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How To Respond To Supplier Price Increases: Is Cost Reduction The Way To Go?
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US consumer prices rose 8% in April 2022, continuing on track with an inflation high we haven’t seen in 40+ years. And it’s a broad-based trend that affects all sectors.
We’re in what analysts call “one of the hardest inflationary environments the industry has seen in decades.” So, don’t be surprised if your suppliers are reaching out lately, informing you of upcoming price increases.
But you’ve got to run a profitable business too. Luckily, when suppliers inform you of price hikes, you don’t need to feel stuck in a corner. You have several levers you can throw to find a pricing compromise that suits everyone.
Here’s your guide to determining why your suppliers are presenting price changes (and whether it was fair), how to respond to any increases, and how to reduce your prices going forward.
Supplier cost (or, from the supplier’s POV, supplier price) is the amount your business pays for a product or good from an individual supplier.
For instance, you can sell toothbrushes for $5, but you may have one supplier that charges $3 for a toothbrush and another that charges $4 for that same toothbrush. In these cases, the suppliers’ costs are $3 and $4, respectively.
Supplier prices usually factor in direct and indirect costs. Direct costs are what it costs the supplier in labor, materials, and facilities required to provide the goods or services to you. Indirect costs include business expenses like travel, marketing, legal fees, and other costs not directly associated with the good or service.
Supplier prices also reflect the markups they add to ensure their business remains profitable, which may fluctuate based on their sales goals and current pipeline.
And they can fluctuate due to circumstances out of the supplier’s control, such as raw materials shortages, increased demand or seasonality, inflation, natural disasters, or other unforeseen business disruptions.
Price increases from your suppliers don’t come out of thin air.
Your procurement team has already heavily vetted these vendors, and you may have been doing business with them for years. So, when your suppliers raise prices on you, there’s probably a good reason.
Figuring out the cause of the price increase is key when figuring out your plan for what to do about it.
The pricing of commodities like cotton, aluminum, or crude oil can significantly affect the rest of the global supply chain. Commodity prices tend to have a ripple effect deep down the supply chain. For instance, fertilizer prices rose 220% due to the Russia-Ukraine conflict between April 2020 and March 2022. This, in turn, impacted food costs.
Often, because certain countries produce a majority of an important commodity, political unrest like we see between Russia and Ukraine can interrupt or completely disrupt a commodity’s supply.
Lauren Davies, marketing manager at UK Oak Doors, says her team had to adapt to supplier price increases simply due to the rising cost of lumber.
“As oak door retailers, the increase of lumber was a big hit,” she shared with Cogsy. “The increase came predominantly from transportation costs increasing and many other factors. These included the delays caused by border issues following Brexit, the COVID-19 pandemic, and increased general cost of living.”
UK Oak Doors had no choice but to increase the prices of affected products to ensure their margins were maintained. Despite this frustrating matter, it didn’t affect them in a silo.
“Luckily, this was market-wide, so we didn’t stand out from the crowd in a negative way,” Lauren added.
If your supplier is raising prices based on the increased cost of a commodity you depend on, you may not have a lot of wiggle room on price. However, if you choose to pass along these price increases, your customers may understand if it’s a widespread shortage.
As a business operator, you know that high-quality talent is a big expense for any business, including your suppliers.
Anything from local fair wage policies changing to COVID-ill workers slowing down production can impact the cost of labor for your suppliers and have a big impact on your inventory costs.
But amid recent inflation surges, labor costs have been rising across the board (the highest increase since 2001). Meaning, your suppliers are spending more than ever on their labor. That cost is then added to your bill.
Transportation-related costs like impost costs, freight expenses, and shipping costs can all increase the price for your supplier.
And unexpected external events (like the Ever Given getting stuck in the Suez Canal) can quickly jack up prices (in the Ever Given’s case, ports clogged and goods incurred extra expenses while waiting to be unloaded).
Source:
Forbes
Unfortunately, transport problems beget more transport problems, too. Truckers could historically get their trucks repaired in a day. But, with backed-up supply chains holding up much-needed parts and newer vehicles, it now takes over a month to get a truck repaired (and get that inventory back on the road).
And all these issues are deeply intertwined, with dramatic repercussions for manufacturers and retailers alike. The Council of Supply Chain Management Professionals released its State of Logistics Report in June 2022, revealing that logistics costs rose 22% across the board in 2021. That’s a steep hike — which may be a huge reason your supplier costs are increasing.
In other words, your suppliers may raise prices due to many invisible factors out of your control, like preserving profitability or increasing their supply chain’s resiliency. But how you react, assess, and move forward is in your power.
When you receive the unfortunate news that your supplier’s prices are increasing, resist the urge to dump them like your college ex.
If the cost increases are due to circumstances outside your supplier’s control and are reasonable business changes, terminating the relationship could impact your standing with other suppliers. After all, if you have a reputation as an impulsive, impatient customer, your calls might start going to voicemail.
