Presentation on theme: "Program How is the purchasing price determined? Pricing methods"— Presentation transcript:
1 Chapter 15 Preparing for partnership with suppliers: cost approaches and techniques
2 Program How is the purchasing price determined? Pricing methods The learning curveAssessing suppliersSupplier development
3 How is the purchase price determined? The price ultimately paid for materials and services is the result of environmental factors (internal and external):Internal factors: can bring about a change in the cost of materials before the finished product is placed on the market (logistical, technical or organizational factors).External factors: those factors that change the availability of a product in a given market (economic, socio political or technological factors).
4 Environmental factors Internal factorsExternal factorsLogisticsfactorsTechnicalfactorsSocio-politicalfactorsEconomicfactorsOrganizationalfactorsTechnological factorsSupplierbuyerBlack boxTrying to raisethe priceTrying to reducethe priceInfluences onthe priceVan Eck et al. (1982)
5 How is the purchase price determined? Corey (1978) considers prices to be based on threemodels:Cost-based pricing: The supplier’s offering price is directly derived from his cost price.Market-based pricing: The price of the product is determined on the market and is generated by market circumstances (demand, supply, stock positions, economic factors etc.)Competitive bidding: The price is influenced by market factors as well as cost factors. This situation is most common.
6 based both on market and cost factors based on market factors Pricing Methodsbased on cost factorsbased both on market and cost factorsbased on market factorspurchase product groupemphasis on cost factors50/50emphasis on market factorsRaw materialsxSemi-manufactured goodsComponentsStandardNon-standardFinished productsMROServicesVan Eck, de Weerd and van Weele (1982)
7 Pricing Methods Factors suppliers have to take into account to set the selling price:Expected demandNumber of competitorsExpected development of the cost price per product unitCustomer’s order volumeImportance of the customer to the supplierValue of the product to the customer
8 Pricing Methods The following pricing methods can be distinguished: Mark-up pricing, a fixed percentage is put on top of the cost price.Target-return pricing, predetermined total profit per product group. The price depends on the fixed costs and the selling volume.Pricing based on the buyer’s perceived value. Base price on what the market can bear, not on the cost price.Value pricing, high quality offerings for fairly low pricesGoing rate pricing, based on competitor pricesAuction type pricing, tender where the lowest offer is awarded.
9 Pricing MethodsA special characteristic of pricing policies for industrialproducts is the discount policy:Cash discount: e.g. 2% discount for payments within 10 daysQuantity discounts: to stimulate larger quantity orders.Volume bonus: linked to the amounts purchased from a specific supplier for a specific period.Geographical discount: given to customers located near the supplier.Seasonal discount: applied to improve capacity utilization in periods when sales decline.Promotional discount: provided to temporarily stimulate the sale of a product.
10 supplier's price elasticity. Pricing MethodsThe following list can help the buyer to gain insight intothe supplier’s cost structure:Materials cost: to be itemized according to the major componentsDirect labor cost: information can be obtained by consulting the collective labor agreements for each particular industryTransportation costIndirect cost: divided into general management costs and sales costsThe higher the share of the fixed costs in the costprice of the end product, the greater thesupplier's price elasticity.
11 The learning curveIt was discovered (in American Airline Industry) that the cost price per unit decreased at a fixed percentage as experience increased..The learning effects result from:Reduced supervision as experience with production growsIncreased profits, from improved efficiency through streamlining the processReduced defects and line reject rates during productionIncreased batch sizes (less time spent on resetting machines)Improved production equipment (after a while)Improved process controlReduced engineering changes
12 Cumulative amount produced Required time in hours per unit The learning curveBasic principleEach time the cumulative production volume of a particular item doubles, the average time required to produce that item is approximately x % less of the previously required number of hours.Cumulative amount producedRequired time in hours per unit100020200016400012.8800010.24160008.280% Learning curve
13 The learning curve The learning curve is preferably used: When it concerns customized components, manufactured by a supplier at the customer’s specificationsWhen large amounts of money are involvedWhen the buyer cannot request competitive quotations because, e.g., a considerable investment has to be made in moulds and specific production tooling which lead the buyer to single sourcing.When direct labor costs make up an important part of the cost price.
14 Supplier assessmentThe need for objective assessment of suppliers increases as therole of the supplier in the business chain grows.Supplier assessment may take place at four different levels:Product level: Focuses on establishing and improving the supplier’s product qualityProcess level: Not the product, but the supplier’s production process is closely investigated.Quality assurance system level: The entire supplier quality organization is subject of investigation by the customer.Company level: Besides quality aspects also financial aspects are taken into consideration. Also auditors want to get an idea of the quality of management (how competitive is the supplier in the future?)
15 Supplier assessment Two types of assessment may be differentiated: Subjective methods are used when companies evaluate suppliers through personal judgments.Objective methods attempt to quantify the supplier’s performance.The following techniques and tools can be used (1)Spreadsheets; used to systematically compare and asses quotations obtained from suppliers. Important criteria are listed on one axis and the supplier quotations on the other.Qualitative assessment; used for suppliers with whom exist close business relationships. Specialists who have experience with the suppliers rate them according to a agreed checklist
16 Supplier assessment Techniques and tools (2): Vendor rating; Limited to quantitative data only. Entails measuring the aspects of price, quality and delivery reliability per supplier.Supplier audit; Entails that the supplier is periodically visited by specialist(s) from the customer. They investigate the production process and quality organization.Cost modeling; Specialist from the buying company estimate, based on the production technology, the cost of the product. This may lead to ‘should cost’ discussions with the supplier.
17 Supplier assessmentFramework for identifying the most important cost drivers:CategoryDescriptionexamplesDesignCosts attributable to product design trade-offsMaterialsProduct line complexityFacilityCosts related to the size of the facility, equipment and process technology employedFacility scaleDegree of vertical integrationUse of automationGeographyCost associated with the location of the facility relative to the customerLocation related wage rate differenceTransportation costs to customerOperationsCost that differentiate a well run facility from a poorly run facilityLabor productivityFacility utilizationRejection ratesLaseter (1998)
18 Supplier assessmentDifference between supplier auditing and vendor rating:AspectSupplier auditingVendor ratingOrientationFocus on futureBased on historical dataApplicationNew and current suppliersCurrent suppliersNatureMainly qualitativeMainly quantitativeScopeBroad, many aspectsLimited, few aspectsWorkTime consumingStandard dataData processingSubjective, manuallyFactual, computerizedRelation with suppliersCo-operationBased on internal administrative data
19 Supplier development Actions for development of suppliers: Supplier suggestion program: actively ask for suggestions for improvements of suppliersSupplier development, ask questions like:What is going well in the cooperation?What could or must get better?What is needed for improvement?How to measure the improvements?Supplier satisfaction survey, collaborative relationship between business partners requires that expectations between all stakeholders involved are made explicit.
21 ConclusionsPricing and cost structures of suppliers are always interrelated, but the effect they have on one another is not always clear.It is crucial to buyers to be able to lift the veil that covers the supplier’s pricing policySome methods to do so:Closely monitoring the supply marketMonitoring individual supplier financial performanceMake analysis of supplier’s cost priceMonitor developments in the supplier’s performance on price, quality, delivery, etc.