Today I wanted to share a blog post to hopefully help you and teach you how to deal with price increases from Chinese suppliers.
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So you received an email from your supplier that prices have to be increased because the Chinese Yuan (RMB) is being appreciated, his labor costs have risen or some other reason.
Never accept any price increase blindly. Let’s first analyze the situation:
- Has he increased the price within the last year? If yes, how often?
- Has he stated on his last quotation the validity of the price?
- What are the reasons he wants to increase prices?
Here are common reasons for price increases:
- Labor costs need to be increased
- Raw material costs have increased
- Chinese Renminbi (YUAN) has appreciated against the USD
- Purchase of machinery to upgrade the factory
Lets go through them one by one and see how you could avoid the increase or find an acceptable solution between the both of you. I also want to give you background on each so that you can understand these reasons.
Labor costs need to be increased:
When I moved to Hong Kong in 2005 the average salary of a worker was around 250USD per month. Yes, that’s right, per month!! Nowadays a worker in the production line can get up to 1000USD or sometimes more. Some of the workers earn more than the staff in the office. Factories need to pay a high salary to workers because it’s so difficult to find them.
Yes, China has over 1.3 billion people but not everyone wants to stand in a workshop or production line doing rudimentary work. Education has improved a great deal since the early 2000’s and people want to work in offices rather than on production lines. So factories have to reach out to far provinces to hire workers. Costs automatically rise in that process. I have been told that some factories rent a bus and drive to far away provinces actively hiring workers to bring them back to the factory that same day on the bus.
What can you do in that case? Honestly not much. But if a supplier keeps increasing prices because of labor costs you might want to look for another supplier who has more machinery or automated processes that require less workmanship. This can actually be more expensive (because of the investment for machinery) but you should have more stability on prices in the future.
Raw material costs have increased:
This requires a little research but if a supplier uses this reason for price increases you can quickly find out if he is lying.
Go onto websites like the following and research the price index on your product’s main material:
Unfortunately, there is not much free information on the Internet; you have to pay for most services if you want real accurate data. You can also check out your local stock or commodity market online and see if you can get free data. Once you find your product’s raw material price check the development over the last few months or even years.
Compare it with the orders that you made to your supplier at the specific price drops or increases. If for example you ordered your item before at a lower raw material price than now, you can use this information to negotiate with your supplier.
I often find that suppliers use this excuse of raw material price to increase their profit margin. When you have data that backs that the raw material price has perhaps even decreased since your last purchase, let the supplier know and share the link or information that you found. Demand the same or an even lower price than what you are paying now.
If raw material really has increased then you might want to check by how much. If the supplier’s price increase does not match the actual raw material price increase, let him know and demand a lower price increase.
Chinese Renminbi (YUAN /RMB) has appreciated against the USD
The Chinese Yuan has risen over 60% since its revaluation in 2005 (when it was pegged against the USD). It has been undervalued for a long time but that has changed since the economic reforms under Deng Xiaoping. Since China opened to the rest of the world and became the world’s factory the Yuan has risen a great deal.
Many factories increase prices once the Yuan gets appreciated against the USD.
If the Yuan gets appreciated against the USD it is usually in the news and you should hear about it. You can also check official USD/RMB exchange rates to verify this claim.
Not much you can do here either, except perhaps asking for one more order with the last price before you accept the new price.
Purchase of machinery to upgrade the factory
This usually doesn’t happen very often, but when the factory claims there is machinery to buy to upgrade the factory it’s actually a good thing for you. It will lower the labor costs over time and you should have a stable price for a while. Ask your supplier to explain the type of machinery he is buying and how you can benefit from it in the future. Let him give you a guarantee or confirmation that this will benefit your price in the future.
Validity of prices
Always ask your supplier to give you a validity of the quoted price. A common time frame should be 90 days, sometimes more sometimes less. In any case, ask your supplier for a validity of 180 days (6 months). It might take you a long time to decide to order this product for various reasons.
If you get back to the supplier after a while and you haven’t confirmed validity he might increase the price. That can put you in a difficult spot if you gave the quoted price to your customer. You might have to re-offer to your customer and that’s never good.
Big retailers usually have 1 year or even longer terms with suppliers. They can do that because the suppliers know that the quantities will be large and retailers often take a long time to decide because of their decision chain/process.
How to avoid or battle a price increase:
- Insist on the last order price for this order. Tell him you are about to give him a re-order.
- Look into raw material price sheets. There are free sources on the Internet. You don’t even need to be updated all the time, but simply look at a price curve of the main material of your product for the last few months.
Has the price dropped or risen significantly? Did the supplier claim that the “xxxy” material has sharply risen? Check it out before you trust him.
- Put measurements in place such as contracts or buying terms to which the supplier has to agree before you do business. Set up your own buying terms with, for example, a minimum validity of prices in all offers.
- Ask for bonus payments or agreements. If you know that you will be reordering from this factory, make a written agreement that you will receive a discount of a certain percentage from the next order based on your previous year.
It is getting more common to agree on bonus payments these days. It works the same way as back home with your local supplier. You agree on certain delivery terms, merchandising payment, back-payments and bonuses if a certain turnover is reached per year.
