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Pricing Set To Be Big Issue

November 29, 2010

Whether we are buying or selling, prices are never far from our mind. But there are a number of forces that are breaking the mould of traditional pricing and raising its importance in the contracting process.

The driver for much of this change appears once more to be the increased volaitility of world markets caused by a global economy. Wild swings in demand, the constant search for lower cost sources of supply and the recurrent crises that threaten even existing contracts and relationships are creating unique conditions for suppliers, which challenge established pricing and charging methods.

To take just a few examples:

  • commodity areas are increasingly subject to short-term contracts between suppliers and distributors. In some markets, there is increasing vertical integration between the producers and the distributors; in others, these links are being broken down. Overall, there appears to be a growing trend towards shorter-term – or even spot – pricing, which makes forward forecasting of supply costs extremely unpredictable in key areas such as metals and energy.
  • the behavior of buyers, constantly pushing for lower prices, has had many impacts, both desirable and undesirable. In some cases, it has forced large-scale mergers which have substantially shifted the balance of power in negotiations. In others, it has destroyed the old equation of fixed prices or discounts in return for fixed volumes or guaranteed spend. Now, buyers want low prices AND flexibility, creating a real economic dilemma for their suppliers.
  • suppliers are also wrestling with the realities of a market where competiveness and survival depend on ‘escaping the commodity trap’. For many, this means either the regular introduction of new products or services, or transitioning to a high value services or solutions model – or both. In either case, their economic model is fundamentally altered. Rapidly changing products increases the reluctance of buyers to make long-term commitments; a move to services or solutions forces increased deferral of revenue, especially when pricing may now be linked to use-based charging.
  • the economic crisis has caused much publicized reductions in public sector spending; but it has also increased the caution of business, which either cannot raise cash or seeks to build massive cash reserves. In both cases, the impact on suppliers is to find new and creative funding methods that allow sales to continue, without demanding substantial capital expenditure by their customers.

In combination, these forces are raising price / charge mechanisms into the forefront of thinking for both buyers and sellers. One interesting question is what impact it will have on the contracting process and organization. When I first became a Commercial Manager, pricing was very firmly part of my remit. It was quite common for contracts and commercial staff to be part of the Finance organization and quite rare for it to be part of the Law Department. Contracts were primarily instruments for business management. In recent times, the pendulum has swung (largely, it seems to me, under the influence of a US model), whereby contracting is often seen as primarily a legal process, with risk analysis trumping economic analysis. Today, this has a negative impact, because there is a pressing need for creative relationships, with close links between cost and revenue analysis, contract models and negotiated terms.

If – as I believe – success in winning business over the next few years will depend on financially-based commercial creativity, does this mean we will see a swing back to a more integrated link between finance and contract negotiation and management? And might this ‘pressing need’ not only impact those in sales contracting, but also reflect into Procurement, with buy-side groups far more engaged in the economic consequences of market management?

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