BUSINESS NEEDS IN PROCUREMENT AND SUPPLY

LECTURE THREE: ESTIMATING COSTS AND PRICES

Introduction to Market Data on Costs and Prices
Distinction between cost and price;
Price: This is what the seller charges for a package of benefits
offered to a buyer.
Cost: This is what the buying organization pays to acquire the
goods or services purchased. This also includes acquisition,
installation, maintenance, operating, insurance, and disposal
costs.
Obtaining prices from the suppliers
There are various methods by which prices can be extracted
from suppliers:
 Suppliers may have a standard price list or price
schedule.
 Prices may be quoted on request.
 Prices may be arrived at through negotiation between
the supplier and the buyer based on price and cost
analysis.
  Prices may be determined by competition ie. Through
auction or reverse auction
 Prices may be determined by the market.
 Economic indices are published for various price data
which indicates changes and trends in average data over
time.
The more specialized or customized the buyer’s requirement,
the less likely there is to be a standard price or price list and
prices are more likely to be estimated and negotiated by
buyer and supplier on the basis of the requirement.
PRICE AND COST RESEARCH
Several sources of market data may be consulted to gather
information on market prices and average costs, and factors
and trends affecting prices and costs.
Primary data
These are data collected especially for a particular purpose,
directly from the relevant sources. Primary research is usually
field research; involving surveys, interviews, questionnaires, or
observation. Below are some primary sources of market data
on costs and prices.
 Communication with suppliers
 The buyer's database of market data
 The marketing communications of suppliers
 Online market exchanges like auction sites and
buyer/supplier forums
 Advisory and information services, including relevant
professional institutions such as (CIPS)
 Trade fairs, exhibitions, and conferences
 Informal networks and information exchange with
colleagues, other purchasing professionals, and suppliers.
Secondary Data
These are data that have already been gathered and
assembled for other purposes, general reference, or
publication. They are generally accessed by desk research
which can be carried out from the researcher's desk. Here are
some secondary research data;
 Financial and trade or industry press and specialist
procurement journals which may carry market analysis, and
statistical digest on cost/price trends.
  Published economic indices such as the Retail Price Index
(RPI), the labor market index, and various commodity
indices.
 Published and online market analysis
 Published statistical surveys compiled by the government
such as – Economic and labour market reviews, and
Business Monitor.
 Price listings and price comparison websites allow the
gouging of market prices.
Understanding supplier pricing
A wide range of factors may be taken into account by
suppliers when setting or negotiating prices and any given
pricing decision will be a combination of factors both internal
and external.
Factors in Supplier Pricing Decisions
Internal factors
 Costs of production and sales, which must be matched by
sales revenue in order to earn profits.
 How badly the supplier needs the business at a particular
time.
 Risk management; eg. Making provision in the price to
cover unforeseen costs or changes.
 How attractive a particular customer is to the supplier.
 Financial position and product portfolio, which may allow
the supplier to accept occasional losses to secure business.
 Where the product is in its life cycle
 Shareholders' expectations and managerial objectives
regarding profit margins.
 The strategic objectives of the organization.
External Factors
 Prices charged by competitors
 Extent of competition ( market structure)
 The nature of competition in the market, which may be
based on price
 Market condition: levels of demand and supply dictating
the price that the market will bear.
 Customer perception of value
 Price elasticity of demand: the extent to which market
demand rises or falls with changes in price
  What a particular customer is prepared to pay.
 Environmental factors affecting the cost of raw
 Environmental factors affecting demand and affordability.
Supplier Pricing Strategies
Suppliers' pricing strategies are likely to be based on either:
Cost or market factors.
Note: Cost-based pricing allows the supplier to cover its costs
and allow for an extra sum to secure a reasonable profit.
Cost-based pricing approach includes the following.
 Full-cost pricing. The supplier calculates the total cost of a
product, adds mark-up to produce a profit and the result is
the selling price.
 Cost-plus or Mark-up pricing. The supplier calculates the
direct cost of a product and adds a markup which
incorporates both an amount to cover indirect costs and a
profit element.
 Marginal pricing. The supplier fixes a price that will yield
a predetermined profit margin ( percentage of the quoted
price).
 Rate of return or target return pricing. The supplier bases
the profit on the desired return on the investment rather
than the estimated product cost.
 Contribution pricing. Where the price is less than the full
cost of the product but covers variable costs in order to
keep the plant running. This avoids the costs of shutting
down the plant and machinery and laying off staff.
Market-driven pricing approaches are as follows:
 Price Volume. The supplier uses cost-volume-profit (or
breakeven) analysis to determine a volume of production
 that will be most economical and will allow it to offer
quantity discounts to buyers to increase sales.
 Market share pricing or penetration pricing. The
supplier sets low introductory prices that will win
customers and discourage competition.
 Market skimming. The supplier sets a high introductory
price to attract buyers who (a) have a strong desire to
get the product early and (b) can afford it.
 Current revenue pricing or contribution pricing. The
supplier aims to cover its operating costs rather than
 earning profit. It may force to accept orders at a low
cost.
 Promotional pricing. The supplier offers a discount for a
specific, limited period in order to boost short-term sales.
 Market segment pricing. The supplier sets different
prices for different market segments, depending on the
price they will bear.
 Competition pricing. The supplier bids competitively to
win a contract.
Factors that affect buyers' decisions on price
Buyers' decisions on what prices to accept are also very
important.
 The buying organisation’s relative bargaining power in the
market and relationship.
 The number of suppliers in the market and the possibility of
substitute products.
 The type of purchase.
 The prices paid by competitors ( if it is available), so that
the buyer keeps his materials costs competitive.
 The total package of benefits offered for the price and
whether ‘value’ is better at a higher price.
  What the buyer can afford, given the quantities likely to
be involved over a given period.
 What is a reasonable price, based on price analysis?
 What is a fair price from the buyers' and suppliers' point
of view?
Price and Cost Analysis
When considering the prices quoted by a supplier or offered
in negotiation, there are two basic approaches that a buyer
can use to decide whether the price is right.

 Price Analysis
  Cost Analysis
Price Analysis- This simply seeks to determine whether the
price offered is fair and appropriate for the goods.
Cost Analysis – This is a more specialised technique often
used to support price negotiations where the supplier justifies
its price by the need to cover its cost. Cost analysis looks
specifically at how the quoted relates to the supplier’s cost of
production.

Accessing supplier cost information

Accessing supplier cost information is very important and these
are the ways it can be accessed.
Open book costing – where suppliers provide information
about their costs to buyers, to reassure them that they are
getting value for money.
Cost transparency – Where both buyer and supplier share
cost information, to collaborate in joint cost reduction
initiatives.
In most cases, buyers will not easily be able to discover details
of a supplier’s cost structure. However, they may be able to
derive some information from a supplier’s tender or may be
able to estimate the cost of a supplier’s product from their
knowledge of the industry.
Uses of suppliers' cost structure
If buyers can ascertain the suppliers' cost structure, the
information will be useful in several ways.
 Cost analysis can keep prices realistic, especially in the
absence of competition.
 It focuses attention on what costs ought to be involved in
producing goods and services.
 It identifies the minimum price the supplier can afford to
charge for sustainable supply.
 It also enables the buyer to estimate how valuable the
business or contract will be to the supplier in terms of
profitability.