Price Determination Chapter 9 Presented By: Adam Hassler Jordan Malandra Melissa Mazza Daniel Palma Doug Staples

Agenda  Determining a Fair Price  Types of Purchases  Methods of Price Determination  Identical Prices  Cost Analysis  Negations  Futures and Commodities  Pricing Information Sources  Case

Price Determination  Supplier needs to be paid a “fair price”  In the long run total sales need to cover total costs, including a reasonable profit Determining a Fair Price Types of Purchases Methods of Price Determination Identical Prices Cost Analysis Negotiations Futures & Commodities Pricing Information Sources Case

Cost Classification  Direct costs: those that can be accurately assigned to a given unit of production  Indirect costs: those that are incurred during the operation of production  Variable costs: vary directly and proportionally with production output  Fixed costs: remain constant  Semivariable costs: partly variable and partly fixed Determining a Fair Price Types of Purchases Methods of Price Determination Identical Prices Cost Analysis Negotiations Futures & Commodities Pricing Information Sources Case

Establishing Price  Depends on commodity and industry  Two traditional methods –Cost Approach Price should be a certain amount over direct costs –Market Approach Price fluctuates with supply and demand Determining a Fair Price Types of Purchases Methods of Price Determination Identical Prices Cost Analysis Negotiations Futures & Commodities Pricing Information Sources Case

Government Influence  Active role in determining prices –production quotas –wage/price controls  Regulates buyer/seller relationship Determining a Fair Price Types of Purchases Methods of Price Determination Identical Prices Cost Analysis Negotiations Futures & Commodities Pricing Information Sources Case

United States Legislation  Sherman Antitrust Act of 1890 –Combination, conspiracy, or collusion with the intent of restricting trade in interstate commerce is illegal  Robinson-Patman Act –Federal Anti-price Discrimination Act of 1936 –Suppliers must sell the same item, in the same quantity, to all customers at the same price –“one-price law” Determining a Fair Price Types of Purchases Methods of Price Determination Identical Prices Cost Analysis Negotiations Futures & Commodities Pricing Information Sources Case

Canadian Legislation  Differs from the U.S. but intent is the same –Suppliers or buyers may not “conspire, combine, agree, or arrange with another person” to raise prices unreasonably or to otherwise restrain competition –It is illegal for a supplier to grant a price concession to one buyer that is not available to all other buyers Determining a Fair Price Types of Purchases Methods of Price Determination Identical Prices Cost Analysis Negotiations Futures & Commodities Pricing Information Sources Case

1)Raw Materials 2)Special Items 3)Standard Product Items 4)Items of Small Values 5)Capital Goods 6)Services 7)Resale Types of Purchases Determining a Fair Price Types of Purchases Methods of Price Determination Identical Prices Cost Analysis Negotiations Futures & Commodities Pricing Information Sources Case

Types of Purchases 1)Raw Materials  Sensitive commodities 2)Special Items  Custom ordered 3)Standard Product Items  Prices are fairly stable Determining a Fair Price Types of Purchases Methods of Price Determination Identical Prices Cost Analysis Negotiations Futures & Commodities Pricing Information Sources Case

Types of Purchases 4)Items of Small Values  MRO 5)Capital Goods  Capital assets 6)Services  Advertising, auditing, insurance 7)Resale  Items formerly manufactured in-house  Items sold in the retail sector Determining a Fair Price Types of Purchases Methods of Price Determination Identical Prices Cost Analysis Negotiations Futures & Commodities Pricing Information Sources Case

Roliscon Ltd. Model Determining a Fair Price Types of Purchases Methods of Price Determination Identical Prices Cost Analysis Negotiations Futures & Commodities Pricing Information Sources Case Segment the Market Determine Value Based Price Competitors And Perceived Value Devise New Price Structure

STEPS INVOLVED IN COMPETATIVE BIDDING 1) Initial selection of sources:  Should be able to supply the item  Deliver on time  Reliable  Competitiveness  Not more numerous than necessary 2) Wording of requests  Complete description of item  Date bid is to be returned Methods of Price Determination Determining a Fair Price Types of Purchases Methods of Price Determination Identical Prices Cost Analysis Negotiations Futures & Commodities Pricing Information Sources Case

