Current inflation means that supplier price increase requests are coming in thick and fast. Once conceded price increases can be difficult to recover so it’s vital that the buyer takes cost avoidance action to eliminate, or at worst minimize, their financial impact as early as possible.
Calculation of a price increase and cost avoidance:
Although cost avoidance savings are often referred to as “soft savings”, as the money has never actually been spent, it is still a vitally important task of purchasing – and should be recognised as such – especially in high inflationary times.
There are two fundamental and mutually exclusive strategies that the buyer can adopt for cost avoidance: Reactive & Predictive.
The REACTIVE cost avoidance strategy is when the buyer waits until the supplier asks for a price increase and then reacts to minimize or eliminate the increase after it is requested.
The 10 most effective reactive cost avoidance actions that a buyer may use in a sequenced step-by-step approach to eliminate / reduce supplier price increase requests are shown in the “Reactive Funnel” illustration.
The PREDICTIVE cost avoidance strategy is when the buyer predicts when the supplier will ask for a price increase and forecasts its value and then tries to eliminate or minimize it before it is requested.
There are 5 predictive cost avoidance actions that a buyer may use step-by-step to eliminate / reduce supplier price increase requests, shown in the “Predictive Funnel” illustration.
The 7-step PREDICTIVE cost avoidance process provides a rigorous and structured approach used to:
- Identify those suppliers who are most likely to increase prices
- Identify the potential size of future price increases (in percentages)
- Identify the potential value of future price increases
- Identify the likely month of future price increases
- Evaluate the overall financial impact by month
- Prioritize cost avoidance actions in descending order of value
- Determine the cost avoidance actions to be taken
- Measure and report the results back to management
Tip: Never invite the supplier to justify their price increase request; If you do ask for justification then in principle you’ve accepted that there is going to be a price increase with the only question remaining being “how much?”