A big customer wants a 3% price reduction every year. How do I respond?

Calculate the whole agreement, not just the first reduction

Assume a repeat 6061 valve-body job sells 1,000 pieces per year. Its current unit price is $100, with $80 cost including allocated setup, stock, machining, deburring, inspection and finish. The buyer asks for 3% off the previous year's price at each anniversary. Hold cost and volume constant first to isolate the requested concession; no inflation or productivity saving is assumed in this table.

After the first reduction, annual profit falls from $20,000 to $17,000. By the third reduction it is $11,267.30, using unrounded compounded prices. Profit is down 43.66% from the starting year. This is different from taking three percentage points off the original price: each reduction multiplies the prior price by 0.97. Specify the calculation and rounding convention in the agreement.

Name the operation that will pay for the concession

Break the $80 cost into $20 material, $40 machine conversion, $8 inspection and $12 outside processing. Assume conversion is 24 minutes at a burdened $100 per hour. To preserve the original 20% job margin at a $97 selling price, cost must fall to $77.60: a $2.40 reduction. At the stated rate, that means removing 1.44 minutes from the conversion time if every saved minute actually removes or productively replaces cost.

Preserving the original $20 profit dollars is a different target: cost must fall to $77, requiring $3 of savings, or 1.8 minutes. A shorter cycle does not automatically lower fixed expenses; verify whether the recovered capacity can be sold, reduces overtime or otherwise changes the economics. Separate repeatable production savings from a one-time setup improvement that disappears when releases become smaller.

Suppose dedicated workholding costs $3,000 and saves $3 of genuine cost per piece. At 1,000 pieces, its entire first-year saving repays the workholding before any price reduction. Giving the buyer the full saving immediately leaves the shop funding the improvement. Agree who pays for the workholding and when verified savings begin to flow through to price.

Trade a promise for something you can schedule

Ask for a firm minimum purchase quantity, economic release sizes, a frozen drawing revision and a defined forecast window. Identify what happens if the buyer reduces releases, changes the material specification, adds inspection or moves the finish to a more expensive supplier. These are proposed commercial protections, not terms that automatically exist because the deal is called a long-term agreement.

Keep outside material and processing adjustments separate from productivity sharing. A genuine machining improvement can coexist with higher purchased costs. Record the baseline scope and compare like quantities and delivery conditions; otherwise a buyer can obtain a price reduction while also transferring extra inventory and schedule cost to the shop.

Counter with a testable proposal

Suggested response: ‘We can review annual reductions against jointly verified savings on this valve body. Current pricing assumes 1,000 pieces annually in releases of 250, drawing revision D and the present inspection plan. The proposed workholding requires a $3,000 investment. We propose reviewing pricing after that investment is recovered, sharing demonstrated recurring savings, and repricing changes to scope or purchase commitment separately.’

Before signing, run the entire term with the buyer's lowest committed volume and your realistic release sizes. Show the owner both margin percentage and profit dollars. If no credible saving or commitment funds the concession, retain the current price or narrow the agreement instead of treating future productivity as money already earned.

• Price blanket quantities and release sizes
• Respond to a lower-price request