Contract Margins vs Contract Pricing


By John Roche, Haybrooke CEO

PrintBuying

There is value in agreeing prices in advance with your suppliers; buyers know that. It can speed up the end-to-end procurement process and help deliver savings to customers, too.

In sectors where it is easy to calculate pricing for products and services – the ‘widget’ market, for example – it makes sense for suppliers to provide up-front pricing for the commodity-type products it provides; these usually being based upon a promised volume of work – i.e. the ‘contract’.

In other sectors, where products are highly customised – the printing industry, for example – the contract pricing model begins to break down. Why?

Consider a buyer wanting contract pricing from its suppliers for its ‘booklets’ category. The booklets fall into two groups: perfect bound and saddle-stitched. These groups are further divided into 4 size splits: A4, A5, 210×210 and DL. Each class of size has 3 paper type options and 8 paper weight options. Then, there are 10 pagination possibilities. Finally, there are 3 colours combinations and 3 special finishes to consider (laminates, UV and the like).

To cover off each of these options in a contract pricing matrix would require:

2 (binding types) x 4 (sizes) x 3 (paper types) x 8 (paper weights) x 10(paginations) x 3 (colour combinations) x 3 (special finishes) = 17,280 quotes.

If we say that an average quote takes 5 minutes to produce (a conservative guess) and, accordingly, costs £2.50 (using an estimating department cost rate of £30 per hour), then the supplier has to invest 1,440 hours (192 working days) at a total cost of £43,200 in order to provide the pricing for it.

But wait, we haven’t yet considered the quantity breaks. Unless there is onlyone quantity to quote for, we need to multiply the number of specification variations with this too!

Let’s say the buyer wants 10 quantity variations (in reality, there is usually many more required for a fully-scoped contract pricing exercise). This increases the workload on the supplier 10-fold. That is:

172,800 quotes = 1,920 working days to complete the exercise (a year of work for 7 estimators!) equating to a cost of £432,000.
In case there are those who think these numbers a little far-fetched, real examples abound of suppliers contacting Haybrooke and asking us the question “can you help us do 40,000 quotes for a contract that might be worth £half a million to us?”

Luckily for the supplier our answer is usually yes (as we can and do help with that sort of thing) but, regardless, it is an incredibly large commitment to place upon a supplier for the purpose of obtaining contract prices.

So what is the alternative?

Contract margins

The concept of contract margins is not new. Rather than agree prices for actual specifications in advance, a buyer and its supplier instead agree a mark-up (or range of mark-ups per volume, production method or product type) for all specifications ordered. The supplier calculates the cost and applies the agreed margin each time an order is placed.

This arrangement is transparent and usually agreeable to both parties. However, there are elements of operating a contract margin arrangement with suppliers that seem to place it at a disadvantage when compared to contract pricing.

Perhaps the most significant perceived shortcoming is the lack of pricing information in advance for the products and services the buyer intends to procure from its suppliers; especially if the buyer is a print manager.

Print managers are often engaged in price justification cases for its end clients. These are necessary to demonstrate how well the print manager can buy from its supplier network and, thus, how much money they will be able to save the client for a typical ‘basket of work’.

If a print manager cannot convince its client that it will be able to save it money on print spend over the next year, say, the client might well decide to place its trust somewhere else.

In order to prevent this unwanted outcome, a print manager instead requires that the supply chain commits to pricing for a wide range of specifications in advance (the ‘contract specifications’). As described above, this can mean a lot of work for the supplier with, in some cases, no actual guarantee of business. Once the suppliers have completed the exercise, however, the print manager can now offer the assurance to its clients that it will be able to save them money for the agreed future period. Phew!

The biggest beneficiary of contract pricing, then, is arguably the print manager. Moreover, it would seem that the only alternative – contract margins – is useless in helping the print manager to demonstrate savings in advance to its clients.

This is essentially true; with one exception.

If the print manager has access to a procurement tool that is able to calculate suppliers’ prices for them, then it now becomes possible to deploy contract margins in place of contract prices. In this case, instead of asking suppliers to commit to calculating hundreds, even thousands of prices, the print manager simply needs to push the specifications through its procurement tool where the contract margins will sit on top of the costs that are calculated.

To be effective for these purposes, the print manager’s procurement solution would need:

  1. Instant supplier pricing based upon actual production methods available
  2. A methodology for processing multiple specifications in one hit
  3. A contract pricing mechanism that moderates the pricing returned for each supplier for agreed timeframes (per client if necessary)
  4. A summary of all of this that can be used to construct a bona-fide justification case
  5. Hell, let’s throw in a market benchmark price comparison for the specifications while we are at it
  6. And the best current live price in the market for each
  7. Oh, and the average of the top 5 and the top 10 live prices, too
  8. And compare all of this to the baseline target of course

Now, where ON EARTH might a print manager find such a system?

Get in touch to see the magic happen! 🙂