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Demand for price reduction is not sustainable

May 23, 2014

Supply management faces a real dilemma. How does it balance its desire to cut costs with the need to ensure competition?

 

Essentially, there is a conflict between the tactical desire for lower input costs with the strategic imperative of maintaining a competitive market. And as industry after industry is discovering, maintaining a balance is not easy.

 

Already we have seen major industries such as oil and gas and automotive suffer from the consequences of their own success in driving down supplier prices. A consequence of these more aggressive procurement practices has been supplier consolidation. Taken together with growing business complexity and the need for higher capital investment to support innovation, we can see a steady shift in power away from producers and into their major suppliers.

 

Government initiatives are starting to have similar effect. Social demands for more and better services are accompanied by an expectation of steady or reduced taxation. That means Governments worldwide are squeezing suppliers to cut costs. The new healthcare regime in the US is a great example. Wider coverage of the population means greater demand for drugs and services. But in return, the Government wants to pay less per unit of supply. So the major providers are under pressure to cut their costs – and one way to achieve this is through merger and acquisition. Already we see consolidation occurring – with some efforts such as Pfizer’s attempted take-over of AstraZeneca on a massive scale. But the consequence of all this will be fewer – and more powerful – suppliers.

 

One implication of this is the need for buyers to weigh carefully the likely tipping point in the power equation – in other words, when will the pressure on pricing shift from demand-led to supply-led? Just before that point is reached, smart buyers will surely be looking to tie down long-term contracts with index-based escalation clauses. Alternatively, we may see some growth of vertical integration as management reverses decades of outsourcing and starts to re-build internal capabilities.

 

Either way, it suggests an interesting and challenging future for talented commercial staff.

3 Comments
  1. Kamal Al-Mikdad permalink

    Excellent post below on procurement. I hope it’s useful for you.

    Sent from my Verizon Wireless 4G LTE smartphone

  2. This article exemplifies the tension between short-term opportunism and long-term market competitiveness. Market design is integral to achieving a balance and the best way to achieve this is to insist on supplier diversity. Award criteria in tenders should seek to address this by insisting on at least two or three suppliers and establishing a bound of 60-80% on the maximum fraction of business to be awarded to the number 1 supplier. This, however, relies on having evaluation engines to compute the award outcome but this is now being addressed by vendors such as Keelvar in the sourcing optimization market.

  3. Eugene P. Grace permalink

    I believe you are talking about issues that are not within the control of any one firm or group without running afoul of antitrust laws. I believe you are seeing the pendulum of the economic cycle swinging through its different quadrants: outsource – cut supplier costs- supplier consolidation – insource – higher employee expense – outsource. Buyers with strategic suppliers need to stay very close to supplier financials to detect early warning signs to better position for negative consequences of supplier’s corporate re-alignment. A key contract clause would be to require supplier’s production of in-depth financial information on a regular periodic basis, most likely quarterly.

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