Demystifying Pay-By-Scan

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Demystifying Pay-By-Scan

I recently participated in a group discussion at the Super Floral Show in Salt Lake City covering the topic of pay-by-scan or as some call it, VMI, or Vendor Managed Inventory. This is a program that has received a lot of attention in the last two years, ever since The Home Depot launched this program across the bedding plant industry in spring 2005. This article is intended to provoke discussion and should be considered neither pro or con. I simply want to state my opinion of current events through my perspective.

The purpose of this article is to clarify some questions that may be out there in the industry in relation to the program. Is it working? What impact does it have on suppliers? Are suppliers happy with it? Is the retailer happy with it? What are the pros and cons from supply side and sell side? If this is such a great concept, then why isn’t it more widespread?

So here we go. What is pay-by-scan? It is a distribution system that allows suppliers to allocate inventory into retail selling sites, maintain the product and replenish as needed. Ownership of the product does not transfer until the customer actually creates the transaction at the cash register. Once the product is scanned at the register, an invoice is created through the electronic data interchange system and growers are compensated in a time period based on their negotiated payment terms.

The retailer never takes possession of the inventory. This burden is squarely placed on the supplier. Therefore, the supplier has increased input in how much inventory goes into a store. This creates interesting pressures both early and late in selling seasons. In the past, growers were definitely more liberal in allocating product to be shipped to retailers where danger of frost and damaged plants could impact sell through. Now that the supplier is liable for losses, more prudent allocation is the wiser business decision. Operators that are anxious to kick-start the season are often at loggerheads with local bedding suppliers to fill tables and overhead racks with tender products to be first and fullest in the game. That’s an easy perspective when you’re playing with house money.

Pay-by-scan takes all markdowns off the retailer’s ledger. In effect, this takes any retailer that is burdened with retail accounting back to cost accounting. For those that don’t have an accounting degree or those who need a quick primer in retail versus cost accounting, retail accounting values the inventory at the current retail pricing. Cost accounting obviously values the current inventory based on its acquired cost. Retailers that use retail accounting are typically very reluctant to take markdowns on current inventory as it is considered a devaluation of assets. Perishable product categories, such as live goods, will suffer in this environment as most operators would just as soon let current inventory devalue to zero rather than take an intermediate markdown to create greater velocity for consumers with greater values. 

An Accounting Refresher

Cost accounting allows for greater flexibility in manipulating retails up and down. What really matters in this system is the maintained gross margin percentage. For example, if you paid $5 for an item and retailed it for $10, you would capture a 50 percent gross margin. If you decided that you needed to achieve a 30 percent gross margin, then you would discount, or put on sale, the $10 item for $7 and get your $3 in gross margin dollars. This is a no-no in retail accounting. Using this example, you would simply set the retail price of $7 and sell all inventory at this retail. There are no up and down or yo-yo retailing.

Retail accounting is also painful when retailers that use it need to adjust retails down to meet competitors. This basically means that either the retailer guessed wrong when establishing retails for the selling season or competition drove down retails in the selling season, causing a downward pressure on retail pricing. Management is never happy about this phenomenon when retails need to be moved down.

This is somewhat of a long-winded explanation of one of the biggest benefits of pay-by-scan to these retailers. It creates a cost accounting system that is much more fluid to meet market demands considering that the retailer and supplier agree on what needs to transpire to benefit both parties in maximizing profits for both.

Retail sellers now have the greatest quality control system in recent retail history. What grower would knowingly ship substandard product if they are solely graded on sell through of the product? This was one of the biggest concerns I had as a mass merchant buyer — that I was indeed getting top-quality product every day from every supplier. As we all know, that isn’t always what happens for whatever reason. Now that suppliers’ compensation is more closely aligned with product sell through, quality has definitely picked up in these programs. It’s unfortunate that it had to come to this system to make more growers sensitive to “harvest discipline.”

Growers have some added flexibility here if they are long on inventory in an item where they can bring products to market at lower costs and corresponding retails, provided the retailer agrees, and drive higher velocity at greater values to the customer where needed. Retailers are happy if their pile of gross margin dollars are higher at the end of the day and growers are usually happy if they get crops that might have to be dumped otherwise, into the buying public’s hands. 

The Service Question

Pay-by-scan is also a selling system that requires a high-level service program. Suppliers are completely responsible for the condition of the inventory and how the program gets displayed and maintained at store level. Thus service is built into costing to pass on these benefits to the retailer. Growers basically have to go to retail merchandising school and, in effect, become retailers. It’s not unusual under this type of program for suppliers in Northern markets to hire two to five people per store to execute programs starting in February for the main selling season and dropping down to a lower level for summer sales. What once was a more efficient staffing process from the mega-retailer has now been pushed down to the “local” growers, who obviously don’t enjoy the same leverage benefits that these superpowers possess.

Growers gain a lot of traction in product mix and what gets advertised. They also have a lot more to say in terms of retail pricing. These are all categories, in the new process, that are jointly negotiated between retailer and supplier. Progressive suppliers can script their own season by being proactive in participating in or writing their own local market ads and providing this information to their merchants. Hand in hand with advertising schedules go production schedules. This reduces surprises that may have popped up in the past, as this seems to have been a problem from time to time.

A major benefit from this type of program for the supplier is exclusivity. They have the right to be the sole source of supply for their category. This eliminates competitive pressures they may have had from store to store on like items. It enables the supplier to control or manage the inventory. They can put in the products they deem appropriate in the quantities that they feel are adequate to meet consumer demand. They can push products into stores based on “what looks best inventory” and manipulate consumer demand accordingly. They can also put as much or as little as they deem appropriate, providing it meets with their regional merchant’s guidance. It basically gives suppliers a much bigger voice in their own destiny.

So far, I haven’t heard of any supplier going out of business as a result of this process. I also have not heard of any supplier that has basically walked away from a retailer because they didn’t want to participate in the program. This is the second full selling season for the program and I would say the jury is firmly out on who benefits from the process.

As we sit here today, retailers have created a “pay-by-scan portal” that has in turn created, for lack of a better term, many “retail mad scientists” that are in the laboratories (their stores) trying to come up with formulas for other product categories that can be siphoned through the portal. For them it means less markdowns and shrink and for suppliers it means more top-line sales. There are many questions arising. Is it good for the supplier? Is it good for the retailer? Is it good for the consumer? Time will tell. There will be lots more discussion to follow, I’m sure.

Vinny Naab is owner of Naab Horticultural Marketing, LLC, a consultant to the horticulture market. Contact him at vincent_naab@haabhortmktg.com.

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One comment on “Demystifying Pay-By-Scan

  1. Pam halberg

    We are entering the world of pay by scan (vmi). Can you help with software info. I understand there is massive amounts of electronic info on a daily basis. Thanks