Lytica Inc. tracks current prices paid – not distributor website prices – on about one million electronic components and uses this information to assess our clients’ spending competitiveness and estimate appropriate pricing for their worst price components. In many cases, we assist customers in implementing better pricing in their supply chain. From this vantage point we’ve identified a number of factors that often lead to companies not achieving their cost-reduction potential. Here are the obstacles:
- Use of the 80/20 rule: Many companies apply all of their effort to the most expensive components and avoid the lesser ones. Over a few years, most of the cost reduction has been taken on these components and getting another 5 or 10 percent savings on the top 80 percent of spending is difficult. Recognizing that 5 percent on 80 percent of your spending from the top 20 percent of components is 4 percent, one needs to achieve 20 percent cost reduction on the other 80 percent of components to match the 4 percent target. We often find 30 percent or greater potential on these ignored devices so paying attention to the 80 percent tail yields savings.
- Quoting is not negotiating: Some companies quote components but do not negotiate. Accepting a first quote as a supplier’s best price leaves opportunity on the table. It never hurts to have a quote from a competitor. Maybe the competitor deserves your business.
- Use of blanket CR targets: When no better information is available, some managers use a “wet-finger-in-the-air” estimate as a cost reduction target such as 5 percent or 10 percent overall. They do this with little knowledge of what cost drivers in the supply chain might be doing. How much cost reduction should you expect given the 2013 to 2014 change in currencies as shown in the table below? Keep in mind that the world price of oil changed by 4 percent with a peak in 2013 at 18 percent, the price of copper by -10 percent and aluminum by 33 percent.
- Over valuing soft benefits: Be careful not to overvalue soft benefits, especially ones that you never test or use. If you are paying a premium for return privileges but have never returned any material or believe you have special access to quantity increases but have never seen anything except standard lead time supply, what are you paying for? Why should a supplier treat you any differently than any of their other customers? Do not overpay for intangibles.
- Not knowing full potential with supplier: Make sure you understand the full commercial potential that you have for the supplier and negotiate based on that; not the value of one component at a time. Negotiating by single component makes you compromise because its volume may not be very high.
- Use of distribution website pricing: Website pricing published by distributors is a good starting point to see if your pricing is out of line. I have seen some customers paying more than these published prices for components. However this internet pricing is not a good indicator of what you should be paying. You need to know how much of a discount is appropriate. Independent benchmarking tells you this, not guesswork.
Materials pricing is a critical factor in your businesses’ profitability and success. You need to be cost effective in these uncertain times to fend off competitors; your suppliers should be willing to help you. Suppliers should be able to make a profit but not at your expense! Setting appropriate pricing with suppliers will drive them to make their business more competitive just as you are trying to do for yours. You are, in fact, helping them in the end.