In a Perfect World
Imagine the negotiating edge you would have if you knew—and could demonstrate—what you SHOULD be paying for the products you buy, especially when suppliers come to you with sad tales about price increases they just can’t hold off any longer because of global commodity price rises.
This is not wishful thinking.
That negotiating advantage is available to you using a modeling tool. It calculates the real effect of fluctuating market conditions on your suppliers’ selling prices, and then displays the results on an easy-to-read graph. And the whole process can take less than 5 minutes!
You only need an educated guess to get started. Let’s use electrical cable as an example. The main commodities are copper and PVC (a typical insulation material). Let’s say your current price is $4.50 per yard. We ‘guesstimate’ that copper is 30% of the selling price, PVC is 20%. The model will allocate the rest to the supplier’s ‘profit and overhead’.
The supplier explains his cost for copper is up 80% over last year. That’s true enough. He also tells you, because he values your business so much, he’s pushing up the price by only 40%, to $6.30.
Not good news, but seems fair because copper is certainly a major cost driver.
Let’s put it to the test!
A Simple Modeling Approach (2 steps)
First you choose the start date for the graph (say, one year ago). Then you enter your percentage estimates. Use an Excel graphing wizard to tool to crank out a graph (similar to below) that shows what impact cost changes to both copper and PVC should have on today’s electrical cable selling price.
Reading the Graph
Numbers at the top of the columns, represent what you should pay. The first month is set at 100 (and corresponds to the $4.50 price). The last column (12 months later) is calculated to be 121.8, which means a 21.8% increase ($5.48 not $6.30) would be fair.
Numbers inside the columns show changes to individual component that make up the selling price. The light blue section models the effect of the rising copper. Yellow models changes to PVC costs. Both are easy to change (or add to), if your supplier offers different data to ‘improve’ on the model.
The dark blue represents an estimate of your supplier’s Profit plus Overhead, which, of course, are also important components of his selling price.
Model Softly; Carry a Big Stick
This is important – Profit plus Overhead should not need ‘improving’ because the model holds them constant over time, (in dollar terms). This ensures fairness, since your suppliers will always earn the same number of dollars… and not a penny more.
One of the biggest advantages to modeling is that it prevents suppliers from ‘lumping it all together’and parlaying raw material cost increases into profit increases.
Seeing is Believing
Most people find it hard to believe that they can actually build something useful in a few minutes….. can’t be that easy!
Judge for yourself. If you do not want to build your own models using Excel, you are invited to take out a free trial membership in Propurchaser to check out the tool there. After you sign up, click Selling Price Models on the left side of your home-page (inside the Toolbox) and follow the instructions.
If you found this article interesting, we think you’ll find the Propurchaser website even more so… Judge for yourself. Click the link below for a free trial membership.
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