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. The CPI rate 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%, benefiting UK consumers
from spiralling inflationary annual cost increases.
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