Tuesday 29 January 2013

The myth of scale economies?

How to measure the actual savings on increased quantities?

Yesterday’s NamNews item ref Morrisons’ latest ‘routine negotiations’ not only scored our highest visitor-count, but more importantly raised the question of how much discount to give when a retailer offers bigger volumes for a lower price…

As always, accepting an offer that ‘feels good’ instead of running the numbers is a good way to compromise profitability...

Also, given the long lead times required to negotiate something you want, the pressure to agree a scale-discount in the heat of the final moments of a last-minute discount-negotiation can cause you to accept ‘an offer you can’t refuse’…knowing that if you do refuse, the guys back of the ranch can label it a bad decision, never having to test it with actual numbers…

The following steps may help:  
  • Keep in mind that a 10% Increase in sales does not necessarily mean a 10% reduction in costs
  • Also, as a supplier, you know more about manufacturing cost-savings than the buyer…
  • Select a specific SKU for one of your leading brands in the customer’s portfolio
  • Check out the sales, order sizes and average delivery delivery-frequencies of the SKU to the customer in question
  • Check with marketing/finance/production the cost savings on sales increases of 10%, 20% and 30%
  • (sales increases greater than 30% have to raise the question of whether you have been missing too many ‘potential’ tricks with the retailer…)
  • Actual savings will be driven by packaging and ingredient scale economies, capacity relationships etc in production and delivery, but it should be possible to arrive at a conservative figure ( you won’t believe how low the savings are, using real figures …hence ‘the myth’ of scale economies)
  • Ask for a quick check of other big SKUs (other brands in your portfolio) to isolate any ‘funnies’ in terms of exceptions
  • In negotiation, focus the discussion on your chosen SKU and limit the ‘give & take’ to a fair share of the real savings
  • Run a reality-check of the incremental sales required to produce the shared savings, just in case…
  • Agree minimum order quantities, and timed delivery frequencies, along with quarterly purchase levels
  • Build these conditions into a deal/contract tied to a discount paid retrospectively on performance, with on-time payment added for good measure
  • After six months consider extending the deal to include the rest of your business with that customer
  • This will hopefully bring your dealings a little closer to real scale-economies at the next ‘routine negotiation’, only this time with the benefit of a little history…
On the other hand, why not simply roll over, and over, and over……like other folk?

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