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Procurement in Industrial Management – BPT 3133 Price and Cost Analysis

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									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                Cost-plus             Price set in
   both demand                   pricing               relation to
     and costs                                        market alone



               DESIGN APPROPRIATE STRATEGIES
 • Price vs. nonprice        • Freight payments    • Leader pricing
   competition               • One price vs.       • Everyday low vs.
 • Skimming vs.                flexible price        high-low pricing
   penetration               • Psychological       • Resale price
 • Discounts and               pricing               maintenance
   allowances
Factors Affecting Price
Decisions


Internal Factors                External Factors
1. Marketing                    1. Nature of the
   Objectives                       market & demand
2. Marketing Mix     Pricing    2. Competition
   Strategy         Decisions   3. Environmental
3. Product Cost                     factors (economy,
4. Organizational                   resellers,
   considerations                   government)
Marketing Objectives
                             Survival
              Low Prices to Cover Variable Costs and
              Some Fixed Costs to Stay in Business.

                Current Profit Maximization
               Choose the Price that Produces the
 Marketing       Maximum Current Profit, Etc.

 Objectives       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           Distribution




                       Promotion
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            Product-
      Pricing low-value   Bundling
      by-products to        Combining
      get rid of them       several
      and make the          products and
      main product’s        offering the
      price more            bundle at a
      competitive.          reduced price.
      Eg.: sawdust          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.
   Valu                Price    becomes      an
          e $2         important quality signal
                2.00
  Sale
          $14          when customers can’t
             .99
                       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
                                                  Competition    Conditions
                                                  Monopoly       One supplier
                                Supply            Duopoly        Two supplier
                                                  Monopolistic   Many suppliers,
    Supplier’s              Buyer’s                              Differentiated
     Market                 Market                               product
                                                  Perfect        Many suppliers,
                                                                 Same product
                                 Demand
                                                  Monopsony      One buyer,
                                      Volume or                  Many supplier
             Market Price             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 Penetration
  Market Must be Highly
  Price-Sensitive so a Low    Ø Setting a Low Price for a
  Price Produces More           New Product in Order to
  Market Growth.                “Penetrate” the Market
  Production/ Distribution      Quickly and Deeply.
  Costs Must Fall as Sales
  Volume Increases.           Ø Attract a Large Number
  Must Keep Out                 of Buyers and Win a
  Competition & Maintain        Larger Market Share.
  Its Low Price Position or
  Benefits May Only be
  Temporary.
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
                           Use Under These
  Market Skimming          Conditions:
                             Product’s Quality and
Ø Setting a High Price       Image Must Support Its
  for a New Product to       Higher Price.
  “Skim” Maximum             Costs Can’t be so High
  Revenues from the          that They Cancel the
  Target Market.             Advantage of Charging
                             More.
Ø Results in Fewer, But      Competitors Shouldn’t
  More Profitable Sales.     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
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                               Simplest
                                             Pricing
                            Cost-Plus
                             Factors
                                            Method
             Pricing is    Pricing is an
                           Situational
             Simplified
                            Approach
                           Unexpected
                           That Adds a
                            Standard
  Price Competition                          Ignores
     is Minimized
                          Markup to the
                            Attitudes
                           Costof the
                                 of          Current
                             Product.       Demand &
                              Others       Competition
      Much Fairer to
     Buyers & Sellers
Cost-Markup Pricing Model
                                      Mark-up
                    Mark-up           = 40%      Re-
                                      = RM60                Cost to
                     = 20%                       tailer’s
                                                 selling
                                                            Consumer
                     = RM18
                                                 price      = RM150
                              W/s     Cost       = 100%
                              selling  = 60%     = RM150
                              price
                    Cost               = RM90
          Mfg                 = 100%
 Cost     selling
                    = 80%     = RM90
 and      price     = RM72
 profit   = 100%
 = 100%   = RM72
 = RM72

MANUFAC              WHOLE
 TURER               SALER            RETAILER               CONSUMER
Margin Pricing Model

 Unit Selling Price = (Cost) + (Margin Rate)(Cost)

 Example :
 Cost - RM 50
 Margin Rate – 25%

 Unit Selling Price           Cost – 100%      MR -
 = RM 50 + (0.25)(50)                          25%
 = RM 50 + RM 12.50
 = RM 62.50                     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
                                 Purchaser should attempt
                               Evaluating whether a supplier’s
                                 to initiate discussion in the
                                 following justifiable and
                               price is areas to discover
                               reasonable
                                 opportunities for cost
                                 reductions :
  Hypothetical Price   RM 20     1. Plant Utilization
  Profit (15%)         RM 3      2. Process Capability
  Subtotal             RM 17     3. Learning-Curve Effect
                                 4. The Supplier
  Direct Material      RM 4          Workforce
  Subtotal             RM 13     5. Management Capability
                                 6. Purchasing Efficiency
  Direct Labor         RM 3
  Mfg. Burden          RM 10
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

								
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