1. Chapter 15 Preparing for partnership with suppliers: cost approaches and techniques

2. Program How is the purchasing price determined? Pricing methods
The learning curve
Assessing suppliers
Supplier 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 factors
External factors
Logistics
factors
Technical
factors
Socio-political
factors
Economic
factors
Organizational
factors
Technological factors
Supplier
buyer
Black box
Trying to raise
the price
Trying to reduce
the price
Influences on
the price
Van Eck et al. (1982)

5. How is the purchase price determined?
Corey (1978) considers prices to be based on three
models:
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 Methods
based on cost factors
based both on market and cost factors
based on market factors
purchase product group
emphasis on cost factors
50/50
emphasis on market factors
Raw materials x
Semi-manufactured goods
Components
Standard
Non-standard
Finished products
MRO
Services
Van Eck, de Weerd and van Weele (1982)

7. Pricing Methods Factors suppliers have to take into account to set the
selling price:
Expected demand
Number of competitors
Expected development of the cost price per product unit
Customer’s order volume
Importance of the customer to the supplier
Value 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 prices
Going rate pricing, based on competitor prices
Auction type pricing, tender where the lowest offer is awarded.

9. Pricing Methods
A special characteristic of pricing policies for industrial
products is the discount policy:
Cash discount: e.g. 2% discount for payments within 10 days
Quantity 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 Methods
The following list can help the buyer to gain insight into
the supplier’s cost structure:
Materials cost: to be itemized according to the major components
Direct labor cost: information can be obtained by consulting the collective labor agreements for each particular industry
Transportation cost
Indirect cost: divided into general management costs and sales costs
The higher the share of the fixed costs in the cost
price of the end product, the greater the
supplier's price elasticity.

11. The learning curve
It 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 grows
Increased profits, from improved efficiency through streamlining the process
Reduced defects and line reject rates during production
Increased batch sizes (less time spent on resetting machines)
Improved production equipment (after a while)
Improved process control
Reduced engineering changes

12. Cumulative amount produced Required time in hours per unit
The learning curve
Basic principle
Each 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 produced
Required time in hours per unit
1000 20
2000 16
4000
12.8
8000
10.24
16000
8.2
80% 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 specifications
When large amounts of money are involved
When 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 assessment
The need for objective assessment of suppliers increases as the
role 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 quality
Process 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 assessment
Framework for identifying the most important cost drivers:
Category
Description
examples
Design
Costs attributable to product design trade-offs
Materials
Product line complexity
Facility
Costs related to the size of the facility, equipment and process technology employed
Facility scale
Degree of vertical integration
Use of automation
Geography
Cost associated with the location of the facility relative to the customer
Location related wage rate difference
Transportation costs to customer
Operations
Cost that differentiate a well run facility from a poorly run facility
Labor productivity
Facility utilization
Rejection rates
Laseter (1998)

18. Supplier assessment
Difference between supplier auditing and vendor rating:
Aspect
Supplier auditing
Vendor rating
Orientation
Focus on future
Based on historical data
Application
New and current suppliers
Current suppliers
Nature
Mainly qualitative
Mainly quantitative
Scope
Broad, many aspects
Limited, few aspects
Work
Time consuming
Standard data
Data processing
Subjective, manually
Factual, computerized
Relation with suppliers
Co-operation
Based on internal administrative data

19. Supplier development Actions for development of suppliers:
Supplier suggestion program: actively ask for suggestions for improvements of suppliers
Supplier 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.

20. Supplier segmentation BASF
Liker et al. (2004)

21. Conclusions
Pricing 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 policy
Some methods to do so:
Closely monitoring the supply market
Monitoring individual supplier financial performance
Make analysis of supplier’s cost price
Monitor developments in the supplier’s performance on price, quality, delivery, etc.