Linear performance pricing: A collaborative tool for focused supply cost reduction

Supplier networks and the buyer/supplier relationships that comprise them are becoming increasingly important to effective supply chain management. Trust, collaboration, and efficient sharing of information are critical for true win/win relationships to surface in an environment where there is constant pressure to reduce costs and still maintain reasonable profitability. The use of across-the-board cost reduction demands and simple market clout may not always be the most effective approach in the long run. This paper describes linear performance pricing (LPP), a tool developed for a major automobile OEM in an attempt to effectively and efficiently provide more focused supply cost reductions. LPP is a data-driven methodology relying on a series of regression analyses that McKinsey and Company [2006. Automotive and assembly glossary. http://autoassembly.mckinsey.com/html/resources/glossary/1.asp (accessed 15.01.06)] describes as a “measurement tool that establishes a relationship between the value provided by a given part (performance) and its price.” We maintain that LPP facilitates a collaborative effort on the part of both the buyer and supplier and has the potential for leveraging the increased visibility of the buyer within the supplier network with respect to tier one or tier two suppliers. It helps by focusing cost reduction efforts of the tier one suppliers and provides lateral market visibility they may not have otherwise. Although widely used throughout the automotive industry in the US and Europe, little discussion of LPP is found in the literature. To promote a better understanding of LPP, we present a detailed example and discuss the managerial implications of the approach.