Monday, December 10, 2012

Understand the real cost.

Many times in a negotiation you may need to decide either to what level you want to negotiate the final price or when a price change should be effective. When that occurs always consider the real cost. What I mean by the real cost is how much more or less will you pay based upon the amount you agree based upon the volume of purchases that will occur. For example one cent (US$.01) may not seem to be a lot of money until you multiple that times the volume that you will be purchasing. If over the period of the contract the volume will be two million units that one cent difference means 2,000,000 x .01 = $20,000.00. While you may not be concerned about a penny, those pennies can add up to amounts that you should be concerned about. For high volume purchases its not uncommon for a buyer to want to negotiate a price down to the mils (1/100 of a cent) so when it’s extended over the volume you buy, you have the lowest real cost.

I can remember a commodity manager who negotiated a price reduction on an item of one dollar and she thought she did a great job. The problem was she negotiated the cost reduction to take effect one fiscal quarter later and didn’t understand the real cost in agreeing to do that. The manager knew that the quarterly volume was 200,000 units so with the agreement to take effect three months in the future it cost $200,000.

There is a real cost with many other contract terms than just price. For example you want a one year warranty on a piece of software you want to license. The supplier only wants to provide your with ninety days warranty. What’s the real cost of that? In effect what that would do is force you to purchase maintenance after the ninety days or 270 days prior to when you wanted to purchase it. If the cost of maintenance is 15% of the purchase price, the real cost of that change is it adds 11.25% to the cost of you license purchase. (15 divided by 365 x 270).

If you make a concession in a negotiation always make it clear what the real cost is for what you are conceding and expect a concession or price reduction of an equivalent or greater value.