October 25, 2011
The practice of suppliers increasing their customer’s pricing is nothing new. Businesses have long focused on creating effective purchasing strategies to deal with pricing fluctuations for critical direct materials such as chemicals, raw elements, paper, energy, and resin based materials. However, due to a number of recent economic issues, business customers are facing price increases for more and more of the goods and services they purchase. The Producer Price Index published by the US Department of Labor shows selling costs of manufacturing industries increased 30 percent in the US over the past ten years. Closer study of this index in specific industries highlights the wide breadth of types of goods and services that have seen significant price increases. For example, over the past seven years selling costs of iron and steel pipe increased 111 percent, office supplies 39 percent, and courier services 40 percent.
Many of the purchasing requirements for which corporate customers face price increases are considered “indirect”, or less strategically important to business operations. However, the cumulative impact of cost increases for these purchases will negatively impact operating costs. For this reason an organization’s purchasing strategy should include a focus on indirect purchase categories, with an emphasis on understanding pricing factors and mitigating price increases to the fullest extent possible.
Strategies for managing pricing fluctuation for indirect spend categories
Here are several effective strategies for companies to effectively manage pricing fluctuation issues for indirect purchase requirements:
- Strategically source indirect purchasing categories: An effective strategic sourcing approach is consolidation and leveraging of purchasing spend to improve a customer’s relative purchase strength. This approach is highly effective for a company to reduce pricing and mitigate future price increases with suppliers. A company should conduct a strategic sourcing review of key indirect purchase categories to achieve best possible pricing terms. A good project should combine a company’s similar purchasing requirements regionally or globally, thoroughly evaluate the supplier options for the requirements, and hold detailed discussions about pricing during the process. This will allow a customer to effectively evaluate pricing trends, competitive pricing levels, and ongoing costing factors that must be managed. Furthermore, through competition and negotiation, supplier pricing is usually reduced, and any terms for future pricing increases will be the most competitive possible. To be effective the strategic sourcing process should include spend mapping to identify key sources, gathering of market intelligence on suppliers and pricing, pricing quotations or proposals, and thorough negotiation of price stability and increase terms.
- Create effective price adjustment terms with suppliers:There are purchase categories where price increases occur relatively frequently or should be expected. In these categories the purchasing strategy should include clear and sensible price escalator/de-escalator clauses with suppliers to guide pricing adjustments. The basis for pricing adjustment clauses should be published price indices or common reference points whenever possible to ensure fairness and uniformity. In other cases, require that suppliers document the price increase they have had from their suppliers which are resulting in their request for a pricing increase to you.
- Institute an ongoing category management approach for indirect purchase categories: Companies that are undergoing procurement transformation efforts often find that they have not actively managed their preferred suppliers of indirect goods or services. Outside of the supplier’s work with day-to-day customer stakeholders, sometimes a supplier’s only other interaction is with procurement for a negotiation once every 2-3 years. These customers are often surprised when their suppliers request price increases, and are unprepared to effectively mitigate these increases when they arise. To combat this, a business should have a purchase category plan in place for all key purchase categories which includes periodic reviews with suppliers to jointly discuss pricing, and to consider process improvements or other potential new ways of working. Typically suppliers and customers will find efficiencies or other improvements that they can implement in their working relationship which in turn will reduce existing pricing and mitigate future increases. This is an especially effective way to deal with price increases for services, as quite often improvement opportunities can be found in these working relationships. For example, a recent client dealt with a pricing increase request for maintenance services by working with the supplier to improve weekly scheduling of the supplier’s resources, which gave the supplier a more clear business commitment and resulted in improved pricing to the customer.
The above approaches form a good basis for improving pricing from suppliers, and mitigating price increases for indirect purchase materials and services.
GEP helps enterprises drive greater savings and value from their indirect spend. Learn more about GEP’s category management services.