How We Make It Expensive For Suppliers To Sell To Us
Michael Harding, C.P.M., CPIM
Michael Harding, C.P.M., CPIM, Harding & Associates, Bristol, VT 05443, 802/453-5379.
82nd Annual International Conference Proceedings - 1997
The Issue. Many companies have spent a great deal of time and effort to reduce supplier prices through long-term agreements, partnering, concurrent product development, and the like. Many of these efforts have been outward focused. Seldom have companies examined their own internal practices, policies, and beliefs to discover if they, however inadvertently, may be contributing to higher supplier prices.
We find that often companies ask for and, in some cases, demand higher quoted prices in order to comply with company policies. Conventional wisdom is hard at work in many companies today. The following is an examination of practices that drive up supplier pricing and policies that make it expensive for suppliers to sell to buyers. You are free to determine the validity of these practices and whether or not your company may benefit from a change in approaches.
The bidding (RFQ) process.
Many companies, especially the accounting and auditing departments, require that purchasing obtain three quotes and that purchasing select the lowest of the three quotes when placing orders. There is often a provision that if purchasing can justify paying other than the lowest price, that price will be considered appropriate by auditing.
What many auditing or review functions miss is that if purchasing accepts the lowest of three bids, they will pay the world's third highest price. This is contrary to commonly held beliefs, but consider:
If you were a seller, how would you determine the selling price of your product? Would you pare your overhead, reduce labor content, accept minimal margins in an attempt to be the lowest price in the market? Or would you first attempt to determine the competitive environment and the buyers' expected or acceptable price before addressing internal cost opportunities? In fact, the sellers' objective is to determine the highest acceptable price for their products in the market and sell at that price. The objective is not to sell at the lowest price. When products sell based on price, they become commodities and their is little opportunity to sell based on profitable elements such as technology, function, and service.
Smart sellers will quote the highest price they believe will be acceptable to buyers and reduce prices after exploring the market's response to their initial prices. If there is no resistance or negotiation, the price will either be accepted or rejected on its face.
Often buyers will send an RFQ (Request for Quote) with a set of specifications or prints and a list of quantities to be quoted. As an example:
"Please quote in quantities of 1000, 2500, and 5000"
Little more is said about the anticipated level of business. Key pieces of information are missing for the supplier to make the best business decision for the buyer. They include:
- Is this a one-time buy or an on-going purchase situation?
- Do the stated quantities represent one month's or one year's requirements?
- Will the buyer split the business?
- Will there be repeat business?
- Are there other parts associated with this buy? Is this a new product or a change in sourcing for an existing part?
The seller has insufficient information to make the best business decision for both parties so they must take a position which protects their interests - a conservatively high price. The assumption with which the seller is left is to take the RFQ at its face value - a one-time buy (if this was a high dollar buy, the seller would undoubtedly call the buyer for added information). But at this stage, the seller has no incentive to peruse the matter further, would not invest in training, technology, or process improvement.
The requested price breaks in our example of 1000, 2500, and 5000 also tells the supplier something about expected prices:
- The buyer expects to pay ever-increasing prices for lower release quantities.
- The seller can charge by ship quantities, not long term pricing arrangements.
- The buyer ignores the supplier's existing price breaks (prior to receiving this RFQ, the seller had but two prices - 1-4999 and 5000>) What a pricing opportunity for the seller!
Often, other considerations such a quality, packaging, direct delivery arrangements, and like are not included in the RFQ and provide the seller with a later opportunity to negotiate the price impact of these special considerations (whether or not there is a direct cost consequence).
Internal cost estimates and standards
Cost estimates whether by engineering, the user, finance, or purchasing tend to be self-fulfilling prophesies. Achieving preset pricing targets can take precedence over improving final prices. It is possible that once a predetermined price is achieved, there is no further purchasing effort to continue to find a better deal for both parties. A target of matching the last price paid is also self-defeating - who said that the last price was acceptable or even good?
Unless there are some specific and overriding considerations to the contrary, include all pertinent information in the request for quote including but not limited to:
- Projected life of product quantity - buyers will want to disassociate individual release quantities from pricing.
- Quality considerations such as Cpk requirements, end-customer support, warranties, and the like.
- Packaging and delivery - standard counts and reusable packaging. Point of use deliveries.
- Request suggested changes and improvements based on the specification included with the RFQ.
- Request quoting suppliers to sit with the buyer and engineer for cross-suggestions before quoting the item.
- The buyer's sourcing strategy such as whether single or multiple sources will be utilized.
- Where appropriate, include families of parts in an RFQ.
These will allow suppliers to make good business decisions based on full business information.
For large buys, buyers would do well to preselect individual suppliers to sit with design engineering at the initial design stage to assist in the design to cost, quality, and manufacturability. If egos permit, buying organizations might do well to have suppliers design the component which they will supply. In these environments, purchasing must be the gatekeeper as to who has access to the design community.
Ultimate pricing would be the result of individual product development and design. Quoting a part after it has been designed is too late to influence the cost and resulting price - 80 percent of a part's cost is determined by its design.
Discard the old and simplistic process of the lowest-of-three bids. While it may provide some comfort to auditors, the process is flawed and tends to drive pricing to a predictably high level.