Procurement in Industrial
Management – BPT 3133
Price and Cost Analysis
CHAPTER OUTLINE
Introduction
Price Determination
Objective, Process and Factors
Price Analysis
Variables that influence an item’s price
Cost Analysis
Techniques : cost-based, break-even
Obtain Prices
INTRODUCTION
Price = Monetary terms
Price often depends on circumstances:
“ you pay more to fly when you want to fly ”
Some consumers are very interested in
getting a low price and pay close attention to
price
There is a tendency to link quality with price
Consumers are often prepared to pay more if
they expect to get excellent service
Adding value doesn’t mean dropping price
PRICE DETERMINATION
In pricing, an organization first must decide
on its pricing objective / goal.
The next step is to set the base price for a
product.
The final step involves designing pricing
strategies that are compatible with the rest
of the marketing mix.
Many strategic questions must be answered:
Will our company compete on the basis of price or other
factors?
What kind of discount schedule (if any) should be adopted?
Pricing Objectives
Management should decide on its pricing
objective before determining the price itself.
Profit-oriented
Achieve a target return — pricing product to achieve a
specified percentage return on sales or investment.
Maximize profits — followed by the most companies.
Sales oriented
Increase sales volume.
Maintain or increase market share.
Status quo
Stabilize prices.
Meet competition.
The Process: An Illustration
SELECT PRICING OBJECTIVE
SELECT METHOD OF DETERMINING THE BASE PRICE
Price based on
both demand
and costs
Cost-plus
pricing
Price set in
relation to
market alone
DESIGN APPROPRIATE STRATEGIES
• Price vs. nonprice
competition
• Skimming vs.
penetration
• Discounts and
allowances
• Freight payments
• One price vs.
flexible price
• Psychological
pricing
• Leader pricing
• Everyday low vs.
high-low pricing
• Resale price
maintenance
Factors Affecting Price
Decisions
Internal Factors
1. Marketing
Objectives
2. Marketing Mix
Strategy
3. Product Cost
4. Organizational
considerations
Pricing
Decisions
External Factors
1. Nature of the
market & demand
2. Competition
3. Environmental
factors (economy,
resellers,
government)
Marketing Objectives
Survival
Low Prices to Cover Variable Costs and
Some Fixed Costs to Stay in Business.
Marketing
Objectives
Current Profit Maximization
Choose the Price that Produces the
Maximum Current Profit, Etc.
Market Share Leadership
Low as Possible Prices to Become
the Market Share Leader.
Product Quality Leadership
High Prices to Cover Higher
Performance Quality and R & D.
Marketing Mix
Customers seek products that give them the best
value in terms of benefits received for the price paid
Product Design
Nonprice
Positions
Price
Promotion
Distribution
Pricing Strategies : Product Mix
Optional-Product
Pricing optional or
accessory products
sold with the main
product. i.e camera bag.
Captive-Product
Pricing products that
must be used with the
main product. i.e. film.
Pricing Strategies : Product Mix
By-Product
Pricing low-value
by-products to
get rid of them
and make the
main product’s
price more
competitive.
Eg.: sawdust
ProductBundling
Combining
several
products and
offering the
bundle at a
reduced price.
Eg. : theater
season tickets
Pricing Strategies
F.O.B. Point-of-Production pricing: Price quoted at
factory- buyer pays transportation.
Uniform delivered pricing: Same delivered price
quoted to all; works if transportation costs small.
Zone-delivered pricing: Set same price within
several zones
Freight-absorption pricing: Seller absorbs
transport cost to penetrate market.
Firms may adopt a one-price strategy or charge
different prices to different customers
Flexible pricing strategies: shoppers may pay
different prices if they buy the same quantity
Pricing Strategies :Psychological
Considers the psychology
of prices and not simply
the economics.
Customers use price less
when they can judge
quality of a product.
Price
becomes
an
important quality signal
when customers can’t
judge quality; price is
used to say something
about a product.
