What’s the use of open book accounting in supplier negotiation?

4 March 2013
Stephen Ashcroft - January 2013Some of the most difficult negotiations with suppliers involve open book accounting. The concept is now widely known, but ensuring suppliers will be receptive to making open book accounting a contractual reality is another matter. Historically, a supplier’s pricing decisions may have been steeped in mystery and the detail of a price confidential. It is logical for a buyer to want to probe the cost drivers, including labour, materials, overheads, profit and the contingency provision. A recommended approach in negotiation is to persuade the supplier that we – the buyers - want them to make a profit. The profit must give due consideration to risks inherent in the procurement and the nature of any capital investment. The level of profit is a negotiable facet of pricing. The business reason is we want a supplier to remain in business in the long term. We accept there is, on occasion, sound reasoning for a supplier to provide for contingency, but it should not be a hidden within the price. Contingency sums should be isolated from the price and a contractual agreement reached about how the contingency can be accessed by the supplier, with the buyer’s knowledge and approval. There is a link between contingency management and the risk modelling on a specific procurement. Overhead recovery is a very problematic area. A well-constructed cost model should expose overheads of a fixed and variable nature. It is not surprising to find accountants playing their cards in a negotiation. We have heard responses such as: “We recover overheads at 183 per cent of direct labour”. What exactly does this mean? In one service contract negotiation, it was found the hourly rate for maintenance engineers included mobile phone charges, mortgages, health insurance, average travel and hotel costs and training. If these are also included in the overhead recovery, double charging is taking place. The logic behind exposing labour and material costs is very important. The supplier must recover genuine costs. When negotiating open book accounting, it is valuable to engage with the supplier’s commercial, legal, finance and operational staff. An often-encountered aggressive question from suppliers is: “What do you want to use this open book accounting for?” Be ready to respond with a structured response, based on excellent business logic. One final point. If the supplier agrees to open book accounting, be sure there is someone in the organisation who has the time and ability to conduct the review/audit. ☛ Stephen Ashcroft is a procurement coach at Brian Farrington. He welcomes comments and LinkedIn connections 
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