Construction procurement. Manufacturing procurement. Transportation procurement. Regardless of what industry you’re in, whether it’s about products, components, or services, or if the negotiations are between two people or between groups – cost-based negotiations are often considered the single most effective procurement method.
A cost-based negotiation strategy enables companies to determine the actual cost of manufacturing a product or a specific service and to understand the underlying cost components and cost drivers. By leveraging the cost-based negotiation strategy, procurement and purchase managers gain the upper hand at the negotiation table. It helps them identify and understand the costs from a supplier’s perspective, gaining useful insights to boost their negotiating skill and drive profitability for the company.
Conducting a cost-based negotiation often relies on performing a spend analysis, such as a logistics cost analysis, vendor spend analysis or contract to spend analysis, to gain an understanding of all the relevant cost drivers. The single most important thing to create a spend analysis is data.
Data, data, data…
Data is the essence of life when it comes to the spend analysis. Without enough data or data with low quality, e.g. data from an unreliable source, the spend analysis becomes next to useless. However, when creating a proper spend analysis (depending on what type of spend analysis it is and how in-depth it is), it provides a multitude of benefits that extends far beyond allowing you to conduct cost-based negotiations:
- Gives full spend visibility
- Helps you identify savings opportunities
- Streamlined and centralized procurement
- Provides insight into potential supply chain risks
- Spend forecasting
- Acts as benchmarking for internal performance
Cost-based negotiations – The process
Cost-based negotiations are less about the actual negotiations and more about the preparation for them. In the end, cost-based negotiations are pretty much about comparing your current supplier costs with the market’s prices to identify where you might be paying too much for a certain product or service, and presenting it to the vendor.
There are hundreds, maybe thousands of different vendor negotiation strategies. Depending on numerous factors such as your negotiation skills, your relationship with the vendor, or current market prices, you’ll have to switch up how you negotiate to suit each specific situation. We won’t go into what these are here, However, here are some Do’s and Don’ts of vendor and supplier negotiation, and some different purchasing negotiation strategies to get you started.
Back to the meat of the matter: the spend analysis. If you do your homework and do it well, we can assure you that the cost-based negotiations will weigh in your favor. Here’s how you create one:
- Identify your current costs/spending for products and services to identify where the biggest cost-saving opportunities are. We want to narrow it down to the most profitable areas as we can’t, at least to begin.
- Extract all spend data from the chosen areas
- Cleanse the data from inaccuracies and remove corrupt records and/or redundancies in a set of data. Make it sparkling clean.
- Enrich the data. As in: make sure all the details in the data are accurate and there are no missing data fields, misspellings, or similar..
- Classify the data into concretely defined categories to be able to identify how and where you’re spending your money.
- Analyze the data and compare it to market data to identify opportunities for saving and other procurement improvements.
- Take action! Finally, the ACTUAL cost-based negotiation. This can however be considered almost the least important step as the negotiation will solely rely on how well you’ve prepared your cost-based arguments.
(Source: Prognos spend analysis. Visit their page to read a more in-depth guide on how to create a spend analysis.)
And there you have it: how you prepare for and perform a cost-based negotiation. Remember, this process can be repeated over and over again for each of your products, services, contracts, or departments.
In conclusion, the cost-based negotiation strategy is the best procurement method, bar none, regardless of whether it’s for construction, manufacturing, or transportation procurement. It relies heavily on the quantity and quality of data as well as the quality and depth of the spend analysis.
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