Inflation is continuing, and as predicted by many, demand is outstripping supply in many commodities. Some price increases may be shorter term, but many sectors have structural barriers to bringing new supply to market.
While supply chain bottlenecks are to blame in some cases, in other markets, new capital investment is needed before supply constraints begin to relax. This means inflationary pressure could remain in many sectors for quite some time. With semiconductors, for instance, we do not expect rebuild of inventory levels to begin until the second half of 2022, barring significant capacity increases.
Companies are seeing suppliers push price increases that, if unmitigated, directly impact margins. Procurement organizations must be ready to push back on these requests in a strategic, data-driven manner. These four steps can help organizations prepare and effectively engage suppliers to mitigate the impact of inflation:
Step 1: Supply Markets and Suppliers Risk Map
The first step is to create visibility to spend areas of potential risk. Procurement organizations must have a clear view of the supply market and the supplier level in which price increases or supplier requests are occurring, as well as the spend areas potentially at risk.
Such a risk map allows them to effectively prioritize action based on the (1) potential size of impact, both in monetary terms and in potential disruption to the business, and (2) likelihood that inflation will drive price changes.
Step 2: Market Understanding and Transparency
A robust fact base and understanding of market dynamics is foundational to an effective mitigation strategy.
A fact base has several elements. For specific products, it is important to understand inputs and relevant commodity price movement, to compare with the magnitude of supplier price increase requests. Developing a perspective on supplier economics is also informative. Finally, developing supplier- or supply market-specific “fact packs” can aid in the selection of the right supplier engagement strategy and serve as an important fact base in negotiations.
These fact packs can contain:
- Relevant contract information
- Results of should costing or cost modeling to understand the starting point or baseline supplier margins
- Comparison of cost trends to relevant indexes
- Analysis of historical category and supplier spend and trends, comparing historical cost versus volume and spend
- Key supply market information, including for competitors, suppliers’ relative market positions and assessment of their current financial situation
- Price benchmarks (as available)
- Assessment of or metrics on recent supplier performance
- List of potential “carrots” to consider in negotiations, including longer contracts, better demand visibility and increased volume commitments.
Additionally, before responding to suppliers, consider other strategic options, like insourcing some activities across the supply chain, adjusting specifications for products purchased and potentially onboarding new suppliers. This process may reveal additional potential sources of value and create leverage in negotiations.
Step 3: A Supplier Engagement Strategy
Armed with a robust fact base, procurement teams can then determine the right approach to engage suppliers and push back on price increases. Generally, these approaches fall into three categories: (1) direct negotiation, (2) collaboration with suppliers and (3) introducing competition or maintaining competitive tension.
Direct negotiation should be used when limited alternative suppliers are available in the market. In these cases, developing leverage can be tricky. It will be important to know the history with the supplier and be able to tell a longer-term value story for the relationship.
In particular, take a holistic view of the current and potential relationship with the supplier. Look across the enterprise and consider what other spend areas could be used as leverage. Think both in terms of carrots (like additional spend and term extensions) and sticks — the subset of spend that could be shifted to another supplier. The right analytics can also enhance the leverage position. Should-cost analysis, often leveraging the right specialized partners to support, or make-versus-buy analysis can be particularly valuable.
Collaboration with suppliers should be used when there is a strong relationship with the supplier and a willingness to work together. Still, in this case, supplier messaging and engagement should be planned carefully. The intent should be to work collaboratively to identify a robust set of opportunities to mutually reduce costs. These should include more challenging levers like specification changes and material substitutes. Creating space for the supplier to propose solutions can result in creative options — a virtual integration of supply chains. The benefits of this collaboration, including greater visibility to demand, volume commitments and specific service-level agreements (SLAs), should flow both ways.
Introducing competition or maintaining competitive tension should be employed when there are viable alternative suppliers in the market and the threat of shifting spend is credible. The classic lever here is taking spend to market through the RFX toolbox, but there are different flavors that can be deployed. In the case of hard to shift categories or embedded suppliers, identifying meaningful portions of the spend to move can get results. Offering new volume or consolidating where it makes sense should also be considered to mitigate price increases or get better terms.
Step 4: Negotiation Plans and Organizational Alignment
Once the strategy has been set, it is essential to align the entire organization, not just procurement. Clearly define roles for supplier engagement and negotiation in order to maintain control of the messaging and manage other stakeholders in the business who have relationships with the suppliers.
Procurement teams should be prepared for backdoor selling and apply backdoor buying where they can. Leader-to-leader communication can also be choreographed and leveraged at the right time. All this action requires planning and coordination. Detailed plans, with multiple scenarios considered, should be developed for supplier responses. As responses come in, they should be rigorously analyzed to inform responses.
Finally, in an inflationary environment, procurement professionals should take care not to sacrifice long-term positions due to short-term pressures. This means ensuring negotiation of contracts that will see price reductions as indexes drop and constraints relax. For example, where cost increases cannot be avoided, procurement teams should position their companies to capture decreases by tying prices to an appropriate index.
Doing so effectively across a large number of contracts requires careful preparation, including standardization of contract terms, indexes used, adjustment formulas and calendars, as well as a digital platform to track the relevant KPIs and trigger adjustments at the right time.