The Art of Pricing

Buyers want to get good value for their money, and sellers want a good return on what is sold. Coming to agreement on what price satisfies both parties involves a process of negotiation.

When someone buys, it is a cost; when someone sells, it is a price. Supply chain professionals are on the buy side so they are concerned about cost: Are their costs competitive, are there cost reduction opportunities, and are they getting good value for their spending?

If pricing is an art, it follows that there is no fixed formula that determines what a supplier will charge. If it were a science then there would be a formula that would predict price from a set of variables. I believe there is no such formula. I believe this because of the multivariate analysis that I do on FreeBenchmarking.com's pricing database where we attempt to correlate pricing with numerous factors that influence price.

The bottom line is that the price paid for an item is mostly set by the relative leverages of the buyer and the supplier. In other words, how badly do you want the supplier’s item and how badly do they want you to buy it? This means that one’s ability to get better pricing is directly tied to the ability to create leverage. It is interesting that premier athletes get their equipment for free (a really good price) as do famous rock musicians their instruments.

From the supplier side, leverage can be created to keep prices up through brand (for example, Gucci or Rolex), by technology differentiation (application-specific standard product silicon), or by creating end market pull (Intel Inside). All of these and other techniques have the impact of keeping prices high.

From the procurement side, leverage can also be created. There are the obvious means like consolidating volume, creating competition through multi-supplier sourcing, and long-term supply agreements, but there are many other factors that can be equally or more effective. One surprise from our multivariate analysis was that the volume relationship did not always lead to the best or even a better price; other factors dominate. These other factors align your purchase with what a supplier wants.

Let’s consider three things a company can do to create leverage with a supplier: 1) Agree to favorable payment days; 2) Link new design win awards to price considerations on production materials; and 3) Sell your company’s success path to the supplier.

Many companies have extended their payment terms with suppliers. They did not see a price increase when they did this, but they have also not seen subsequent price reductions that their competitors are getting. After all, cash is not free. Think about it: A supplier that has to meet payroll most likely values cash over margin. Paying in fewer days will not only improve price, but will most likely also improve access to constrained supply.

Linking new design wins to production price concessions requires coordination across R&D and operations organizations, but the results can be remarkable.

Selling your company’s success story to suppliers is an underused strategy. Get the supplier excited about the opportunity you are creating. If your company's story is compelling enough to have you continue to work there, it should be strong enough to get a supplier excited. Get them wanting to participate in your success.