This usually only works with suppliers that you already work with. But you can certainly try it on any supplier. Even if you get a few hundred USD discount or bonus payment it’s definitely worth it!
You could set the following simple bonus payments with your supplier:
Turnover Goal 2017: xxxxx USD
If reached, bonus payment of 5% (for example) to be discounted from the next order.
For every xxxx USD above this amount a further 1% (for example) to a maximum of X% applies.
Send this agreement to your supplier. You can obviously work out a more detailed agreement but this is a simple illustration on how it could look. In any case I am sure there is some bonus or discount that can be arranged on future orders.
The best option would be a direct bank transfer of the bonus at the year’s end but most suppliers will only agree on a discount deducted from any future order.
How to negotiate a good price with a low order quantity:
It is quite common that the supplier will send you a price based on a certain order quantity. Say 10USD for a quantity of 1,000 pieces. Sometimes suppliers will give you 2-3 different prices for different quantities. If you are planning to order an item, you should have a general idea of how to negotiate when you ask your supplier for a quote.
DOUBLE (2,000) or even TRIPLE (3,000) this expected order quantity when asking for a price. It’s a tactic I use to see what the price range can be. If I actually order this item later at the quoted price but I am below the requested MOQ of the supplier I will pledge with the supplier to keep the price so that we can get started.
I will also mention that it will be a trial order and if everything goes well I will order the initial MOQ that the price was based on.
Perhaps the supplier will not give you the price based on your 1,000 pieces but he will give you the price based on 2,000 pieces to show his support.
This works in most cases. A supplier always will want to support you because they need to feed their factories with orders, even if they t make less profit, just to keep production running and to be cost effective.
Ask for a mixed calculation:
Say you buy 4 items from the same supplier and there is one item out of your assortment that is really price sensitive but the other 3 items are not.
Ask your supplier to keep the price on the price sensitive item the same (or decreased) and allow him to increase the other items at the same time (up to the maximum of the original price increase).
This way you can still offer the price sensitive item at the same price to your customers and lose only a little bit of profit on your higher margin items.
Advanced raw material purchase:
Many suppliers like to increase the price on your re-order. Let him know that you have an order coming up and that he should purchase raw material now at the lowest prices and that you want to have a better price than the previous order. He may want a written order confirmation for that so that he can purchase raw material on your behalf. Other suppliers offer on hand (or not)
If you have other suppliers’ offers on hand that are cheaper than the same item from your current supplier then tell your supplier and demand at least the same price. If you don’t have another offer on hand you could also pretend that you have an offer that is (say 10%) cheaper. Some suppliers may ask who it is from or if they can see it, but you don’t necessarily have to send it to him.
If you do have an offer from another supplier I would actually send it to my current supplier and ask him to lower the price.
How I got 7 suppliers to pay my buyer 100,000USD in bonus payments
I had a buyer for Christmas items flying in from Austria pre-order season. We arranged to meet up with 9 suppliers over 2 days in our office in Hong Kong. I asked the suppliers to come in and meet with us to discuss the upcoming orders and next season items. The suppliers were happy to come and meet us because we usually would place orders in excess of 100,000USD to each of them per year.
We started off each meeting the same way. We told them we would be selecting new items and then we would tell the supplier how happy we were with the previous season and that we wanted to enlarge business this year. This got them in a happy mood. We selected a few new items to add to the assortment with each supplier. Eventually my buyer sat back and I started to talk about newly introduced bonus payments to each supplier.
We wanted 10% of the last year’s order amount in bonus payments to be deducted from the next order. I also prepared an agreement to fix the payments right there and then with the supplier’s signature. We sat a long time with each supplier explaining the difficult economic situation, the EUR/USD exchange rate and how this all made it difficult for the buyer to succeed in his business.
We needed the supplier’s support, there and then or else there might not be any increased orders. (You can always use other reasons, such as economic situations in your country, etc.) Two suppliers wouldn’t pay anything but we ended the 2 days of negotiation with over 100,000USD in bonus payments (some suppliers had orders of over 300,000USD from us). This was a lot more than we expected.
How did I do that?
Initially the suppliers were reluctant. Since I wasn’t the actual buyer but the product manager it sure was a good thing the buyer was there. This way the supplier saw the buyer and had no way of wriggling himself out easily. Chinese do not want to lose face in front of their customers. They often promise the “best prices / best services,” etc., and it was time to prove they meant what they said. If you continually insist on a bonus and financial support they will eventually give in, because they want your future business and they don’t want to upset you.
In your case, since you will be the buyer, you see the importance of coming to China to negotiate your deals. A negotiation like this is highly unlikely to succeed via a phone call or an email. You don’t need to have an office here. You can hold meetings and negotiations in your hotel or at the factory.
Even if your quantities or order value are not as big as the example above you still have an edge. Even the smallest discounts on your next orders could cover the airfare ticket you bought to get to China. Not to mention the suppliers you met on other days to source for new ideas. It will definitely be worth it.
Before you go into a negotiation with a supplier, plan ahead with a clear strategy similar to the one described above.
I do hope that this blog post helped you in some ways to get leverage when negotiating with your suppliers.
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All the best and happy sourcing,