- Are your margins eroding from supplier-imposed price pressure?
- Have you challenged the price increases sufficiently?
- Are you adequately informed to negotiate a better outcome?
- Have you considered what levers you can pull to mitigate “margin leakage”?
- Are you planning ahead, and developing a “go to market” strategy?
Lived experience tells us that inflation has been unacceptably high in Australia since COVID, and the RBA is still fighting to bring it back under control.
As depicted in the ABS chart above, the red arrow signifies the unprecedented “surge” in inflation since COVID in 2020. These levels have not been experienced since the 1970’s. We have seen rates peaking at 7.8% in December 2022, compared to 1.5-2.5% average for the proceeding decade since the GFC in 2008.
The most recent 3.8% CPI figure is a rise on the 3.6% figure recorded for the year to the March quarter, with the ABS noting that “this is the first increase in annual CPI inflation since the December 2022 quarter” when inflation peaked at 7.8%. However, the trimmed mean inflation – a measure the RBA watches closely which is CPI net of volatile items like petrol prices – was slightly lower than expected at 3.9% for the year to June.
These latest figures give some hope that the RBA is done with its run of rate hikes and will keep the cash rate steady when it meets next week.
How does this impact you?
As the inflation works its way through the system, suppliers pass on the higher costs to their customers by repricing their goods and services in line with the escalation formula in the contract. This enables suppliers to protect margins and minimise their exposure.
One can argue that you should do the same and pass on the increases to your customers. However, this can result in reduced sales volumes, particularly when consumers are already feeling the inflationary stress and are cutting back their consumption, as indicated by the contraction in GDP to recessionary levels.
What can you do?
Procurement is an easily available lever to create value and counter inflation. By adopting a proactive approach, the following 5 procurement strategies can help you fight inflation.
1. Push back and challenge proposed supplier increases
Determine whether the price increases levied by the supplier reflect the true cost increases to your supplier – the “should cost” of your supplier’s underlying cost exposures or the extent to which inflationary pressure is impacting their pricing – and if not, renegotiate to mitigate price increases proposed.
“Should cost” is the aggregate of the key cost components, e.g. labour, plant, fuel, materials, general overheads weighted by the proportion of each cost component. Applying the relevant indices to these cost components will ensure that the price escalation reflects the supplier’s true cost and is not overstated.
Many contracts use CPI in their price escalation as a single index applied to the total supplier cost. This can result in you paying a higher increase than is necessary. To ensure you are informed to negotiate with suppliers, first ensure the escalation formula or its application is appropriate and linked to publicly available data, for example ABS. Of note, the ABS keeps multiple CPI indices, notably transport, services, and international trade.
2. Value Engineering
Immediate levers include adjusting batch sizes or order frequency. A longer-term action can be changing or rationalising specifications and reducing high-cost SKUs or features. While value engineering incorporated in the design will have longer term benefits, in the short-term demand management strategies can be used to reduce the internal demand for the high-cost components and promote substitutions.
3. Supplier collaboration on productivity enhancement
Inflationary price increases affects both you and your suppliers. Collaboration with your suppliers can create real opportunities to achieve win–win outcomes, so that both can sustain margins through the adverse market conditions.
This will require you to engage with suppliers to jointly identify and deliver cost savings whether in the supply chain, in process improvement or from other productivity and efficiency enhancement opportunities.
4. Supply chain optimisation
Procurement through the analysis of contracts, invoices and spend can help you identify hidden costs and value leakage across the supply chain. Focusing on reducing these and optimising the supply chain can deliver lower costs. This can contribute towards a lower overall cost and offset parts of the inflationary increase.
5. Go to market
If your supplier sees your business as tactical and is not prepared to come to a mutually beneficial agreement, then don’t renew the contract. Use the power of competitive tension and leverage the market to refresh the prices and negotiate more favourable contract terms with a new supplier(s).
You can start this journey by developing a procurement or go to market strategy that considers the commercial levers to best exploit your buying power accounting for market dynamics and economics. This will inform your procurement strategy for how best to approach and time your procurement activity to obtain the best deal.
Your procurement strategy should aim to reduce your risk exposure to single suppliers’ performance and actions (e.g. price increases) and ensure you have a wide range of suppliers. This will ensure you maintain your bargaining power and that the market remains competitive.
How do I take action?
Siecap can assist in developing procurement strategies and deliver ‘cost out’ opportunities to restore lost margin. Our experienced consultants are available to assess your situation and the market environment you operate within and provide you with actionable recommendations that will guarantee an improvement to your business. Reach out now at https://siecap.com.au/contact-us/ to get started.