The following article was prepared by Mike Taylor, C.P.M., for distribution to ISM affiliate newsletters. January 2007
In recent newsletter articles I suggested analyzing the selling price of materials and services to negotiate a better contract. That is, by looking at the various cost elements involved in establishing the seller’s price, we can find opportunities to be creative in negotiating cost savings. With direct cost elements, it is usually obvious how to improve the bottom line and lower the selling price. Changing the raw material, shipping terms, components, labor mix, schedule, etc. are common ways to improve the pricing structure. Read more about negotiating direct costs…. Cost Counts
But what about indirect costs? Indirect costs are seller’s expenses included in the selling price which are allocated to multiple projects using indirect cost pools. Expenses like the seller’s accounting department budget, CIO salary or engineering management are charged to the buyer over and above direct expenses associated with the product or service. Each project and customer pays for a little piece of the seller’s overhead costs. Read more about indirect costs….. Indirect Costs
On the face of it, it seems implausible to negotiate out of the contract indirect costs associated with the supplier’s accounting department or company president. I agree – it’s nearly impossible to get a better contract by cutting indirect costs out of the deal.
But consider for a minute that negotiating a better contract isn’t always about saving money. A more valuable, cost-effective and complete contract is also a much better contract. Read more about negotiating more than just price… Creative Negotiating (part 2)
So here is a thought. In addition to cutting direct contract costs to lower the price – think about improving the contract by taking advantage of the indirect costs already included in the seller’s price. Negotiate a contract that identifies and makes better use of every possible benefit available and already included in the selling price as indirect costs.
Example: A pump equipment company might advertise that all pump orders include “at no extra charge” the services of a field technician to assist in aligning the pump coupling. Savvy buyers know the field technician is not free; the technician’s salary is included in the seller’s overhead expenses and allocated to all sales. Thus, if the buyer is already paying for the service, why not make positive use of the service. A good approach would be to ensure the contract includes a deliverable for the technician’s service and an agreed installation schedule with plant maintenance.
Seem a little obvious? Sure, but if the contract document isn’t complete, the technician’s service (which is already paid for) could be missed because of scheduling problems or changes in personnel. How many times have you missed getting the “included” or “free” extras just because it wasn’t convenient or pre-planned? Once we understand that this overhead expense is already included in the selling price, then it makes a lot of sense to be sure it is clearly part of the contract negotiation and identified as a deliverable.
What else could we be taking advantage of? Try opening the subject by asking a seller to identify all of the ‘hidden’ or ‘included’ advantages of doing business with him. It will give the salesman a chance to do what he does best; sell his company. Listen carefully when salesmen talk about the “extras” that the company offers. Make sure to get lots of details, ask lots of questions and then be creative about including those ‘selling points’ in the contract.
Here are some examples of overhead cost items to creatively write into contracts. These are all expenses that a seller might have buried in his overhead rates that are worth asking for and specifying:
I’m sure there are many more examples of overhead expenses buyers pay for and sometimes fail to receive.
By taking advantage of overhead cost elements and writing them into the agreement, experienced buyers create more complete and much more valuable contracts.
Read more articles in the Purchasing Toolbox at http://www.mltweb.com/prof/tools.htm and in the BuyTrain news article archive at http://www.mltweb.com/tools/buytrain/index.htm Return to MLTweb
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