The Raucous About Food Service Rebates | Better Food Cost Control Alternatives

Posted by: Seva Procurement on Apr 24, 2014 at 5:51 pm |

The past year has seen the emergence of many new food service distribution trends.  Among these trends is the growing desire by restaurant owners and operators to gain access to the available pool of food service manufacturer rebates, along with the corresponding rise in food service buying groups.  Unfortunately, this rising trend has often resulted in little more than frustration by all parties involved–restaurant owner, distributor and manufacturer.  A closer examination of the rebate driven, non-committed procurement model as a food cost control technique, along with the history of this practice, reveals serious and inherent flaws in the system.

The underlying principle behind this reality has been addressed in a previous Seva Procurement blog article, Strategic Relationships in Food & Beverage Management.  The primary thesis of the article was that effective procurement strategies are not based on leveraged negotiation alone, but rather through a combination of negotiation and an understanding of the cost structure in the supply chain.  In other words, to get the best price, operators need to not only negotiate pricing based on their available purchasing leverage, but to also try and reduce factors that inflate costs throughout the various points in the food service supply chain.  Examples of such costs are delivery drop sizes, non-committed volume, cost of extending credit and the level of in-person customer service required.  In short, our belief is that any effective procurement strategy will attempt to reduce costs throughout the supply chain, rather than adding to them.

The inherent failure of rebates as a procurement strategy is due to the fact that manufacturer rebates increase supply chain costs, rather than reducing them.  As mentioned previously, the economic realities of such practices are the inevitable increase in costs for everyone–including the restaurant operator.  To understand this, it is helpful to briefly examine the historical supply chain landscape that has led to the current rebate frustration.  Over the years, distributors have served a role beyond that of merely shippers of products.  Because manufactures had no direct access to the end consumer, manufacturers have turned to distributors to market their products.  Specifically, manufacturers looked to distributor sales representatives to leverage their customer relationships and market products.  To promote this relationship, manufacturers offered rebates to distributors, also known as allowances and earned income, that were based on the case movement of their products.

While under the original supply chain model these trade spend practices were logical, the supply chain landscape has shifted over the years, making the execution of rebates, as they were intended, inefficient and ineffective.  As distributors began to offer far more private label products, manufacturers realized that distributor sales representatives no longer marketed the manufacturer’s branded products, but rather the distributor private labels.  This shift from partner to competitor has caused many manufacturers to question the effectiveness of their distributor allowance programs and seek alternatives.  While distributors have continued to collect these rebates, it has become increasingly apparent by manufacturers that these rebates are being paid out on volume that would have existed regardless of any rebate programs, as the purchases were not the result of marketing efforts by the distributor.

The logical evolution of this practice was for manufacturers to try and provide these rebate incentives directly to the consumer and bypass the distributor as a means of marketing.  Again, this seems to be a logical solution for manufacturers trying to influence consumer purchasing behaviors, once they were unable to rely on distributors to execute this role.  Manufacturers, again, often had no access to the consumer to promote these rebates, other than food shows, so they required a replacement to the distributor sales representative.  As a result, purchasing cooperatives and buying groups began to spring up to fill this roll, offering rebate incentives to influence member behaviors.  The emergence of these buying groups, however, came with their own set of problems that has rendered them ineffective as a procurement management tool.

First, the emergence of these buying groups, also know as group purchasing organizations (GPO), have directly impacted distributor revenue, as rebates that are paid by manufacturers to the end consumer through buying groups are deducted from the allowances they pay to the distributor–this volume is known as non-qualifying volume.  Normally, the distributors are the default recipients of these manufacturer rebates, but this revenue stream is reduced every time a manufacturer pays a rebate directly to the consumer through a buying group program.  From an economic perspective, the manufacturer position makes perfect sense–they are willing to offer marketing rebates to whomever can drive case movement, which was the intended goal from the very beginning.

On the other hand, it is understandable that distributors do now wish to see their allowance revenue decreased–no company wants to lose an existing revenue line.  Even so, a very strong and compelling argument could be made that this is simply an economic readjustment and that distributors will need to cope with the loss of this income, as it was not a direct result of their fundamental business model to begin with. This statement would be easier to make and execute, if it were not for prior distributor business decisions that now make the loss of these allowances impossible for the distribution model.  Specifically, as consolidation and increased competition among distributors has increased over the years, distributors began to offer master agreements and street pricing that factored in this rebate revenue on the back end, as most rebates are considered “off-invoice” and do not factor into the cost of the product for the purposes of determining the customer sales price.  For example, if a distributor had a break-even point of 8% over cost, they may be willing to extend an 8% contract to a potential new customer to gain their business, because they know the resulting volume will generate an average of 2% in allowances from the manufacturer, providing them the necessary margin to service the new business.  So, while the master agreement extended to a consumer might be at the break-even mark, or a slight loss, this is balanced out by these manufacturer allowances.  In our opinion, this is where a lot of the current trouble can be traced.  Over the years, this type of practice became more prevalent among distributors, despite that as a business practice it was probably unwise for distributors to manipulate pricing in such a manner if they had considered the likely long-term possibilities.  Regardless of its prudence, this practice has added a layer of complexity to the supply chain that needs to be more closely examined to uncover whether rebates will, in the end, provide any benefit to the restaurant operator, as it is unrealistic to expect that any business will operate at a loss.

