Eradicating Inflationary Cost Increases

As organisations face ever-increasing cost management issues, they must review their current and future spending requirements. Not conducting an annual financial price review will incur yearly costs that are 7 – 9% (£2.8M - £3.6M) on average, higher than the open market within a £40M annual budget.

Over a typical four-year Framework Agreement or Contract budget of £160M, assuming a constant annual turnover of £40M, an organisation’s costs will increase by £9.0M - £11.8M or 5.63% - 7.38% ahead of the market, as annual cost increases are compounded.

Suppliers will invariably utilise the Retail Price Index (RPI) rather than the Consumer Price Index (CPI), which is often the higher of the two most common price indices, when negotiating contractual terms and conditions or annual price increases 

Most supply contracts, especially within the public sector, allow suppliers to increase their costs by the annual CPI rate, which measures the prices of products and services paid by consumers and is published by the UK Government monthly. 

Public sector Suppliers, when negotiating prices annually, will often use the highest rate of RPI or CPI within the relevant 12-month negotiation period to justify cost increases, even though the rate of RPI or CPI at the time of the negotiation may be lower, adding up to £5.9B in costs for UK taxpayers. The UK's CPI inflation rate reached 10.1% in March 2023.

Suppliers will justify increasing their prices annually by stating that their costs have increased by this amount, even though this might not be true. Average industrial prices in March 2023 had risen within the UK by the following rates:

 

• Salaries – 7.1%.
• Materials – 4.1%.
• Energy – 29.4%.
• Transport – 6.8%.
• Land/Building – 2.9%.

Internal organisational price cost inflation rates will vary between industry sectors and the location of markets served. However, an organisation's real-world internal cost inflation rate will invariably be much lower than the CPI rate, as costs are generally lower than turnover. 

To demonstrate the impact of average UK cost increases mentioned above, an average supplier with a turnover of £40M will see their real-world costs increase as follows:

 

• Salaries – assuming 29% of all costs = £823,600.00.
• Materials – assuming 21% of all costs = £344,400.00.
• Energy – assuming 3.3% of all costs = £388,080.00.
• Transport – assuming 4.1% of all costs = £111,520.00.
• Land/Building Leases – 7.9% of all costs = £91,640.00.

Allowing this supplier to increase their prices by the CPI rate of 10.1% would see their customers paying additional costs of £4,040,000.00 instead of the supplier’s actual cost increase of £ 1,759,240.00 or 4.3% of turnover. Suppliers will increase their prices annually by using their turnover as the figure to calculate the rise rather than their internal costs.

Suppliers increasing their costs based on turnover rather than actual costs will lead to customers paying £2,280,760.00, increasing customer costs by 5.7% ahead of market pricing. Over four years, costs will have increased by £7.23M, taking the annual compounding of such increases into account.

Permitting suppliers to increase their prices by the highest RPI or CPI rate in any 12 months, let alone the actual RPI or CPI rate when negotiating prices, does not add value to the products or services organisations purchase. They merely increase the UK’s inflation rate.

Purchasing organisations can protect themselves from the ravages of price inflation by adopting a commercial policy that:

 

• Utilises open tendering to secure the best pricing.
• Shares the risks of cost inflation through contractual pricing clauses.
• Ensuring that all supplier price increases are justified.
• Robustly reducing maverick purchases.
• Reducing non-value-adding spending.

The absolute insanity is that the UK public sector allows Suppliers to increase their prices by the annual CPI rate based on their sales turnover, which is much higher in most cases than their actual costs, which typically amount to an average of just 42% of turnover.

However, instigating category management and commercial pricing policies across the UK public sector would decrease UK spending by up to £5.9B annually, effectively decreasing the CPI rate from the highest rate of 10.1% to just 8.4%, benefitting UK consumers from spiralling inflationary annual cost increases. 

*UK Government Inflation data 2023

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