As promised in my previous post, LiveChat Follow-Up on Price Competitiveness, Part 1, I am outlining in this blog the final two actions from my top five steps to ensuring competitive pricing in the current environment. This follows on the request from EBN readers for more specific information on how to achieve better pricing, beyond what we were able to cover in last month’s LiveChat.
The last two suggestions follow:
4. Manage markups. Understand your supply chain and where value is created in it. Always maintain control of your approved vendor list (AVL) and make sure your suppliers know that you are the customer. Suppliers have marketing and R&D budgets, so make sure these budgets are spent to your benefit and not to the benefit of intermediaries.
Two intermediary groups are worth your attention, as they may stand between you and your component manufacturer and affect your price. They are distributors and contract manufacturers. Both of these provide valuable services, but be sure that what you pay for is fair and that their services do not overlap. For example, distributors often manage in-house stores for contract manufacturers that are paid for through the distributor’s markup. Meanwhile, contract manufacturers charge a material overhead (MOH) to cover the cost of buying, inventorying, etc. Before the distributor implemented in-house stores, this work was included in the MOH. Make sure the current rates accommodate this change and are reasonable for what you’re getting.
The distribution markup rate is harder to gauge and can sometimes become out-of-line if not carefully managed. The industry has set the value provided by distributors at about 15 percent, which is the gross margin reported by the big two distributors. This rate translates into a distribution component price that should be about 12 percent higher than what your company would be able to get dealing directly with a manufacturer (yes, I must acknowledge that some suppliers will only deal with you through the distributor).
The 12 percent recognizes that the distributor gets better pricing than your direct price because it’s doing some of the pre- and post-sales service that offsets what a manufacturer would normally do as an internal cost. You should implement a process to get direct and distribution quotes to gauge the variation in markups and use this knowledge to leverage pricing down. If possible, negotiate a fixed distribution markup and hold the distributor to it with ongoing markup testing.
What’s key is having accurate data that you get from direct and distributor quotations obtained by sampling both on and off AVL manufacturers and their products. It is hard to argue against accurate data. An additional point worth noting is that manufacturers that want your business will often work with you to influence the distributor to your advantage.
5. Understand Japan disaster-influenced price increases. The earthquake in Japan has had a devastating impact on many individuals and companies. From my comfortable home in North America, I can only imagine the hardship and suffering being experienced by many hardworking Japanese families. This is a true tragedy. That being acknowledged, one impact, beyond many personal tragedies, will be a general increase in pricing for some electronic components. While many increases will be justified, some won’t be.
Many companies are incurring the extra costs to build and deliver products, but this is not true for all. Many suppliers will benefit from increased production volumes that fill factories that were otherwise running with excess capacity. Don’t let your compassion for the Japanese allow less scrupulous suppliers to take advantage of this situation and improve their margins. Make sure that any price increases you accept can truly have their roots traced to the disaster in Japan.
By Ken Bradley – Lytica Inc. Founder/Chairman/CTO