So, what should you do then? Well, you won’t know the best step to take without conducting a supplier cost analysis. Then, you’ll know whether to approach the negotiating table or walk away.
Price increases are unpleasant, but they usually come from a trackable source. So, the 1st step for due diligence is: Investigate where this increase is coming from.
Here’s how:
As of writing this article in September 2022, procurement professionals scramble to meet inflation-nervous consumers with lower-priced goods.
Shoppers are savvier to DTC marketing tactics than they were 10 years ago. So, many ecommerce brands are reworking their marketing materials to focus on their products’ durability and long-term value (while many of them raise prices themselves). Hopefully, this will nudge price-sensitive customers toward a purchase.
But suppliers are feeling the inflation pressure too. Though inflation is at a 40-year high, don’t accept “inflation” as a blanket rationale for increased supplier costs. Just know that right now, inflation may be the only reason they need to invoice more for your next order.
Find a starting point for your analysis, recommends the Institute for Supply Management. This can serve as a reference to help you figure out the change in your input costs over time.
Consider reviewing the past few years of price fluctuation for that product or service in your own historical data. Then, check it alongside your current price and the overall market data for that category.
As you review, be on the lookout for these signals:
You won’t always have a full picture of what was going on, but the context you have in your own records is in your control.
It never hurts to triple-check the bill of materials (BOM) for the product that’s increasing in price. BOMs are the list of “ingredients” for any product you sell. And they’re a key document your suppliers use to deliver your products correctly.
So, review past BOMs for this product alongside each other in your cost analysis. You might find a particular raw material or part is responsible for the increase. That is, if your supplier didn’t already point it out.
It’s also totally fair to ask your supplier for a cost breakdown of each material used in production over time.
Ideally, you’ll see how materials costs have changed for a particular product over a year or 2. This should give you a more accurate idea of how that material’s price (and subsequently, the cost of the finished goods) has changed over time.
There’s no perfect price you can name for your supplier that considers all the economic challenges facing your business and theirs.
However, given all the factors involved, you can identify a price increase range that makes sense. Then, determine whether your supplier’s quote fits in that range.
McKinsey wrote a handy guide to calculating a price increase range. Here’s the gist of it:
Identify the main cost inputs that have the highest level of change, especially in an inflationary environment — these will likely be commodities, labor, and transportation.
Estimate the percentage of the product’s total supplier cost that these inputs make up. For instance, the raw leather needed to make a shoe may make up 30% of the manufacturing cost.
You need a point from which to calculate the change in cost inputs. This could be looking back at the beginning of your supplier relationship or X number of months or years ago.
Then, calculate the percentage increase of the supplier cost since then. For instance, you started working with the supplier 3 years ago, and your supplier cost for that shoe has increased by 20% since then.
To calculate your price increase range, use the following formula:
[% of commodity price increases in the market] x [% of supplier cost impacted by market increase] x [% of supplier increase in cost over time] = % increase that would be reasonable for your supplier to quote you
Say you sell leather shoes. The cost of leather as a commodity increased 7% in the market, and your supplier told you the price is going up 10% to reflect that.
You can then calculate that since your shoe’s input cost of leather is 30% of the total supplier cost and your supplier’s cost has increased 20% over time. Meaning, you could determine that via 10% x 20% x 30% = a 0.6% increase is more in the ballpark.
If the price has increased and can’t be changed, at least 1 stakeholder will have to pick up the tab of those higher costs: you, your supplier, or your customer. The best way to resolve a pricing increase is by striking a transparent compromise that works for everyone.
Before making a final decision, gather as much information as possible.
And remember: At the end of the day, your supplier is trying to run a profitable business, just like you. Say you put in the work required to make your partnership mutually beneficial. Then, there’s a chance this price increase can open the door to a richer long-term relationship.
“Ensure the working relationship works both ways,” advised Lauren Davies at UK Oak Doors. “You must make sure that both parties are happy with agreements and be prepared to make some compromises now and then.”
Luckily, there are a few ways you can go about it.
Your supplier may have more flexible cost variables than you’re aware of, whether through a certain business process, lower distribution costs, talent pool, or other advantages not visible to you. Meaning, there might be more wiggle room than you know. But you won’t know until you ask.
The best way for you to improve any business relationship is to provide transparency. What data do you have about your demand planning or inventory levels? Any up-to-date information you can share with your suppliers will make it much easier for them to return the favor and proactively communicate with your team.
The freight and raw materials cost has doubled (or more) across the board. This means that stockouts have become more expensive for retailers. And not just in the typical ways we think of, like displeasing customers and losing revenue. Now, it’s much more expensive to order more inventory later at a higher price.
Approach the table with these factors in mind. Bring your price increase range calculation (remember, we calculated this above!) and explore possible compromises or plans. For instance, you and your supplier may find it advantageous to update service-level agreement (SLA) terms to ship your orders faster in exchange for a cost raise.
