5 Price Analysis Methodologies to Apply to Negotiated Costs

How can you find out if you’ve got a good deal from your negotiation? Here are some price analysis tools that could help you out.

One of the key performance measures that invariably arises at the end of a negotiation is if the final price achieved is a good one or not.

If we, as buyers, have purchased the product or service for a number of years, we can rely on our experience. But we have all faced a situation when we have to deal with an unfamiliar product. What do we do then?

I have outlined the pros and cons of some different approaches to price analysis. There’s no magic formula we can apply to confirm if the negotiated cost is accurate to the market price.

Each price analysis method has its own strengths and weaknesses. Knowing them will help us to understand which one to apply in which situation.

Price Comparison

The most basic method. You take the final price, and compare it against the prices quoted for the same product by other suppliers in the market place. This is the most common method, and it’s usually applied to common products, or those with transparent pricing.

Pros:

• Doesn’t require too many resources.
• Relatively easy to find out if the cost is over the market average.

Cons:

• It can only be applied to common products – it should not be used, for example, for the cost of a lab analysis service, or customised goods.
• You have to work with updated costs – in some areas, like electronics, a 6 month old cost may be obsolete.
• You have to compare exactly the same product, under the same circumstances – not, for example, two different mobile phones, or services from two different countries.

Cost Structure

If it’s not possible to find equivalent market prices for the products or services, procurement can use the approach of a detailed cost structure analysis.

In order to do it, we ‘only’ have to replicate the manufacturing process, and assign an estimated cost to each stage. We can then benchmark this result against the cost provided by the supplier.

With a service, rather than a product, the process requires disaggregation of the service into its constituent parts (salaries; materials; equipment), and a cost assigned to each.

Pros:

• Provides a detailed view of costs.
• Can be used as a basis for supplier partnerships, and to visit supplier facilities to look at the manufacturing process.
• Allows for negotiation on each constituent part of the good or service, increasing potential for savings.

Cons:

• In-depth knowledge of the manufacturing processes and costs is needed.
• Resource heavy.
• Without supplier input, manufacturing process costs will be estimated, increasing the error margin exponentially.

Price Index

If the product has a published price index, then it is logical that the index will be a good guide to check if the negotiated cost is a good one. It would then be a matter of comparing the negotiated and index price to see if the negotiated cost was good or not.

The process is a bit more complex than that, but for the purposes of this article, there is no need for further explanation.

Pros:

• Price indices usually are available on the Internet under paid subscription. As an added value, these sites usually offer forecast analysis that could be helpful for ongoing procurement strategy.
• Can show trends and provide a comparison to the cost the last time the product was purchased. For example, if a product index has decreased a 5 per cent, but the supplier has only offered a 2 per cent cost decrease, then it’s clear that there is room for further negotiation.

Cons:

• The indices are just a guide, there is a more complex cost structure which has to be considered. For example, other factors, such as a trader’s fee, would not be expressed as part of the product cost.
• Indices only have a partial influence on the final price. A drop of 30 per cent on a factor, such as petrol price in the plastics market, wouldn’t necessarily mean a 30 per cent drop in the product price.
• Markets can fall victim to speculation, or an issue that distorts the index. Being unaware of these issues prior to a negotiation could lead to a higher than expected cost.

Unit Price Analysis (UPA)

The Unit Price Analysis (UPA) is a mathematical model which predicts the right cost that a product or service should have based on its specific properties or details. It’s like a price calculator.

Pros:

• We have access to a goal cost before starting negotiations.
• Companies have developed their own UPAs based on non-linear regression statistical analysis. You can hire their services in the same way as you sign up for Price Index sites.
• They are quite helpful when calculating complex project costs, and provide an accurate cost result for EPC projects.

Cons:

• Building this model from scratch is expensive. Nearly all companies outsource this service.
• You must be sure that data comes from a trustworthy source before using it for a negotiation.
• UPAs are unitary prices based on a specific volume. The data doesn’t support different volumes.

Conclusion

In addition to the price analysis tools outlined above, there are a number of other, less common, ones. They are less used as they can only usually be applied to very specific cases.

There is no, one correct method. The specific circumstances of each sourcing activity will determine which method can be best applied to the post-negotiation benchmarking activity.