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
InternalFactors
Factors External
ExternalFactors
Factors
1.
1. Marketing
Marketing 1.
1. Nature
Natureofofthe
the
Objectives
Objectives market
market&&demand
demand
2.
2. Marketing
MarketingMix
Mix Pricing
Pricing 2.
2. Competition
Competition
Strategy
Strategy Decisions
Decisions
3.
3. Environmental
Environmental
3.
3. Product
ProductCost
Cost factors
factors(economy,
(economy,
4.
4. Organizational
Organizational resellers,
resellers,
considerations
considerations government)
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-Bundling
Pricing low-value by- Combining several
products to get rid of products and offering
them and make the main the bundle at a
product’s price more reduced price.
competitive. Eg. : theater season
Eg.: sawdust 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$22 important quality signal
Sale .00
$14
.99
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
Competition Conditions
Monopoly One supplier
Supply
Duopoly Two supplier
Monopolistic Many suppliers,
Supplier’s Buyer’s
Differentiated
Market Market
product
Perfect Many suppliers,
Demand Same product
Volume or Monopsony One buyer,
Market Price Quantity
Many supplier
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
Market
Market Must be Highly Penetration
Penetration
Price-Sensitive so a Low
Price Produces More SettingaaLow
 Setting
 LowPrice
Pricefor
foraa
Market Growth. NewProduct
Productin
in Order
Orderto
to
New
Production/ Distribution “Penetrate”the
“Penetrate” theMarket
Market
Costs Must Fall as Sales Quicklyand
andDeeply.
Deeply.
Volume Increases. Quickly
Must Keep Out AttractaaLarge
 Attract LargeNumber
Number

Competition & Maintain ofBuyers
Buyersand
andWin
Winaa
Its Low Price Position or of
Benefits May Only be LargerMarket
Larger MarketShare.
Share.
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
Market Skimming Conditions:
Product’s Quality and
Setting aa High
 Setting
 High Price
Price
Image Must Support Its
for aa New
for New Product
Product to
to Higher Price.
“Skim” Maximum
“Skim” Maximum Costs Can’t be so High
Revenues from
Revenues from the
the that They Cancel the
Target Market.
Target Market. Advantage of Charging
More.
Results in
 Results
 in Fewer,
Fewer, But
But Competitors Shouldn’t
More Profitable
More Profitable Sales.
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
 Sealed-Bid
Company Sets Prices Based on
?
What They Think Competitors
?
Will Charge.
Going-Rate
Company Sets Prices Based on What
Competitors Are Charging.
Setting Prices
Competition Pricing Model
Cash Discount

A d ju s tin g B a s ic P r ic e to R e w a r d C u s to m e r s
F o r C e rta in R e s p o n s e s

C a s h D is c o u n t S e a s o n a l D is c o u n t

Q u a n tity D is c o u n t T r a d e -In A llo w a n c e

F u n c tio n a l D is c o u n t P r o m o t io n a l A ll o w a n c e
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
Method
Factors
Pricing is Pricing is an
Situational
Simplified
Approach
Unexpected
That Adds a
Standard
Price Competition
Markup to the Ignores
is Minimized Attitudes Current
Cost of the
of Demand &
Product.
Others
Much Fairer to Competition
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 to initiate discussion in the
supplier’s price is justifiable following areas to discover
and reasonable opportunities for cost
reductions :
Hypothetical Price RM 20 1. Plant Utilization
Profit (15%) RM 3 2. Process Capability
3. Learning-Curve Effect
Subtotal RM 17 4. The Supplier
Direct Material RM 4 Workforce
5. Management Capability
Subtotal RM 13 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