3) Submission of bids  Keep the bids confidential 4) Treatment of quotations  Keep sealed until all quotations are final 5) Quotation analysis  Consistent bid specifications  Other costs Methods of Price Determination Determining a Fair Price Types of Purchases Methods of Price Determination Identical Prices Cost Analysis Negotiations Futures & Commodities Pricing Information Sources Case

Firm Bidding -The policy -Temptations to cheat for the buying firm -Benefits -The alternative (BAFOS) Methods of Price Determination Determining a Fair Price Types of Purchases Methods of Price Determination Identical Prices Cost Analysis Negotiations Futures & Commodities Pricing Information Sources Case

The Collusive Bidding Problem -Legal Action -Accept reality -Seek out of area sources -Substitution -Reject bids Methods of Price Determination Determining a Fair Price Types of Purchases Methods of Price Determination Identical Prices Cost Analysis Negotiations Futures & Commodities Pricing Information Sources Case

Identical Prices  Intensive competition or collusion?  Investigate when: –Prices differs from historical pricing patterns –Communication between sellers and buyers –“Artificial” product standardization –Very specific requirements –Deviation from uniform prices (industry wide) Determining a Fair Price Types of Purchases Methods of Price Determination Identical Prices Cost Analysis Negotiations Futures & Commodities Pricing Information Sources Case

Identical Pricing When it occurs:  Re-bid or negotiate with 1-2 suppliers  Award contract to: –Smallest firm/Market share –Largest domestic content –Will grant non-price concessions –Best past performance Determining a Fair Price Types of Purchases Methods of Price Determination Identical Prices Cost Analysis Negotiations Futures & Commodities Pricing Information Sources Case

Identical Prices  How to avoid: –Use small sellers –Split large contracts among bidders –Firm bidding (no revision) –Use criteria that ensures non-identical bids Determining a Fair Price Types of Purchases Methods of Price Determination Identical Prices Cost Analysis Negotiations Futures & Commodities Pricing Information Sources Case

Use of Negotiation  Attempt to find an agreement that allows both parties to realize their objectives.  Appropriate for: –Large dollar purchases (> $50,000) –Seller’s market –Single provider  Costly procedure Determining a Fair Price Types of Purchases Methods of Price Determination Identical Prices Cost Analysis Negotiations Futures & Commodities Pricing Information Sources Case

Use of Negotiation  Areas to negotiate on: –Quality –Customer Support –Supply –Transportation –Price  Negotiating is not Price Haggling Determining a Fair Price Types of Purchases Methods of Price Determination Identical Prices Cost Analysis Negotiations Futures & Commodities Pricing Information Sources Case

Price Changes  Guarantee against price decline  Price Protection Clause  Escalator Clause  Most-Favoured-Customer Clause  A valid contract must include a price or a method of price determination. Determining a Fair Price Types of Purchases Methods of Price Determination Identical Prices Cost Analysis Negotiations Futures & Commodities Pricing Information Sources Case

Discounts  Two types: –Indefensible legally or commercially Inside prices –Legitimate & fair Cash or quantity discounts Determining a Fair Price Types of Purchases Methods of Price Determination Identical Prices Cost Analysis Negotiations Futures & Commodities Pricing Information Sources Case

Price-Discount Problem  What is the best quantity to order?  Given: R = 900 units (annual demand) S = $50 (order cost) K = 0.25 (carrying cost) C = (cost of quantities) $ units/order $ units/order $ units/order $ units/order Determining a Fair Price Types of Purchases Methods of Price Determination Identical Prices Cost Analysis Negotiations Futures & Commodities Pricing Information Sources Case

Price-Discount Problem  Solution is quantity with lowest total cost

Rationale for Not Conducting Cost Analysis  In many cases suppliers do not know their true costs  Some suppliers will not divulge such information  Seller’s costs do not determine market prices  Buyer only concerned with getting the best product, at the best price, in the right quantity Determining a Fair Price Types of Purchases Methods of Price Determination Identical Prices Cost Analysis Negotiations Futures & Commodities Pricing Information Sources Case

