Supplier negotiations are a critical aspect of running a business, and it’s essential to understand how to effectively negotiate with suppliers to reduce costs and increase the quality of service. Negotiating with suppliers can be challenging, but by understanding the product and cost drivers, knowing supplier leverage, and using the right techniques, you can secure better prices and terms for the products and services your business needs. In this article, we will delve into some key elements that will help you to engage in effective negotiations with suppliers.
Know the product and its cost drivers
Having an in-depth knowledge about the product is a crucial first step in cost negotiations. This includes having a comprehensive understanding of
- Technical knowledge regarding product functionality
- Sub-components and raw materials that make the product
- Upstream supply-chain and logistics
- Manufacturing processes involved in creating the product
- Quality and performance metrics
Armed with this knowledge, the next step is to identify cost drivers and to determine a baseline for negotiation. A simple method for establishing a cost baseline is to compare against a similar product with a known cost or by using a Request For Proposal(RFP) process to get proposals from multiple vendors for comparison. Depending on the availability of more granular data and reliable estimations, it is also possible to build a detailed cost model (a.k.a should cost model) by breaking the cost down to all major drivers such as
- Raw material
- Labor and Manufacturing
- Quality and Yield
- Shipping and logistics
By gaining an in-depth knowledge about the product and its cost drivers, you can be better prepared for negotiations, know what to negotiate, and make informed decisions.
Understand Supplier’s Leverage
In addition to understanding the product and cost drivers, it’s also important to understand the supplier’s leverage in the negotiation. This means analyzing the supplier’s position in the market, their competition, their financial situation, and their ability to meet your needs. For example, if the supplier is a market leader with a strong reputation and limited competition, they may have more leverage in the negotiation and might be less likely to budge on price. Conversely, if their revenue or market share is decreasing, they may be more willing to negotiate on price or terms in order to secure a sale.
Furthermore, understanding the supplier’s customer base and the volume of sales, can give you an idea of their bargaining power. If the volume you are bringing is a considerable portion of their total sales, leverage will be tipped in your favor and vice versa. If the product you are procuring is of high strategic interest to the supplier, such as one that utilizes cutting edge and differentiating technologies compared to their overall product portfolio, they will be more willing to work within your demands.
There are different negotiation tactics that can be used with each of the scenarios mentioned above and by understanding the supplier’s leverage, you can develop a strategy that is best suited for the situation at hand.
Techniques To Ace Supplier Negotiations
There are several techniques that can be used to negotiate costs with suppliers. These include:
1. Leveraging multiple suppliers
For high volume operations, it is common to leverage more than one supplier to source products and services. By creating a healthy amount of competition between suppliers, this technique enables the sourcing managers to bring down costs, negotiate favorable terms, and improve the quality of service from the suppliers. If one supplier is performing better, the buyer can increase the purchase volume of that supplier while reducing it on the other. This incentivizes the low performing supplier to improve their operations.
In situations where there is only one viable supplier in the market, and the sourcing volumes are quite large, some companies go as far as creating a new supplier in order to introduce competition. One way to do this is by bringing in a supplier from a foreign market. Another way is to approach a supplier engaged in an adjacent field, and collaborate with them to produce the goods you need. For example, if you are having difficulty finding a second source supplier for a specialized thermal imaging camera, you can approach a well established optical camera manufacturer and explore the possibility of enabling them to produce the thermal camera you need.
2. Volume to gain economies of scale
Increasing purchasing volumes is another way to gain leverage with suppliers. In situations where a buyer has the necessary inventory management and long-term planning capabilities in place, higher volumes of products or raw materials can be procured to take advantage of economies of scale. To mitigate the financial risk of over-procurement, it may be advisable to order only the high-cost or long lead time components or raw materials required to manufacture the product being procured.
Another way to increase purchasing volumes is by consolidating purchase orders across different departments within a company. A large corporation with multiple business units that order similar products can consolidate their purchase orders to gain volume leverage. Smaller companies can gain the similar benefits by creating or joining purchasing consortiums. A purchasing consortium is a group of companies that pool their purchasing volumes and negotiate collectively with suppliers. However, it’s important to carefully evaluate the terms of the consortium and ensure that they align with your company’s procurement goals and values.
3. Using contract terms as a tool
Negotiations involve two parties reaching a mutual agreement on a multitude of parameters. Some parameters like cost are important to both parties, parameters like quality might be more valuable to the buyer than the seller, and other parameters like contract length may be more valuable to the seller than the buyer. The art of negotiation involves a give-and-take approach between the buyer and seller to reach a mutually beneficial agreement. Skilled negotiators understand this dynamic and use it as a tool to their advantage. One way to do this is by helping the supplier reduce their risks by offering a longer term contract or agreeing to a supplier friendly payment term in exchange for meeting price points or other demands. Conversely, instead of asking for a discount, one can meet the supplier’s price point if they agree to add additional value or services that were previously not included in the quote. The key to effectively using this strategy is to understand all the variables at play, identify what is essential to each party involved, and strategize on how to leverage these variables to reach a mutually beneficial outcome.
4. Design modifications
Design changes can be a powerful tool in supplier negotiations. By working collaboratively with suppliers and leveraging their expertise, companies can identify opportunities to modify raw materials, dimensions, tolerance levels, and other product characteristics while still meeting end-user requirements and maintaining high quality standards. For instance, a company may propose switching to a different type of plastic for a product housing, altering the finishing requirements on an aluminum surface, or adjusting the shape complexity and edge rounding requirements on die-cast parts. Similarly, a company may explore opportunities to change the specifications on a sensor or other components. By identifying these opportunities and working closely with suppliers to implement the changes, companies can negotiate better terms, create more competitive products, and enhance their overall value proposition.
5. Play hardball
Playing hardball in supplier negotiations involves taking a tough and uncompromising stance on certain issues in order to secure the best possible deal. This strategy can involve making aggressive demands and even being willing to walk away from the negotiation. To use this strategy successfully, companies must have a clear understanding of their priorities and be prepared to back up their demands with solid evidence or leverage. It is also essential to strike the right balance between firmness and flexibility, as being too rigid can make negotiations difficult or lead to strained relationships with suppliers. Ultimately, playing hardball should be used judiciously and only in situations where there would be a contingency plan if the desired outcome is not reached.
While cost reduction is an important aspect of negotiation, it’s crucial not to overlook the quality of the product or service. A supplier may offer a lower price, but if the quality of their product or service is poor, it can jeopardize operations and even lead to increased costs in the long term. In addition to cost, factors such as lead times, capacity constraints, defect rates, on-time deliveries etc all play a key role in evaluating suppliers. It’s important to strike a balance between cost reduction and service quality when negotiating with suppliers, to ensure that you’re getting the best value while also reducing risk levels.
Supplier negotiations are a vital part of running a business, and it’s essential to understand how to effectively engage in them. They should efficiently solve the underlying problems while fostering positive relationships and lasting agreements between the parties involved. Skilled negotiators achieve this by having a sound understanding of the product, knowing leverage factors, and using the right negotiation techniques to invent creative solutions for mutual gain. Remember, negotiation is a process and it takes time. Be prepared, communicate clearly and be willing to walk away if the deal is not favorable for your business.
- “How to Negotiate with Powerful Suppliers”, HBR, https://hbr.org/2015/07/how-to-negotiate-with-powerful-suppliers