PRICE ANALYSIS
Determine if the price offered is appropriate
without examining the specific cost and profit
calculations (cost details)
Price been compared with:
1. Other price offers
2. Prices previously paid
3. Going rate if applicable
4. Prices charged for alternatives which could
substitute for what is offered
Any prices well below the norm should be
examined with care
Major Considerations in
Setting Price
PRICE ANALYSIS
Variety of variables that directly and
indirectly influence an item’s price
Market structure
Price mechanism & competition conditions
Economic conditions
Pricing strategy of the seller
Detail analysis of internal cost structures
Market-Driven Pricing Models
Using the producer price index to manage
price
Market Structure
Price mechanism
Competition conditions
Price
Supply
Supplier’s
Market
Conditions
Monopoly
One supplier
Duopoly
Two supplier
Monopolistic
Many suppliers,
Differentiated
product
Perfect
Many suppliers,
Same product
Monopsony
One buyer,
Many supplier
Buyer’s
Market
Demand
Market Price
Competition
Volume or
Quantity
Market Driven Pricing Models
1. Price volume models
Supplier analyzes the market to find the
combination of price per unit and quantity of
sales that maximizes its profit on the assumption
that :
Lower price will result more units being sold
Greater volume will spread the indirect cost over more
units
2. Market Share Model
Based on assumption that long-run profitability
depends on the market share obtained by the
supplier (penetration pricing)
Market Share Model
Use Under These
Conditions:
Market Must be Highly
Price-Sensitive so a Low
Price Produces More
Market Growth.
Production/ Distribution
Costs Must Fall as Sales
Volume Increases.
Must Keep Out
Competition & Maintain
Its Low Price Position or
Benefits May Only be
Temporary.
Market Penetration
 Setting a Low Price for a
New Product in Order to
“Penetrate” the Market
Quickly and Deeply.
 Attract a Large Number
of Buyers and Win a
Larger Market Share.
Market Driven Pricing Models
3. Market-Skimming Model
Prices are set to achieve a high profit on each
unit by selling to supply managers who are willing
to pay for products or services of perceived
higher value
4. Promotional Pricing Model
Pricing for individual products that is set to
enhance the sales of the overall product line
5. Revenue Pricing Model
Obtaining sufficient current revenue to pay for
operating cost – during market slowdowns
Market-Skimming Model
Market Skimming
 Setting a High Price
for a New Product to
“Skim” Maximum
Revenues from the
Target Market.
 Results in Fewer, But
More Profitable Sales.
Use Under These
Conditions:
Product’s Quality and
Image Must Support Its
Higher Price.
Costs Can’t be so High
that They Cancel the
Advantage of Charging
More.
Competitors Shouldn’t
be Able to Enter Market
Easily and Undercut the
High Price.
Promotional Pricing Model
Involves setting price
steps between various
products in a product
line based on:
Cost differences
between products
Customer evaluations of
different features
Competitors’ prices.
Market Driven Pricing Models
6. Competition Pricing Model
Pricing actions or reactions to pricing proposals
offered or expected to be offered by the
supplier’s competitors
Determine the highest price that can be offered
that will still be lower than the price offered by
competitors
7. Cash Discounts
Offer incentives to pay invoices promptly
Payment with certain period of time
Competition Pricing Model
Setting Prices
Going-Rate
Company Sets Prices Based on What
Competitors Are Charging.
?
?
Sealed-Bid
Company Sets Prices Based on
What They Think Competitors
Will Charge.
