Every consumer who fills up a gas tank or visits the supermarket has known it, and now the message that commodity prices are up everywhere is finally sinking in to corporate executive suites. Oil prices reaching $140 a barrel, record wheat and soaring precious metal prices, along with increased transportation and packaging costs have penetrated supply chains in every industry and have profoundly affected the U.S. and global economies. We enjoyed a buyer’s market for more than a decade, where cost improvement was a way of life, but it is now time to reach back into the supply management toolbox and pull out the cost containment tools.

Sales professionals are well trained in the art of conditioning and requesting price increases, but they may be using the cover of high commodity pricing to seek increases that are motivated by non-cost-driven factors such as new management, a merger or acquisition, private equity ownership with high expectations for return on investment, declining stock price or a management commitment for savings to Wall Street. Supply managers need good research and solid plans to contain costs when every sales representative is looking for a price increase. We divide the approaches into two phases – a proactive phase and a reactive phase.

Proactive Cost Containment
Proactive cost containment steps prepare you for price increase requests that you expect from suppliers. They help you condition suppliers’ expectations and eliminate requests that aren’t justified on cost.

Step 1: Forecast your exposure – Look at each of your spending categories and anticipate where price increase requests might come. If you can, break down each supplier’s costs to understand what role material, labor, overhead and profit contribute to the price you are paying. If a commodity is responsible for only a small share of the price to you, it should not drive a big price increase.

Gather data about suppliers that are planning increases. Have their volumes gone up, giving them faster recovery of their overhead?

If you are unable to do a full cost analysis, you can at least do a pricing analysis in the market. Either analysis will put your company in a better position to challenge an increase.

Step 2: Deter potential requests – The buyer’s mantra for the last few years has been “continuous cost improvement.” Communicate to suppliers that you have not abandoned that approach. Back up your conditioning stance by making the process of requesting an increase difficult. Inform suppliers that you will need written notice and three months to consider any increase requests.

Insist that requests are accompanied by a detailed statement of the actions the supplier has taken to reduce or eliminate the need for an increase. Set up a rigorous internal approval system to deter supply managers from recommending increases they might otherwise waive through because of time or work pressures.

Finally, do not agree to a supplier request for a review meeting unless it will advance your interests. Such a program of deterrence should force suppliers to explicitly demand an increase. Make them state that they are prepared to destabilize and damage your relationship simply to achieve increased prices.

Step 3: Pre-empt the increase – Armed with your price forecasts or cost analyses, plan activities to preempt requests. Investigate alternative materials and suppliers. In highly competitive markets, it may be possible to plan the issue of a request for quotation immediately before an anticipated request for a price increase. Offer an extension to the current contract if prices remain stable.

Whatever strategy you employ, it will be more powerful if you launch it before the price request hits your desk.

Reactive Cost Containment
When a formal request for a price increase does arrive, there are several more steps you can take to contain the potential damage.

Step 4: Respond – While it is appropriate to be slow in responding to requests for price review meetings, always respond swiftly to the request when it is formally received. By far, the best reply is a speedy and straightforward rejection. That puts the ball back into the supplier’s court.

Step 5: Challenge – If the supplier persists, present an analysis to support your view that no increase is needed. Let the supplier try to “break” your analysis rather than provide a justification of its own. In this way, you control the agenda and are likely to force the supplier to reveal more information about his cost base than would be exposed otherwise.

Any costs within the supplier’s absolute control should be challenged. Labor cost increases are nearly always offset by productivity improvements. In competitive markets, add your observations about the options you perceive are available to you.

Step 6: Validate – Use external sources to validate the factors claimed to contribute to the increase. Include your own factor for expected continuous improvement in yield/waste for material costs.
If material Y has gone up by 5 percent, question whether the same amount of Y is still used. Consider how the use of more recycled material might have changed your price index.

Step 7: Offset – If some level of increase appears unavoidable, then look for offsetting additional value from the supplier. Postponing the implementation of the increase by six months will halve its fiscal year impact, and may buy valuable time to develop further tactics to avoid its impact.

Ask to lengthen payment terms, set up consignment stocks or increase year-end rebates. The sales representative may be measured only on the increase in headline prices achieved, so offsetting tactics can prove very productive.

Step 8: Negotiate – By this stage, the supplier should understand that any negotiation is going to be difficult and underpinned by facts and data. If you are operating with a strategic single source, it may be worthwhile introducing a cost variation clause, to provide a set of principles that govern cost.

Generally, it’s best to insist that any price change you negotiate will remain in force until costs dictate a change is needed, rather than for a specified time period. Only if you anticipate higher costs in the immediate future should you agree to fixed prices for a specific time as a buffer. The key message to drive home to suppliers is that price increase requests will not be considered merely because a specified period of time has elapsed.

Step 9: Record and review – While price increases are not good news, they are important. Your report on them may not show a favorable year-to-year cost improvement, but it should compare “as requested” prices to “as agreed to” prices. That will provide senior managers an objective performance metric. If containment is not reported, the true contribution of supply management to a business will continue to be under-appreciated.

Finally, review the accuracy of your cost or price analyses and examine how your research can be improved. Continuous improvement applies to your processes as well as your results, and proactive steps against price hikes are generally more effective than reactive ones.

Bill Michels is CEO for ADR North America, based in Ann Arbor, Mich. To contact the author or sources mentioned in this article, e-mail This e-mail address is being protected from spam bots, you need JavaScript enabled to view it