A colleague recently penned an excellent pieceÃ‚Â on strategies buyers can use to mitigate cost increases.Ã‚Â Herb Shields, the author, suggests several tactics purchasing professionals may use to delay and/or mitigate price increases imposed by suppliers. Some of these tactics includeÃ‚Â rejecting “dear customer” letters to looking at substitute products or delaying decision-making. At MetalMiner, weÃ‚Â often write aboutÃ‚Â ways to mitigate cost increases withinÃ‚Â the metals industryÃ‚Â by deploying sophisticated hedging strategies, implementing product substitutionsÃ‚Â or perhapsÃ‚Â running reverse auctions in stagflationary environments.
But one of the most effective tools used in preparation for a negotiation is a cost build-up worksheet or analysis. Yes, I’m talking about those painful spreadsheets folks use after a reverse auction or electronic bidding event to extract additional information from the supply base about their bids and cost structure. Cost breakdown worksheets, when well developed and completed by suppliers, provide huge opportunities for analysis and insight on the part of the buying organization. They can also be used as a means for more effective negotiations pre-bid.
The other day, I threw out a back of the napkin calculation on steel costs per ton (not inclusive of profit and transportation) of ($500). Rather than just guess at the cost, I thought it might be helpful to stiffen up the napkin so to speak and walk through a cost build-up model to determine whether or notÃ‚Â the steel producers’Ã‚Â request for a $250 surcharge from automotive OEM’s, for example, is justified. We did the math taking a look at some of the cost models on Steelonthenet.Ã‚Â It is important to note that the model below SHOWS THE SPOT MARKET PRICE (which is higher) than what the steel producers may have been able to secure under long term contract from their iron ore and coking coal suppliers. Here is how the prices break out for one ton of steel:
Raw materials: $436
Freight to move raw materials: $83
Other raw materials (not iron ore, coking coal or scrap): $65
Other (interest, depreciation, energy credits etc): $8
Total: $610, obviously profit not included.
What can we conclude about our friends in the automotive industry? Well, clearly the days of $400/ton steel are over. The raw material costs alone put that out of reach. And if the steel producers locked themselves into a contract with the automotive companies at $700/ton, then maybe it does seem appropriate to ask for the surcharge. But let’s also remember that the steelmakers also lock into 1, 3 or 5 year agreements with key suppliers of raw materials so the math above wouldn’t really apply to the automotive industry.
But is $1050/ton justified? What do you think? Comment below.
If you would like to see our detailed cost build-up spreadsheet, drop me a line at “lreisman” (at) “aptiumglobal” (dot) com, we’d be happy to share it!