for them.
   
• Less than 20% of the local [e.g., not national chain accounts] discounts affect the ultimate price to the operator [e.g., the operator price from the distributor remains the same with or without the deviated offer].
   
• Of the discount amount, when it does “pass through” and result in a lower price to the operator, the pass-through impact is less than 30% of the full possible amount.
   
• More than 40% of the “wins” by any given distributor are actually straight conversions of business a second distributor already had for the same item [but now at your expense].

What should you do about it?  There are three relatively simple yet effective steps you should take today:

1. Begin notifying the operator that you are offering a discount for their business.  This will help drive integrity into the market on pass-through value and also take a step in the direction of building a value-added link between your brands and that operator.
    
2. Write a policy and create a process to control “Public” vs. “Private” offers.  Public operator pricing offers should be communicated across the relevant distributor community to level the playing field and introduce the notion of competition for the ultimate price of your product.  This should be the majority of your blanket bid prices and local/regional operator pricing offers.  Within your policy and process, you should escalate approval requests that are private in nature, where only a select few privileged distributors are made aware of the prices.  This should be driven by a request from the operator to secure their pricing agreement to only their appointed distributors.  If the operator is not involved in naming the distributors, your process should ensure there is a healthy debate around “what’s in it for you” to go private.  Private offers ought to drive some degree of security for your business. 
    
3. Validate the source of volume and the incumbent competitive product.  The reasons for validating the current supplier and the source of volume before you jump into the fray are simple … you should make sure you are not supporting the conversion of your existing business, either with the same distributor who already has the business, or, from one distributor to another.  This can be an especially costly scenario when the pricing offer is also a private one.  In that case, it is more likely that the pass-through value will be low and the operator will continue paying close to “list” price for your product.  In that scenario, your deviated pricing funds are really just more sheltered income labeled with a different description.

The Real Costs of Operator-Deviated Pricing: 1% Plus of Gross Sales

Aside from ensuring value for the dollars you are spending, there is an even bigger economic story that supports taking action right now.  As a starting point, your annual savings begins at 1% of gross sales for executing a process to better validate deviated pricing claims [e.g., billbacks].  Consider the following, which is based on our analysis of more than 1 million deviated price claims processed in the past 2 years. 

For each increment of $50 million in gross sales:

• The average manufacturer offers operator discounts on 40% of their overall volume [this includes national accounts, bids and regional or local operator discounts].
   
• The industry averages 15% as the depth of the discount between list price and contract or bid price, eg, a $40 per case average selling price leads to an average operator deviated price of $34 per case.
   
• Based on that, the typical manufacturer spends just about $3 million on operator discounts, or, about 6% of gross sales [15% of the 40% of the $50 million].
   
• Of those $3 million, some are rebates paid directly to the operator [such as Foodbuy, Premier, ARAMARK, etc.], but, across the industry operator deviated pricing is now 65% of the operator spending pool.
   
• That means we are spending roughly $2 million out of every $50 million in sales, or 4%, on operator deviated pricing discounts [65% of the $3 million].
   
• Based on our analysis of more than 1 million distributor billback claims representing more than $1.5 billion, our data suggest that the error rate on those claims is close to 30%.  The overwhelming majority of that error rate is concentrated on the accuracy of the claim rate.
   
• That means, rather than claiming $6 on the $34 contract price from this example [with the $40 per case into-stock price] -- on average, the claim is $7.80 per case.  If that sounds high, keep in mind that any claims made against items that were not specified in the operator agreement or bid each contribute their full value to the statistics.  Currently more than 15% of the items claimed against deviated pricing offers were not eligible during the timeframe the claim was made.
   
• Based upon that, out of each $2 million spent on operator deviated pricing, the statistics suggest potential “over spending” of $585,000, or just over 1% of the $50 million in gross sales

Now, let’s consider the administrative costs if you want to audit those claims and if you have to take on that challenge without sophisticated technology to help you: 

• The $2 million in claims suggest roughly 2,000 billbacks [or deductions] at an average value of $1,000 each.
   
• In a manually-driven validation process, your resources are likely to invest 30 minutes for each claim audited, looking up into-stock prices and confirming the details from the contract or bid you offered.
   
• That equates to right around 975 hours, or just over 40 days.  Assuming 2,000 “available” hours annually per FTE, that means one half of a full time person for every $50 million of sales is spent on deviated price validation and reconciliation.
   
• Even at a bargain rate of $40,000 per year for that resource, you would have just spent 2% of your operator discounted budget of $2 million on the administration of those prices.  You have to wonder if the finance folks built that extra 2% into the equation when they determined just how low you would have to go to meet competition for the business at Chet’s Chevron.

Here is a final thought: Assume that the math is off by half.  Rather than $585,000 from deviations and another $40,000 in resources, it would be “only” slightly more than $300,000 for every $50 million.  So, before you conclude that this is just an example of the “cost of doing business”, ask yourself this … how many hours did you spend this week in meetings where the decisions you made can earn you $300,000 for every $50 million on the conservative side, with an upside over $600,000?

Thank you for taking time to visit the blog.  For more information about Blacksmith Applications and our solutions for industry issues such as this, you should visit our web site at www.blacksmithapps.com.   You can also post comments or additional thoughts on this subject from the comments link below.