4 Vendor Pricing Improvement Strategies
Rick describes a number of vendor management concepts to get the best prices on your raw material and supplies.
1. Getting the best pricing from your suppliers by helping them make money
Many companies start a supplier relationship with tough negotiating, driving down the price and asking for “giveaways to sweeten the pot,” like free freight. In my role as Vice President of Operations at a manufacturing company, our goal was to be our key suppliers’ most profitable account. But wait, isn’t that giving away money?
Not at all. Our suppliers gave us world class pricing, often much lower than our competitors. Here’s how we did it…
First, we researched industry cost structures to understand the components of cost – materials, labor, overhead and profit. We strove to leave profit for our supplier alone (and actually added to it over time), but we were relentless in driving down the other costs through concurrent engineering (including the supplier in product design) and detailed understanding of shifts in commodities prices. For more on this idea read In a Volatile Economy, Purchasing Practices Need to Change.
When we found savings in the product, or commodity prices moved in the market, we split the benefits with the supplier 50/50, so our profit and theirs would go up while bringing the overall cost down.
Second, we required our suppliers to provide detailed cost structure information so we could both work on improving profitability. This required a high degree of trust, which is the foundation for mutually profitable partnerships. During frequent face-to-face meetings, we worked together to reduce total cost of ownership (TCO)of the item, again splitting the benefits between both parties.
Over time, the profit numbers grew while the total cost shrank – a win/win in a true supplier partnership. As a side benefit, when we needed extra effort from our suppliers, they were more than willing to go the extra mile because we were their most profitable account.
What kind of partnerships does your company have with its suppliers? Do they give you world class pricing?
2. How Supplier Partner Programs Can Reduce Materials Cost Volatility
There are a number of ways to reduce materials costs or at least make them more predictable in volatile times. One method is supplier partner programs. Many companies try to cut materials costs by being “tough negotiators,” but as noted earlier they could get lower prices by inviting their suppliers to be part of the team.
In supplier partner programs, companies bring suppliers into the inner circle, including them in product design efforts, communicating with them continuously, and providing detailed sales/product forecasts. The supplier wins because they know they are getting the lion’s share of the company’s business for the part or service they provide.
Partnerships start by rationalizing the supplier base; reducing the number of suppliers for a particular commodity to a few certified, developed and trusted suppliers. Purchase volume per supplier goes up, materials flow is smoothed and the total cost of ownership drops significantly. As if that isn’t enough, supply chain reliability goes up and risk goes down. A true win/win for everyone!
3. Reducing Materials Cost Volatility – Escalators
There are a number of ways to reduce materials costs or at least make them more predictable in volatile times. One of those is the use of escalator clauses in customer and supplier contracts.
Escalator clauses indicate that you and your customer/supplier agree that prices should change under certain conditions. When market conditions are volatile and you use longer-term contracts, commodity price changes can put you or your customer/supplier in a risky position. Worst case, they may lose significant amounts of money because of post-agreement price fluctuations. Note that escalator clauses work both ways, moving up and down based on a mutually agreed-upon benchmark such as Consumer Price Index, Chicago Mercantile Exchange or various industry benchmarks.
Escalator clauses are common in business-supply contracts, labor agreements, utility pricing and even leases. Escalator clauses for fuel prices have become common place in supply contracts. I also know of several companies that use escalator clauses for steel and for molding resin.
The essence of escalator clauses is that they work both ways, protecting the margins for both parties whether prices go up or down. Many companies think their customers won’t accept escalator clauses, but as long as they work both ways, they are in both parties’ best interest. For more on managing raw material costs read Raw Materials: Are You “Buying Right”?
4. Reducing Materials Cost Volatility – Blanket Purchase Orders
Another method to reduce materials costs or at least make them more predictable in volatile times is by using blanket purchase orders (POs).
A blanket purchase order is a long-term agreement between a customer and a supplier specifying the purchase of one or more items and defining the volume, usually for a one-year period. It has one purchase order number with multiple releases that can occur as frequently as several times a day.
There are numerous benefits to using blanket POs. Issuing the PO once and then putting releases against it cuts down on processing and streamlines the purchasing and invoicing processes. The primary advantage is that the pricing for the items on the blanket is based on the total volume the blanket represents. For example, many blankets cover a period of a year, so the price is based on the annual amount you plan to use rather than the smaller amount on individual POs. A blanket allows you to take advantage of that annual volume for cost reduction.
A common belief with blanket POs is that the annual volume defined in the blanket is a commitment to buy, but nothing could be further from the truth. The commitment is what you make it to be. In my past experience with blankets, we would commit to the supplier’s lead time, which was usually 30 days, so our actual commitment was 1/12th of the total volume of the blanket.
To use blanket POs effectively you must communicate frequently with the supplier so they can see any volume changes that your business might be experiencing. You also need agreements with the supplier clearly stating purchases or production outside your commitment is at their risk. However, the benefit to the supplier is they effectively lock in your business for a year and have visibility into the volume changes you are experiencing (which, hopefully, are up!).
Blanket POs can be a powerful tool for materials cost reduction and, properly constructed, can represent a true win/win for both parties.
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