Editor’s note: Because of the sensitive nature of this topic, many of the interviews used require the condition of anonymity. The article reflects the thoughts and opinions of many OEMs, with many names withheld.
The trend of large CPGs, pharma, and food and beverage companies forcing extended payment terms isn’t news. From a mainstream perspective, The New York Times’ Stephanie Strom wrote about the trend in April 2015, Big Companies Pay Later, Squeezing Their Suppliers. And PMMI’s own Chuck Yuska has gone to bat for OEMs in various mainstream media editorials and opinion pieces.
“Late payments are squeezing small businesses that create almost 60 percent of new American jobs and employ half the workforce,” Yuska stated in a recent editorial in the Rochester Business Journal. “Late payments are also against these corporations’ self-interest: If these suppliers can’t hire, their productivity and innovation will stagnate. And if they shut down, prices will invariably rise.”
But for the OEMs themselves, the situation is most often relegated to hushed tones over drinks at association meetings and trade shows. It’s difficult for an OEM owner to publicly discuss. If one OEM takes a stand, a competing builder may look more attractive to CPGs by comparison. It’s not a hill many are willing to die on, but they may die on it anyway. Suppliers are essentially floating loans to the extent of funding their customers’ projects—out to 180 days as one contract we saw suggests. The trend is becoming impossible for OEMs to bear, much less willfully ignore.
CPGs risk hurting themselves with extended payment terms
Because extended payment terms present an existential risk to OEMs, the negative impacts hurt the very end users who implemented the terms.
“In the long term as a customer, they’re going to face limited choices. Or declining innovation and solutions because of the suppliers’ inability to fund their businesses,” says Glen Long, SVP, PMMI. “Customers will have less choice in terms of the number of vendors to choose from. And the innovative solutions that are coming from these members will decrease if they’re less inclined to take this business.”
An engineer at one Midwestern OEM has seen this movie before. Coming from the automotive assembly field, he saw smaller automation houses pushed into extended payment terms by the muscular ‘Detroit Three.’ And when delaying already long-tail automation projects, the negative cash flow became unfeasible for the suppliers, resulting in their shuttering or leaving the market.
A similar dynamic could befall OEMs, alongside their ‘big boy’ customers. Leverage lies so heavily on the CPG side, forcing OEMs into one of two choices. One family-owned OEM explained how it walked away from a “huge client” due to that client’s intractability on unfavorable terms.
"They" Make the Rules Now
Another Western OEM went the other direction. “We have had to extend our window for them because those companies are not willing to budge. They set the rules, so we have to either be flexible to get the order from those big companies, or to just lose the order altogether. They seem to have no problem walking away if we aren’t going to give them the terms they want,” he says.
The Midwestern OEM went on to cite different types of projects, and how some can handle positive or neutral cash flow than others. But the differences in those project types portend something bigger for the industry as a whole.
“[We generally desire payment terms intended and desired] to be at least cash flow-neutral,” the Midwestern OEM says. “Large or very custom systems with a high content of engineering should be more cash flow-positive due to risk inherent with custom projects. They add that standard machines that have a short lead time allow them to be more flexible with payment terms.
But such extended payment terms cause major distress to OEMs with comparatively few, engineering-heavy projects, per year. And in so many cases, those smaller, one-off, high-engineering-content jobs are the vanguards of real innovation that drive the industry forward. These are the innovations that stand to make CPGs more competitive. That being the case, OEMs say that CPGs aren’t doing themselves any favors with extended payment terms on such jobs.
“It hurts small/medium/big companies who pay their suppliers net 10 or net 30, like our company,” says Emmanuel Cerf, PolyPack, Pinellas Park, Fla. “We then become the financial institution for our customers.”
