Price is the most difficult of all the contract terms to be negotiated. When negotiating price, the negotiator must concurrently consider the type of contract to be used. Contract type and the negotiation of price are directly related, hence, they must be considered together.
image source: grammarly.com
The techniques for negotiating the price are:
ADVERTISEMENTS:
1. Cost analysis
2. Price analysis.
1. Cost Analysis/Cost Negotiation:
In this technique, each applicable cost element is negotiated individually, e.g., design engineering cost, tooling cost, direct materials cost, labour hours, labour rates, sub-contracting overhead cost, other direct costs, profit and so on. One cost element, direct labour cost is discussed as an example to illustrate how all applicable costs are negotiated.
For most negotiated contracts, direct labour cost is not only the most difficult of all costs to analyse and to negotiate, but it is also the most important. It is the most important because in purchasing high cost, high technology capital products that are non-standard or manufactured in small quantities (the very type of purchases that are negotiated), labour and overhead costs combined traditionally represent the largest element of total product cost.
ADVERTISEMENTS:
Determining the absolute number of hours needed to perform a contract can also be difficult. Absolute numbers of work hours are related to methods of manufacturing, the kinds of tooling used, and the accuracy of a seller’s estimating and accounting methods.
In buying, standard time can often be combined to determine reasonably accurate estimates of direct labour cost. However, in buying products not previously manufactured, such readily usable tools are not available.
For products not previously manufactured, sellers generally develop their quotations (estimates) using one of three methods (1) by totaling the standard times used in the manufacture of similar items, (2) by employing detailed time and motion studies, and (3) by bidding a ball park estimate suitably padded for protection against unforeseen contingencies.
2. Price Analysis/Price Negotiation:
Price analysis is the most commonly used technique of negotiating the price. There are various sources of information from where the firm can collect the information about the price. These sources provide the buyer with price lists, catalogues etc.
ADVERTISEMENTS:
From these competing vendor data, the buyer firm can readily determine two very important facts: (a) the nature of the market, and (b) the extent of vendor interest in this particular purchase. The two methods of price negotiation are:
i. Trend comparison
ii. Price comparison
i. Trend Comparison:
Historical prices paid for purchases of similar quantities can be analysed to disclose helpful price trend information. For example, if prices have been increasing, it is reasonable to expect that the seller will attempt to maintain a similar pattern of increase. Hence, by carefully analyzing the reasons for all price increases, the negotiator can structure his bargaining position.
Similarly, the negotiator can analyse decreasing prices to determine whether the price decrease is too little or too much. If he determines it is too much, he must then determine whether the trend is creating, or is likely to create, quality or service problems in contract performance. If the decrease is too little, he must then determine whether the benefits of improved production processes are being proportionally reflected in the lower bid prices.
ii. Price Comparison:
The negotiator’s first step in price analysis is to determine the extent of market competitiveness and vendor interest. His second step is to examine in detail the absolute and relative differences existing among the various prices quoted by the competing vendors.
From this examination, a buyer detects that differences in prices among vendors exist, but he does not learn the causes of these differences. His search for causes begins in the purchasing department’s supplier information file.
The bid prices of the competing vendors are compared with past price of similar purchases from the supplier information file. The causes of all significant variations are pinpointed and analysed.
Adjustments are made for changes in factors such as specifications, quantities ordered, and times of deliveries’ variations which have taken place in the general levels of business activity and prices, and differences which have resulted from learning experience.
After these adjustments are made, the negotiator (sometimes with the help of an engineering estimator or a price analyst) determines whether or not the prices offered are reasonable. From this determination, the negotiator decides on the target price he will use for his negotiating position.