Martin mentioned the old Marketing rule of thumb that it costs 6 times as much to win a customer as to retain one. And that triggered a few thoughts about procurement.
The costs of bidding for business are considerable, whether it is a formal tender process or a more traditional business to business relationship of meetings and negotiation. Having won a contract, obviously the business has to perform well in order to retain it, but assuming it does then there is and advantage to both sides if the relationship continues.
My question is whether Procurement think about this sufficiently, and whether we put enough emphasis on squeezing prices in return for extending contracts. Obviously it saves procurement time and money in avoiding a new bidding process, but there are a few processes going on that we might not think about in sufficient detail.
The cost of sales is obviously shared across all potential customers that suppliers target, but if we are already contracted then the cost of sales to us should be lower. Perhaps not by a factor of 6, but certainly by 2 or 3. Do the pries charged during the extension reflect that?
In addition we can think about the well known experience learning curve (or Boston Learning curve) which has been demonstrated back to the days of the Model T Ford. The more units made, or the more times we carry out a service the more efficient we get. The relationship is a log-log one, so is commonly portrayed as a curve where every time we double cumulative production the cost per unit goes down by a certain amount. This obviously does not happen without some effort on the part of the Supplier, but is an indication that longer contracts become particularly attractive to suppliers as set up costs are written off and experience learning reduces the cost of delivery.
Taking this into account, some suppliers will initially submit a loss leading price assuming that profits will come later in the contract. If we start targeting those savings then the supplier risks making less money than anticipated - hence the phrase that loss leading leads to a loss!
When considering the end of a contract, it is common to more or less roll over the existing price - maybe taking into account variables such as inflation and raw material costs. Should we be looking instead to have price reductions taking into account the reduced price of sales AND experiential learning.
There is no such thing as a free lunch, and we might see that initial prices rise if we want to share in the future efficiency savings - but it is something we probably should think about a bit harder.
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