Negotiations Utilizing a Cost Model
I’m going to start this blog with a request for feedback. What I’m about to write is my opinion and has worked best in my experience. I recognize that there are exceptions to the advice I’m giving, but those are just that, exceptions. Others may have had different experiences and I’d like for you to share them with the membership.
The best way to utilize a Cost Model in a negotiation is to not even hint that you have a cost model. Rarely would I suggest that it is “Open Book” on both sides. I’m sure this goes directly against what a lot of you have been taught and are doing. Afterall, you are the customer and the old adage “The customer is always right” still works today. I realize this is against a lot of the current thought, but this is a negotiation and a negotiation is a battle. You should want to win the battle. Now to be honest, I’ve taken my share of negotiation training from the large training houses who teach it has to be a WIN WIN to be successful. During these training classes, no one wanted to go against me because I wanted to win.
So how do you use a Cost Model in a negotiation? Again, by not hinting that you have one until you absolutely must. You use the model as secret intelligence you’ve gained for this battle. You keep it in you pocket and use its knowledge. You start by asking questions. This is very hard for most of us because we are all smart people, very smart people. We tend to want to demonstrate our intelligence by starting with what we know. I recommend the opposite approach. You start out with questions like “I don’t see how this part is worth $X.XX. Could you please explain it to me? Could you show me how you calculate the price?” If you need to, use your management as an excuse, “I need to explain to my management why this part is so expensive. Could you help show me so I can explain it to them?” If you take this approach vs you telling them it’s worth $Y.YY because you did a cost model, you will be in a much better negotiating position.
Why will you be in a better position? Let’s look at what COULD happen if you are up against a seasoned seller and announced you had a cost model. A seasoned seller will now start to question you on your inputs. Challenge everyone of them. Thus delaying any real discussions based on what it actually costs THEM to produce while forcing you to JUSTIFY your model. They will challenge you on the smallest details, finding holes in your assumptions. Create doubt within their management, your management, your buyers, engineers, etc. All the while, the actual impact of the holes may have a very minor impact. Simple example: You use $20/hr for labor and they use $25/hr. For a plastic part being molded in 30 seconds with 4 cavities and an operator manning 4 machines, the difference is ($20 per hour per machine / 4 machines / 120pcs per hour) = $0.041. Using $25 will give you $0.051, or a difference of $0.01. This is just one example. A well-seasoned seller will push you to provide each and every input for your model; floorspace, utilities, supplies, indirect and so on. Each and every time your inputs do not match theirs, more doubt is created and more confusion enters the discussions. As a bonus to the seller, this all takes time and therefore delays any immediate cost reductions. I’ve seen this approach take months to years to resolve, if they ever get there.
What is the better solution? I recommend you ask questions and know the impact of their response by doing your homework upfront. What do I mean by this? As I stated above, ask them to defend their pricing. “Would you mind explaining how you got to your price? I just can’t see how it comes to $X.XX.” When they break down the pricing push for it in the 5 buckets of cost Material, Labor, Manufacturing, SG&A and Profit at a minimum (these buckets have been discussed in a previous blog). Using the same labor example from above, if they try to tell you the labor portion of the molded part is $0.25, you know it’s not feasible. They are over 5X what you calculated (based on math, science and benchmark data). Then your probe further (all the while knowing your calculation inside and out). You ask questions like, “What cycletime are you using for this?” If they tell you it’s 30 seconds +/- then you know it is a labor RATE problem and not a USAGE problem. (RATE and Usage also discussed in a previous blog).
The idea is to question THEM on the buckets and have THEM defend their price vs YOU defending the model. I think we all can agree the model will never be perfect, nor will ever match everything the supplier says. We must remember the model is just ONE TOOL of MANY TOOLS to be used in the battle we call a negotiation.
To sum it all up, have the supplier defend their price vs you defending your model. Have faith that your model is good. It should be based in math, science and solid data. Run sensitivities to show the impact of areas you might question. Examples: Know what happens if you increase the cost or usage of material by 10%-30%, or double the cycle time, or change the operator balance or used a different percentage for overhead. Know all of these in advance. Plan your questions appropriately and anticipate their responses.
Obviously, there are times and places for true open book discussions. Those are rare and require mature seasoned experts on both sides and agreements between both companies to follow through on their commitments.
Please comment and provide your feedback for all members to read and discuss.
Gerald (Jerry) Collins
Owner and Founder of Society of Cost Engineers