Every Procurement team strives to realize continuous cost reduction. This goal, however, looks more like a dream to most organizations. Dismissing year-over-year cost reduction as unsustainable, they look for quick wins where they can get them. In certain cases, these quick-win cost reduction opportunities are really anything but.
At the start of the fiscal year, many Procurement professionals receive unwelcome news from their downstream direct material suppliers. Prices have gone up. However minuscule, these changes can add up, and Procurement cannot afford to ignore them.
The justifications for these changes run the gamut. Some are direct results of increases to index and material pricing. In these situations, the supplier has no choice but to raise their prices. Other times, the explanation is foggier. "Prices went up," a less scrupulous supplier might say. Whatever the situation, whatever reason your supplier provides for the change, it's important not to let it go unchecked. Procurement should obtain documentation that clearly and accurately explains the rationale behind any price increase.
Trust is an essential aspect of any supplier relationship. Without mutual trust and respect, Procurement departments and their suppliers will struggle to drive savings and establish strategic partnerships. Too much trust, however, and the department can run into even more costly trouble. A surplus of trust could lead your team to look the other way or conduct halfhearted negotiations when an unreasonable price increase comes along. Over time, this can shape supplier behavior and damage long-term cost reduction efforts.
A supplier might announce a price increase and invite you to negotiate. Ultimately, the process will result in a net price increase disguised as "savings." For example, let's say a packaging supplier experiences a 5% increase on the Lower Grade Polyethylene Index. In anticipation of an easy negotiation, they might pass a 10% price increase onto their customers. If the negotiations result in an 8% price increase, the customer can report cost reduction of 2%.
On paper, the supplier has made concessions to Procurement. Better still, Procurement looks to have realized its cost reduction goals. World-class Procurement groups know better than to fall for this facsimile of savings, but countless organizations do not. Many find themselves unwittingly losing money while celebrating their continued cost reduction victories.
Transparency, honesty, and thorough assessments are necessary in every supplier relationship. By avoiding vague and unclear communications, Procurement can better avoid vague and unclear price increases. The department should ask detailed, commodity and service-specific questions that truly require suppliers to engage and open their books. With more actionable insights into the cost drivers behind price increases, Procurement can manage (and mitigate) them in the future. A small extra bit of digging can go a long way in making cost reduction dreams a reality.
Want to learn more about developing strategies for continuous cost reduction? Reach out to the strategic sourcing specialists today.