The Interest Rate on Your Customers

Your customers are lending you money at credit-card rates, and you sent them a thank-you note for it. That's what an annual prepay discount is, once you run the number nobody runs.

At one company, a 15% annual prepay discount had sat on the pricing page for three years. About forty percent of new customers took it. The CFO modeled the cash benefit each year and booked it as a win. The prepay revenue landed in month one instead of trickling across the year. Cash position improved. Working-capital exposure dropped. On its face, a clean trade.

What the CFO never modeled was the interest rate behind it.

Here's the math. Say the list price is $100 and the prepay price is $85. In our trade the customer lends us $85 for a year, and we hand back $15 in forgone revenue to borrow it. In our numbers that's $15 on $85, or about 18% a year. That's the rate.

That's credit-card money. The company was borrowing from its own customers at credit-card rates and calling it a cash optimization.

The right comparison is the cost of other working capital. For a company at this stage, a venture debt line usually prices in the single digits to low teens. A bank line for a profitable company prices lower still. Both come in well under what our customers were charging us. A company sitting on an available debt line while offering a 15% prepay discount is borrowing twice: once expensively from customers, once cheaply from the bank. It makes no sense. Then it spends the cheap money on something other than the working-capital problem the customer money was quietly solving. This is the mirror image of running working capital quietly and on purpose.

Two honest options. Cheaper capital exists. Reprice the discount against the real cost of capital, or change the funding source. Drop it to a 5% prepay discount and, for most companies, the implied rate falls below outside money while still rewarding customers who want to lock in a year. Or offer no prepay discount at all, bill annually by default, and fund working capital from outside sources at market rates instead of from customers at a premium.

The default path is big prepay discounts nobody treasury-manages. It's the most expensive money most companies are quietly borrowing, and the one line nobody on the finance team owns. The same thing happens when a discount quietly becomes the business model: the number stops getting questioned. The CFO who runs it writes a memo nobody enjoys reading. That memo also recovers real margin over the next two years.