A playing field tilted toward foreign competition
Financial advisers manage big CPG and food/beverage companies, not the people to whom OEMs are directly selling. Those folks, sometimes engineers themselves, are often sympathetic to the OEMs’ plight. John Giles, manager, Operations Engineering, Amway, Ada, Mich., is a good example. In response to a PP-OEM survey in which 42 percent of OEM respondents considered net 60 to be a fair payment window, he said:
“To me, the surprise is that [so many] said net 60 is OK. We went to a net 60 model two years ago and it was a disaster [for] OEMs. It ends up being a procurement and negotiating thing for us,” he says. “But we take the first stab at that net 60 days and we’re responsible for that. If the OEM doesn’t deem that acceptable, then we let them deal with the procurement department. We get out of it at that point.”
The European Union legislated its way around this disconnect with the Late Payment Directive. This on-the-books 2013 EU law safeguards smaller businesses from extended payment terms from their larger customers. A collection of sovereign nations trading across borders, this only made sense as over-border trade is notorious for creating extended payment term situations. The U.K. enacted its own version, the Prompt Payment Code. While nonbinding, it encourages reasonable payment terms.
“In the European Union, they abide by the Late Payment Directive. It requires public authorities to pay their suppliers within 30 calendar days of receipt of an undisputed invoice,” Yuska says. “In Europe, payment terms for business-to-business payments as fixed in the contract cannot exceed 60 days unless otherwise expressly agreed, provided that the terms are not ‘grossly unfair.’ Under the directive, the 60-day limit also applies where a public authority is carrying out ‘economic activities of an industrial or commercial nature’ by offering goods and services on the market. However, the U.K. has opted to keep the limit at 30 days for this type of contract.”
The Supplier Pay Initiative
The Obama administration created the Supplier Pay Initiative (called SupplierPay) as an American version of the U.K.’s code. Created in 2014, it’s a similarly voluntary pledge, unlike the European binding legislation. But OEMs say SupplierPay has no teeth to bring companies to the table. Or worse, CPGs are coming to the table, but not fulfilling their pledge’s commitment.
While the roster of companies signing up for SupplierPay has grown, the program has less than stellar results. Some stats say that more than half of the companies who pledged have extended their overall payment days by a median of +1.9 days. Without legislative muscle, OEMs see this as a weak first step, and Yuska agrees.
“Sadly, all that appears to be window dressing,” he says. “Based on supplier reports, the situation appears to be getting worse in the CPG industry. Companies like Anheuser Busch-InBev, General Mills, CocaCola, and others continue to withhold payment for 90 and even 120 days upon delivery of services.”
In a letter to suppliers, a large CPG offered this rationale:
“A recent study confirmed that our current payment terms are significantly shorter than the industry standard. As a result, we have made our standard payment terms a minimum of net 60 days.”
Fear of a New Standard
Yuska worries that a multinational company adopting devastating extended payment terms practices as “industry standard” clears the way for other companies to follow suit. That will force small and medium-sized businesses to carry the burden of extended payment terms. And it’s not like those companies aren’t in a position to pay, as many are sitting on piles of cash.
Cerf worries that the fact that big muscle can dictate an unfavorable business environment helps threaten American technology. Meanwhile, foreign counterparts can get government assistance to export equipment and, therefore, accept unrealistic terms.
“The industry has become a financial game instead of a technological enterprise, the bottom line is that bankers do not produce anything, they just move money around to be able to keep a part of it,” he says.
The aftermarket problem
Long-standing OEMs have thousands of machines in the field designed to last. But they won’t last without regular maintenance, and wear part replacement is a necessity.
If longer payment terms force builders out of the industry or force consolidation, some OEMs note that parts and services will become more expensive.
One Southern OEM with machines around the world said that over the course of a machine’s life, the general operation requires fresh parts. Some manufacture those parts at the time of order. A CPG may have 50 machines from a vendor that he or she has to keep operating 24/7. Interruptions occur without a steady, quality parts supply.
“Would you shift your source of wear parts from the original equipment manufacturer, who designed the part, to, say, China?” that OEM asks. “It could and does work for some parts, to be sure. But it’s also adding risk, both in availability and quality.”
