Shrinking Spend Year-on-Year

shrinkingspend.jpgContinual budget reductions are a pain to customers and contractors alike. Here’s a scenario that’s probably too familiar.

A customer has hired a facility service contractor. A fair market price has been negotiated in a competitive bid process. The first year goes well. Service delivered, everyone’s happy.

>>> 2nd Year

Customer must reduce total spend by 5%. Even though the facility hasn’t decreased, it’s actually added square footage, employees, or both.

Contractor wants to retain the contract. So they squeeze out the 5% reduction. Customer may or may not be aware how it was done. Probably through some combination of:

  • Higher productivity from contractor’s familiarity with site(s)
  • Reduced benefits and/or wages
  • Termination/transfer of higher wage contractor’s employees
  • Bringing non-contract projects into lower contract pricing
  • Skinnied down profit – if there was any cushion to begin with

>>> 3rd Year

Customer is given the same charter as the 2nd year, another 5% reduction. Again the facility’s service needs have increased in square footage, employees, or both.

But this reduction means the customer is seeking 10% lower spend this year than for the original contract 2 years earlier.

However, over these last 2 years both customer and contractor know:

  • Contractor’s labor wages should’ve increased, if they haven’t
  • Fuel costs rose significantly
  • CPI (Consumer Price Index) compounded more than 6%

Some Industries are Strapped

Being in a hard-pressed industry isn’t an embarrassment – it’s unfortunate.

Telecoms, airlines, some areas of high-tech, retail, and now mortgage banking, know the on-going horror of year-on-year reductions.

Their reductions are to survive, to keep the doors open.

Even if a company isn’t in a volatile industry, it can end up puckered as a lemon pickle because a strategic choice goes wrong.

Things happen.

5 Traditional Reduction Paths

For the customer and contractor in a strapped industry the only answer is…reductions. The question, as always, is “how?”

There are combinations of these, but here are the five major paths:

  1. Contractors open a vein & retain the contract at a loss – not healthy if it happens
  2. Contractors reduce price and secretly reduce service – integrity quick sand
  3. Contractors reduce price by lowering wages, benefits & margins – a slow death
  4. Contractors are allowed to revise specifications for reductions
  5. Customers put the contract out to bid – hoping there’s a lower cost contractor out there

4 Reasons Reductions May Be Adversarial

If reducing spend is a fact of life, why is it commonly adversarial? Why can’t contractors reduce price every year?

Although these don’t happen all the time, if there is any unspoken contention between customer and contractor it’s probably due to one or more of the following:

#1 CUSTOMERS FOCUS ONLY ON DOLLARS

Contractors may feel adversarial when customers only look at their dollar spend. They’re missing the value boat by not focusing on what they’re receiving for that spend.

This leads to unrealistic, wishful thinking that contractors’ pricing can go down indefinitely – without a scope reduction.

Yes, innovations occur. But not on a scale of 5-10% annually, year after year.

If customers take only the lowest priced contractor they’ll end up with less than expected, or scoped.

You may have heard of customer horror stories in reverse auctions where the winning price was lower than the direct labor cost – where union states FTEs, hours, wages and benefits. How could a contractor deliver?

#2 LEAN CONTRACTOR MARGINS

Contractors can feel adversarial after a competitive bid process, when their margins are pretty lean.

The typical reductions customers seek, 5-10% per year, are likely not there. Unless contractors work for no profit. And that’s not why they’re in business. Just ask them.

#3 PERCEIVED FAT CONTRACTOR MARGINS

Customers may feel adversarial towards contractors if they believe contractors’ margins are full, fat, and obese.

And there may be contractors with net profits over 20%. But they’re the exception. They’ll soon have market price margins when rebids occur.

However, the majority of contractor margins and pricing are at “market price”, which is why it’s called “market price”.

#4 WE SAID – YOU SAID

Customers and contractors can both feel adversarial when they look at the same situation and see it differently

For instance, contractors may believe customers disregard their need to make a profit. They might think: “After all our hard work, going those extra miles. That’s gratitude for you. All customers want to do is cut my margins”.

Customers also suffer from the same disease.

Customers may believe there’s a whale’s layer of profit that can be reduced drastically. They might think: “Hey, we’re in a tough situation here. Our ship could sink. My contractors can help by emptying some of that profit bucket.”

A 6th Path to Reductions

This 6th path isn’t really new. Top tier customers and contractors already use it. Maybe it’s time for the rest to take a look.

Here it is: Customers work with contractors to reduce costs. Together.

No surprise. But to really do it is unorthodox. It does require courage and commitment. On both sides, customer and contractor.

Take a look at how.

4 Steps on the 6th Path

1st STEP – FULLY DISCLOSING PRICE

In this case, a contractor wishing to revise scope shares their pricing structure with their customer. All direct and indirect costs – full disclosure. Similar to a Cost Plus, or Time & Material format. Download our Pricing Survey form. You can use the format to present pricing information.

Yes, this allows customers to question the amounts, factors, and percentages used.

But contractors know what makes up those numbers. And to get to point #2 it’s a necessary step.

Be ready though. Some customers may challenge those numbers after they’ve been explained to them. Before sharing, contractors must identify the negotiable and non-negotiable numbers. Then diplomatically work through customers’ negotiations.

Again it’s a savvy contractor that explains truthfully, openly, and then takes a stand on non-negotiable numbers.

However, contractors fully disclosing their pricing demonstrates good faith. And most customers will respect the trust given.

You didn’t think there’d be a simple answer, did you?

2nd STEP – REDUCE SPECIFICATIONS

Contractors want to do this with customers. But unless pricing is fully disclosed, customers won’t get the full benefit of the specification change.

It’s a judgment call whether the contractor discloses their pricing first, or the customer commits to working with the contractor before seeing their pricing structure.

However it’s arrived at, customers and contractors must focus on reducing specifications. Together.

The obvious first place to look are specifications that deliver little, or no value. They’re easily axed or revised as needed.

Incumbent contractors will have the greatest insight for how things are and might be.

With specifications reduced, direct operating costs go down, and lower pricing follows.

In full disclosure pricing, customers see how revised specifications impact contractors’ total pricing.

3rd STEP – ALIGN MARGINS TO MARKET

This step will take considerable time and effort. Customers may not have that luxury, so if customers and contractors are OK without it, skip it.

With that said, some customers will be required, or feel obligated, to check their contractors’ margins in the market.

Use a Pricing Survey to accomplish this margin check. This is not a bid, but a survey. For a “how-to” process see “Dear Customer…about your RFP”.

But customers and contractors can’t stop here. They must continue to the next step. Or else bad things happen.

4th STEP – SCALE DOWN EXPECTATIONS

With any reductions in specifications, service will change. And customers’ end-users will notice. So tell ’em first. Before the changes are implemented.

Together the customer and contractor can raise end-users’ awareness about the new service level. Market the reduction with a positive spin. Ways to announce include:

  • Meet & greets with donuts in lobbies
  • Posters, fliers or table tents in lunchrooms
  • Group email notification, asking for feedback

Lastly, Key Performance Indicators (KPIs) and performance-based contracts need to match the new specifications.

No one would want end-users rating customer satisfaction poorly because the specifications changed, but they didn’t know. Avoid the firestorm. Publicize the change.

How do you thrive in the shrinking spend year-on-year?

~~~~~~
Chris Arlen
President, Service Performance

Technorati: performance based contracts, key performance indicators, KPIs, contract reductions

Questions or Ideas?

Send us an email and we'll get back to you, asap.

Not readable? Change text. captcha txt