Conducting fact-based negotiations is an effective cost reduction strategy when sourcing existing components. In this post, I will explain how to leverage a product cost management (PCM) platform to conduct fact-based negotiations and provide real-world examples of manufacturers successfully using this strategy to obtain significant savings on current products.
First, let’s start with the basics.
WHAT IS A PRODUCT COST MANAGEMENT PLATFORM?
A Product Cost Management platform is a highly intelligent manufacturing costing software that uses both global and highly-localized product cost inputs to help businesses estimate the should cost of their products.
A Product Cost Management (PCM) platform gives you the insights you need to conduct a fact-based negotiation with suppliers. This helps to ensure that you purchase each part at a fair price, that you’re not overspending for the part, and that your suppliers are not losing money.
WHAT IS FACT-BASED NEGOTIATION?
Fact-based negotiation is a highly effective cost reduction strategy.
During fact-based negotiations, the detailed component cost information within your PCM platform enables you to have focused discussions with your supplier about parts that you may be overpaying for. A PCM platform also helps you to identify the biggest gaps between your data and your supplier’s data.
How do you use a product cost management platform to conduct fact-based negotiations?
In a fact-based negotiation, the more facts you have, the stronger your negotiation will be. A Product Cost Management platform should provide you with a complete breakdown of critical negotiation areas including:
secondary processes such as paint and packaging
The key to successful fact-based negotiation is gap identification. Your goal during this process is to identify outliers and the biggest differences between their data and yours. This is a much more effective strategy than saying “your price is too high” or “I want a 10% reduction in costs”. Instead, you come to the negotiation table armed with specific cost variations to explore and discuss. This keeps your negotiation focused on facts and figures instead of accusations and emotions.
HOW TO IDENTIFY CANDIDATES FOR IMMEDIATE COST NEGOTIATION
When looking for cost reduction opportunities among existing components, the first thing you have to do is narrow down your targets by determining the scope of what you’re going to negotiate.
The reality is: you can’t possibly negotiate everything that you buy.
Learn more about how to conduct a spend analysis in this article. In general, we recommend that you target the items on which you spend the most money, because that’s where the biggest saving opportunities are.
STEP 1: RUN YOUR ESTIMATES
It goes without saying that in order to have a successful fact-based negotiation, you need to have your facts straight first. When you estimate the costs for the components that you have chosen as candidates for re-negotiation, it’s a good best practice to double-check that you used the correct material and volumes and have accounted for any secondary processes such as paint, polishing, heat treatments, etc.
Negotiation Tip: You want to have the most accurate cost estimate possible when conducting these negotiations. But it’s also important to remain realistic. An estimate is called an estimate for a reason. Your overall number does not have to be exact; it just has to be a very good estimate for you to be able to open your negotiation.
STEP 2: IDENTIFY PRODUCT COST GAPS
Once you have generated your estimates from your manufacturing cost estimating software, you want to identify those parts where the estimated cost is significantly different (> 20%) from the price you are paying currently with your supplier. Those are the parts you want to target for immediate negotiation.
Sometimes the difference between your estimate and the price you are paying is very big. The estimate may be perhaps half the price, or maybe even a quarter of the price you are paying.
When the estimate gap is this big, it’s easy to dismiss those estimates as a fluke of the system. But in many cases, there is strong cost-saving opportunity here. In fact, a big difference between your estimate and the price is an indication that something may be missing from the estimate or that something about the production process is not well understood.
Negotiation Tip: Ask your supplier: Can you help me understand the difference between what I’m seeing on my cost estimate and what I’m paying today?
Think a 5x cost savings is too good to be true? Think again! For one truck manufacturer, conducting a spend analysis in this way helped them save $250,000 annually.
CASE STUDY: SPEND ANALYSIS FINDS $250K ANNUAL SAVINGS OPPORTUNITY
We worked with a truck manufacturer, whose product cost management platform was estimating that a truck roof should cost about half of what the company was paying.
When we contacted the supplier, we focused heavily on fact-based negotiation to foster an open conversation.
We said, “We’ve been analyzing all of our high-spend parts, and generating some cost estimates. We estimated the cost for this roof, but it isn’t nearly as much as we’re paying, and we want to understand where the cost is going into it. Can you help us understand that?”
As it turns out, the paint process being specified required the supplier to polish the roof. And because it was a concave part it couldn’t be put through a sander because a sander might deform it. So, it had to be polished by hand, and that added a significant amount of cost.
