Is the price right?

According to Dominic Jephcott, CEO of supply network specialist Vendigital, Asia's traditional pricing model needs fixing. Low economic growth is causing pricing shocks in Asia as old market-based pricing models fail. Aerospace companies need to develop cost- and value-based models to ensure sustainable pricing. With flat demand in the USA and Western Europe, any exciting aerospace growth is mainly confined to Asia. A third of all new commercial aircraft are forecast to be manufactured in China, whilst India is growing its defence capabilities and Singapore its MRO. This strong demand requires significant localisation, so sourcing in low-cost or strategic emerging Asian economies is becoming more important. Most tier 1 and 2 companies have set targets for purchases from Asia within the next few years as a result of customer pressure. Stuttering overall growth in the Chinese economy and increasing input costs are starting to cause pricing shocks, as contracts have been based on outdated pricing practices. Throughout years of high growth, Asian suppliers have charged Western aerospace companies whatever price they can sell at, usually based on market experience. Western manufacturers assumed that tenders from Asian suppliers were rational and quality was a ‘given'. However, unbeknown to many Western buyers, the idea of cost-based pricing, where suppliers understand their costs and then price accordingly, is extremely rare in Asia. Even the best factories have rudimentary, if any, cost modelling capability. Pricing is necessarily limited to what Western customers are prepared to pay. In times of hyper-growth, with overheads already covered, the tendered price for incremental business only needed to be above marginal costs. This was then followed by testosterone-fuelled ‘haggling', to maximise the proportion of margin in the total supply chain that Western buyers can obtain. The supplier then matches whatever quality it can achieve against the agreed price. With seemingly unstoppable growth disappearing and costs rising, Asian companies have started increasing prices to remain profitable. Western companies must prepare for a correction and some real drama as these hard-negotiated prices unravel, and those who risk long-term margin reductions caused by increases from Asian suppliers who ‘got it wrong', are seeing their non-aerospace business contracts decline and input costs rise. They now need to correct prices to stay in business. The solution is that companies help their Asian suppliers move from price-based contracting to cost- and value-based pricing. This involves developing cost models at a regional level. These can then be personalised to individual suppliers, helping both parties agree a fair price based on understood costs. The buyer has to determine what the costs should be, what margin they're prepared to pay the supplier and what the price should be. They then must convince the supplier it's a fair cost. To preserve long-term competitiveness, prices must account for productivity improvements and buyers may need to teach suppliers how Lean manufacturing techniques can reduce costs. Asian suppliers are good at making constant, small changes that ‘nibble' cost from a product. Unfortunately, this isn't always in a controlled manner, resulting in quality problems or even deliberate quality ‘fade'. Western companies must constantly look for innovation in their supply chains to maintain long-term cost and quality competitiveness. Whereas their Asian suppliers are good at ‘evolution', they must provide radical step-change improvements through ‘revolutionary' new materials and processes. The traditional Asian model of purchasing, asking suppliers for a price and then haggling over the lowest quote, is broken. Western manufacturers must mitigate the risk by working collaboratively on cost, value and quality with their Asian suppliers, through continuous improvement and innovation to ensure pricing is both competitive and fair. This will enable them to avoid sudden price shocks and give them sustainable pricing that will protect their margins on long-term customer contracts. There is a real opportunity for massive savings and value enhancement by moving to emerging market supply chains. However, a transition to this radical new cost and value pricing approach is needed to harvest them. www.vendigital.com

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