Inflation-Fighting Procurement Tips You Can Use
As inflation tightens its stranglehold on the global economy, your suppliers will be passing the effects directly to you – but thanks to CPO Live speaker Jimmy Anklesaria, you’ll be armed and primed
Everything from diesel fuel to semiconductors to coffee beans cost more now than they did even a few months ago. Inflation is a reality for all suppliers, who understandably want to pass on higher costs to their customers.
While higher prices seem to be an expectation these days, procurement pros should dig deeper to understand the real effects of inflation on the goods and services they buy. It’s not as simple as accepting an across-the-board price increase at face value.
At the recent CPO Live Roundtable event in London, Jimmy Anklesaria, a procurement consultant, company founder, university professor and ISM Shipman Medal recipient, related his views on managing inflation in your procurement process.
He noted that suppliers love to work with buyers who accept the overall consumer price index inflation as justification for across-the-board price increases.
“That’s what I call being an ignorant buyer and suppliers love those people,” Anklesaria says. “Don’t be the old-fashioned table-thumping, reduce the price at any cost type of buyer. Taking a supplier’s price increase and knocking it down by a few points is not negotiation. It’s called bargaining. One needs to know how to manage costs during inflationary times by using time tested processes.”
He shared his wisdom from decades of procurement experience through multiple economic cycles.
5 components of PRICE
Understand the elements that go into the price of products
· Direct material
· Direct labour
· Manufacturing overhead
· General selling & administrative
Inflation doesn’t affect all the elements equally. Fuel costs for transportation may represent only about 15% of the cost of a product. But a company demand a 45% fuel surcharge apparently to offset rising fuel costs. A procurement manager may feel great about negotiating only a 30% increase in the fuel surcharge. But fuel price increase is, in reality, a minor component of the overall price. By agreeing to a 45% surcharge a buyer is, in effect, agreeing that every single element of cost has gone up by 45%. That means driver’s wages, insurance, depreciation of the truck, repairs and maintenance, road taxes and the entire general, selling and administrative expenses have also gone up by 45%. Same with profit. It does not make sense. So, the buyer is overpaying for the fuel surcharge on a per mile or per kilometer basis.
4 steps to manage price increases
The key to managing costs during inflationary times is to ignore the general inflation rate and focus on pricing for critical products and components. For electronic devices, track the price of semiconductors and glass for monitors. If the price of glass goes up 20%, it doesn’t necessarily mean all the other components increase by the same amount.
Analyse the numbers
Break down a supplier’s price into the key cost elements and then identify the top two or three critical components. Then, dive deeper into those critical components of price.
Track pricing targets (Indices)
Identify a tracking mechanism to monitor changes in the market price for each cost element. These are usually indices published by the statistics bureau of governments or by professional bodies. One is able to find such indicies for both material and labor in a host of websites.
Beat the index
An index represents the “average” rate of change in a given commodity or labor category. The top 25% of companies obviously beat the index and so this must be factored into your discussion with a supplier. Develop a minimum advantage target that gives your organisation a competitive advantage in pricing. Suppliers need to show that they buy better than the average in order to earn your business. For example, if the price of a certain commodity goes up by 10% one would expect your supplier to pay around 7% more than they did for the same product or service. Similarly, when the market falls by 10% one would expect the supplier’s price for that commodity to drop by 13%. Competitive Advantage Measurement Systems should be part of the negotiation strategy.
Use the 20-40-40 rule
This approach guides the emphasis on procurement negotiations with suppliers. In inflationary times, it’s difficult to negotiate lower prices. But procurement can provide guidance in reducing expenses through other means without beating down suppliers.
20% — Price management, i.e., identifying and tracking costs of critical products
40% — Demand management, i.e., looking for ways to reduce demand for products or services to cut spend.
40% — Specification management, i.e., looking for ways to take costs out by using less materials or labor and still meet requirements.
Anklesaria recounted a tale of working with a major telecommunications device manufacturer. Mobile devices were packaged with a 2.5-meter charging cable. He suggested reducing the length to half a meter, saving 85 million euros for the company. He also recommended reducing the amount of gold in the connectors that would still meet standards for durability but cost much less
“That how you tackle inflation—you don’t go chasing suppliers and arguing about a few percentage points in price. That’s rubbish,” Anklesaria says.
Jimmy Anklesaria spoke at our last UK CPO Live meeting – don’t miss future speakers of his calibre: register for the whole series!