Six Ways We Will Have To Re-Negotiate COST Post-Crisis
Many expect prices to rise post COVID-19 crisis; Jonathan Dutton looks at why, and suggests SIX ‘old’ ways we could negotiate cost in the ‘new’ normal in the near future…
Prices are inevitably rising. And, inflation will rise too, from an average below 3% for the last ten years or so, back to more ‘textbook’ norms of the past – but, hopefully, nothing like the 1980’s when inflation looked more like 10% than 2% or less. Nobody, least of all the RBA, wants to predict rising inflation rates, but they will rise, many agree.
A key factor holding down inflation has been the very stable wage growth over the last decade (i.e. almost none – we haven’t had a pay rise in ages) as well as reportedly low business confidence and political uncertainty which stunts business investment and, in theory, growth. The goal of ‘growth without inflation’ has led to such low range inflation expectations over recent history (around 2-3% or so).
Why prices will rise
Anyway, as I said, prices will rise – for a combination of primary reasons on both sides of business:
On the consumer side, there will be less choice. That is, less vendors available to supply. A number of firms will simply not recover from this crisis, for obvious reasons. And they will not be easily replaced by new entrants, who will struggle to raise capital during austere lending periods. Less vendors means less supply, meaning higher prices if demand sustains. Part of the reason for fewer vendors in the market will be the amount of competitive business models that need high levels of demand to bring even a modest margin. This is a feature of buoyant and competitive markets in the past. And will affect businesses large and small – like Qantas maybe (filling planes with the middle-seat free reduces load factors by 30% or so) and like CBD cafes (who needs eight sandwich shops per skyscraper now? Ten socially distanced patrons per sitting offers revenues way below break-even point). More firms than we can think of will fall into this trap of operating quite unprofitably below necessary high-volume demand (hotels often target > 70% occupancy). This will be exacerbated when shareholders compare returns from businesses struggling around break-even point. Moreover, RoI targets from business owners will rise with inflation benchmarks. Public sector departments and bodies will feel pressure to manage on less after immediate reflationary strategies give way to the reality of the pain of public debt and the goal of driving the federal budget back into the black to start paying down that massive debt we have all just incurred. 2. On the supply side, the winding back of globalisation now, due to obvious global risk factors, will increase cost for all – organisations will be increasingly re-shoring, dual-sourcing and buffer-stocking to de-risk supply chains. All these things add cost. Wage rises are still unlikely, as unemployment will be high and firms very sensitive to rising costs in low-confidence markets. BUT supply side costs will inevitably rise as lower supply meets gradually rising demand and current subsidies and allowances disappear after 30th September. Closer to home, suppliers will face rising costs themselves from their own supply chains. They will lose economies of scale if not operating to optimum scale and, most importantly, working to lower demand levels whilst simultaneously striving desperately to recover crippling losses and pay off debts incurred during the lockdown. This means price rises. And, finally, whilst a high Aussie dollar might make imports cheaper (and benefit consumers and demand here) these can be offset by other international factors not least rising prices for our exports, trade tariffs (including China issues), commodity volatility or shortages & bottlenecks in other markets – all these things affect risk profiles and prices.
Risk is the early priority
Yet, Initially, as we return to work in the office, the focus for most supply side managers will fall on RISK – how do we de-risk the supply side and ensure that we can always deliver in future? Will our business continuity plans (BCP) hold up next time? They didn’t for many during the COVID-19 shock.
A recent Grosvenor Performance Group survey found that pre-crisis, just 6% of procurement managers saw supply RISK as their primary goal. Immediately post-crisis, supply RISK became the key issue for 40% respondents, with cost reduced to top-priority for just 15% of respondents, down from 29% and the usual ‘top spot’ pre-crisis:
[GPG also produced a useful study on Procurement’s “Eight savings myths debunked” a year or so ago, which unknowingly set the scene for difficult cost negotiations in future.]
Cost pressures will not subside
So, after risk plans have been reset, will COST rise back up the agenda for procurement managers? Do ducks swim in ponds? COST will rise in importance again, post-crisis, because it must.
That is, firms will feel the pressure to return towards pre-crisis margins – however difficult that journey will be. Cutting costs will be relatively easier than driving up revenues in depressed and cautious consumer markets – certainly after government wage subsidies and widespread rent and mortgage relief subside after 30th September.
And cutting costs wherever possible will ease that migration to new business models which so many organisations will have to pursue to compete in the ‘new normal’ world as the crisis of the last few months has accelerated business evolutions that had already begun – some of which were listed in the previous article PESTLE analysis, like the cashless society for one example.