Cash Discount
Adjusting Basic Price to Reward Customers
For Certain Responses
Cash Discount
Seasonal Discount
Quantity Discount
Trade-In Allowance
Functional Discount
Promotional Allowance
COST ANALYSIS
It looks at one aspect only : how quoted
price relates to cost of production
Useful technique for keeping prices
realistic in the absence of effective
competition
Concentrates attention on what costs
ought to be incurred before the work is
done
Cost Analysis Techniques
Cost-based pricing models
Cost-markup pricing model
Margin pricing model
Rate-of-Return pricing model
Product specification
Estimate supplier costs using reverse price
analysis
Break-even analysis
Cost-Based Pricing Model
Certainty About
Costs
Price Competition
is Minimized
Much Fairer to
Buyers & Sellers
Unexpected
Situational
Factors
Pricing is
Simplified
Cost-Plus
Pricing is an
Approach
That Adds a
Standard
Markup
to the
Attitudes
Costofof the
Product.
Others
Simplest
Pricing
Method
Ignores
Current
Demand &
Competition
Cost-Markup Pricing Model
Mark-up
= 20%
= RM18
Cost
and
profit
= 100%
= RM72
MANUFAC
TURER
Mfg
selling
price
= 100%
= RM72
Cost
= 80%
= RM72
WHOLE
SALER
Mark-up
= 40%
= RM60
W/s
Cost
selling
= 60%
price
= RM90
= 100%
= RM90
RETAILER
Retailer’s
selling
price
= 100%
= RM150
Cost to
Consumer
= RM150
CONSUMER
Margin Pricing Model
Unit Selling Price = (Cost) + (Margin Rate)(Cost)
Example :
Cost - RM 50
Margin Rate – 25%
Unit Selling Price
= RM 50 + (0.25)(50)
= RM 50 + RM 12.50
= RM 62.50
Cost – 100%
MR 25%
Unit Selling Price
Rate-of-Return Pricing Model
Unit Selling Price = Unit Cost + Unit Profit
Example :
Supplier wanted a 20% return on its investment of
RM 300,000 (which might include R&D, equipment, etc.)
to make 4000 parts with a total cost of RM50 each.
Unit Selling Price
= RM 50 + (0.20)(RM 300,000)
4000
= RM 50 + RM 15
= RM 65.00
Reverse Price Analysis
Also known as “Should Cost”
analysis
Evaluating whether a supplier’s
price
is
justifiable
and
reasonable
Hypothetical Price
RM 20
Profit (15%)
RM 3
Subtotal
RM 17
Direct Material
RM 4
Subtotal
RM 13
Direct Labor
RM 3
Mfg. Burden
RM 10
Purchaser should attempt
to initiate discussion in the
following areas to discover
opportunities
for
cost
reductions :
1. Plant Utilization
2. Process Capability
3. Learning-Curve Effect
4. The Supplier
Workforce
5. Management Capability
6. Purchasing Efficiency
Break-Even Analysis
To identify the point
where revenue equals
cost & the expected
profit/loss at different
production volumes.
Strategic planning tool
– to estimate expected
profit or loss over a
range of sales
Break-Even :
TR = TC
= VC + FC
Break-Even Analysis
Fixed costs: These are costs that are the same regardless
of how many items you sell. All start-up costs, such as rent,
insurance and computers are considered fixed costs since
you have to make these outlays before you sell your first
item.
Variable costs: These are recurring costs that you absorb
with each unit you sell. For example, if you were operating a
greeting card store where you had to buy greeting cards
from a stationary company for $1 each, then that dollar
represents a variable cost. As your business and sales grow,
you can begin appropriating labor and other items as variable
costs if it makes sense for your industry.
Break-Even Analysis
Example :
Purchase or Sale Price - RM 10
Variable Cost per Unit – RM 6
Fixed Cost – RM 30,000
Break-Even Unit :
TR
= VC + FC
RM10 (x) = RM6 (x) + RM 30,000
RM4 X
= RM 30,000
X
= 7,500 units
Net Income / Loss
= TR – (VC + FC)
How Buyers Obtain Prices
A price list is made available
Prices are quoted on request
Potential suppliers submit sealed bids
or tenders
Purchase are made at auction or by
reverse auction
By negotiation