The Eagle Blog

What is More Important Cost or Delivery?

Staffing Industry Analysts produce a number of periodicals, analysis and information about our industry. Procurement professionals are one of their target markets and the following is an interesting perspective about the fact that staffing suppliers need to make money too! The article is in response to a question from a procurement person.

As you can see the role of procurement is to squeeze, but even this professional recognises that there is only so much blood in a stone!

An interesting sidebar .. SI Analysts suggests that the typical gross margin for technical contractors is in the 23% range!
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Be careful what you ask for

By Bryan T. Peña Bryan T. Peña is senior global commodity manager, professional services and technology, for Avery Dennison Corp.

The Question:
We asked our staffing supplier for a 5 percent reduction in bill rates while offering a 20 percent increase in business. The supplier initially said it couldn’t agree because the bill-rate discount would cut too deeply into its profit margin. Are we being unreasonable? If so, what other concessions should we consider?

The Answer:
As I’ve said in previous columns, the contract renewal period is a great time to look at your vendor program holistically and identify places to optimize the relationship. And from a procurement standpoint, the search for savings is never-ending. However, there is a point at which you need to look beyond simple dollars and seek ways to bring other types of value to the table. While such things are disregarded by most finance and accounting departments, you still can make a case for them.

To discuss how to calculate acceptable pricing concessions, we need to discuss margin versus markup. Many contracts focus on the markup as the primary driver for pricing. It can range from 18 percent to more than 100 percent and is the difference between bill rates and pay rates — something quite different from gross margin.

In basic terms, margin is profitability expressed as a percentage of bill rate and markup is bill rate expressed as a function of pay rate. If a temp is paid $10.00 and you add a 50 percent markup, the bill rate is $15 and assuming for simplicity, no other tax or benefit costs, the gross margin is 33 percent of the bill rate.
Why should you care? In order to get something, you need to give something in return. And most often in procurement circles, that translates to, “I’m going to increase your business so you should discount your price.” There is nothing empirically wrong with this approach — after all, it is the basis for the consulting industry.
But you need to be realistic about what you expect. Depending on the profitability of your account to the vendor, the amount of concessions you can expect is directly proportional to the amount of additional revenue you will generate.
Getting Real. Let’s assume a staffing vendor has a gross margin of 15 percent and a customer wants a 5 percent discount on bill rates. For the vendor to stay even, the company would have to increase volume by 50 percent. Again using a $10 cost basis, a 15 percent gross margin translates to a 17.7 percent markup for a final bill rate of $11.77. By subtracting the cost from the final price we get a profit of $1.77 per unit. If we apply a 5 percent discount to the price we get a new bill rate of $11.18. But costs remain the same, so we get a profit of $1.18, or a 59-cent reduction for the vendor. To ensure your vendor the same dollar amount of profit he was at before, you would need to deliver 50 percent more business. Obviously this is a very simplified example but in basic terms it should hold true.

According to Staffing Industry Analysts Inc., the publisher of this magazine, the typical gross margin on contingent workers with technical skill sets is 23 percent. This translates to a markup on cost of around 30 percent. In this example, that same 5 percent discount would need to be accompanied by a 15 percent increase in revenue just to get the vendor back to the same dollar amount as before.
The case for your aggressive discount demands becomes bleaker when we begin to discuss net margin. Net margin is just what it says: gross margin less operating costs, which include everything from computer repairs to rent to the purchase of new light bulbs.

Again using the benchmarking data, a staffing company’s typical net margin is in Q2 2006 is anywhere from 3.9 to 4.5 percent. By plugging a 5 percent billing discount into this equation, you would obliterate your vendor’s entire profit.
In reality, most well-negotiated major contracts have a net margin of even less, which makes it even more unlikely to expect major concessions in the form of discounts.
Let’s go back to the initial question and figure out the short answer.
If we assume your supplier’s current contract is in line with averages in the benchmarking data, and if you continue to insist on a 5 percent bill-rate discount, you would have to find a new vendor. That’s because your current supplier is likely to walk away. Or, if it agrees, and continues to make such bad business decisions, it will soon go broke.

Hope Remains. Despite the financial realities I’ve noted, there are still reasonable concessions you can ask for that could save your company at least some money. One thing to look at is payment terms. For instance, you could ask to pay invoices in 60 days rather than 30. And you could negotiate a discount for early payments. Depending on your internal cost of funds, this could really equal serious money. Check with accounting or finance.
Ask for free or reduced-fee drug screens and background checks. Your staffing supplier may have an agreement with its primary screening vendors that would make this possible.
Check with HR on the number of contingent workers converted to traditional employees. If they are high enough, you could re-negotiate the conversion fees. Similarly, you could ask for a longer period during which you can convert a temporary worker free of charge.
Also, take a look at something called “tenure rates.” Some suppliers will reduce their markups on temps who stay with you for a specified period of time.
While everyone tries to chase hard-dollar savings, we need to remain aware of the business realities faced by the people across the table from us. They need to make a profit and it doesn’t do anyone any good to have the best contract rates in the world if your requisitions go unfilled. Only by partnering with your vendors to mutually manage profitability can you ensure a truly productive long-term relationship.
Submit your questions regarding staffing, procurement or vendor relations for future Procurement Guy columns to bryan@procurementguy.com. Please include your contact information.


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2 thoughts on “What is More Important Cost or Delivery?

  1. Terrific blog posting!! The information offered by Guy is applicable to many industries.

    In fact, in certain cases, I would go as far as suggesting open book negotiations with customers/purchasing agents. Let them know your costs and negotiate fair and reasonable profits. In my previous business we did this on several occasions with larger contracts. Its a great win for all stakeholders since the customer ultimately gains a better understanding of the vendor’s challenges, likely receives improved service and delivery- which translates to cost savings in the long run. In some cases…our margins increased slightly because we eliminated the tender process. A good portion of the increased profit was given back to our customers in the form of improved service and support.

  2. Terrific blog posting!! The information offered by Guy is applicable to many industries.

    In fact, in certain cases, I would go as far as suggesting open book negotiations with customers/purchasing agents. Let them know your costs and negotiate fair and reasonable profits. In my previous business we did this on several occasions with larger contracts. Its a great win for all stakeholders since the customer ultimately gains a better understanding of the vendor’s challenges, likely receives improved service and delivery- which translates to cost savings in the long run. In some cases…our margins increased slightly because we eliminated the tender process. A good portion of the increased profit was given back to our customers in the form of improved service and support.

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