SIX ‘old’ ways to reduce new pressure on costs
So – the big question, HOW will procurement be able to address cost in such an environment post-crisis? Haggling down the price? Not so easy now. Tendering indirect goods and services some more? Unlikely.
As we have mentioned before, many times, the success of procurement in recent years had led many to experience the trend of savings tending towards zero over time. Especially in INDIRECT categories. In other words, there is only so many times you can use competitive tools like tendering to drive cost reductions. And, the market is less likely to respond to these moving forward as suppliers will hold the line on price – because they have to.
More likely, is that we will be digging out the old textbooks on how we used to negotiate down cost in stressed markets and applying them to our ‘new normal’ environment:
Negotiation works best – and could become the default procurement strategy setting; so best polish up your skills fast (ask me how, by the way). Negotiating-not-tendering (a tool best used for competitive markets) is more effective in stressed markets. Negotiating the outcome nearer to the one you want is also more efficient use of time versus go-to-market processes taking months – as users may well point out before long.
Negotiating is also a way of leveraging the strong SRM built up during the testing times of the lock down perhaps? Try leveraging other prizes for the supplier such as longer-term contracts or buying more (non-critical) volume from them as a strategy in return for lower costs. Attacking the ‘common enemy of waste’ with buyers and sellers working together more as a team, is a helpful mindset. There is still too much waste in the supply side process.
Annual price increases – re-framing cost negotiation as an annual price increase. That is, limiting price rises to 12 month cycles in times of growing inflation. Best arranged in step with your budget cycle, though, not their seasonality and their standard industry price rise times.
Agreeing PVF driven contracts – that is ‘price variation formula’ (PVF) agreed and set into longer term contracts to vary price “officially” according to relatively predictable ratios and commodity prices. Preventing suppliers from leveraging up price quoting nebulous component data and a bit more added margin in times of inflation.
Preserving cash and keeping working capital – that is, managing payment terms largely. Not to make modest interest on unspent money so much, as slowing cash out of the business in advance of revenue returns downstream from customers. Maximising working capital to invest cash into new business models as they develop, in other words, meeting structural change.
Encouraging suppliers (especially SMEs) to use factoring or reverse-factoring (supply chain finance facilities provided by the buyer’s partners) to choose their preferential payment terms may become the norm to ease cash-flows for everyone at a marginal cost.
Rebate deals – additional discounts in the form of quarterly rebates (synced to seasonality – or sales targets) aligned to volume spend targets might be a better way to taking advantage of upturns than downturns. But this can be a useful tool for returning REAL savings (cash) compared to booked savings (cost avoidance or budget savings then spent on other things by loose users). Specific quantity price breaks [QPBs] are tables of prices against pre-set volume levels that enable this negotiation.
A short-cut is to use off-the-shelf group buying contracts through aggregators like Supply Clusters, as they offer such arrangements mostly in this format to their members. And have the added benefit of using others’ volume to drive up discounts, pre-negotiated to specific but fair industry terms.
Clawbacks and credits – both these tactics were used effectively by many buyers during the lockdown. Reports of 67% office cleaning savings, 25% reductions in rent, 15% insurance rebates were common. Some organisations were even collecting airline credits to cash-in as a bulk deal, as they anticipate far less travel downstream.
Buyers addressing low-volume usage worked well – if not contractually but morally, as well as from their suppliers’ longer-term relationship perspective. Certainly, from those suppliers which see structural change coming and want to delay any effects of that trend – for example, successful homeworking proving we need less office space and facilities in future.
Other opportunities also present themselves as ‘spot-buys’ – oil prices at an all time low (even negative for a minute) as well as two year lows for energy prices as highlighted by Supply Clusters earlier this month. Staying awake at commodity dashboards will be a new requirement for busy buyers in volatile markets.
Starting the negotiation from previously unused volume in the recent past at least puts your supplier on the back-foot in requesting price increases. Target your marginal volume categories for obvious savings, before goods/services delivered using higher fixed-cost overheads.
The old enemy returns
The most critical message to help shape your strategy is to fit your approach to your needs. The challenge now being that our business environment has changed so dramatically. And it will not be returning to normal, but only a ‘new normal’ which allows for the accelerated evolution of that rapid PESTLE analysis we scoped recently.
We have experienced structural change in our market and the old norms will not apply in future. Starting with the likely return of that old enemy – inflation.
About the author:
Jonathan Dutton FCIPS is the former founding CEO of CIPSA - the procurement peak body in this region. He now works as an independent management consultant specialising in procurement and has a non-executive role at Supply Clusters and is a brand ambassador for PASA www.jdconsultancy.com.au
This article was republished on PASA website 24th June 2020