Leveraging innovation
Donald Copertino, senior counsel at Becton Dickinson, a large pharmaceutical end user, is pushing for more innovation for his company’s pharma packaging lines. He has been relying particularly on smaller OEMs for more unique, custom solutions. In working with these OEMs, the company recognizes that net 120 payment windows are not compatible with innovation. Larger OEMs can commit more manpower to multiple projects at once. Smaller OEMs, however, may only have enough people on the floor to handle one project at a time. This puts them in a dangerous position if they were to take on a project with a long payment window. However, the company says there is value in working with smaller OEMs. Smaller OEMs make it easier for the company and other multinationals to be flexible to accommodate their terms.
“OEMs need to understand the payment terms they are getting [come from] corporate procurement groups, and a net 90 or longer payment schedule isn’t uncommon for them. OEMs are designed to be innovators, and a lot of times, they can’t adhere to an unrealistic net 120 payment schedule because their cash flow doesn’t support necessary innovation,” Copertino says. “Our business understands that long payment windows are not reasonable for a small, nimble OEM that might have 10 people in the company. How can you wait a quarter before you get paid?”
Until help arrives, OEMs try to make it work
Though each OEM may have a specific set of tactics relating to payment terms, some general strategies help to mitigate friction for OEMs.
Copertino urges OEMS to negotiate with end users and procurement groups when possible. He says that he and other large multinationals willingly accommodate shorter payment windows for female- or minority-owned business, or family businesses.
“It’s definitely something that should arise during negotiation. Although there is no formal process in the industry for these small businesses to negotiate terms, if you don’t ask for shorter payment windows, you aren’t going to get them. But don’t spend six months trying to negotiate to meet in the middle. End users need to get their lines up and running quickly. So, negotiations [are] a waste of time that they do not have,” he says.
Another tactic can involve making the end user pay more for longer windows. A second Midwestern OEM with whom OEM spoke builds the cost of long payment windows into their terms. This gets customers to agree to shorter windows.
Cerf agrees with that tactic. “What our customers do not realize is that they are paying more for our equipment than if they respected net 30 days terms. Our cost of operation is much greater as, in turn, we have to finance our R&D and/or growth,” he says.” For example, we have had to secure a loan to add 24,000 sq. ft. of production area. If all of our customers paid us net 30, we could have paid cash. Instead, the cost of the loan ultimately [adds on] to our equipment costs.”
In an effort to level the playing field further, OEMs can use the “proof of principle” method. This tool reduces and manages technical risk and demonstrates feasibility. Set a payment schedule that specifies events and milestones with payments that should follow. These milestones could include the initiation of purchase, design reviews, fabrication of a system, factory acceptance testing, site acceptance, or delivery of final documentation. However, OEMs should avoid disclosing the cost of specific events, like purchasing machine components, in the schedule.
“Procurement groups will try to disassemble your bid where you are telling them why a certain amount is going to components or other factors. They could come back and say, ‘That is too expensive.’ Instead of allocating money for what those components cost, focus on [the time of purchase] and put that into the system and what milestone you can classify that as,” Copertino says.
Incentivize Scheduled Milestones
Other OEMs introduce incentives into schedule milestones. Incentives and penalties may also help both parties adhere to terms, conditions, and schedules more closely.
“We use bonuses for early deliveries and penalties for late deliveries. We offer both the carrot and the stick because we have to hit the schedule right on target. Developing the schedule together during specifications is extremely important and allows you to create these incentives,” Copertino says.
When developing a unique payment schedule, assign different payment terms for different milestones to mitigate longer payment windows. For example, a net 10 window for the up-front payment may provide the OEM with more cash flow faster.
“If we are working with a longer window than net 60, most of the time, we end up settling on a larger down payment to counter it,” one OEM said.
In contrast, the Western OEM says its biggest challenge is landing its standard payment of 40 to 50 percent down before product initiation.
He says there is a lot of pushback to get that initial payment as small as possible. And has had end users asking for as little as 10 percent to get started.
Beyond negotiation tactics, a sure-fire way to ease payment window friction points is something most OEMs are already doing.
“Once you have established a relationship with an end user, it makes contracting easy. There is value to an end user in knowing that you are a valuable OEM supplier,” Copertino says. “As you develop relationships over time, those terms could relax a bit to help your company be much more effective.”
