Supply chain disruptions drive price increases – this seems commonsensical. The lasting impacts of COVID, compounded by the Russia-Ukraine conflict and lockdowns in China blocking shipments, have created production disruptions, freight delays, and port congestions – and with supply shortages, prices are increasing.
However, amidst the collision of these disruptive global events, businesses are being made vulnerable to supplier price increases that are simply explained away by “supply chain disruptions”. At Efficio, we are seeing many of our clients confronted with unjustified or excessive price increases that misuse the current situation as justification for driving up their profit margins.
We help our clients differentiate between reasonable and unjustified price increases and defend against the latter. To achieve this, we work with our clients to install a dedicated price task force that takes the approach outlined below:
Registering and prioritizing price increase requests in a structured way
Understanding cost drivers, modelling the impact of price increases, and using benchmarks to assess the appropriateness of requests
Developing and implementing strategies to counteract price increases
Preparing for the medium term to better manage volatility and strengthen supply chain resilience
Are the price increases justified?
When faced with increased prices from suppliers, the main question businesses need to ask themselves is: which price increases are justified? Businesses need to be equipped with the knowledge to recognize when to seek alternatives and when to accept short-term price inflations.
We recommend a structured approach to understand how justified a cost increase is:
- Determine the main cost components of a given product (for example, logistics, packaging, and printing).
- Determine the weight of cost components in a product’s cost (for example, logistics constitutes 5% of total product cost). A small increase in a main component’s cost can have a bigger impact than a large increase in a marginal component’s cost.
- Look back historically and evaluate how prices have evolved. If supplier prices have continuously increased above inflation or market index, there is a stronger case to be made against the increase from the buyer perspective.
- Establish an acceptable price increase, based on the above data.
- In parallel, use supply and demand benchmarks to determine the appropriateness of price levels for indirect spend categories which are easily comparable (for example, cost per minute for mobile calls, typical costs for admin staff’s laptops)
Following these steps will better equip you to analyze and challenge blanket statements by suppliers that blame their price increases on inflation.
Short-term actions to defend against price increases
All incoming supplier requests for price increases should be dealt with consistently, as outlined below:
- Formally reject the immediate approval of the price increase.
- Request justification for the proposed price increase, including cost component breakdowns. As much as possible, reverse the burden of justification onto the supplier.
- Analyze the price increase based on historical price development, cost breakdown, and appropriate benchmarks.
- Prepare a negotiation strategy. Include considerations such as:
- How justified the price increase is according to your analysis
- Whether alternative suppliers are available
- Whether unit prices can be decreased in return for increased order volume
- How supplier margins have developed versus own margins
Collecting information such as price breakdowns from multiple suppliers during regular recurring RfPs can be helpful; the more data points you collate, the better-positioned you will be to evaluate the price increase, even if your team is not equipped to do a detailed bottom-up price calculation for each component and product group. Access to benchmarks and category-specific knowledge can also support this process: eFlow, Efficio’s purpose-built digital procurement software, provides benchmarks; third-party software such as Facton and Saphiron are useful for determining target costs.
Even if the negotiations conclude in accepting the supplier’s proposed price increase, you should come out of the process having defined trigger points for price changes (for example, cost of fuel for logistics); this allows wiggle room for future negotiations and lets you go back to suppliers in a timely manner when the pressure on these triggers are eased.
Longer-term actions to defend against price increases
Longer-term measures should be initiated alongside these short-term measures to help protect against price inflation and supply instability. These include:
Stock increases: Increasing inventory unlocks access to volume discounts and allows you to weather short-term price fluctuations.
More intensive use: Make sure wastage is minimized and recycling is maximized.
Stronger strategic planning: Improve the accuracy of demand planning, forecasting for a longer period of time and employing planning tools.
Make vs buy: Revise make vs buy decisions. Consider internalizing the production of higher-risk products.
Product specification revision: Revise product specifications, focusing on finding substitutes for key components that can reduce incremental costs.
Supplier exploration: Look into expanding your current supplier base.
The specific events behind the current price increases may not last; however, they have highlighted the need for businesses to bolster their supply chain resilience by equipping themselves with the knowledge and capability needed to weather potential future disruptions that drive price hikes.