Dear Leaders

A weekly letter with actionable leadership ideas.

Supplier Management

By Hamza Shayk

Dear Leaders,

The approach to negotiating with your suppliers is simple: treat them as your partners, be tough but fair, and don’t lock yourself in a situation that is impossible to walk away from.

1. Understand the balance of power:

Understanding and playing the balance of power between buyer and supplier is a key skill in supplier management. Understand how important your business is to the supplier – what percentage of its revenue and profits you represent. And how important the supplier is to you – what percentage of your costs it represents, how critical it is to the functioning of your business, and how easily you could find a substitute.

Most businesses can gain by consolidating their supplier base. Higher volume per supplier usually gets you better prices. Having fewer suppliers also gives you more account planning time with each one, to figure out ways of working better together to mutual advantage and to apply best practices to the total supply chain.

Optimizing your relationship with your suppliers isn’t just about who has the power. Even when you hold the cards, invest time in relationships with key suppliers and be an intelligent negotiator.

2. Always aim for a win/win:

-Understand your suppliers’ economics: Don’t just focus on the price being charged, understand how the total supply chain fits together. Spend time with key suppliers to build this understanding in regular review meetings that aren’t just about price negotiation.

-Ensure there’s a profit in it for the supplier: Understanding your suppliers’ economics will also help you understand their real bottom line. Having that knowledge, negotiate with the goal of leaving a decent profit for the supplier. Negotiating so hard that there’s no profit in it for the supplier is self-defeating and unsustainable. Moreover, churning suppliers will only be more costly to you in the long run.

-Best tradeoff between price and payment terms: Don’t squeeze suppliers on both price and payment terms. Whoever has the lowest cost of capital should take on the greater cash-flow burden in exchange for better pricing. For example, large, well-capitalized fashion retailers in the West buy from small-scale under-capitalized clothing producers out in Asia. The retail chains have lower cost of capital and stronger cash positions. They should be able to offer faster payment in return for deeper price cuts and still come out better off.

3. Don’t get locked in:

If you can’t walk away from a supplier, sooner or later you’ll end up paying over the odds. To avoid getting locked in:

– Always have at least one other supplier as a credible alternative. It may be better to spread your business over two suppliers, even if you pay a bit more.
– Work on reducing the cost of switching – time, money, risk, technical difficulty
– Avoid long-term contracts unless there are overwhelming economic advantages.
– Maintain an active marketplace: ensure that big supply contracts go through a regular retendering process and review approved supplier list at least once a year.

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