As suppliers enter 2017 looking to recover lost margin with double-digit price increases, we’ve found that the operators with the most successful responses are the ones who most effectively use data.
In this post, we share how Oil & Gas Supply Chain teams can respond to the 5 most common arguments suppliers use to raise prices.
1. “My costs for X are up”
We often hear suppliers come to the negotiating table with arguments like “our overhead is up by 3% this year” or “our labor costs are up by 5%, which means that our costs are rising by 7%”. So what are some effective ways to respond to a supplier who necessarily has better visibility into their own cost structure? We suggest starting with 3 key questions:
- Have the costs really gone up that much?
- What are the other cost drivers doing?
- Are factors like supply/demand offsetting the cost structure?
Developing a standard negotiation packet filled with market data on the particular item or service can be an effective way to respond. In this case, we suggest starting with a cost model that breaks down the cost of the item into its individual cost inputs, and then tracking how those inputs have moved with the market over time.
For example, if a joints supplier came to you saying “the price of labor for steel mills services is rising,” you could instead point to the other commodities that are exerting downward pressure on joints. In the graph below, we can see that steel has a much stronger impact on the price of joints than iron and steel mills services does, suggesting that the overall outcome should be a price decrease.
2. “I bought my steel (or other raw material) when prices were high”
We often see suppliers argue that because they bought their raw materials when the price was higher, they now need to recoup that cost.
We’ve seen three sets of data-backed arguments be particularly effective in combating this contention:
- First, we suggest running a simple benchmarking analysis to compare Supplier A's prices to the prices you're receiving from other providers of the same items and services. Quantifying the extent of the premium can show that their pricing is out of line relative to others who had the same lead time on their input cost purchases.
- Second, a simple due diligence is critical to validating the facts underlying the claim. Because commodity costs are so volatile, a timeline of fluctuations in commodity prices can help ensure you are paying a price that is actually in line with suppliers’ costs. Were input prices really as high as they contend at that point in time?
- Lastly, if you can see that one input cost has risen, but those losses will be mitigated by lower costs for other input costs, you can make a compelling case that their sunk costs are offset by other recent wins.
3. “Demand is picking back up, so capacity is tightening and prices are going up”
One of the most common ways suppliers ask for price increases is substantiating their request with arguments around increasing demand. While it may be perfectly reasonable for a constrained market to cause price increases, we often see suppliers coming back for double-digits when much more tempered escalations are in line with the market.
One powerful tool for holding down price increases is to employ index-based price adjustment mechanisms within key contracts. By tying price adjustments to movements in actual cost structure, we find that prices tend to rise much more slowly than if suppliers ask for round-numbers like 20%, 30%, or even 40% increases.
Interested in learning more about putting in place favorable price adjustment mechanisms? Click here to download our Index-Based Contracting eBook.
Whether it’s mitigating risk of suppliers raising prices , or simply being able to come to the negotiating table armed with quantitative support for your position, using data to support your stance means a better chance of leaving the negotiations with a favorable outcome. That’s why we advocate leveraging a data-backed position.
For more information on approaching supplier arguments with data, shoot us a note at firstname.lastname@example.org.