In the face of a changing regulatory landscape and fluctuating commodity costs, buyers face a range of market environments where they lack the upper hand. However, by entering negotiations armed with market knowledge and an understanding of the characteristics that work against them, buyers can increase their leverage.
ProcurementIQ analyzed a range of markets with characteristics that often work against buyers, including volatile prices, high market share concentration and changing regulations. Procurement and supply chain professionals can use the strategies and tactics provided to help increase their spend efficiency and encourage competitive RFPs with suppliers.
Using Long-Term Contracts to Combat Volatile Prices
Price volatility is the primary market risk factor that directly impacts a buyer’s ability to anticipate how much a product or service will cost. However, even though volatile prices can mean a lot of ups and downs in costs that can work against purchasers, that doesn’t mean all is lost.
Take fuel prices, for example. Prices for fuel have been all over the map during the past three years as oil prices have fluctuated with a supply glut and slow growth in demand. Gasoline prices have plummeted at an estimated average of 14.4% per year during the past three years, in line with the falling price of crude oil, which is a key input needed to produce gasoline. While buyers have benefited overall from this massive decline, gasoline prices are forecast to rise at an average annual rate of 4.2% during the three years to 2020 as the price of crude oil bounces back. To combat these price changes, buyers with large gasoline procurement needs, such as rental vehicle companies and trucking companies, should consider a long-term contract in the very near future. These contracts typically include price ceilings and floors to keep buyers’ costs within a predictable range during the life of the contract. Smaller buyers can take advantage of the market’s vast number of midsize and small suppliers to negotiate better terms. The resulting high price competition among these suppliers means they’re more likely to negotiate with potential customers.
The price of natural gas has followed a similar trend, having fallen at an estimated annualized rate of 11.7% during the past three years due to excess supply. However, demand for natural gas is expected to pick up as electricity consumption rises among businesses with operations that run on natural gas as an energy source. With natural gas prices forecast to rise at annualized rate of 2.3% in the next three years, buyers should lock in contracts as soon as possible. Because prices will continue to be volatile as supply and demand trends fluctuate in the coming years, buyers should ensure their contracts include price ceilings or other restrictions on how much and when suppliers can raise prices to keep costs manageable.
Leveraging Competition in Highly Concentrated Markets
Buyers generally have limited leverage when a small number of dominant companies are able to dictate prices due to limited competition. This trend – known as high market share concentration – is evident in the domestic air travel market, where ProcurementIQ research indicates the top four airlines account for nearly 65% of total market revenue. A similar trend has been taking place in the electroshock weapons market, where Axon-owned Taser International accounts for more than 50% of the market alone.
Top suppliers in markets with high market share concentration are often able to charge a premium because buyers are limited in their ability to use the presence of other suppliers as leverage during negotiations. Even so, there are other market attributes that savvy buyers can use in their favor. For instance, buyers can look into less fragmented segments of the market. In the domestic air travel market, top suppliers must still compete with low-cost carriers to attract customers. As a result, buyers should leverage the growing popularity of low-cost carriers to obtain better terms.
In the electroshock weapons market, there are many more suppliers of close-range weapons like stun guns and stun batons than of long-range weapons like Tasers. As a result of the greater competition among close-range weapons suppliers, buyers will have an easier time negotiating price breaks for these goods. Buyers can also take advantage of the market’s low price volatility, which indicates predictable pricing trends that allow buyers to take their time in the procurement process without the fear of sudden price changes.
Curbing Costs Despite Changing Regulations
Rapid changes to regulation and a low availability of viable substitutes work against buyers because they cannot use similar products or services to negotiate prices down. For example, the regulations involved in transporting, treating, storing and disposing of hazardous and nonhazardous solid waste require buyers to purchase hazardous waste disposal services and also prevent them from bringing the services in-house. Instead, to reduce costs, buyers should negotiate long-term contracts with suppliers to protect themselves against potential increases in disposal costs as regulations continue to change. Buyers need to ensure their supplier has a thorough knowledge of local, state and federal regulations to safeguard against noncompliant services. Buyers with a variety of service needs can also purchase related services, such as solid waste collection and recycling, from vertically integrated vendors to obtain bundle discounts, or contract with a local specialty vendor to get a reduction in transportation fees.
In other markets, a shift in public opinion has led to regulatory changes that are affecting both suppliers and buyers. For instance, the regulatory environment in the vending machine rental market has been especially fast-paced as the drive to reduce obesity rates, particularly among children, has been gaining popularity. The FDA now requires suppliers that own more than 20 vending machines to provide calorie information on food sold in those machines. According to ProcurementIQ, rising compliance costs are likely to raise rental prices. In addition, the only substitute to renting a vending machine available to buyers is purchasing one, which means buyers can’t use a multitude of substitutes as leverage when negotiating with suppliers.
Luckily for buyers, there are about 17,000 suppliers of vending machine rentals, and the services they provide are similar across the board. Because suppliers can’t differentiate their services, no one company can dominate the market and set prices. With competition being high, especially among smaller suppliers, buyers will be able to negotiate a favorable price for services. Buyers should just keep in mind that negotiating with larger suppliers will be more difficult due the brand names large vendors carry and their larger customer bases, which make them less dependent on a single customer for revenue.
Striking the Right Balance
The procurement landscape is in a constant state of flux. As a result, procurement professionals must be aware of changing market environments to stay successful and efficient, particularly when dealing with difficult markets. Understanding the characteristics that don’t work in their favor can lead procurement professionals to make smarter and more effective purchasing decisions. So, although a market may seem disadvantageous at first glance, insight and a strategic approach can help buyers reduce costs and boost negotiation power across a range of markets.
- Committing to a long-term contract that includes price ceilings will keep costs in a predictable range for buyers sourcing goods and services in markets with volatile prices.
- When market share concentration is high, buyers can look into more fragmented market segments, which typically have a higher number of suppliers and more competitive prices.
- Buyers purchasing from heavily regulated markets can use contracts to lock in current prices before they increase. If substitutes are few, bundling related goods and services or taking advantage of a market’s many suppliers can boost buyer leverage in negotiations.
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