Negotiating Smarter by Focusing on Cost, not Price

Guest Blogger
Kelly Barner, Editor, Buyers Meeting Point

Anyone with procurement or purchasing experience knows that price and cost are not the same thing. Price is what the buyer pays in return for goods and services and costs are the supplier’s direct and overhead costs to produce the good or service. The difference between the two numbers is the primary focus of most negotiations. Some of it is kept by the supplier as profit margin, and some of it is claimed by procurement as savings.

The best thing procurement can do in advance of a negotiation is to research and understand all of the relevant costs. This ensures that negotiations will be fact-based rather than instinct-driven – a focus that should create an advantage for procurement.

There are multiple ways that procurement should allow a detailed understanding of costs to influence their negotiating strategy. Doing so requires procurement to dig into the details of costs, categorizing them by type and determining how much control the suppliers have over each one.

Supplier Cost Advantages
Depending on the category being sourced, some costs will be nearly the same across all qualified suppliers. Unless small players are bidding against very large ones in a product category, materials costs (especially raw materials) are likely to be comparable. These costs are often beyond the control of any one supplier and – unless they are out of line with similar costs elsewhere in the market – trying to negotiate them will not create the scale of value procurement is looking for.

It is the costs specific to each supplier that procurement should position as the focus of a negotiation. Some of these costs (such as rent, headcount, and insurance costs) are straight overhead, and they point to each supplier’s administrative efficiency. Other costs are more ‘direct’ in nature and point to the supplier’s process efficiency. Material waste is an example of a direct cost that can either create an advantage or a liability for a supplier. Another example is the direct internal labor associated with producing the product in question. Perhaps the company has invested in equipment that allows them to produce greater quantities with higher quality rates and less labor time. Looking at each supplier’s process efficiency related costs shows their abilities relative to the competition.

When procurement negotiates for price reductions alone, they are anchored to a top level point that does little to shine a light on the relative efficiency of each supplier. Conversely, when procurement negotiates those prices relative to individual supplier costs, they position their company to take advantage of significant efficiencies that allow both buyer and supplier to walk away from the negotiation satisfied.

Procurement-driven Costs
Although procurement can usually relegate the management of costs to the responsibility of the supplier, some of these costs are due to buy-side requirements or ways of doing business. Opening the door to learning about the costs driven by the buying company does not require procurement to change or sacrifice their specifications, but it does allow them to make a more informed decision about whether those requirements creates sufficient value to offset the associated cost.

Suppliers can be a wealth of information on this topic. They work with many companies across the same product categories and therefore can easily spot the differences in requirements. They also know what it costs them to meet these requirements. If procurement is truly interested in bringing prices down, they must be willing to understand what portion of the suppliers’ costs is driven by their constraints.

Making discussions of cost a two-way street provides strategic suppliers with an opportunity to shine. A good supply partner will find a way to meet requirements at a lower cost while a poor or mediocre supplier will consider it enough that they are able to meet the buyer’s unique requirements.

Prices are driven by what the market is willing to pay. They are usually not buyer-specific and leave a lot of detailed information obscured from view. Procurement may be able to negotiate decent savings by reducing prices, but this only represents the tip of their potential impact. Instead, procurement should take a cost driven approach that allows them to get a solid understanding of what it costs each supplier to provide them with a product or service. This approach ensures that the return for procurement’s effort is maximized and that they select a supplier focused on keeping costs – and not prices – low.

Buyers - Are you interested in fulfilling your procurement needs?

Suppliers - Are you interested in showcasing your capabilities to engineers and procurement professionals who are actively seeking new metalforming suppliers? 

If so...Attend Sourcing Solutions on September 29, 2016 in Indianapolis!