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The Key to Successful Should Costing Fact Based Supplier Negotiations

The Key to Successful Should Costing Fact Based Supplier Negotiations
April 16, 2021

Negotiation is essentially an art of doing a business transaction leading to the finalization of purchase and sale of contract goods and services. The discussions and movement toward a mutually win-win situation will happen when the customer and the supplier make a contract that covers all aspects beneficial to both.

Typical objectives of negotiations are:

  • To maximize customer value by procuring products or services at the right cost 
  • To achieve certainty and transparency in terms of supply and procurement means and methodology
  • To bring mutually beneficial solutions for both the customer and the supplier
  • To enable business expansion in new markets with the right products at the right time

This blog post is an attempt to bring to the reader a broad view of the author’s experience supporting HCL customers during should costing-based supplier negotiations. This is a part of rendering end-to-end product cost management solutions and services to them.

Pre-negotiation activities

First, we need to arrive at a cost baseline for the part or set of parts applicable to the supplier on the basis of should costing. Based on industry best practices, a zero-based should cost model (ZBCM) is developed. The key ingredients for this are the raw material cost, the conversion cost, and the overheads involved. The ZBCM developed as such is an ideal scenario cost model, and is then compared with the present part cost and the difference, to estimate the cost gap. This gap is the potential savings that could result from negotiations.

The conventional process followed for next steps include

  • Consulting the customer commodity managers (representative/s of the supply chain team) and refining the cost model based on inputs from this team
  • Revisiting the gap and parallel analysis of the impacting cost drivers
  • Ascertaining the present conditions employed by the supplier for the manufacture of subject parts by making a supplier visit with the commodity managers
  • Refining the cost model to arrive at the supplier-based cost model (SBCM) and a re-estimation of the gap along with cost driver analysis

The SBCM thus arrived at, along with the cost driver analysis findings, form the basis for final negotiations.

Process Challenges

While executing the above-mentioned activities and leading to final negotiations, some of the typical challenges encountered are as follows:

  1. Effective preparedness for final negotiation:
    • Lack of clear, baselined expectation with commodity managers
    • Integration issues with commodity managers, site managers, and suppliers
  2. Exercising control over suppliers
    • Design, development ownership, and monopoly of suppliers
    • Delayed negotiation closure due to last minute changes on the agreed data points by suppliers
  3. Clear understanding of supplier needs:
    • Lack of a win-win situation
    • Lack of supplier awareness on the program
    • Uncertainty on negotiation closure due to operational challenges (payments, drawing quality, and order quantities, etc.)
  4. Moving timeline targets
    • Ineffective internal and external tracking mechanism; seriousness from all stakeholders on the opportunity lying on the table
    • Ineffective use of the escalation matrix

To address the above-listed process challenges, we recommend the execution of the following set of activities:

  • Adequate preparation for negotiation
  • Setting the right negotiation ground rules
  • Adopting the right negotiation approach

Preparation for negotiation

Before approaching the supplier for final negotiation, the following preparations must be made:

  • Plan for a pre-supplier workshop with the customer commodity managers so that  both are aligned and speak the same language in front of the supplier
  • Have a complete understanding of the cost breakdown structure, current purchase order price, incoterms, volume, batch size, and preparation to tackle supplier concerns
  • Leverage assessment (single/dual source, business share, current business status etc.) and thorough understanding of supplier key performance indicators
  • Assign role play during negotiation (what to speak and who should speak)
  • Establish an accountability matrix with all stakeholders
  • Be more aggressive during negotiation to capture the smallest saving opportunity related to raw material costs, profits, and overheads. Discuss identified continuous opportunities and get supplier and customer on-board.

Setting negotiation ground rules

  1. Onboard the right suppliers and get the concurrence or buy-in from the identified suppliers to share all required information and be part of the entire program cycle.
  2. Have complete belief in the cost model.
  3. Create a win-win situation with new business opportunities in the pipeline.

It is very easy to assume that because supplier is important that doesn’t mean that he feels the same about you. The customers need to improve the confidence level of the suppliers by showing them the growth plan and ask for a collaborative approach during the long run. Openly discuss and bring out points and reasons for bringing them on this program.

  1. Answer to technical queries to be spontaneous and confident.
  2. Schedule follow up meetings with suppliers with detailed briefing on the activities. planned in each meeting and closure of time-bound negotiation.

Approaches to negotiation

There are two kind of negotiations that are prevalent in the industry:

  • Category-1: Based on novelty of the supplier– Is it an existing supplier or a new one?
  • Category-2: Based on expected future engagement– Should it be adversarial versus a partnership?

Category-1:

In terms of the supplier and the buyer, the following relationship must be considered.

  • Tactical procurement– Used when a new buyer is on board with the following relationships:
    • Adversary relationship, “take it or leave it”
    • Transactional relationship– Normal ordering
    • Single sourcing, agreement at fixed price for a specific time
  • Strategic Procurement– Used for old suppliers and buyers with the following relationships:
    • Strategic alliance– Working together for a specific purpose
    • Collaborative– Commitment with shared risks/benefits under strategic procurement
    • Co destiny– Interdependency as part of strategic procurement

Category-2:

Adversarial negotiation– This is also known as the distributive or win-lose negotiation approach. In this approach, the focus is on ‘positions’ and every time one party wins, the other loses. As a result, the other party is regarded as an adversary.

  1. This approach is basically hostile and aggressive
  2. Strategy is based on secrecy and unpredictability
  3. The desired outcomes of the negotiations are not known

Partnership negotiation– This is also known as the integrative or win-win negotiation approach. In this approach, the focus is on the merits of the issue, which are resolved through creative problem-solving, and one or both parties can gain without the other having to lose. Since the other part is considered as a partner, he may be more willing to share concerns, ideas, and expectations.

Partnership negotiation is an approach wherein the focus is on the merits of the issue are resolved through creative problem solving and one or both parties can gain without the other having to lose.

  1. This approach is basically friendly and non-aggressive
  2. Strategy is based on openness and predictability
  3. The desired outcomes of the negotiations are known

This is clearly evident and based on HCL’s experience of supporting their customers on the related areas of engagement:

  • In Category-1, either approach may be considered depending on the circumstances
  • In Category-2, partnership negotiation is the recommended approach for successful supplier negotiations