If you ask business leaders to describe today's economic environment, the one word you will hear consistently is "uncertain." A number of European countries risk default on sovereign debt, and the IMF recently reported a "marked increase in the risks to financial stability." Even in developing economies that are experiencing strong growth, there are still signs for concern. For example, Fitch Ratings warned recently that they may downgrade China's credit rating due to high debt loads at the country's banks.
In the midst of slow growth in developed economies and heightened concerns about a double-dip recession, supply chain professionals are under great pressure to reduce costs and simultaneously manage risks related to key supplier viability and supply assurance -- plus non-financial risks related to safety and quality. Based on our work with clients, and global research on supplier negotiations, we suggest six key strategies to keep in mind.
Negotiate supplier contracts with a commitment to fairness and a focus on long-term mutual benefit. In light of considerable market uncertainty, many suppliers are open to significant price reductions in exchange for early contract renewals and/or longer term agreements. Customers face a window of opportunity where they can preemptively lock in pricing now that will be attractive in a few years, and simultaneously cement preferred relationships with key suppliers. Customers and suppliers alike have used the global economic crisis as an opportunity to change a history of short-term, widely fluctuating prices (based on changing supply and demand dynamics) to establishing long-term contracts where suppliers benefit from greater predictability of revenue, and customers benefit from lower and more predictable costs.
A surprising number of companies maintain rigid policies that prohibit volume commitments to suppliers. We've observed that leading companies provide low-end purchase commitments to suppliers (based on forecasts) at levels where there is little to no risk to the customer. In return, customers are able to negotiate significant price reductions, as well as reduce the risk of quality problems and supply disruptions. In addition, companies are providing longer term forecasts to their suppliers, plus more frequent rolling updates.
Conduct joint value discovery sessions with suppliers. It's not always best to identify cost savings and risk reduction or mitigation opportunities during the contract negotiation period. Nor are supplier account teams or customer sourcing teams necessarily the best people to do so. Instead, how about hosting a workshop that involves cross-functional teams from customer and supplier to determine a number of factors (i.e., volatile commodity costs, ways to reduce costs/risk through advance or consortium purchasing, material substitutions, spec redesigns, streamlining business processes/operations).
- Monitor supply chain risks and act to safeguard the viability of critical suppliers. A company's supply chain is only as strong as the weakest link. Companies need to put increased emphasis on rigorous monitoring and analysis of supply chain risk factors (such as those shown in Figure 1), recognizing the causal connections across various factors.
- Optimize supply chain leverage. Forward-looking companies are using this period of economic uncertainty to engage suppliers in innovative efforts to achieve cost savings while safeguarding supplier profitability -- often by forging new links of collaboration among multiple nodes in the supply chain. In many cases, significant opportunities exist when companies bring together tier one suppliers with critical upstream suppliers of raw materials or input components.
Formalize negotiation strategies and processes. According to our research, companies report realizing, on average, only 55% of the value they target through their strategic sourcing efforts. Furthermore, the lack of a consistent approach to negotiations and the lack of negotiation skills (especially among engineers and other technical staff) are at the root of such disappointing outcomes. Now is the time for companies to manage negotiation as a formal business process and invest in negotiation skill development -- not only for sourcing and procurement professionals, but also for the extended teams of engineers, project managers, and others involved. The ability to engage in tough conversations with suppliers in a principled, fact-based and collaborative manner that preserves (and even strengthens) sound business relationships is essential to success in the current economic environment.
Ensure alignment/integration of negotiation strategies with long-term category strategies, and with key supplier relationship goals and plans. Too many companies negotiate reactively based on immediate, short-term risks, pressures, and opportunities rather than being guided by clearly defined long-term strategies that balance short- and long-term risks and opportunities. Our research shows that companies that align their negotiation strategies with category management strategies, and supplier relationship management goals realize, on average, 59% more of the value that target through strategic sourcing initiatives.
- Jonathan Hughes, Partner and Jessica Wadd, Senior Consultant at Vantage Partners