The myth of scale economies?

How to measure the actual savings on increased quantities?

Yesterday’s NamNews item ref Morrisons’ latest ‘routine negotiations’ not only scored our highest visitor-count, but more importantly raised the question of how much discount to give when a retailer offers bigger volumes for a lower price…

As always, accepting an offer that ‘feels good’ instead of running the numbers is a good way to compromise profitability...

Also, given the long lead times required to negotiate something you want, the pressure to agree a scale-discount in the heat of the final moments of a last-minute discount-negotiation can cause you to accept ‘an offer you can’t refuse’…knowing that if you do refuse, the guys back of the ranch can label it a bad decision, never having to test it with actual numbers…

The following steps may help:  

• Keep in mind that a 10% Increase in sales does not necessarily mean a 10% reduction in costs
• Also, as a supplier, you know more about manufacturing cost-savings than the buyer…
• Select a specific SKU for one of your leading brands in the customer’s portfolio
• Check out the sales, order sizes and average delivery delivery-frequencies of the SKU to the customer in question
• Check with marketing/finance/production the cost savings on sales increases of 10%, 20% and 30%
• (sales increases greater than 30% have to raise the question of whether you have been missing too many ‘potential’ tricks with the retailer…)
• Actual savings will be driven by packaging and ingredient scale economies, capacity relationships etc in production and delivery, but it should be possible to arrive at a conservative figure ( you won’t believe how low the savings are, using real figures …hence ‘the myth’ of scale economies)
• Ask for a quick check of other big SKUs (other brands in your portfolio) to isolate any ‘funnies’ in terms of exceptions
• In negotiation, focus the discussion on your chosen SKU and limit the ‘give & take’ to a fair share of the real savings
• Run a reality-check of the incremental sales required to produce the shared savings, just in case…
• Agree minimum order quantities, and timed delivery frequencies, along with quarterly purchase levels
• Build these conditions into a deal/contract tied to a discount paid retrospectively on performance, with on-time payment added for good measure
• After six months consider extending the deal to include the rest of your business with that customer
• This will hopefully bring your dealings a little closer to real scale-economies at the next ‘routine negotiation’, only this time with the benefit of a little history…

On the other hand, why not simply roll over, and over, and over……like other folk?