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REBATES AS A FORM OF DISCOUNTING

Peter Cox explores the world of rebates, giving the facts behind the numbers to determine when, and in what situation, they are a good idea. 

Pest controllers and pest control groups ask for and receive rebates from suppliers for many varied reasons. Usually it is a volume rebate, whereby the pest controller or distributor buys up big and the more they buy the greater the rebate. Sometimes a manufacturer will give a rebate as an inducement to move loyalty to them.

In America, the whole supplier and end retailer relationship has changed in the last 25 years. The retailers (Wal Mart for example), through their market share and power, are demanding better prices from manufacturers. At some point the decision has to be made by the supplier, whether they can produce the item for a profit, if not why make it?

What is the effect on the manufacturer of giving say a 10% rebate to a distributor? What will the rebate be used for? Once a rebate is given to one retail group it won’t take long for the rebate to be asked for by other retailers.

Case study of giving a 10% rebate

Before Price Reduction With a 10% Price Reduction
Sales

– 1000 units at $50.00

$50,000 $45,000
Less Cost of Production

– 1000 units at $42.50

$42,500 $42,500
Gross Profit $7,500 $2,500

The reduction in profit goes straight to the bottom line and as such, directly effects the shareholders/owners by reducing their shareholders equity in the balance sheet.

Obviously, this is the worst-case scenario. How much does the manufacturer need to sell to be making the same amount of gross profit i.e. $7,500?

To work out the sales target we do a simple breakeven calculation:

Sales Target = Gross Profit Target / Gross Profit % as a decimal
From our example: = Gross Profit required  $7,500
Gross Profit % after 10% reduction:
= (Gross Profit per Item / Sales price per item) x 100
= ($2.50 / $45.00) x 100
Gross Profit % = 5.55%
Sales Target = $7,500 / 5.55%
= $135,000 (rounded)
Unit Target = $135,000 / $45.00 (price per unit)
= 3,000 units
Sales Increase Required
= (3,000 – 1,000 / 1000) x 100
= 200% !!!

Is there a 200% increase in sales volume available for this product? Can the retail group promise the manufacturer that they will increase their purchases by 200%? I would vouch to say in a lot of cases the answer would be “No”.

The following table is a useful guide as to the sales volume required to increase the amount of gross profit, if products are discounted.

The effect of a mark down on gross profit dollars

The following chart shows how many more units in percentage terms you must sell to earn the same gross dollars as at the previous selling price.

If you cut your price With your present gross profit being:
10% 15% 20% 25% 30% 35% 40%
5% 100.0 50.0 33.3 25.0 20.0 16.7 14.3
6% 150.0 66.7 42.9 31.6 29.0 20.7 17.6
7% 233.3 87.5 53.8 38.9 30.4 25.0 21.2
8% 400.0 144.3 66.7 47.1 36.4 29.6 25.0
10% 200.0 100.0 66.7 50.0 40.0 33.3
11% 275.0 122.2 78.6 57.9 45.8 37.9
12% 400.0 150.0 92.3 66.7 52.2 42.9
15% 300.0 150.0 100.0 75.0 60.0
16% 400.0 177.8 144.3 84.2 66.7
18% 900.0 257.1 150.0 105.9 81.1
20% 400.0 200.0 133.3 100.0

The same table can be used for suppliers considering rebates or pest control companies considering price discounting. It can be a dangerous game!

Times can be tough for pest controllers, but offering discounts or demanding rebates does not help the business or the manufacturers in the long run. Increasing profit for pest controllers in a highly competitive and, if I could be so bold, over serviced business sector, can be found in being more efficient, through better margin and inventory management practises. That is what financial management is all about.

Peter Cox, Peter M Cox & Associates