May, 1993

Fruits of Thought

The Cost-Plus Pay-Off

Two trends are booming in the produce industry. Each alone poses a significant challenge for the trade, but combined they may be laying the groundwork for the crushing of countless produce firms under liability lawsuits, Robinson-Patman Act violations and PACA violations. The trends are the various rebate schemes being created by major buyers combined with the growing use of cost-plus pricing agreements, particularly by foodservice distributors.

The rebate schemes pose real challenges. Under these programs a big buyer “invites” various suppliers such as shippers, brokers and wholesalers to “participate” in a program. These programs, which often are given grand sounding names such as “partnering toward profitability,” all end up with the same thing: suppliers agreeing to rebate the buyers a set amount per package at the end of each month, quarter, season, etc. The rebate is often disguised as a “promotional allowance,” though it typically does not buy any promotion greater than being included in a price list that the buyer, say a foodservice distributor, passes on to its customers.

Now there is nothing inherently wrong with these types of programs. As long as prices between buyer and supplier are set through negotiation and the buyer is buying for his own account, these programs can even be smart buying tactics.

In many cases, as long as the buyer doesn’t get piggish and ask for more of a rebate than the supplier can bear, the buyer may actually be buying cheaper. Produce prices are usually quoted a certain way: by the quarter, the half or the whole dollar. If the quote on melons that day is $10.00, it’s not likely that the buyer will pay $10.10 because a program calls for the buyer to be rebated a dime.

But the programs do pose challenges particularly to the suppliers. One point of controversy derives from the fact that many produce sellers act only as the grower’s agent. This raises the question of who is supposed to pay these rebates: the agent, out of his commission, or the grower as a reduction in his net return? The answer to this question depends on the nature of the payment and the specific wording of the contract between grower’s agent and the grower. Grower’s agents cannot just automatically deduct payments for promotional allowances and other rebates from a grower’s account.

Another big problem for suppliers is the Robinson-Patman Act. This act requires that similarly situated customers must be treated in a similar fashion. To put it simply, if there are two supermarkets in town and they purchase similar quantities from a supplier, that supplier cannot usually give a rebate to one and not to the other.

Some of the vendors in produce are already petrified at the possible liability of participating in these programs. One large broker had a law firm draft an agreement that requires buyers asking for these rebates to acknowledge that prices are higher than they would be in the absence of the rebate. Further the agreement requires the buyer to indemnify the broker against any claims by the buyers’ customers, because the real problem and the real danger that is posed to industry firms has to do with the combination of these rebate programs with cost-plus contracts.

Cost-plus agreements are very common today in the foodservice distribution industry. Big chains of restaurants and hotels have a major distribution job to ensure delivery to all their sites. They can’t possibly be negotiating every day for the best price because they would have no way of getting the best-priced produce to the restaurants. So they enter into cost-plus agreements with foodservice distributors. Under these agreements the distributor agrees to sell to the restaurant or hotel chain at the cost of the goods plus a defined up-charge for procurement, quality control, warehousing, transportation, profit, etc.

Now here is where the going gets good. Some innocent produce wholesaler or shipper is sitting there selling 35 percent of his business to a foodservice distributor. The distributor calls up and informs him that he, from now on, wants a “promotional allowance” of 25 cents a box payable to the foodservice distributor every month.

First the produce vendor explains that his margins are too small and that he would have to raise prices to compensate. When the buyer explains that the company still wants the rebate, the produce vendor says, “Look, this is making my bookkeeping too complicated. How about this: on each invoice, I list the price, then take off the quarter, then bill the net price.” The buyer the drops the bombshell: “We don’t want any mention of this rebate on the invoices.” And suddenly what’s going on is crystal clear: The purpose of these rebate programs, when done in the context of cost-plus pricing, is to allow the foodservice distributor to defraud its customers as to what the real cost of the produce is.

Now the produce suppliers are in a real fix. Not only do they have the problems mentioned earlier but now new dangers lurk. For one thing, the PACA requires the issuance of accurate invoices. Will these invoices meet that standard? And, are produce suppliers, by agreeing to supply fraudulent invoices, serving as an accessory to the foodservice distributor’s fraud on its own customers? And, how far-fetched is it to think that one day some restaurant or hotel chain will get wise to all this and file a lawsuit on the grounds that the vendors were conspiring with the distributor in an effort to defraud the restaurant or hotel chain?

This whole area is a bomb waiting to explode. Anyone who is buying on a cost-plus basis had better be careful because there is a real possibility that the invoices your vendor makes available to support his “cost” claims do not tell the whole story. Any supplier who is asked to pay rebates should, at very least, insist, for his own protection that all the relevant terms appear on each invoice.

Not too long ago the produce industry was perceived as a dirty one, where pay-offs and bribes were commonplace. But even then, it was individuals who were acting immorally. In this situation, it’s the companies themselves that are trying to cheat their best customers. They may be big buyers, but we can’t let them bring the whole industry down with them.  pb