As more consumers elect to participate in rebate buying groups, distributors are faced with losing the revenue that they relied on to make the master distribution agreements and street pricing they extended economically viable.  In other words, their prior business model is seriously undermined if the economics of trade spend are realigned, as the growing popularity of buying groups is trying to do.  The astute reader should begin to see the inherent flaw behind these rebates–that any operator savings resulting from these rebates will be countered by the necessary increase in distributor pricing so that they can continue to operate at a profit.  A big part of the current acrimony between restaurant operators and distributors is due to the fact that most operators (those that have negotiated programs in place) are unaware that their current prices have typically been artificially lowered by the distributor because of these off-invoice allowances. It is worth noting, however, that we are looking at larger macro principles and that there are no doubt countless examples of distributors that are both charging a hefty profit, as well as collecting these rebates.  Our goal in this article, however, is to address the economic weaknesses of rebates and trade spend, as well as the reality that rebates are not effective for those operators looking to seriously manage their procurement practices, because of these weaknesses.

The result of this reality is that distributors have recently made a concerted effort to block the growth of buying groups.  This attempt by distributors has, in fact, proven to be highly successful in many cases.  As buying groups often require the electronic transmission of client purchasing data directly from the distributor to process rebates, by refusing to provide this data feed, distributors are able to basically block an operator’s ability to participate in these programs.  By so doing, distributors are able to stave off the inevitable, uncomfortable reality of having to raise their prices because of this shift in trade spend.

There is another issue that has developed with the emergence of buying groups, as well.  In the beginning, buying groups were setup to represent larger hospitality companies.  Manufacturers would extend rebates to these groups because they would then work with the members to ensure purchases were aligned behind the participating manufacturers.  As the strength of these group purchasing organizations grew, along with their book of manufacturer rebate deals, many of these groups decided to extend their programs to smaller, independent and regional operators.  By so doing, these groups were able to increase their overall case movement and capture more manufacturer rebate dollars–some of which are passed on to the operator and some of which are kept by the group purchasing organizations as a fee.  While this seems like a wise business strategy on their part, it often altered the spirit of the existing manufacturer rebate programs because these buying groups were reporting this independent and regional volume to collect available rebates, but they were doing little, if anything, to modify operator behavior in favor of participating manufacturers.  In the end, manufacturers ended up with the same predicament that they had with distributors–they were paying rebates to operators for volume that they would have had regardless of whether they paid the rebates. The result is the failure of rebate buying groups to be an effective, long term solution because it fails to address the needs of the manufacturers, again adding costs to the supply chain.

Because of all these issues, we are seeing an increased pressure by both manufacturers and distributors to curb these rebate and trade spend programs.  To be clear, it is not that either party is against offering valuable procurement programs to operators that provide mutual benefit, but that these programs are inefficient and ineffective at producing mutual benefit.  Our belief, and recommendation, is that this non-committed trade spend should be removed from the supply chain ecosystem so that costs can be accurately assigned to each supply chain partner and the true cost of goods and services understood.  From that point, more efficient practices and programs can be implemented that will result in benefit for all.

While there are undoubtedly operators that have been able to benefit from these rebate programs, we believe that the value derived from these programs is misleading.  The very inefficiencies created by these trade spend practices, as defined above, should indicate to operators that there are better ways to manage procurement that will result in significantly higher savings.  In fact, the average savings that an operator receives from rebate buying programs is 1% of their total spend–2% at best.  That being said, there is incredible tension in the industry at the moment due to fighting over whom this 1% belongs to.  The reality is that almost 100% of this trade spend is simply increasing supply chain inefficiencies, driving costs up for everyone–including the consumer.  By focusing on these programs, operators are missing many procurement opportunities that can deliver actual procurement value. In other words, attention is being incorrectly directed towards rebate programs as a way of reducing procurement costs, rather than focusing on those programs that truly offer value by avoiding all of the inefficiencies described in this article.

We refer to these rebate programs as misleading, because operators often feel that they are extracting value from the supply chain by joining these buying groups–which are everywhere now.  In reality, they are leaving about 13% in savings on the table because they are using a program that works against supply chain efficiencies and basic economic principles.  In contrast to these rebate programs, procurement solutions, such as those of Seva Procurement, work with restaurant owners, as well as manufacturers and distributors, to provide operators with procurement strategies that are able to significantly lower costs.  The end result of programs such as ours are savings directly off the invoice, rather than rebates, of 10-15%.  The point here is not to market the Seva Procurement program, but to try and combat the rising industry tension surrounding rebate programs and offer some visibility through this current rebate tempest.  For all of the previous reasons, operators should be wary about using any rebate program as part of their procurement strategy.  Whether they decide to use Seva Procurement as their procurement solution, or whether operators decide to manage their own procurement, our advice is to work with your suppliers, not against them, to get access to true procurement savings that will drive double digit savings–far beyond any non-committed rebate program.