Increasing your prices may be unavoidable at a certain point, but you have options for rolling out your pricing increase. For instance, you can consider a regular pricing raise schedule or selectively roll out the increase to specific customers first. Then, communicate that increase respectfully and transparently to your customers.
Switching suppliers typically isn’t the recommended route. However, if you’re unable to negotiate your contract or find any point of flexibility, your supplier might not be the best long-term business partner for you. After all, you need suppliers that will work with you through these massive economic shifts and global disruptions!
When vetting other suppliers, don’t ditch your current supplier until you’re completely sure you’ve secured the next one. Also, be sure you have enough inventory to carry you through the changeover in case of supply delays during the transition.
🔔 Reminder: Switching suppliers takes several months on average. The more SKUs you have or, the more business you do, this process can drag out even longer. Just make sure to plan well ahead (6-12 months, at least) to ensure you have enough stock on hand during the changeover.
The best way to prevent customer frustration or out-of-the-blue supplier increases is to build resilience in your supply chain. For instance, you can prepare your company for the next clogged port (or anything else) by negotiating lock-in prices for long-term contracts, transferring risks to external entities, and reducing input costs.
Set yourself up for success by setting your supplier costs in stone wherever it makes sense.
“We have had successful relationships with some of our suppliers, in which they were willing to lock in prices for 2 years,” shared Lauren at UK Oak Doors. “These are suppliers we have long-standing relationships with and have built up trusting working relationships. These massively help all-round, as price increases seem to be constant at the moment!”
👉 Try it yourself: Share your inventory plan with your supplier when negotiating better vendor contract terms. Then commit to placing a certain number of orders in that timeframe to lock in a lower price.
Risk transfers are a risk management technique where a company transfers risk to an external party. (Easiest example: Insurance!)
It’s a bit in the economic weeds, so analysts at McKinsey don’t recommend leaning on this strategy too hard since it can be a higher risk. They also say an in-house finance team that understands the sophisticated positions involved is a prerequisite to pulling this off.
One way to do this: Partnering with other retailers who need the same supplies as you! You can contact to swap or share raw materials with another manufacturer. This helps you and the other party reduce costs and gain flexibility in your supply chain.
Kodak, for example, partnered with labs to do this and eventually transitioned to a broader chemical company instead of just niching into photography to reduce costs.
Input costs are the direct costs of creating a product or service, like labor and factory overhead. They’re a helpful (and easy) area to cut costs. Your commodities, your holding costs, your freight partners – all those costs add up.
Steps you can take to reduce input costs:
When it comes to reducing supplier costs, though, your ultimate secret weapon is having a production plan in hand. If your suppliers know what’s coming up next, they’ll be more likely to work with you on price. Lucky for you, Cogsy can help with this.
You can’t afford to work from PO to PO when inflation, supply chain chaos, and other potential disruptions leave your business increasingly vulnerable to sudden changes. Cogsy’s production planning feature allows you to forecast inventory orders, so you can stay on track to meet your revenue and demand goals.
Best part? With this newfound transparency, you negotiate better payment terms. For instance, baby and toddler brand Lalo used Cogsy’s production orders feature to loosely plan their next 12 months of inventory.
With a plan in hand, it was easy to share information transparently and more accurately with their suppliers. Now, they pay 50% less on their purchase order down payments. This frees up tons of working capital to invest in growth (they’re currently seeing 400% YoY growth) or mitigates inflation fallout.
After all, having a cushion of working capital helps you grow and insulates you from pricing increase whiplash.
You don’t necessarily need a formal price negotiation letter to communicate with your suppliers. Ideally, you have decent enough relationships with them that render a formal letter unnecessary. But it is important to go into that conversation armed with data.
Negotiate better terms with key inventory metrics from the past (like your price increase range, calculated above) and a rough sketch of your production plan (Cogsy can help you build this).
That way, your supplier will fully understand why their price increase doesn’t track with historical trends. And (hopefully) they’ll know how you’d like to collaborate with them going forward. These 2 key pieces make any negotiation go much more smoothly.
When a supplier raises prices, you need to gather information about the source of the price increase, evaluate market trends, and conduct a supplier cost analysis. Then, decide whether you want to accept the increase, negotiate better contract terms (which we highly recommend) or find a new supplier if all else fails.
If your supplier requests a price increase you can’t pay, you might have to make some hard decisions quickly, like finding alternative suppliers, using “back in stock” sales tactics, or simply accepting a temporary stockout. If you are using Shopify to manage your online store, read our guide on setting up Shopify back in stock notifications.
Supplier costs are not usually set in stone. You need good data about your historical supplier costs and production planning for the next 6-12 months to effectively converse with your suppliers. That’s because you’ll have an easier time negotiating if you make it easy for your suppliers to do reliable business with you. So, provide transparency as far as possible (we recommend sharing your 12-month plan with suppliers). Why does this work? Because regular, predictable orders are easier to negotiate on price.
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