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Even if your new venture provides a service to your patient-customers (instead of a good/product), you'll still need supplies for your operations. Negotiating a price for those supplies would be far easier if you knew what the cost of goods sold (COGS) for your supplier. One way of determining an estimate of your supplier's cost is by dissecting price fluctuations. Let's deconstruct one here.
Your supplier has traditionally invoiced $1375 per month for supplies you need to run your venture.
S/he wants to raise the price to $1415. You've decided to look elsewhere for supplies and your end your business with him/her.
Four (4) months later, you learn that your former supplier has lowered the cost to $1200 per month.
If you decide to return to your former supplier, you'll make some careful assumptions to uncover your supplier's cost of goods sold and negotiate an even better price.
Using price fluctuations by your supplier's can clue you into his/her COGS. COGS is what your supplier pays to manufacture the product that you need for your venture. Together with the price of the good, COGS will give you the bookends of the gross profit margin.
It is safe to assume your supplier was making a profit π at P = $1375. S/he raises the price by $40 to $1415, presumably because his/her COGS increased by the same amount.
The π equations
Let's start with the first π equation before the price increase:
π (yearly_old)= ($1375 - cost)*12
Since the price increased by $40 ($1415 - 1375), the new equation is:
π (yearly_new) = ($1415 - (cost +40))*12
Four (4) months later, you learn that the price of the same good is $1200. That dramatic drop in price would only happen if the supplier couldn't find a buyer at $1415 - 4 months of $0 revenue.
π (in the intervening period) = ($0)*4 months - (cost + 40)
Lastly, the new price is $1200 - we know that at P = $1200, the supplier will make a positive π.
π (yearly_revised) = ($1200)*8 - (cost + 40)*12
Where did 8 come from? Since the supplier returned to you 4 months later, s/he has only 8 months remaining in the year to generate revenue and make a profit.
Cost when π = 0
Now that we have our new profit equation, we can set the π = 0 and find the maximum cost that the supplier experiences.
π (yearly_revised) = ($1200)*8 - (cost + 40)*12
set π (yearly_revised) = 0
0 = ($1200)*8 - (cost + 40)*12
cost = $760
Remember that the new cost is $40 more than what it was when you were a customer of this supplier → $800.
Profit margins
Now that we have an estimate of the COGS, we have the two bookends for the supplier's gross profit margin.
Having insight into your supplier's gross profit margin is key if you want a stronger negotiating position. It also gives you actionable information to find a new supplier or, even more daring, vertically integrate your new venture and manufacture the good yourself.
Hope this helps. Please send me your comments through one of the social media channels below.
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