The following article was prepared by Mike Taylor, C.P.M., for distribution to ISM affiliate newsletters. January  2007

Cost Counts

January 2007

A few years ago I read an article about a purchasing agent at Costco. It highlighted an important cost-related negotiation strategy that I had seen every time I walked through Costco, but failed to recognize.

As well as many other products, Costco sells really big, 8 lb boxes of breakfast cereal. In addition to being enough cereal to last a few weeks, the unit price [price per corn flake] to customers is significantly lower than the small boxes in the local grocery store. The big boxes are on the shelf not just because Costco has extra room – but because the Costco purchasing agent negotiated for big boxes, lowering the overall cost [then shared the savings with customers].

Consider packaging for example. Each box of breakfast cereal includes a printed box. The colorful boxes aren’t cheap and the cost of each box gets added to the selling price of the product. By obtaining cereal in 8-lb boxes, the buyer gets more product and many fewer boxes. No only are there fewer boxes, there is less handling of the product in the factory and fewer secret decoder rings [I wish I still had my decoder ring]. In fact, the cost savings go much further.

Consider the other costs which are reduced by the change in packaging. The producer only folds, glues and fills one big box instead of many little boxes. Costco ends up storing a large quantity of cereal on the shelf in those big boxes which moves the inventory out of the producer‘s warehouse. The product is shipped once a month on a large pallet instead of once a week in cartons. The shelf is stocked only once a month, not once a week. Costco only has to scan and sell the product to customers once a month instead of once a week. Costco only processes one purchase order, invoice and payment instead of many. You get the idea.

In this negotiating strategy the buyer and seller have identified and either eliminated or reduced significant cost elements. Then they split the cost savings so that the producer may even make more profit on the product and the buyer gets a much lower unit-priced product to sell to his customers. Instead of costing 10 cents an ounce, the corn flakes now might only cost 7 cents - so the producer, Costco and the consumer each save a penny an ounce [and in an 8-lb box those pennies add up].

By negotiating a change to something as simple as the packaging size, Costco and the producer have effectively reduced many associated costs of handling, storage and freight. And so it is the same in every item we purchase. There are many little costs which get added in to the final selling price. If we can negotiate a change to reduce one or many of those costs, the overall unit price can be significantly reduced.

Next time you negotiate a long term purchase, instead of arguing about a few cents discount off the asking price, negotiate a lower the overall cost.

How? An easy way to explore this negotiation strategy is by looking at the products you purchase on a regular basis and thinking about packaging.

1. Start by calculating your current unit price for the product. What is the consumer’s cost per corn flake? You may even also want to include some of your costs to use the product – such as waste or handling. This is important because you’ll need to reevaluate this to see the impact of every proposed change.
2. Is there packaging that gets discarded or does not add value? Could be the box, internal wrapping or those nasty little foam pellets. [true confession: I once purchased O-rings in special kits of 10 for several years and paid extra for the special packaging. Then I found out we had stopped using them in kits of 10 and spent a lot of time repacking them after delivery. So we paid extra for packaging that cost us even more after delivery. That was a no-brainer to fix once I figured it out]
3. Can you use the product in bulk packaging, less packaging or even with no packaging?
4. Could the product be useful if it was delivered in another form instead of the current packaging? Example: a kit instead of individual components.
5. What are other packaging or delivery options? Remember a consignment inventory is just a different delivery option.
6. Now take the big leap in negotiating strategy and bring in your best supplier. Ask to talk with the most experienced, knowledgeable and creative people the supplier has. Bring along your most experienced people who handle and use the product. This is the team.
7. Instead of attacking, start the negotiation by explaining the goal of the investigation to your new negotiation team. 
   Goal: “I want to work together with you to see if we can reduce the overall unit price of the product by changing the costs of packaging and delivery. If we find savings to share, it would mean a lower unit price for me and an increase in unit profit for you.
8. Then compile a complete list of questions to discuss, starting with items 1-5 above. I’ll bet your negotiation team will think of many more costs to question associated with packaging, storage and handling. Remember your supplier may have hidden costs you are not aware of [storage, tax, spoilage, inventory loss].  Also keep in mind that some changes could actually increase cost in the short term in order to achieve big savings in the long term.
9. Once you have a full list of questions, start brainstorming alternatives. Remember the rules of brainstorming – every idea gets heard – no mater how strange. Two or three strange ideas could evolve into a significant process improvement. Consider the first Costco buyer who suggested a huge box of corn flakes. Turned out to be a winner.

Experienced buyers understand that the overall cost of a product or service is where the big money savings hide. Happy hunting.

Mt

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