Friday, September 2, 2011

Getting Competitive Pricing When You Are Locked Into A Supplier

There are a number of ways that you can be locked into a supplier. They may be the only source for the item. They may have been designed into a product or service where it would be difficult or costly to change them. You may have voluntarily locked yourself in by giving the supplier a firm purchase commitment or a commitment to provide them with all or a percentage of your requirements. Since competition is the best weapon to managing pricing you want to avoid being locked in but there will always be times when you can’t avoid it. How do you manage those situations?

If you make firm purchase commitment or requirements commitment both of those types of commitments should be conditioned upon a number of factors. You want the assurances that the Supplier will remain competitive over the entire term of the commitment. Competitiveness means not just the price of the product or service you are purchasing, but the technology of the product being competitive in the market. Competitiveness also applies to the terms they agree upon and the Supplier’s performance for quality, delivery and the overall cost of doing business with the Supplier. That’s because not all cost involved in the relationship is included in the price. You also want relief from those commitments for situations when the supplier can’t meet your demand, doesn’t perform, or is unable to perform such as in force majeure situations. For the price aspect before you get locked into a supplier you should include a benchmarking provision in your agreement. Agree upon how benchmarking will be done and have language in your agreement that they must either adjust their price to the benchmark price or you have the right to cancel the firm aspect of the commitment without liability.

If you haven't made a firm commitment on volume or on requirements, the issue is always the trade off between any price premium you have versus what it will cost to change suppliers. If you go to a supplier strictly for benchmarking purposes you should tell them that. In that case you use benchmarking to highlight the cost difference from several perspectives. You can use the price differential to show how that will make it easier for you to consider alternatives as the cost of switching will be paid for by the savings. Many times a supplier will be happy to provide a benchmark price as they will see that as a sign that you are unhappy with the pricing you are getting from your current supplier and see that as a potential for future business. With the incumbent supplier you can also discuss how the cost difference will impact your future sourcing decisions if nothing is changed. In both cases the supplier will get the message. Whether they will respond to that message and offer more competitive pricing will depend upon what the impact of loss of your business will mean to them.

If you use the benchmark suppliers for other items and you have a good relationship with them or the they think they have a reasonable chance of getting business in the future the data won't be exact, but it will be relevant. If they don't think they may get business in the future they probably won't respond or would want to get paid for the activity. In that instance it would be better to hire an expert to provide you with benchmark data.

A supplier can also benchmark by using cost models. There are Bottom-up Models, Top-down models, Algorithm based models, Predicted cost estimates, Comparison models/ Analogy models and Parameter cost models. Most of those require a detailed knowledge of the product or service and the costs. Benchmarking falls into the comparison/analogy type of model. Its the easiest to do if you don't have the knowledge of the product or service and its costs. If you don't have that knowledge and don't want to benchmark, you would probably need to hire an industry expert to provide you that type of data.

Many of the concerns with using other suppliers to provide benchmark data can be managed to make them legitimate. One is to not use any of the losing bidders as part of the benchmark so there is no bias. If you are forced to include one of the prior bidders in the benchmark activity and you have three or more benchmark suppliers I've used the approach that we throw out the low bid and create the benchmark based upon the average of the remaining quotes just so the supplier would agree to a benchmark as that would eliminate the bias issue. I've also gone to other suppliers and have paid them to provide a detailed cost estimate as a form of benchmark.

I’ve been locked into suppliers by designs and have then worked with engineering to identify and qualify alternatives. That’s the primary option you have if the supplier doesn’t respond to your messages and continually abuses their position. When the orders to them stop many are shocked and will ask how they can get the business back. My response, which is always tempered based upon other business that we may have with the supplier as either a supplier for other items or as customer, will vary. If the two solutions are not directly interchangeable, I would tell them that the business is gone as I’m not going to get locked into them again as a single source and that I can’t afford to manage two different solutions. If I need them and the solutions are interchangeable I may tell them that they need to not just match the competitors price but offer a better price so they effectively pay for the cost they drove by their behavior. They forced me to invest in developing an alternative. If I don’t need them and we don’t have any customer relationships I probably would tell them that if we need them we’ll call them. A good sales person will listen to the messages their customer gives them and will respond before it gets to that point.

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