In this case, it turned out the supplier was charging the right price – the part should cost as much as the supplier was charging due to the large amount of manual labor – but now the customer knew the reason for it.
They went back to Engineering and reassessed what they could do about the paint spec, because it was costing them about $250,000 per year.
That’s the type of actionable information you may find when you conduct fact-based negotiations with your suppliers.
STEP 3: IDENTIFY STANDARD PRODUCT COST OUTLIERS
Next you want to identify your standard outliers. A standard product cost outlier is when the price difference between what your product cost management platform estimates it should cost – and what you actually pay for that part – is greater than 15%.
This gap is significant enough to be called an outlier. In these cases, you may be missing a process or there may be some other valid reason for the difference. This is why it’s important to obtain a detailed cost breakdown for outliers.
What is Included in a Product Cost Breakdown?
Many companies ask for a detailed breakdown of the cost right from the start. If you have not, the first step in resolving your cost outliers is to obtain a breakdown of the cost from your supplier.
Your cost breakdown should outline critical insights including:
manufacturing process costs
the main forming process
any extra machining costs
any secondary processes such as painting, or inspections
and any transportation costs they may be charging you
You will then use this cost breakdown to compare to the estimate you generate with your product cost management platform.
In many cases suppliers will not be able to give you this entire breakdown, but they should, at least, be able to give you a breakdown of the material costs, principal manufacturing cost, tooling costs, painting and other secondary process costs, and transportation costs. Almost all suppliers will know these costs.
Negotiation Tip: Ask your supplier, I’m seeing a cost difference in my estimate of about 40%. Can you help me understand your cost breakdown for this part? Specifically I’d like to see details regarding material costs, tooling costs, and painting costs.
If you don’t find a quantifiable reason for the cost difference, then you need to investigate the details and begin the process of fact-based negotiation.
STEP 4: IDENTIFY EXCESSIVE PREMIUMS
At this point, you should have both a breakdown of cost from the supplier and a breakdown of cost from your product cost management platform.
To identify areas where you may be paying excessive premiums for outsourcing, open a conversation with your supplier about secondary processes.
Negotiation Tip: Ask your supplier which secondary processes they conduct in-house versus which ones they outsource. These costs can add up to a very expensive premium.
If your supplier is sending a part out for paint, or they’re sending the part out for heat treatment, how much of a premium, over and above what they’re paying, are you paying them? Is it as much as 50%? Because if it is that high, you could easily negotiate that down to something more reasonable, like 20%.
The same concept applies to transportation. If the supplier is paying for the transportation to send the part to and from a sub-supplier, then yes, you need to pay for that because it’s part of the cost, but you shouldn’t be paying a high premium for that.
You should be willing to give them some premium, but not an excessive premium.
STEP 5: IDENTIFY KEY AREAS TO FOCUS COST SAVINGS INVESTIGATIONS
Now that you’ve solved for costly premiums, the next step is to identify where the biggest differences in the detailed cost breakdowns. Organize these by gap percentage so you can focus your cost savings investigations.
Is your biggest difference in material costs?
Is it a case where the utilization is not as good as you had expected?
Is the manufacturing process different?
What are the setup costs?
Does the supplier know what the setup costs are?
What batch sizes are they running?
What are their labor costs?
Identify the largest differences and then investigate the reasons behind them.
STEP 6: EXAMINE MANUFACTURING PROCESS AND PRODUCTION VOLUME
It’s important to find out how the supplier is making the part, so you can compare it to what your product cost estimating tool is suggesting. If your estimate is different, find out the reasons as to why the discrepancy is there.
You may find out the supplier has a limited capabilities. Limited capacity may have been acceptable when your volumes were low, for example, but when your volumes go up, you may not be using the best supplier.
Or, you may have a part of which you initially purchased one thousand parts per year and it was best to make it on a turret press at that volume. Now, you’re buying fifteen thousand parts per year. It’s probably more cost effective if you stamp the part.
Negotiation Tip: If your product is better suited to stamping than on a turret press, offer to buy the die and the tooling. Buying these may be a better long-term saving investment than continuing with the turret press at higher volumes.
Sometimes, your supplier simply doesn’t have the capability to provide the part via the most economical process because they just don’t have that type of equipment. In these cases, you may need to change suppliers to save the most money.
CASE STUDY 2: ROUTING CHANGE REDUCES PART COST BY 80%
I worked with a customer that had been buying the same spacer for over a decade. They were paying about $4.80 for the part which was cut from a bar and then machined, which was the only way to meet the tolerances when it was originally designed and manufactured. Our product cost estimating tool determined the part should be made with a laser, and calculated it should cost about $0.85.