Rationale for Conducting Cost Analysis  General costing data will help assess the reasonableness of the quoted price  First-buyers cannot complain if efficient suppliers end up out of business if pricing below cost  Second-buyers cannot maintain an attitude of indifference when suppliers sell below cost and then become intensely concerned when prices rise drastically when the suppliers fight to stay in business Determining a Fair Price Types of Purchases Methods of Price Determination Identical Prices Cost Analysis Negotiations Futures & Commodities Pricing Information Sources Case

Total Cost of Ownership TCO defined “All relative costs, such as purchasing administration, follow-up, expediting, inbound transportation, inspection and testing, rework, storage, scrap, warranty, service, downtime, customer returns, and lost sales.” Determining a Fair Price Types of Purchases Methods of Price Determination Identical Prices Cost Analysis Negotiations Futures & Commodities Pricing Information Sources Case

Reducing TCO Supplier Cost Reduction:  Long-term purchase agreements  Joint cost-reduction programs  Early supplier involvement in design  Commitments to purchase suppliers’ capacity Buyer Cost Reduction:  Technical support  Training  Asset sharing or other financial support  Proprietary technology Determining a Fair Price Types of Purchases Methods of Price Determination Identical Prices Cost Analysis Negotiations Futures & Commodities Pricing Information Sources Case

Activity-Based Costing  Aims to turn indirect costs into direct costs by tracking cost drivers behind indirect costs  Used to determine value added and which do not –Those which don’t are eliminated  One method used to reduce TCO Determining a Fair Price Types of Purchases Methods of Price Determination Identical Prices Cost Analysis Negotiations Futures & Commodities Pricing Information Sources Case

Forward Buying and Commodities  Forward buying ensures supply –price is a secondary concern  Speculation seeks to take advantage of price movements –supply is a secondary concern  Gambling aims at predicting price trends with little knowledge or experience Determining a Fair Price Types of Purchases Methods of Price Determination Identical Prices Cost Analysis Negotiations Futures & Commodities Pricing Information Sources Case

Forward Buying  Risk management is key in commodity acquisition  Used to provide company with a more stable price environment –hedging will make you either better off or worse off depending on price movements  No foolproof method to ensure proper forward buying –recommended that the company sets up procedures Determining a Fair Price Types of Purchases Methods of Price Determination Identical Prices Cost Analysis Negotiations Futures & Commodities Pricing Information Sources Case

Commodities Exchanges Conditions for a Successful Exchange: 1)Accurate grading 2)Liquid market Hedging Requires the Following Conditions: 1)Trading in “Futures” - the buying and selling of the commodity for delivery at a specified future date 2)A fairly close correlation between “basis” and other grades 3)A reasonable but not necessarily consistent correlation between “spot” and “future” prices Determining a Fair Price Types of Purchases Methods of Price Determination Identical Prices Cost Analysis Negotiations Futures & Commodities Pricing Information Sources Case

Limitations of the Exchanges  Grading often inaccurate  Most contracts are offset with an opposite position so supply must be received from another location  Markets can be manipulated or affected by financial markets Determining a Fair Price Types of Purchases Methods of Price Determination Identical Prices Cost Analysis Negotiations Futures & Commodities Pricing Information Sources Case

Hedging: What is it?  It is price insurance  Done by simultaneously making a purchase and a sale in the same market but at different times. –A loss in one position will be offset by a gain in the other position  Not always advantageous –it is a zero-sum game Determining a Fair Price Types of Purchases Methods of Price Determination Identical Prices Cost Analysis Negotiations Futures & Commodities Pricing Information Sources Case

Please refer to Case 9-5 on page 404 Determining a Fair Price Types of Purchases Methods of Price Determination Identical Prices Cost Analysis Negotiations Futures & Commodities Pricing Information Sources Case

Some Points to Remember…. 1)Purchases made on the 1 st of the month 2)NO futures 3)Inv. cannot be >1.2 million lbs (penalty is $2000 plus $0.06 per lb over 1.2M) 4)Stock out costs are $0.06/lb 5)Inventory carrying cost is $0.004/lb on ending inv 6)Closing inventory target of 200,000 lbs Determining a Fair Price Types of Purchases Methods of Price Determination Identical Prices Cost Analysis Negotiations Futures & Commodities Pricing Information Sources Case