Download Cost-based pricing.

Practice
15. Supplier assessment:
cost approaches and
techniques
© Cengage Learning – Purchasing & Supply Chain Management 4 ed (1-84480-024-5)
Program
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•
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How is the purchase price determined?
Pricing methods
The learning curve
Supplier assessment
© Cengage Learning – Purchasing & Supply Chain Management 4 ed (1-84480-024-5)
How is the purchase price determined?
The price ultimately paid for materials and services is
result of environmental factors (internal and external):

Internal factors: can bring about a change in the materials’
costs 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)
© Cengage Learning – Purchasing & Supply Chain Management 4 ed (1-84480-024-5)
Environmental factors
Internal factors
Logistics
factors
External factors
Technical
factors
Organizational
factors
Supplier
Trying to raise
the price
Sociopolitical
factors
Economic
factors
Technological factors
Black box
Influences on
the price
© Cengage Learning – Purchasing & Supply Chain Management 4 ed (1-84480-024-5)
buyer
Trying to reduce
the price
How is the purchase price determined?
Corey (1978) considers prices to be based on three
models:
1.
2.
3.
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.
© Cengage Learning – Purchasing & Supply Chain Management 4 ed (1-84480-024-5)
Method of price setting
purchase product group
based on based both on market and cost
cost factors
factors
emphasis
on cost
factors
Raw materials
Semi-manufactured
goods
Components
Standard
50/50 emphasis
on market
factors
x
x
x
x
x
x
Non-standard
x
x
x
Finished products
x
x
x
x
x
x
x
x
x
MRO
Services
x
© Cengage Learning – Purchasing & Supply Chain Management 4 ed (1-84480-024-5)
based on
market
factors
x
x
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
© Cengage Learning – Purchasing & Supply Chain Management 4 ed (1-84480-024-5)
Pricing Methods
The following pricing methods can be distinguished:





Cost-plus pricing. Adding a fixed percentage mark-up to the
cost price.
Target-profit pricing. The price is determined based on profits
that should be made.
Pricing based on the buyer perceived value. A rule in
marketing: do not base your price on the cost price but on
what the market can bear.
Pricing based on the competitors prices.
Tender-based pricing. Based on a request from the principal,
contractors are invited to submit bids for a specific job. The
job is awarded to the contractor with the lowest bid.
© Cengage Learning – Purchasing & Supply Chain Management 4 ed (1-84480-024-5)
Pricing Methods
A special characteristic of pricing policies for industrial
products is the discount policy which is applied:
• Cash discount: e.g. 2% discount for payments within 10 days
• Quantity discounts: to stimulate larger quantity orders.
• Bonus agreement: 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.
© Cengage Learning – Purchasing & Supply Chain Management 4 ed (1-84480-024-5)
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
© Cengage Learning – Purchasing & Supply Chain Management 4 ed (1-84480-024-5)
The learning curve


It was discovered (in American Airline Industry) that the cost
price per unit decreased at a fixed percentage as experience
(the cumulative production volume of a type of aircraft)
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
© Cengage Learning – Purchasing & Supply Chain Management 4 ed (1-84480-024-5)
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
1000
Required time in
hours per unit
2000
16
4000
12.8
8000
10.24
16000
8.2
© Cengage Learning – Purchasing & Supply Chain Management 4 ed (1-84480-024-5)
20
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.
© Cengage Learning – Purchasing & Supply Chain Management 4 ed (1-84480-024-5)
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:
1.
Product level. Focuses on establishing and improving the supplier’s
product quality
2.
Process level. Not the product, but the supplier’s production
process is closely investigated.
3.
4.
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?)
© Cengage Learning – Purchasing & Supply Chain Management 4 ed (1-84480-024-5)
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.
Personal assessment; used for suppliers with whom exist close
business relationships. Specialists who have experience with the
suppliers rate them according to a agreed checklist
© Cengage Learning – Purchasing & Supply Chain Management 4 ed (1-84480-024-5)
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.
© Cengage Learning – Purchasing & Supply Chain Management 4 ed (1-84480-024-5)
Supplier assessment
Framework for identifying the most important cost drivers:
Category
Description
examples
Design
Costs attributable to product design
trade-offs

Costs related to the size of the
facility, equipment and process
technology employed

Geography
Cost associated with the location of
the facility relative to the customer

Operations
Cost that differentiate a well run
facility from a poorly run facility

Facility



Facility scale
Degree of vertical integration
Use of automation
Location related wage rate
difference
 Transportation costs to customer


© Cengage Learning – Purchasing & Supply Chain Management 4 ed (1-84480-024-5)
Materials
Product line complexity
Labor productivity
Facility utilization
Rejection rates
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
© Cengage Learning – Purchasing & Supply Chain Management 4 ed (1-84480-024-5)
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.
© Cengage Learning – Purchasing & Supply Chain Management 4 ed (1-84480-024-5)