Editor's note: This article originally ran on April 5, 2021. See Paul expand and update his advice in the June 15, 2023 IW Members Only Webinar "Supplier Pricing Negotiations: Approaching Options and Risk with Eyes Wide Open Globally."
Price increases come in all shapes and sizes from suppliers and in ways you might not expect. Here’s a recent example.
One of our clients designed a strategic component into a consumer product. For many years, the contract manufacturer of the product was required to use this component, and the price for the final assembly had this particular component baked in. In early January of this year, without warning, the supplier sent an invoice for over two years’ worth of purchases of this strategic component to our client’s accounting department, bypassing the supply chain team, hoping the invoice would simply get processed and paid. The change was escalated during the approval process and the supplier was confronted. Pushing back, the supplier changed tactic, claiming raw material price increases (unrelated to the component) required overall price increases to the entire assembly.
This wolf-in-sheep’s-clothing shows the creative ways a supplier may try to package price increases.
The last couple of quarters have been particularly busy for price increase asks across the board, with nearly every supplier, all industries, looking to shore up margins. Material prices, exchange rates, shipping capacity problems—the sales pitches for increases shared these common themes. Many suppliers waited until just before Chinese New Year to make the announcement. That put many customers in a tough spot. Those refusing an increase risked moving the back of the line for capacity, and missing key shipping dates. Those taking an increase risked tough conversations with end customers, whose forecasts (and fixed contracts) did not account for sudden changes.
The resulting strain on supplier-customer relationships can last for years and put all business at risk.
Over the past few weeks, CMD has been tasked by clients with numerous negotiations related to price increases. There are no ‘one size fits all’ methods. We handled each situation differently. Total deal size, total capacity of a supplier consumed, availability of a backup (BATNA) plan, relationship history, competitive environment—all are among the endless backdrops that set the stage for variety of unpredictable performances.
Michelle Liu, operations leader, is CMD’s lead negotiator for price discussions. Assuming a supplier comes at you with an “across the board” increase, here are a few approaches she considers.
If the negotiation starts off tense, let the supplier vent. By doing so, you gain a special advantage by showing empathy. We’ve found that by allowing suppliers to express their emotions, they will eventually come around to a rational state for a business discussion. Then both parties can listen better, and you can shift the conversation from feelings to facts. Be authentic and genuine, so the supplier feels you are reasonable and not trying to take advantage of them or avoid their point of view.
2. Unpack the BOM
Review commodity price trends and divide each bill of materials (BOM) into material types. Recently, commodity prices are at historic highs for many metal and plastic categories. If your assembly is mostly metals, which metals? The increase should not exceed the historical movement for specific metals in specific categories, and should not apply to portions of the assembly that have seen no price movement for months. Facts are friends.
3. Carve out SKUs
Sort your product line into baskets. One approach might be to segregate the increase to lower-volume parts where there may be more margin to work with. Try to protect higher-volume parts were margin may be thinner. Lock in on prices, in writing, for as long as possible.
4. Make it temporary
Like a gas surcharge in the transportation industry, carve out the price change as a separate line item and keep your historical contracted pricing the same. Ensure the supplier knows you’ll debate this topic periodically to understand why it must be kept a bit longer or removed. Make the discussion data-driven. Before the end of each meeting, set the next review date.
5. Determine timing
We’ve seen situations lately where suppliers will argue that the price changes apply for POs shipped weeks ago. Carve out what applies when. We recently successfully argued an increase should apply only to orders placed after a certain date, to allow enough time to work upstream and requote end customers.
6. Be a historian
In general, Chinese suppliers aren’t keen on long range planning. So when hit with tariffs, raw material increases, etc. - they may not have a plan to handle disruptions. They often forget what they have committed to in a contract. So be a historian - go back to the contract. If and when the conversation gets emotional, bring it back to facts and the contract. Be fair, but facts driven.
If applicable, remind suppliers of situations when you took an increase and didn’t ask to share the burden. In recent history, this happened with a client of ours who absorbed the tariff on a specific product a few months ago, and successfully asked the supplier to absorb this latest round of increases related to plastic material pricing. In a partnership, everyone should share the burden.
7. Explain your costs.
Suppliers often overlook logistics, warehousing, fulfillment, marketing, sales, and many other costs of bringing a product to market. Currently, transportation times and costs are at historical highs and most deals are quoted FOB in the port closest to the supplier. The brand owner bears responsibility for all transportation costs and working capital during transit time – both of which in recent months have more than doubled. Make sure the supplier understands you are absorbing these higher costs and you’re looking for a partner to share the burden. Open the supplier’s eyes to the costs they don’t see.
Make your end customers aware of the pressure you’re under. While lone voices asking for help may lose business based on price, an entire chorus of voices has a different impact and gives end customers a feel for global market pressure vs. a one-off.
The Bottom Line
In our experience, it may take several rounds of discussions before arriving at a final agreement. And even then, as our opening example illustrated, decisions are often not final. Make sure the agreement is in writing with clear instructions. Communicate the changes with your AP team and once the next round of invoices land be sure to review them carefully to confirm the agreed-to decisions were reflected. If suppliers think they can get away with something, they will try (sorry to sound cynical but we’ve it seen all too often).
While it may be tempting to threaten a supplier with taking business elsewhere, supply chain switches are often unrealistic for many reasons, and suppliers know that. Think hard about what the supplier means to your business and bottom line as you approach every price conversation, with thoughtful attention.
What’s worked for you over the years? We welcome your feedback.
Having lived in, learned, and worked in Asia for three decades, Paul Stepanek is a leading expert on Asian business strategy. He is the founder and president of Complete Manufacturing and Distribution (CMD), a company that helps leaders worldwide accelerate results with Asia initiatives, including market strategy, sourcing, manufacturing, logistics, quality management, facility construction, business process outsourcing, continuous improvement, e-commerce, and more.