Suppliers are susceptible to price challenges

By Staff -- Purchasing, 9/7/2000

Despite a broad-based decline in margins for the manufacturing sector during the first six months, a number of industries use inflation trends to improve the bottom line. These industries-classified as "overachievers" by Thinking Cap Solutions-pose both price-negotiation challenges and opportunities to buyers. "In addition to benefiting from short-run margin gains, these industries also enjoy margins that are above their five-year norm, says Elizabeth Baatz, editor of Thinking Cap Solutions' ICE-Alert report. "These kinds of margins allow buyers to build a strong cost-based negotiation strategy to exert downward pressure on prices."

According to Baatz, an industry becomes an overachiever in one of three ways:

• Suppliers raise product prices despite benefiting from a deflation-related reduction in per-unit manufacturing costs. (Prices rise. Costs fall. Margins improve.)

• Suppliers enjoy lower manufacturing costs, but pass along only a portion of savings to buyers. (Prices fall. Costs fall faster than prices. Margins improve.)

• Suppliers see manufacturing costs rise, but use the increase as a foundation to push through even larger price increases. (Costs rise. Prices rise faster than costs. Margins improve.)

"Over the last six months, the third method of overachieving has reigned supreme," she says. "Of the 71 industries sporting higher margins in the first half, 53 used the third approach to win at the inflation game. Another 17 took the first route to expanded margins by hiking prices despite falling costs." Only one industry, structural wood suppliers, saw costs fall and passed along a portion of savings to buyers.

Interestingly, producers of electronic capacitors led the list of selected industries with inflation-related margin increases over the last six months. Since last December, they increased product prices an average 23.5% despite only a 3.2% increase in the cost of making a typical unit of industry output. U.S. capacitor makers' aggressive pricing tactics have yielded an estimated margin improvement of $9.89 for every $100 of product sold. These industry margins are well above normal; in fact, they are at a five-year high. "Given that producers' margins are above their long-run norm, a buyer can construct a convincing cost-based argument for why current prices should be lower," Baatz says. "The challenge for buyers, however, will be to make that argument stick."

She suggests that many industries present buyers with good opportunities for building cost-based arguments for lower prices. However, strong U.S. end market growth may keep smaller-volume buyers from claiming their share of inflation windfalls garnered by suppliers, according to Baatz. Reason: "When demand heats up, capacity utilization rates rise and suppliers can, to some degree, pick and choose their customers."

She points out that larger buyers usually don't have as much to fear from heavy demand, at least not from a price negotiation standpoint. "To the most important customers, suppliers often will relinquish their inflation windfall by lowering tags," she says.

Prepared by: Thinking Cap Solutions Inc., Port Angeles, Wash., a company specializing in industry cost escalation analysis for purchasing applications. For more information, contact Elizabeth Baatz, Thinking Cap Solutions Inc. (360) 452-6159, or FAX (360) 457-2913 or E-mail ebaatz@ice-alert.com.