Cost Plus Pricing
The 5th in a series of eight posts titled: “The View From the Other Side”
Major contracts from large lab distributors may offer “Capital Equipment @ Cost Plus 10%.” In all the negotiations I’ve been involved with, the customer perceives this as a valuable concession. However there was never a customer who ever asked: “How do you define cost?” And nobody ever asked for an audit to ensure that this was how the selling price was calculated.
Utilizing customer psychology to their advantage.
In most cultures, asking a vendor how much money they make on a sale is wholly inappropriate. It’s just not done. Distributors are well aware of this when offer to sell products on a cost-plus basis. Questioning the vendor is akin to asking someone outright if they are cheating.
If you were to be told that you were going to be charged “cost plus 10%” for an item, most would interpret this to mean you would be charged 10% over what the vendor paid for the item. As an example, if the manufacturer charged the vendor $100 for an item, you would expect to pay $110. You would be wrong.
Distributors have multiple qualifiers that go in front of the word “cost”:
- Vendor Cost (also called transfer price) is the price the vendor charges the distributor for that item.
- Landed Cost - the vendor cost plus the shipping and duties that the distributor pays to get the item to their warehouse. Note that this applies even if the item is being drop shipped direct from the factory to you which is the case for most equipement.
- File Cost - (also called “shielded cost”) The cost your sales rep sees for the item and the “cost” your 10% is added to. File cost may include a host of other charges such as:
- Marketing expenses required to source the product - especially overseas sourced items.
- An additional amount added (called a shield) that may be looked at as a “reward” to the company for negotiating an exceptionally good price on an item. This fee also is used to discourage sales people from selling one brand vs. another - especially if there is a private label product available.
- Rebated Cost - many vendors offer incentives to distributors, primarily for achieving a certain level of growth. For each sale that is made during a period, a cash rebate is given later in the year. In some cases the rebate is applied IN ADVANCE and clawed back later if the goal is not met.
And there is even a variable definition for what 10% is:
1.) The normal way of calculating it (e.g., $100 x 1.1 = $110.)
2.) And the way distributors think of margin in terms of % Gross Margin. This is calculated differently (e.g., $100 / .9 = $111.11.) In nearly all contracts, this is how the final price is calculated when applied to the file cost.
What can you do?
My recommendation would be to lay this all out on the table during the contract negotiations. When you bring it up, they will ask for a recess and go back and huddle to decide how to respond. You will likely not be able to negotiate over which cost definition will apply. But you should get language in your contract that states how the percentage is calculated.
A better approach would be to have language in the agreement that states that you be granted the following:
1.) The right to audit. This should include the capability of seeing the system cost used to calculate the final price ON THE DATE OF THE SALE! That is very important as costs can be manipulated easily even on a daily basis.
2.) The right to bid capital equipment. The only good way to check and see if you aren’t being fleeced is to send an RFP to a couple of competitors and check the price.
3.) The right of first refusal. If you get a much lower price from a competitor, you may wish to concede a right to the contracting vendor to match or beat that price.
Keeping them honest.
Cost plus agreements are perhaps the fairest way to do business with a distributor in a B2B relationship. Most customers are just fine with the profit marin being a little higher than what you might get if you did a full throated RFP.
In contracting, distributors have come up with many clever ways to extract more of your cash. Nothing exemplifies this more than what’s happening in a cost-plus discount arrangement.
What we will discuss in this series:
- 1.) Contract Terminology 101 - what are the components and what do they mean to you?
- 2.) Contact vs. Agreement - What’s the difference? Do you have the right to shop elsewhere? What about a “generic” or group contract?
- 3.) The Hot List and Price Caps - The pros and cons.
- 4.) Guaranteed Cost Savings - Hard vs. soft cost savings. Metrics. Penalty clauses.
- 5.) Cost Plus Pricing - Depends a lot on how you define “cost.”
- 6.) Rebates and Prebates - Sound too good to be true? Most likely it is.
- 7.) Profitization - How it’s done and how you can protect against it.
- 8.) LPS On Your Side - The LPS approach. How it addresses these issues and is a better fit for many lab