Trends & Issues

Strategically Managing Supplier Price Increases

The negotiation process for supplier price increases should focus on strategic issues, rather than simply price. A company needs a negotiating strategy that is more about improving supplier performance than just trying to minimize costs. — By Sharon Ross

In an ideal world, procurement and supply chain managers would establish a framework early in the sell-buy relationship that focuses holistically on the supplier relationship. It is not just price that is important, though traditionally the goal has always been to negotiate the lowest price possible through a competitive process. Furthermore, the usual process would involve suppliers negotiating price increases annually as allowed by contract.

However, it is not unusual today for current suppliers to request unexpected price increases for a single commodity or an across-the-board price increase due to a convergence of factors. These factors may include supply disruptions forcing a supplier to find new costlier sources, increasing labor rates as countries strive to mandate living wages, environmental disasters, the pandemic, inflation, and the list goes on.

There are general negotiating principles for guarding against unreasonable price increases, but they work best when a solid supplier relationship is established from the start.

Moving From Tactical to Strategic
The Red Bear Negotiation Co. are expert negotiators who work with some of the largest clients in the world. Successful supplier negotiation is no longer an adversarial process because of the importance of developing strategic supplier relationships for the long term.

Getting the lowest price is no longer the only goal. The negotiation process should also consider strategic areas like logistics, communication technologies like an electronic data exchange, increased efficiency and the ability to minimize supply chain disruptions. You may otherwise negotiate the lowest price but lose some of the strategic advantages. This principle is applicable to the initial price setting process, which in turn will be a guiding principle for any price negotiations that take place in the future.

For example, a supplier may approach a customer with a price increase without disclosing important information such as the supplier’s cost structures, making it difficult to recognize where economies could be realized. Understanding cost structures and breakdowns is at the core of successful price increase negotiations. A supplier may state what is wanted from the negotiations, and the buyer should ask “why?” Understanding the supplier’s underlying needs can produce more profitable agreements for both sides.

In one example provided by Red Bear, a major automaker identified an innovative heat shrinkable tubing product that would overcome design challenges in the manufacturing operation. The automaker approached the supplier, a small, growing company and offered to pay 10 cents per linear foot, but the supplier insisted 22 cents was the minimum price. Near a state of negotiating gridlock, the automaker told the supplier the company wanted to do business, but they should work on finding a creative way to resolve the impasse. Through research and discussion, the buyer discovered the supplier’s manufacturing process was very inefficient, leading to artificially inflated prices. To solve the problem, the automaker provided technical consulting to improve efficiency, which lowered the cost. It was a win-win for both sides, but just as importantly, it set the guidelines for future price increase negotiations. The automaker made it clear it was willing to work with the supplier, but prices had to be justified by performance.

Unexpected Price Increases are a Fact of Life
Michelle Liu is CMD's lead negotiator for price discussions. She deals with suppliers (in this case mostly from China) who unexpectedly increase prices, a common occurrence due to the impact of COVID-19. Common justifications for this include rising material prices, shipping capacity problems and exchange rates. Suppliers timed the increases to put their customers in an untenable situation – refuse the increase and accept the risk of being moved to the back of the production line (and possibly missing shipping dates). Accept the increase, and have to deal with the impact on end customers with fixed contracts and forecasts that have no room for sudden changes.

While each situation is unique, Liu has a set of approaches to choose from for a best fit. She advises letting the supplier vent at first, so conversations running high on emotions can then shift to facts. Then she follows the 21st century approach to price negotiations. The bill of materials is divided into material types to identify those experiencing market price highs (i.e. metal, plastic, etc.). If the product is made mostly of metal, for example, look at the historical movement for the specific type of metal in specific categories. The price increases negotiated would only apply to the component material in portions of an assembly.

She also suggests another approach based on SKUs. Protect the higher-volume parts, where margins tend to be thinner, and lock in prices for as long as possible. Another option is to negotiate a price for a limited time period, with the understanding that the increase will be revisited periodically to see if it remains justified.

During negotiations, also make sure suppliers understand the full costs of bringing products to market, including logistics, warehousing, marketing, sales and other costs. Often, they do not recognize all the costs, so the negotiating process includes explaining the need for a supplier who is willing to share the cost burden.

Planning for Price Increases Before Prices Go Up
The common theme among negotiation experts is to get a cost breakdown when initially negotiating pricing with a supplier. The cost breakdown will identify the percentage of each type of material, labor, overhead and profit which makes up the product.

Then, zero in on the justification for the price increase, and match it to the cost breakdown. For example, if wood goes up 28 percent but only accounts for 7 percent of the price, the price would increase by 2 percent and not by 28 percent.

Developing a price increase defense tool that provides the right negotiating guidance in terms of cost breakdown is a good start, but it is not a tool to use alone. A supplier that wants to increase prices or charges a price that is too high may have ways to lower the price without even realizing it. The buyer’s negotiating duty is to help discover those ways.

The common theme among negotiation experts is to get a cost breakdown when initially negotiating pricing with a supplier.