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.