Do You Cost Model? Why Not?

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That’s one of the questions I’m going to ask at a 2 day public seminar I’m leading in Singapore next month. If you look at all the negotiation courses out there, they all focus on ways to influence suppliers to achieve your objectives.

None of the negotiation courses out there, and I really truly mean none of them, talk about cost modeling.

Is this a problem? Well, of course it is. Imagine going to a car dealership to buy or lease a new car and not having performed any kind of number crunching beforehand. All you have in your bag of tricks is a series of behavioral influencing techniques. Don’t you think that would put you at a gigantic disadvantage?

Mind you I’m not saying that influencing techniques aren’t important. They’re critical and indispensable. What I’m saying is that if that is all you’ve learned and practiced when it comes to negotiations, then what you have is an incomplete strategy.

The foundation of all purchasing negotiations is data. Either you’ve done your homework and analysis or you haven’t. No amount of behavioral influencing techniques, as effective as they may be, will make up for this.

Some of the most tested and true data based negotiation techniques are must cost models, total cost models, should cost models, and benchmarking.

Should cost models are used when custom product/service or sole sourced providers are being assessed. The reason for these cost models is that there is no other way of assessing whether or not TCO is being optimized, due to the custom or sole source nature of the purchasing scenario.

Must cost models are used when you KNOW that price exceeds budget under all scenarios. This is the one and only time in negotiations where it is to your advantage to disclose budget. This can result in tremendous innovation and breakthrough, because it forces reassessment of cost drivers to hit new price targets.

Total cost models are used when there is a material difference between acquisition cost and total cost. This is critical when making a lowest price decision can be counterproductive from a TCO perspective. Post acquisition costs are often ignored or misunderstood in purchasing decision making, and that’s where total cost models ensure that the right TCO decisions are made.

Benchmarking is best used for undifferentiated products/services where apples to apples comparisons can be performed, usually through an RFX process. Using industry available benchmarking information is often less reliable, unless it is a TRUE commodity item, such as copper, oil, or other traded commodities.

For any high value negotiation, one of the above cost modeling techniques must be performed, and the right one must be used. There are also lots of rules for doing cost models, from differentiating between facts, assumptions, and estimates to doing sensitivity analysis with key variables to change control techniques. You also have to understand the various types of costs, such as fixed, variable, average fixed cost, opportunity costs, sunk costs, switching costs, etc.

I’ll never forget my first negotiation ever. I had all my influencing techniques down. I was confident and ready. I told the supplier, who had everything to lose, that I wanted and expected an 18% discount, up from the 15% we were getting previously. I used every negotiation influencing technique I had studied.

The supplier had one response: “Why 18%? Why not 20% or 25% or 27%?” I sat there like a bag of potatoes. I literally had no response. He caught me. I didn’t do cost modeling. Nobody taught me cost modeling. I had no data based negotiation strategy upon which to rest my case.

I don’t remember the outcome of that negotiation (it was probably suboptimal), but I will never forget how I felt. Never again would I go into a negotiation without having done cost modeling.

Are you doing cost modeling for all of your major negotiations? Does your analysis lead you to the lowest TCO answer? Do you know what type of cost models to do and when? Do you follow all the cost model rules above and do sensitivity analysis on your findings?

If you ever ask yourself “could I have done better in that negotiation?” Cost modeling helps eliminate all doubt, and shows to management and customers that you got the best possible deal for your company.

Make it a part of your arsenal, be a complete purchasing professional, and put your results and career on the fast track to success. Being good at cost modeling is one of the most confidence building skills you can establish in our profession.

Contact me if you’d like to get cost model training or have an in-house seminar done for your organization. I’d love to partner with you and help jump your TCO results into high gear.

SPECIAL ANNOUNCEMENT! 

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This book is intended to give an overview of the highly critical skill of purchasing contract management (or what sales professionals would call ‘sales contract management’).

Purchasing professionals are consistently plagued by inadequate knowledge of purchasing contract law, which becomes a capability and therefore a career liability. The goal of this book is to address this problem and turn this liability to an area of strength and competitive advantage for purchasing professionals.

This book is intended to be a timeless reference guide, and is written for the practitioner – the person who wants concrete and actionable direction to do their job better and get their career on the fast track. The importance and purpose of contracts is covered, followed by how to customize purchasing contracts to fit the purchase, and then a detailed (116 pages) coverage of all major contract clauses, what they mean, and how to negotiate them.

The book closes out with best in class post contract management practices. 

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