Negotiating with Indices
The results are in for your RFP (Request for Proposal), now it’s time to pick the supplier(s), sign the contract, and place the orders (Woohoo!). But, have you considered the next critical step in the process: Negotiating the price with market indices as a driving factor?
Editor’s note: This article is part of the MyPurchasingCenter content archive. It was originally published in 2015 and appears here without revision.
An Index price is a weighted average of the prices of a select basket of goods and services relative to their prices in some base-year. Many industries can be tied to their relative market index. For example, the Chemical Data Index (CDI) provides market data for U.S. plastics, petrochemical and petroleum industries. While entering negotiations with indices being a driving factor behind your suppliers’ cost can be tricky, you should know that all pricing is negotiable. Here are a few key areas to consider when developing a strategy to negotiate a price or service, and improving relationships with your supplier base.
Know the Market
Before entering negotiations with a supplier, be sure to understand not only the market but also your company’s current spend and volume of the product you’re sourcing. One way to get this information is through benchmarking. A benchmark report is a strategic tool that measures the business performance, supply chain efficiency and supplier relationship adeptness, as well as pricing against established best practices in the industry.
Useful data to build a benchmark is invoice data for internal insight. Invoice data highlights the unit price you have paid throughout the year; this can be tracked against the index and quoted prices, and establishes a baseline for the unit cost. For market data, use the market indices and quotes of incumbents and alternate suppliers. Reviewing quoted prices can provide insights into current market conditions, such as supplier competitiveness in comparison to the market index. Market data, combined with clear visibility into your organization’s needs is valuable when it comes time to evaluate suppliers and to see if there is room for negotiation.
Pricing models are valuable when dealing with index pricing-based products. Pricing models generally refer to the methodology behind how a company prices a good or service. However, for the purpose of this article we mean the price structure. Having an understanding of your potential supplier’s raw material cost is helpful not only when comparing pricing to other suppliers, but also when identifying alternative areas for negotiations. However, you will experience that most suppliers are protective of their pricing structures. Suppliers will say the price structure is proprietary information and even insist that a contract is needed before disclosing this information or will not always disclose complete percentages of the price structure for raw materials, overhead, etc. To gain insight on the pricing model asks them direct questions such as:
- What index is used in the pricing structure?
- What is the approximate percentage of the price that composes raw material cost?
- Is there a target percentage for market fluctuations that causes an increase or decrease in pricing?
- What percentage of raw material based increases is passed through to the customer?
The answers to these questions will help give you an idea of how the supplier models their product pricing without directly asking them to divulge all the information before you’ve signed the contract.
Another item to inquire about is the pricing policy. A pricing policy helps you understand how often the supplier reviews the market index and adjusts pricing to market fluctuation. This information can help with contract negotiations (placing a pricing agreement in the contract) and as the buyer, you can anticipate when a price might increase or decrease throughout the year.
For raw materials and finished goods affected by pricing indices, a pricing agreement should be considered during the negotiation. Pricing agreements help establish transparency between the supplier and customer on all parameters that might affect price. In a pricing agreement, you will see the complete pricing structure and pricing policy, and establish a schedule to review pricing on a continuous basis. A pricing agreement is a two-way street with the supplier, but be mindful of yearly volume commitments, and tiered pricing of volumes - you do not want to pay more per unit then necessary. This plays into strategically planning your purchases in correlation with product forecasts and demands. In the end, keep in mind that pricing agreements should benefit all involved and not be slated one way or the other too heavily.
With all these considerations in mind – let’s return to your sourcing event. Now that you are knowledgeable of the market, the suppliers and your company’s spend, when sitting at the negotiation table you are informed enough to make the right moves! Keep in mind negotiating is an art, but with the tools above you can have a successful discussion with suppliers, and achieve goals beneficial to all parties.