Best Practices

The Four Cornerstones for Leveraging Cost Transparency

Cost transparency is the golden arrow in a procurement professional’s negotiations quiver: the key to building and maintaining a robust, sustainable, low-cost supply chain

This is a true story about Cost Transparency.

ProPurchaser President Rod Sherkin’s first purchasing job was with Pillsbury/Green Giant. He had only been in the role a few weeks when he got a call from his can salesman. He said, “I’m sorry, Rod, I’ve got to raise your can price.” This was huge because they paid more for the can than the corn.

“Look, I really don’t want to do this, but we just got a price increase from U.S. Steel. We’ve got to pass along half of that increase to you,” the sales rep said. He even had a letter from his steel supplier. It read, “Dear Continental Can, we’re sorry to inform you… ”

They negotiated and Rod wound up with a 3% price hike instead of 4%. There really wasn’t another option: he had to agree to pay more. If the company didn’t have cans when the corn ripened in the field, someone was going to get fired.

Within the first few months, Rod had fielded half a dozen similar calls from suppliers asking for increases. The reasons were always the same: they were “just trying to stay whole”, responding to price increases from their own suppliers. The higher prices he was facing were driven by higher costs.

That’s when Rod realized how critical it is to better understand suppliers’ costs: their raw material, labor and transportation costs. He needed a way to independently estimate what the impact of input cost changes should have on his contracted prices.

He started by subscribing to American Metals Market to track the price of steel used to make cans. After a few months, he saw steel prices had moved back down. He called the can supplier and said, “Hi John, I noticed the price of steel is back down to where it was eight months ago, before you raised the price of cans.”

The end of the line went silent for a good 15 seconds. Finally, John said, “I was just about to call you.”

They both knew that wasn’t true, but it did not matter. The next day John called and rolled back the last price increase. Rod had tangible proof of how powerful cost transparency can be.

*****

Procurement professionals are driven to realize savings to keep their companies competitive. Because of that, they often focus on prices: historical prices, current prices, proposed new prices, price variances…

If procurement wants to deliver maximum, long-term value, they really need to focus on suppliers’ costs (not prices). They should only accept increases if they are cost justified! Moreover, they should demand price decreases when they see suppliers’ costs falling.

Today’s procurement professionals are fortunate: they can easily access amazing data. They can build a solid foundation of information for decision making and negotiating. But they still have to make sure they are anchoring their arguments to suppliers’ costs. Costs make a more compelling argument at the negotiating table. They are closely tied to the supplier’s actual profitability. Making a supplier’s costs transparent puts the buyer in the driver’s seat.

Since negotiating with that can supplier many years ago, Rod has been an advocate for cost transparency through these Four Cornerstones for Leveraging Cost Transparency:

  1. The ‘Golden Rule’ of Negotiations: never enter a negotiation without first researching what has happened to your supplier’s costs.
  2. Should-cost modeling: what it reveals about what you should really be paying.
  3. Convert sales representatives into champions for your cause.
  4. Make your supply chain an enduring competitive advantage for your organization.

These are common sense guidelines that can strengthen a supply chain, improve supplier relationships, and boost your bottom line. Unfortunately, they aren’t always common practice.

Cost transparency is the golden arrow in a procurement professional’s negotiations quiver: the key to building and maintaining a robust, sustainable, low-cost supply chain.

If you’re interested in judging for yourself if cost transparency really works, join thousands of other procurement professionals and take out a free trial to ProPurchaser (no credit card required).

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