The customer went back to the supplier and requested a re-quote, and also had the part quoted at other suppliers. One of the new quotes was about $0.80 per part using a laser process.
This is a perfect example where the product cost management platform estimate was less than one fifth of what the part actually cost to buy. The customer could have easily said “That can’t be right,” and moved on.
Instead, they took the time to figure out why there was such a big cost difference between their cost estimating tool and the historical purchase price. As a result, they were able to get a significant amount of savings on the one part.
STEP 7: EXPLORE MATERIAL COST DIFFERENCES
Sometimes you’ll find your biggest differences are in material costs. This could be caused by several different factors.
Example 1: Raw Material Costs are Too High
You may find out your supplier is paying a lot more for the raw material than you expected. In those cases, if you have the buying power that a smaller supplier may not have, you may offer to purchase the material and ship it directly to their factory.
Example 2: Material Utilization is Too Low
In other cases, the cause of significant material cost differences is utilization. If utilization is low, you want to inquire whether they are selling the scrap, and whether or not you are getting any credit for that.
Example 3: Credit for Scrap
Sometimes suppliers will give you credit for scrap. Many suppliers will say your scrap credit is already built into the cost of the material by giving you a discount up-front on the cost of material per pound. However, not all suppliers give this discount up front or a credit for your scrap. Ask your supplier about this key cost saving area.
STEP 8: SCRUTINIZE SETUP COSTS
Set-up cost is often ignored but it can be a source of low-hanging fruit when negotiating for cost reductions with suppliers. If your product cost management platform indicates the setup costs for a part is a significant portion of the total cost, say 15% or 20%, then it’s worth investigating the batch sizes with your supplier.
You may assume the batch size is equal to the order quantity, but that may not be the case, so you should find out what it is.
What if my supplier doesn’t know setup costs?
Your supplier might not know what the setup cost is. Some suppliers don’t break it down; it’s simply included as part of their overhead. If that’s the case, show them that your estimate for setup is a significant part of the cost. Ask your supplier if they’d be willing to give you a reduction in price if you double or triple your order quantity.
Negotiation Tip: If the savings associated with lowering your setup costs are much greater than your cost to carry the inventory, by all means, double or triple your order quantity. In fact, the supplier may hold the inventory for you for a fee much lower than the cost of making the parts in small batches.
STEP 9: REQUEST A REQUOTE
Sometimes, you find out that the supplier just misquoted, or that they quoted a part when you were buying very low quantities, perhaps during your first year of production, and the price never changed.
Negotiation Tip: If it’s been a few years since your original quote, don’t be afraid to ask for a reqote. Say to your supplier, my cost estimation software is showing this part at a much lower cost. Can you please send me a requote?
This strategy helped save one business 30%!
CASE STUDY 3: RE-QUOTING RESULTS IN 30% PART COST REDUCTION
Here’s the story: They had a battery cover which is also used as a step to get into the cab of the truck. When they generated an estimate for this part in their cost estimating software, the tool suggested that it should cost a little over $22. They were paying $40 for each one.
When they approached the supplier, the supplier came back and re-quoted the part at $27.50, which provided a significant annual savings.
Remember that the estimate may not always be 100% accurate. So even though the requote came in at $27.50 over the estimate, the gap in cost was enough to enable them to save significantly over the original $40 that they had been paying.
In this case, the part had been quoted at $40 initially when the volumes were very low. The part was loaded into the system with this supplier, at this cost, and as the volumes ramped up the part was never re-quoted, because you can’t requote every part; it’s just impossible.
HOW FACT-BASED NEGOTIATIONS CAN REVEAL SURPRISING SAVINGS OPPORTUNITIES
Going through this process is a key way to reveal cost-saving opportunities for your business.
In some cases, your manufacturing cost estimating software may indicate that you should be able to save 30-50%, when in fact you end up saving 15, 20, or 30%. That’s still a significant cost savings. And it comes from negotiating with the facts that your product cost management platform provides.
Be careful not to dismiss the cases where your PCM platform indicates that you should be paying much less for the part, even if ½, ⅓, or ¼ of what you currently. In those cases, knowing the reason for such large discrepancy may lead you to take actions that will save you large sums of money.
TELL US ABOUT YOUR EXPERIENCE
Are you using a product cost management platform to analyze your existing parts and identify potential savings opportunities? Has it helped you negotiate better pricing with your suppliers? Tell us about it in the comments.