Thursday, December 16, 2010
Understanding a Product or Service
If you are going to negotiate the price of a product or service on a cost basis, you need knowledge about what you are negotiating. For negotiating the cost of a service you need to understand all the different tasks that are required to perform the service, the quantity and type of labor that is required and any tools that are needed. In negotiating the cost of a product you need to know how the product is made, the materials that are used, the process steps it will go through, the equipment that is used and the quantity and type of labor that is required to perform each step during the process. You may not need to know the actual cost, but as a minimum you need to have a benchmark cost to compare their cost against for them to justify why their cost needs to be different than the benchmark.
The easiest way to understand what’s involved in producing the product or performing the service is to witness it first hand. Have the Supplier take you through all the steps the product or service goes through from start to finish. Look at who does the work, what skills they have, what equipment they use, how long it takes and you begin to see a little about what it takes. If the Supplier is willing to provide you with a Bill of Materials for a product, read through it to see the types of materials that are used in production of the product as many times the cost of the materials can represent eighty percent (80%) or more of the product cost.
If you and your team know enough about what it takes to build a product or provide a service even if the Supplier is unwilling to provide you with a detailed cost breakdown, you should be able to create what’s called the “should cost” or your estimate of what you think it should be costing to use to have the Supplier justify why their cost should be any different. If you don’t make the investment of time to learn about the product or service and what it takes to make or perform it, you are left with using the “you need to do better tactic” but you can’t explain to them where or how they need to do better.
The other advantage of learning about their product or service is you can discover that the Supplier is using materials that are greater quality than you need, or they are performing processes or tasks that you don’t need and if they can eliminate them the cost can be reduced. I had a friend that was hired as a consultant to help reduce cost for engine parts for a large equipment manufacturer. Before he started he was worried if he could do the job as he had no experience in the industry and came to me for advice. I told him that there are two ways that you can reduce the cost of what you pay. One is to pay less, which means that the Supplier makes less. The other is to look at all the materials and processes used and see whether they were needed, could be changed or eliminated. To do that, he needed to see the item being manufactured. He did, and identified an item that had a number of process steps that he thought were too many. Then he checked with their engineering staff and found that the requirement was part of a specification that had been in place for a long time, but was no longer needed because of the quality of the materials they were using today versus what they had in the past. That one change saved the company millions of dollars on their product cost. The Supplier was happy to reduce the price as their cost was reduced so they weren’t giving up profit and on their books it was more profitable. To my friend it meant a multi-year consulting engagement. He wouldn’t have been able to do any of it if he didn’t take the time to learn about the product.