Are suppliers entitled to windfall profits just because their costs have increased?

(Part I: Price Productivity Micro Analysis)

© Frank Haluch 2011-2025


When a supplier announces a price increase, driven by an increase in cost, does the price increase also create a Windfall Profit? This article addresses the 1-for-1 price increases we are seeing today. That is “Our cost increased by 10%, therefore, our price increases by 10%.”


To find the answer to the Windfall Profit question, use the following sequence to analyze a supplier’s price increase request.


Suppose a supplier’s Price per Unit is $12.50 and total Variable Cost (per unit) is $10.00.  Therefore, the Contribution Margin is $2.50. (TABLE 1)

The supplier is claiming a 10% increase in costs and is “passing” the cost through to its customers with 10% increase in price.

Using the supplier’s Proposed price information, determine the resulting Contribution Margin. (TABLE 2)

Note the price increase would result in a $0.25 (or 10%) supplier Windfall Profit!

Finally, counter the proposed price increase by finding the Price that maintains the Current Contribution Margin.  (TABLE 3)

This straightforward analysis assumes access to a suppliers’ Variable Cost and Contribution Margin.  Having access to this information can be obtained from the supplier or by accessing USA Government economic statistics. 

Typically, the supplier will not give out Variable Cost or Contribution Margin data points! 

To quickly react to a supplier price increase, the procurement professional has to be familiar with the above analysis and have access to reasonably accurate Variable Cost and Contribution Margin data.

SourcingApps contains a database of North American Industry Classification System codes (NAICS) and USA government statistics that can approximate variable costs sufficiently to begin discussing price increases that do not contain Windfall Profits. 

Using SourcingApps, the supplier price increase information and the Buyer’s knowledge of NAICS; the above analysis can be performed in as little as 10 minutes!  (How many supplier price increases have been accepted in your company over the last two years without a challenge?  Can this excessive spend be brought back?)

The next article will take this analysis one step deeper and show that a price increase based on “direct material” cost increases of 10% and passed through as a 10% price increase produces a 43.79% increase in Contribution Margin.

Are suppliers entitled to windfall profits just because their variable costs have increased?

(Part II: Price Productivity Macro Analysis)


In Part I, Price Productivity Macro Analysis showed that an inflationary driven price increase potentially could contain a Windfall Profit for the supplier.  The example showed the proposed price increase was reduced by 20%.  Using the same example, this post digs deeper and demonstrates how a Price Productivity Micro Analysis produces 63.4% reduction in a proposed price increase.  Part I showed how a 10% price increase was countered with an 8% increase.  This post shows how the same 10% price increase is countered with a much lower 3.66% increase.

The analysis starts with the notification from the supplier stating: “Our costs increased by 10%, therefore, our price needs to increase by 10%.”

Step 1: With the Unit Price and estimated Variable Costs, the Contribution Margin is calculated using the simple formula:

Unit Price – Variable Costs = Contribution Margin

In our example: $12.50 - $10.00 = $2.50 (Highlighted in Orange below.)

Step 2: Variable Costs are made up of Direct Material, Direct Labor, and Variable Manufacturing Overhead.  To determine the impact of increased cost, the procurement professional inquires “What cost changed and by how much?”  For this example, the supplier indicates their variable costs have increased by 10%.

Step 3: Determine the percentage breakdown of Direct Material, Direct Labor and Variable Manufacturing Overhead that make up Variable Cost.  Using the supplier’s NAICS code, the most recent US Census Bureau Annual Survey of Manufactures and Quarterly Financial Report we can breakdown the percentages as 58.15%, 8.22% and 33.65% respectively.  (Highlighted in Yellow below.)

Step 4: Calculate a 10% price increase for each of the Variable Costs.  (Highlighted in Red below.)

Step 5: Find the price increase percent that maintains the Contribution Margin at $2.50.  As shown in the chart below in green highlight, a price increase of 3.66% will cover the 10% increase in Variable Costs while avoiding a Windfall Profit for the supplier.  The buyer counters the proposed price increase with an evidence-based $12.9576 offer and the negotiation begins.

A procurement professional can perform the above steps in as little as 10 minutes.  How many price increases were accepted over the last two years without an evidence-based challenge?

This example used the Price Productivity Micro worksheet found in the Cost Analysis section of Souring Apps (currently not available to new subscribers).  Once the NAICS was identified, the Price Productivity Calculator extracted information from the Sourcing Apps data base to calculated Step 3.  The NAICS used in this example was 31-33 Manufacturing.  The data base contains 648 NAICS codes and 13 years of US Census data.

Sourcing is for Convergent Thinkers!