The Magic of Margin 3 – Create Price Competition

The ability to create price competition in a purchasing situation is contingent upon the ability to make a market. Market-making is practiced in all industries globally, and requires at least these two conditions…price variation within the vendor offerings and the ability to commoditize the offerings.

Remember these three sentences?
“Give me a better price!”
“You’re going to have to do better than that.”
“If we don’t get to a reasonable compromise, we will be forced to switch.”

These and others are utilized as transactional negotiation tactics by purchasing agents, quite effectively. We support the improvement of the negotiating process, to attain higher value transactions between buyers and sellers. Consequently, we have at times educated supply chain managers on what vendor tactics are, and how to counteract them. By pointing out the flaws in traditional negotiation, we have been able to help provider organizations better achieve their mission, and the required efficiency and margin to sustain it.

The ability to create price competition in a purchasing situation is contingent upon the ability to make a market. Market making is done everywhere, but in healthcare, market making requires two things:

1. Price variation among, and within vendor offerings
2. The ability to substitute one vendor offering for another, i.e. commoditization

Price Variation

Price variation between vendors is rampant, and not just between branded and generic products. Different branded products, even from the same company, can occupy different price points for the same core functionality. Price variation makes sense as a market segmentation strategy, and as a tool to induce purchasing behavior, e.g., end of period pushes and offering discounts and incentives. Supply chain managers rely on price variation to play one solution against another and obtain a discount on the targeted solution. This strategy is incredibly effective, even without significant practice and planned execution; vendors seem deal prone in almost every category. Furthermore, consulting companies have created price surveys and are recording offered prices as benchmarks useful for contract renegotiation.

Vendor Substitution

The ability to substitute one vendor’s product for another’s is also very important for market making. Ideally, there are multiple perfect substitutes, where options from multiple vendors are symmetrical. In other cases, where there are not perfect substitutes, the buyer needs to get the users of a product or service to agree that any vendor’s offer is acceptable. To make a market in this scenario, all that is needed is the participation of a few vendors that have passed regulatory clearance, to pursue the business. Rivalry will be increased, and prices will be reduced.
The primary tool used by purchasers in gaining user agreement on vendor substitution, is the value analysis process. (We have discussed value analysis extensively in another blog series.) In brief, value analysis is a formalized process that allows purchasers to benefit from users’ input. During the subsequent evaluations of various options, users begin to accept the idea that their preferences are being heard, and also that multiple options could satisfy their needs. Once this threshold has been reached, the market is made.

The Flip-side

Just because multiple devices or drugs have been cleared by regulators for the diagnosis or treatment of a specific condition, doesn’t mean that each option is equal. There are extremely few categories of products that are perfect substitutes. The best example of a perfect substitute is money from one source or another. Both sources can bring money, and money is a perfect substitute for itself. However, consider an example. If money comes to a customer from a donor who has a bad reputation, versus a donor that has a good reputation, is one source of money more desirable than the other? The answer is yes. The money from a reputable source is considered more valuable than a greater amount of money from a disreputable source. Therefore, even in the purest commodity, there can be an imperfect substitute, and unacceptable trade-offs would be required.

In the next installment, we will extend the concept of substitutes to differentiation tactics, and pricing power in competitive situations.

First installment – The Magic of Margin in Deal Making.

Second installment- The Magic of Margin – Generate Margin

By:
Gunter F. Wessels, Ph.D., M.B.A.
Total Innovation Group Inc., Practice Principal, Partner
and
Sam O’Rear, MA, BS
Total Innovation Group Inc., Senior Partner

Total Innovation Group
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