How to analyze whether a Supplier’s Price Increase Request is reasonable?
Solution: This can be determined with AIMDRIVE-AI Price Analysis and can be complemented using AIMDRIVE-AI Cost Analysis.
Example: Consider a product you have been regularly buying over the past year from a supplier at a price of $10.00 per unit. The supplier now informs you that they need to raise their price to $11.00 in view of increasing costs, i.e. a Price Increase Request of 10%.
AIMDRIVE-AI Price Analysis:
- Identify the industry of your supplier and obtain the Market Average Price Movement of products sold by this industry. You find that the market average price movement over the past year was -1%.
- Use this benchmark to challenge the supplier’s Price Increase Request of 10%.
However, the Supplier cites an increase of 20% in wages of Production workers over the past year due to a shortage of skilled workers in their region, and that this may not be reflected by the national industry index you have chosen to compare to.
AIMDRIVE-AI Cost Analysis:
- Obtain the Industry Average Cost Profile of products sold by this industry to understand the proportion of the Products’ Sales Price that is attributable to Production workers wages, i.e. the Direct Labor cost.
| Industry Average Cost Profile | % |
|---|---|
| Direct Materials | 50.0 |
| Direct Labor | 5.0 |
| Manufacturing Overhead (MOH) | 20.0 |
| Cost of Goods Sold (COGS) | 75.0 |
| GSA & Other Expenses | 20.0 |
| Profit Before Tax (PBT) | 5.0 |
| TOTAL | 100.0 |
- In this example, the Industry Average Cost Profile indicates that the Direct Labor cost represents on average 5.0% of the overall Product Price.
- A 20% increase in Direct Labor cost, which itself represents 5% of the price, would justify a 1% increase in the sales price (20% of 5%). Hence, this would only justify a price increase of $0.10 (1% of $10.00) for this Product.
- Assuming no other cost element has changed, this should result in an adjusted price of $10.10, as opposed to the proposed $11.00, or a cost avoidance saving of $0.90 on this Price Increase Request.
Note: Conversely, from time to time you may be faced with a Price Decrease notification from a supplier and be tempted to promptly accept it. In such a case, before accepting it, follow the same steps to validate whether the offered Price Decrease is sufficient or should be greater than proposed.
