The Advantages of Incumbency
By Rakhi Agarwal, MBA, C.P.M., CPIM
When planning for the budget cycle and trying to work on the next year’s savings plan, it’s often easier to negotiate a lower price for a current product or service than finding a new, cheaper source. If there are no performance-related issues with the source, it’s often easier to work with an incumbent supplier. You know the supplier and its capabilities, and have established a relationship.
Nevertheless, there can a breaking point to the value generated by negotiating with an incumbent that may necessitate replacing the current suppliers or creating a new sourcing value proposition for the same product or service. But unless there are (1) performance and quality issues that cannot be resolved or (2) issues that impact assurance of supply and become a threat to the company’s revenue, staying with a current supplier is often the best choice — whether or not there is still room for negotiation and savings.
Here are the top three reasons why:
Time and cost. Qualifying a new supplier is time-consuming and not easy. It takes time to find the right source that can meet specifications and deliver per the required timeline. Many of the man-hours spent by the quality and production departments to find a new supplier (and the costs associated with the process) can be avoided by working with an incumbent.
Time is a big factor, especially in pharmaceutical sourcing, where the qualification process for a key intermediate or an advanced pharmaceutical ingredient (API) can take 18-24 months or even longer, depending on the regulated market for the product.
The supplier qualification process is also costly. For example, in the pharmaceutical industry, for a qualification and validation of a new API source, at least three commercial-size batches of a final product are required to be manufactured and tested. If there are multiple presentations and variations of a drug — for example, injectable, oral or suspension form —each form would need to have at least three batches to be manufactured and tested with the new API source. This is required even though the qualification is for the same API from the same source, which adds exponentially to the cost.
Also, when you qualify a new source, if the source is indicated in the FDA filings, the filings need to be opened and updated, which adds another layer of risk, time and man-hour cost to the process. If the drug is sold in regulated markets across the world, each market’s set of federal rules and regulations must be followed for the filings update before permission is granted to sell with the new source. If market approvals aren’t received before batches expire, the entire lot must be discarded at additional cost of disintegration or landfill. If the batches aren’t destroyed properly, there are liability implications as well.
Immediate impact on savings. Long-term contracts with incumbent suppliers can mean cost savings. Negotiations resulting in savings have a direct impact on the bottom line and EBITDA. The cost of goods sold is reduced, and the profit/loss impact can be tracked easily and immediately. For a sourcing professional, this is also a win-win situation, as savings delivered is a key metric for measuring the performance of a sourcing individual or group. One way to maximize this savings is to have a two-way tier contract, meaning a price reduction at higher volume, with added price reductions if business is continued year after year.
Supply chain continuity. A stable supply of good quality raw material for production is the most important goal of any business production. Supply chain continuity is important in any industry, and sourcing and procurement professionals must assure supply for the business to meet its financial goals. Working with incumbent sources provides that assurance of supply, as there is already an established working relationship between the parties.
Qualifying a new supplier, however, can generate anxiety and stress: There is a “fear of the unknown” that surrounds the entire activity. It’s common to have questions like:
- Will the supplier will be able to deliver on the quality of the product on a regular basis?
- Can the supplier maintain the price long term? Or is the deal a onetime “silver lining” to enable the supplier to get a foot in the door?
- Will the supplier maintain and follow the good manufacturing practices associated with the manufacturing that product?
- Above all, will the suppliers maintain data integrity?
The stressful environment created by fear of the unknown persists at least for the duration of the qualification process and often for another year or so, until a trust is established between the two parties. Trust between a supplier and customer is essential, but it takes a long time to build — and can get shattered in no time by a few mistakes or wrongdoing on either side. Should that happen, the regular flow of the supply chain gets disturbed, and chaos ensues.
Additionally, pressure to succeed is intense for the supplier as well as the sourcing professional. To ensure a smooth transition and avoid a loss of sales opportunities during the ramp time and transition, an inventory plan must be built. This isn’t easy and can create stress.
Negotiating with current suppliers isn’t always an option. But if it is, it’s often much easier to do so, reaping benefits while avoiding the unnecessary stress associated with qualifying a new source. Keeping supply chain continuity intact assures supply of the raw materials and revenue realization.
There are benefits of the negotiating with an incumbent supplier, and experienced sourcing professionals should be able to take advantage of them.
Rakhi Agarwal, MBA, C.P.M., CPIM, is head of strategic sourcing at AMRI in Albany, New York.