University

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University
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Price DeterminationChapter 9

• Presented By
• Adam Hassler
• Jordan Malandra
• Melissa Mazza
• Daniel Palma
• Doug Staples

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Agenda

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

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Price Determination
Determining a Fair Price Types of
Purchases Methods of Price Determination Identic
al Prices Cost Analysis Negotiations Futures
Commodities Pricing Information Sources Case

• Supplier needs to be paid a fair price
• In the long run total sales need to cover total
  costs, including a reasonable profit

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Cost Classification

• 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 Identic
al Prices Cost Analysis Negotiations Futures
Commodities Pricing Information Sources Case

• 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

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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 Identic
al Prices Cost Analysis Negotiations Futures
Commodities Pricing Information Sources Case
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Government Influence
Determining a Fair Price Types of
Purchases Methods of Price Determination Identic
al Prices Cost Analysis Negotiations Futures
Commodities Pricing Information Sources Case

• Active role in determining prices
• production quotas
• wage/price controls
• Regulates buyer/seller relationship

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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 Identic
al Prices Cost Analysis Negotiations Futures
Commodities Pricing Information Sources Case
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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 Identic
al Prices Cost Analysis Negotiations Futures
Commodities Pricing Information Sources Case
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Types of Purchases

1. Raw Materials
2. Special Items
3. Standard Product Items
4. Items of Small Values
5. Capital Goods
6. Services
7. Resale

Determining a Fair Price Types of
Purchases Methods of Price Determination Identic
al Prices Cost Analysis Negotiations Futures
Commodities Pricing Information Sources Case
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Types of Purchases

• Raw Materials
• Sensitive commodities
• Special Items
• Custom ordered
• Standard Product Items
• Prices are fairly stable

Determining a Fair Price Types of
Purchases Methods of Price Determination Identic
al Prices Cost Analysis Negotiations Futures
Commodities Pricing Information Sources Case
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Types of Purchases

• Items of Small Values
• MRO
• Capital Goods
• Capital assets
• Services
• Advertising, auditing, insurance
• Resale
• Items formerly manufactured in-house
• Items sold in the retail sector

Determining a Fair Price Types of
Purchases Methods of Price Determination Identic
al Prices Cost Analysis Negotiations Futures
Commodities Pricing Information Sources Case
13
Roliscon Ltd. Model
Segment the Market
Determining a Fair Price Types of
Purchases Methods of Price Determination Identic
al Prices Cost Analysis Negotiations Futures
Commodities Pricing Information Sources Case
Determine Value Based Price
Competitors And Perceived Value
Devise New Price Structure
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Methods of Price Determination

• 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

Determining a Fair Price Types of
Purchases Methods of Price Determination Identic
al Prices Cost Analysis Negotiations Futures
Commodities Pricing Information Sources Case
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Methods of Price Determination

• 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

Determining a Fair Price Types of
Purchases Methods of Price Determination Identic
al Prices Cost Analysis Negotiations Futures
Commodities Pricing Information Sources Case
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Methods of Price Determination

• Firm Bidding
• -The policy
• -Temptations to cheat for the buying firm
• -Benefits
• -The alternative (BAFOS)

Determining a Fair Price Types of
Purchases Methods of Price Determination Identic
al Prices Cost Analysis Negotiations Futures
Commodities Pricing Information Sources Case
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Methods of Price Determination

• The Collusive Bidding Problem
• -Legal Action
• -Accept reality
• -Seek out of area sources
• -Substitution
• -Reject bids

Determining a Fair Price Types of
Purchases Methods of Price Determination Identic
al Prices Cost Analysis Negotiations Futures
Commodities Pricing Information Sources Case
18
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 Identic
al Prices Cost Analysis Negotiations Futures
Commodities Pricing Information Sources Case
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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 Identic
al Prices Cost Analysis Negotiations Futures
Commodities Pricing Information Sources Case
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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 Identic
al Prices Cost Analysis Negotiations Futures
Commodities Pricing Information Sources Case
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Use of Negotiation

• Attempt to find an agreement that allows both
  parties to realize their objectives.
• Appropriate for
• Large dollar purchases (gt 50,000)
• Sellers market
• Single provider
• Costly procedure

Determining a Fair Price Types of
Purchases Methods of Price Determination Identic
al Prices Cost Analysis Negotiations Futures
Commodities Pricing Information Sources Case
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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 Identic
al Prices Cost Analysis Negotiations Futures
Commodities Pricing Information Sources Case
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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 Identic
al Prices Cost Analysis Negotiations Futures
Commodities Pricing Information Sources Case
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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 Identic
al Prices Cost Analysis Negotiations Futures
Commodities Pricing Information Sources Case
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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)
• 45 0-199 units/order
• 43 200-399 units/order
• 41.50 400-799 units/order
• 40 800 units/order

Determining a Fair Price Types of
Purchases Methods of Price Determination Identic
al Prices Cost Analysis Negotiations Futures
Commodities Pricing Information Sources Case
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Price-Discount Problem

• Solution is quantity with lowest total cost

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Rationale for Not Conducting Cost Analysis

• In many cases suppliers do not know their true
  costs
• Some suppliers will not divulge such information
• Sellers 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 Identic
al Prices Cost Analysis Negotiations Futures
Commodities Pricing Information Sources Case
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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 Identic
al Prices Cost Analysis Negotiations Futures
Commodities Pricing Information Sources Case
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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 Identic
al Prices Cost Analysis Negotiations Futures
Commodities Pricing Information Sources Case
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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 Identic
al Prices Cost Analysis Negotiations Futures
Commodities Pricing Information Sources Case
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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 dont are eliminated
• One method used to reduce TCO

Determining a Fair Price Types of
Purchases Methods of Price Determination Identic
al Prices Cost Analysis Negotiations Futures
Commodities Pricing Information Sources Case
32
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 Identic
al Prices Cost Analysis Negotiations Futures
Commodities Pricing Information Sources Case
33
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 Identic
al Prices Cost Analysis Negotiations Futures
Commodities Pricing Information Sources Case
34
Commodities Exchanges

• Conditions for a Successful Exchange
• Accurate grading
• Liquid market
• Hedging Requires the Following Conditions
• Trading in Futures - the buying and selling of
  the commodity for delivery at a specified future
  date
• A fairly close correlation between basis and
  other grades
• A reasonable but not necessarily consistent
  correlation between spot and future prices

Determining a Fair Price Types of
Purchases Methods of Price Determination Identic
al Prices Cost Analysis Negotiations Futures
Commodities Pricing Information Sources Case
35
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 Identic
al Prices Cost Analysis Negotiations Futures
Commodities Pricing Information Sources Case
36
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 Identic
al Prices Cost Analysis Negotiations Futures
Commodities Pricing Information Sources Case
37
Case
Determining a Fair Price Types of
Purchases Methods of Price Determination Identic
al Prices Cost Analysis Negotiations Futures
Commodities Pricing Information Sources Case

• Please refer to Case 9-5 on page 404

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Some Points to Remember.
Determining a Fair Price Types of
Purchases Methods of Price Determination Identic
al Prices Cost Analysis Negotiations Futures
Commodities Pricing Information Sources Case

1. Purchases made on the 1st of the month
2. NO futures
3. Inv. cannot be gt1.2 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