Purchasing and Supply Chain Management
Price-Cost Management
Price/Cost Management
„
„
Price analysis examines price proposals
without examining elements of cost and
profit
Cost analysis addresses actual or future
costs
Goals of Price/Cost Management
„
„
„
„
Develop accurate price/cost information
to enhance negotiating effectiveness
Drive continuous price/cost improvement
Effectively beat out the competition
Determine type of supplier relationship
Approaches
Price/Cost Management Approaches
Market Based Pricing
Cost Based Pricing
Non-collaborative
Collaborative
Approaches
„
Market-Based Pricing
„
„
Cost-Based Pricing
„
„
The price the buyer pays is not linked to the
supplier's cost structure
The price the buyer pays is directly linked to
the supplier's cost structure
Hybrid
„
Some elements of cost may be known by the
buyer
Market-based Pricing
Supply
PRICE
Dollars
„
Supplier's
Market
Buyer's
Market
„
Demand
VOLUME
Based on supply and
demand
Suppliers and buyers
determine the price
according to what either
suppliers are asking or
buyers will offer
Market-based Pricing Approaches
„
Market testing
„
„
Quantity discounts
„
„
„
Volume consideration linked to price
Longer term agreements linked to price
Price change control
„
„
Initial price determined by competitive bid, and
on-going negotiations thereafter
Ceilings established on future price changes
Reverse price analysis
Reverse Price Analysis
Hypothetical Price
Profit / SG&A Allowance (15%) Subtotal
Direct Material
Subtotal
Direct Labor
Manufacturing Burden
$20
$ 3
$ 17
4
$ 13
3
$ 10
X TOTAL VOLUME
= TOTAL FIXED COST
(Will vary as volume changes)
Cost-based Pricing - Non-collaborative
„
„
„
Market-testing - initial contact through bid
and on-going negotiations
Target pricing - established ceiling cost to
achieve a competitive position in the market
for the finished product
Supplier uses target price as a basis for
accepting the order
Cost-based Pricing - Collaborative
„
„
„
„
„
Cost identified - margin or ROI negotiations
Identification of cost drivers
Targeted goals
Establishment of value added / non-value
added costs
Continuous cost improvement
(collaborative)
Supplier Pricing Issues
„
Pricing objectives
„
„
„
„
Long-term versus short-term
Price leader versus follower
Establish entry barriers
Pricing Strategy
„
„
Cost based pricing (cost + fixed markup)
Market based pricing (penetration, skimming,
floor pricing)
Pricing Strategies
„
Demand (skimming) pricing
„
„
„
„
Introduction and growth of life cycle
“What the market will bear”
Works under conditions of no competition
Cost-plus (penetration) pricing
„
„
„
Maturation stage of life cycle
Minimum acceptable price
Appeals to a mass market with objective of
sales increase
Pricing Strategies
„
Survival pricing
„
„
Market share pricing
„
„
Forgoes sales and profits - puts society first
Rule-of-Thumb (myopic) pricing
„
„
Used to take market share from competitors
Social responsibility pricing
„
„
Price remaining capacity at marginal cost
DM + DL + 40%
Buy-in (foot in the door, low ball) pricing
„
Cover VC only
Pricing Variables
„
External
„
„
„
„
Nature of the product (life cycle)
Seller’s market characteristics
Buyer’s control variables
Internal
„
„
„
Seller’s internal characteristics
Management orientation
Accounting and costing methods
Measures of Price Management Effectiveness
„
Types of measures include:
„
„
„
„
Percent improvement of price paid over
inflation
Percent improvement of price paid vs. prior
year
Target prices achieved
Ratio of actual price change improvement to
comparable market index change
Price Change to Market Index Change
„
„
„
„
Most appropriate for market-based products where
pricing is function of supply and demand
Price change measure for a purchase family which
compares difference in an index to price paid for a
purchase family
Useful to ensure an external benchmarking
perspective for product / service family category
Critical issue: “target” for how much “better than
market” in increasing and decreasing market
Market Index Measurement Approach
„
„
Market based index: 3/31/98 = 125
Market based index: 6/30/98 = 137.5
„
„
„
Company price index: 3/31/98 = 150
Company price index: 6/30/98 = 160
„
„
Index change rate = (137.5 - 125) / 125 =+10%
Company index rate = (160-150) / 150 = +6.67%
This indicates “better than market”
performance by 3.33% for the quarter
Issues to Consider: Price Index
„
„
„
„
„
How did the procurement situation affect the price
fairness and reasonableness at the time?
How have conditions changed? (e.g. delivery
requirements)
What is the effect on price of changes in the
quantity of a material or service purchased?
Was the procurement situation a sole source or
competitive?
Historic prices might involve onetime engineering,
tooling, and start-up costs
Issues to Consider: Price Index
„
„
„
„
„
„
Does not consider total cost performance
May not be appropriate for critical items with high
value-added by supplier
Need to track history of a particular index and
also check validity periodically
Does not benchmark competitor’s pricing
agreements
How are index comparisons driving procurement
strategies?
Forecasts/indices MUST be from impartial third
party