Whether you’re a market intelligence luminary and can predict the rise of manufacturer pricing before the announcement letters arrive, or you’re blindsided during a period of already high pressure to generate savings, managing cost increases is a sensitive but necessary part of any purchasing department. Dependent on the category, supplier relationship, and overall spend leverage, there are a few ways of dealing with these increases that can result in cost increase avoidance, and even at times, additional cost savings.
When to negotiate directly with your supplier:
Typically a client’s first instinct when undergoing a period of cost increase is to outright refuse to accept the pass through costs. While negotiating directly with a supplier, leveraging moving business elsewhere should an increase be incurred, has certainly been effective, it can also damage the relationship. The risk of this approach is the supplier finding other ways to increase costs outside of unit price, a reduction in service quality, and at worst the supplier terminating the relationship and disrupting your supply chain. To minimize these risks, this approach should only be taken under certain conditions. One condition is that you are in the top 5-10% of the supplier’s customer base. This meaning that you are one of, if not the largest customer they service, and they rely on your business for a large sum of their revenue. You should also ensure that the remainder of your costs are fixed, meaning freight is included in the unit of measure cost, any service pricing is stated and held firm, and surcharges are not able to be added. Lastly, the standoff approach should not be taken with a supplier that provides, mission critical, custom, or niche products.
When to go to RFP:
Should any of the above conditions not hold true, that may be signal that it is time to survey the market. Engaging alternate suppliers in a competitive sourcing event will open up opportunity to drive competition, identify lower cost substitute products, and establish a relationship with a vendor more suited to your organization’s size. An RFP should also be the primary strategy if there is a large amount of tail spend in a particular category which can be cleaned up and leveraged in a new contract with a new vendor, or if there are overlapping categories (i.e.: hoses and PVF) which can be leveraged under a conjunctive supplier for additional synergies.
When to engage in a tri-lateral agreement:
In the event that all of the criteria were in place for a direct negotiation, yet results were not desired or substitutions are not acceptable for a particular product, there may been an alternate strategy that can be used to prevent the cost increases. If spend is significant with a particular manufacturer, organizations can enter into a tri-lateral agreement with the manufacturer and distributor, negotiating set pricing through the manufacturer that the distributor must pass through. This special pricing allows the distributor to continue to provide the service as expected without them having to personally take a loss to hit the targets. It also drives more transparency within the relationship, and will establish a direct line of contact with the manufacturer for communication regarding new products, emerging technologies, or market forecasts.
Occasionally, especially during periods of significant raw material pricing spikes, absorbing a partial increase is inevitable. To manage this risk, agreements should have shared pass-through costs between the distributor/supplier and customer, supply base rationalization should be ongoing in categories with high tail, and purchasing volumes and practices should be optimized. Otherwise, adopting one of the aforementioned approaches will ensure that you maintain a competitive advantage during period of market uncertainty.