Float That Money! The Politics of Paying Contracts
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During my legal career, I’ve represented both the sales side and the customer side in negotiating deals. While buyers and sellers argued over many issues, one provision always seemed to stay the same: the customer would pay a bill within 30 days. People refer to this kind of contract provision as the “payment terms.”
So color me surprised when I noticed one of my large clients insisting that it would only pay a bill within 45 days. They also pushed back on the seller’s right to terminate the contract for late payments, requiring the seller to give up to 90 days advance notice before it could do so. Floating your money for this extended time period gives you some great advantages when you’re the customer. A customer can use its levitating dollars during the extra time to garner interest or invest the money, money which, in the past, the seller would have had. Presto! Like magic, the extra time means extra dollars for the customer.
What happens to the seller? Think about it: 90 + 45 = 135 days to pay a bill. Most salespeople will tell you that waiting over 4 months for payment will clobber their cash flow and make it very hard for them to pay their own bills. The solution? The seller starts doing the same thing to its vendors. Now, when people negotiate the payment terms in a contract, they’re left in the rather disingenuous position of begging customers to pay within 30 days, then turning around and asking for much more time to pay when it comes to their own creditors.
Besides being a blatant violation of the golden rule (which we all want to follow, right?), the lack of reciprocity makes for an uncomfortable negotiating relationship and hits you with credibility and loyalty costs when it comes to your business partners.
A great example is playing out right now. Apple appears to be taking longer and longer to pay developers who create iPhone applications. Here we have a situation where Apple has tremendous power because it’s the gateway to the iPhone platform. Apple takes all the money users pay for developer’s apps and then relays the developer’s cut to them (minus Apple’s share), per the Apple contract agreed to by every developer. According to the copy of the Apple contract here, Section 3.5 requires Apple to pay the developer within 45 days after the end of the month that Apple received the developer’s payment from a user.
So if you buy my WhichDraft App (doesn’t exist yet, but I can dream, can’t I?) on March 1, Apple doesn’t have to relay your payment to me, the developer, until mid-May! While waiting over 70 days for my money is bad enough, according to this report Apple might be taking even longer. And since Apple controls access to the platform, the developer is left with a difficult choice: keep waiting while her own bills pile up, or threaten to sue Apple, which could provoke Apple into rejecting her apps entirely, effectively shutting the developer out of the entire platform’s market.
The situation makes me imagine Steve Jobs as the Soup Nazi: “No more millions of iPhone users for you!” Sure, there are laws against this kind of behavior, but if you’re a small developer, do you really have the time and money to litigate this kind of dispute? For most people, I think not.
That’s the power of a network access agreement. However, at some point, the pain could be so great that developers just move to a different platform.
Palm Pre, anyone?
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3 Comments
May 1st, 2009 at 4:43 am
In a sales negotiation where this extra-float issue comes up, the customer’s finance department may have decreed that the accounts-payable process will only issue payments on those terms (e.g., net 45 + 90) unless an exception is approved by Finance. If that’s the case, the actual buyers may well claim, “we’d love to agree to net 30 days, but we’d have to get approval from those rule-obsessed trolls in Finance, and that would seriously delay the deal.”
There are a couple of possible come-backs to this:
1. “We’ll be glad to let you have the extra float, but since we’re not a bank or a finance company, we’d need you to agree to pay interest at prime + X after 45 days.” To agree even to this, the customer’s negotiator would probably have to get approval from Finance, which by hypothesis s/he isn’t likely to want to do.
2. It’s sometimes easier to steer the conversation into a discussion about pricing: “The pricing we offered was premised on payment net 30 days. We’d be glad to let you have the additional float if that’s what your finance department requires, but we’d need to increase the purchase pricing — we have to take into account our increased financial risk and the time value of money.” The customer’s actual buyers can then decide whether they’d rather spend the extra money or go to Finance for approval of net 30 days. (My experience is that buyers would often rather give up the extra float than pay more on the front end.)
The weakness in either of these responses, of course, is that toward the end of the quarter, some sales people can be so eager (read: desperate) to close business that they won’t hold their ground — this kind of sales person wants everyone else in the vendor’s organization to make concessions so they can get their commissions.
May 1st, 2009 at 9:34 am
Great comment, D.C. An analysis like the one you give us above demonstrates how complex negotiations are and how there are many factors that defy neoclassic economic thinking when two large companies put a deal together. Internal politics, leverage, clout, and budget battles loom as powerful influences over what kind of deal will ultimately be struck, particularly, as you astutely point out, whether or not a purchaser can convince the finance department to support shorter payment terms or a price increase.
May 4th, 2009 at 4:52 am
[...] the customer would get the benefit of several weeks’ extra float on its money. Jason Anderman raises this issue at WhichDraft.com; here’s an edited version of what I responded at his [...]