Flip the switch to Cost Containment

We enjoyed a supply managers’ market for over a decade where cost improvement and value improvement was a way of life. But record commodity prices, like $100 per barrel of oil, record wheat and soaring precious metal prices, has not only penetrated many of our supply chains, it has had a profound impact on the U.S. and global economies.
Supply managers are kidding themselves if they are not planning for cost increases in steel, aluminum, plastics, chemicals, freight, fuel, capital equipment and travel resulting from the dynamics of oil and energy markets. Many suppliers, working on already thin margins, will be aggressively pushing through price increases in 2008. Before they hit, here are three things to do to prepare for them.

1. Forecast your exposure. How much do you know about your suppliers’ cost structures? How much is actually tied up in commodity materials that are rising rapidly in price? If you can’t realistically do a full cost analysis, you can do a price analysis of your suppliers’ materials inputs. Knowing that could help create a negotiation environment where costs become transparent and the discussion turns to cost containment solutions for you and your supplier both.  For instance, there may be alternative designs or materials worth considering.

2. Condition against increases. Your expectation should be that over time your suppliers should be continuously improving — creating efficiencies that bring more value for your purchases, or lower your costs. Make it clear that price increases run against the grain of those principles. They should be hard to accept and suppliers should know that. Requesting an increase should be “difficult,” requiring the sales representative to work hard. Demand three months notice, in writing, of all increase requests and insist that they are accompanied by a detailed statement of the actions the supplier has taken to reduce or eliminate the need for an increase. A rigorous internal approval system will deter supply managers from recommending increases they might otherwise waive through because of time pressure or the desire for a quiet life.

 3. Preempt the increase. If you haven’t already, this is a good time to investigate other suppliers, prepare RFQs or RFPs and distribute them before you receive requests for higher prices. Find out what changes your suppliers have made. A new plant might have brought productivity improvements that would justify a price reduction. The same might be argued about higher volume sales covering the same overhead. Working ahead of your supplier could change the whole structure of the negotiation in your favor.

All these actions can prepare you for the inevitable.

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