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Procurement in Industrial Management – BPT 3133
Price and Cost Analysis
CHAPTER OUTLINEIntroductionPrice Determination
Objective, Process and Factors
Price AnalysisVariables that influence an item’s price
Cost AnalysisTechniques : cost-based, break-even
Obtain Prices
INTRODUCTIONPrice = Monetary termsPrice 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 priceThere is a tendency to link quality with priceConsumers are often prepared to pay more if they expect to get excellent serviceAdding value doesn’t mean dropping price
PRICE DETERMINATIONIn 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 ObjectivesManagement should decide on its pricing objective before determining the price itself.
Profit-orientedAchieve a target return — pricing product to achieve a specified percentage return on sales or investment.Maximize profits — followed by the most companies.
Sales orientedIncrease sales volume.Maintain or increase market share.
Status quoStabilize prices.Meet competition.
SELECT PRICING OBJECTIVE
SELECT METHOD OF DETERMINING THE BASE PRICE
Cost-pluspricing
Price based onboth demand
and costs
Price set inrelation 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
The Process: An Illustration
Factors Affecting Price Decisions
Internal Factors1. Marketing
Objectives2. Marketing Mix
Strategy3. Product Cost4. Organizational
considerations
Internal Factors1. Marketing
Objectives2. Marketing Mix
Strategy3. Product Cost4. Organizational
considerations
External Factors1. Nature of the
market & demand2. Competition3. Environmental
factors (economy, resellers, government)
External Factors1. Nature of the
market & demand2. Competition3. Environmental
factors (economy, resellers, government)
PricingDecisions
PricingDecisions
Marketing
Objectives
SurvivalLow Prices to Cover Variable Costs
andSome Fixed Costs to Stay in
Business.Current Profit Maximization Choose the Price that Produces the
Maximum Current Profit, Etc.
Market Share LeadershipLow as Possible Prices to Become
the Market Share Leader.
Product Quality LeadershipHigh Prices to Cover Higher
Performance Quality and R & D.
Marketing Objectives
Price
Product Design
Distribution
Promotion
NonpricePositions
Marketing Mix Customers seek products that give them the best value in terms of benefits received for the price paid
Pricing Strategies : Product Mix
Optional-ProductPricing optional or accessory products sold with the main product. i.e camera bag.
Captive-ProductPricing products that must be used with the main product. i.e. film.
By-ProductPricing low-value by-products to get rid of them and make the main product’s price more competitive.Eg.: sawdust
Product-BundlingCombining several products and offering the bundle at a reduced price.Eg. : theater season tickets
Pricing Strategies : Product Mix
Pricing StrategiesF.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 zonesFreight-absorption pricing: Seller absorbs transport cost to penetrate market.Firms may adopt a one-price strategy or charge different prices to different customersFlexible 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.
Value $22.00Sale $14.99
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 offers2. Prices previously paid3. Going rate if applicable4. Prices charged for alternatives which could
substitute for what is offeredAny prices well below the norm should be examined with care
Major Considerations in Setting Price
PRICE ANALYSISVariety of variables that directly and indirectly influence an item’s price
Market structurePrice mechanism & competition conditions
Economic conditionsPricing strategy of the seller
Detail analysis of internal cost structuresMarket-Driven Pricing Models
Using the producer price index to manage price
Market Structure
Price mechanism
Competition Conditions
Monopoly One supplier
Duopoly Two supplier
Monopolistic Many suppliers, Differentiated product
Perfect Many suppliers, Same product
Monopsony One buyer, Many supplier
Competition conditions
Supply
Demand
Price
Volume or Quantity
Buyer’s Market
Supplier’s Market
Market Price
Market Driven Pricing Models1. 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 soldGreater volume will spread the indirect cost over more units
2. Market Share ModelBased on assumption that long-run profitability depends on the market share obtained by the supplier (penetration pricing)
Market Share Model
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 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.
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 Driven Pricing Models3. 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 ModelPricing for individual products that is set to enhance the sales of the overall product line
5. Revenue Pricing ModelObtaining 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.
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 productsCustomer evaluations of different features Competitors’ prices.
6. Competition Pricing ModelPricing actions or reactions to pricing proposals offered or expected to be offered by the supplier’s competitorsDetermine the highest price that can be offered that will still be lower than the price offered by competitors
7. Cash DiscountsOffer incentives to pay invoices promptlyPayment with certain period of time
Market Driven Pricing Models
Setting Prices
Sealed-BidCompany Sets Prices Based on What They Think Competitors
Will Charge.
Going-Rate Company Sets Prices Based on What
Competitors Are Charging.
??
Competition Pricing Model
Cash Discount
Cash Discount Seasonal Discount
Q uantity Discount Trade-In Allow ance
Functional Discount Prom otional Allow ance
A d jus tin g B as ic Pr ice to Rew ard Cu s tom ersF o r C erta in R esp on ses
COST ANALYSIS
It looks at one aspect only : how quoted price relates to cost of productionUseful technique for keeping prices realistic in the absence of effective competitionConcentrates attention on what costs ought to be incurred before the work is done
Cost Analysis Techniques
Cost-based pricing modelsCost-markup pricing modelMargin pricing modelRate-of-Return pricing model
Product specificationEstimate supplier costs using reverse price analysisBreak-even analysis
Cost-Based Pricing Model
Certainty About Costs
Pricing is Simplified
Price Competition is
Minimized
UnexpectedSituational
Factors
Attitudes of
Others
Ignores Current
Demand & Competition
Cost-Plus Pricing is an
Approach That Adds a
Standard Markup to the Cost of the Product.
Simplest Pricing Method
Much Fairer to
Buyers & Sellers
Cost andprofit= 100%= RM72
MANUFACTURER
Mfgselling price= 100%= RM72
WHOLESALER
W/sselling price= 100%= RM90
Cost = 80% = RM72
Mark-up = 20% = RM18
RETAILER
Re-tailer’sselling price= 100%= RM150
Mark-up = 40% = RM60
Cost = 60% = RM90
Cost toConsumer = RM150
CONSUMER
Cost-Markup Pricing Model
Margin Pricing Model
Unit Selling Price = (Cost) + (Margin Rate)(Cost)
Example :Cost - RM 50Margin 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 AnalysisAlso known as “Should Cost” analysisEvaluating 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 Utilization2. Process Capability3. Learning-Curve Effect4. The Supplier
Workforce5. Management
Capability6. 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 salesBreak-Even :
TR = TC
= VC + FC
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
Break-Even AnalysisExample :Purchase or Sale Price - RM 10Variable Cost per Unit – RM 6Fixed 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 availablePrices are quoted on requestPotential suppliers submit sealed bids or tendersPurchase are made at auction or by reverse auctionBy negotiation
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