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Price vs. Volume Poll: The Results Are In

The results of a recent EBN poll regarding the relationship between component price and volume are in — with strong support (75 percent) for the idea that a relationship exists.

As reported in my blog a few weeks ago, this is the complete opposite of what I observe using freebenchmarking.com data. Faced with this dichotomy, I decided to conduct a thought experiment, starting with the assumption that there is a strong price/volume relationship, to see where it would lead.

I begin with the assumption that there is a price vs. volume curve. Or is it curves? I know that distributors have strategic accounts to which they give better pricing, so there must be two curves. Manufacturers stratify customers into tier 1, tier 2, tier 3, and rest of world (ROW) accounts with different discounts off list price, so that gives us at least another four.

I also know that pricing changes with time. At a minimum, I am now on one of six time-sensitive curves. Additionally, if I negotiate with a supplier or manufacturer, my price will improve — otherwise negotiation would be a waste of time.

Conclusion: My price is derived from a family of time-sensitive curves that wiggle.

Now, what happens if I add competition by including pricing from alternate sets of curves from other suppliers? In my view, the number of possible wiggly price curves grows to create a near random map, and the question becomes which curve are you on and what have you done to influence its selection?

The fact that there is such a strong belief in the price/volume relationship is interesting as beliefs beget actions that beget results. We see this phenomenon, called the Pygmalion effect, in athletes where their belief in their ability leads to strong performance and championships. We also see it in situations where a belief that something isn’t possible leads to failure. Whether it exists or not, how constrained are you by your price/volume belief? Do you accept the salesman’s price/volume argument too readily?

In my thought experiment, I brought in alternate suppliers as a means of expanding the number of possible price/volume curves. Do you believe this affects pricing? Is there a premium that is paid on single-sourced items over multi-sourced devices?

I have been performing more analysis with freebenchmarking.com data and have derived a means of determining if there is a single-source premium. Do you think there is a price penalty for being single sourced, and, if so, how much is its impact on price?

4 comments on “Price vs. Volume Poll: The Results Are In

  1. Cryptoman
    July 6, 2012

    I definitely think that there is a price penalty for being single sourced. In this competitive world we live in today, everyone tries to find ways to identify weaknesses of the buyer to charge a premium to make more money. This has become the standard practice unfortunately. If a supplier knows that you desparately need the part he provides and there is nowhere else you can get it, he will charge you a premium.

    Besides the financial penalty, I also believe that there are other penalties that cost you in terms of time. When single sourced, your questions are responded to with long delays and your phone calls are not answered most of the time. When you are single sourced, you have no option but to retry over and over again and the supplier knows that.

    Regarding the argument on volume vs. price, I thought the justification of high prices for less volume was the increased cost per unit. Is this not the case? Are we simply led to believe that this is the case? I just want to make sure that I interpreted the argument correctly.

     

  2. bolaji ojo
    July 8, 2012

    The answer is not that simple or straighforward. Single-sourcing can be a strategic choice and the risks can be less of a challenge if carefully managed. As to the pricing connection, isn't it more likely that a supplier with which a company has a single-source agreement could actually offer better pricing (for instance, if the volume is large enough) to guarantee the continuity of the relationship?

  3. Cryptoman
    July 8, 2012

     

    isn't it more likely that a supplier with which a company has a single-source agreement could actually offer better pricing (for instance, if the volume is large enough) to guarantee the continuity of the relationship?

    I agree that a large volume carries a lot of weight in terms of getting a good service. However, how large is “large enough” for the supplier? The supplier will always favour the “larger” volume customer and that's where the problem really is. The single source  is single from the standpoint of the buyer not the supplier. Therefore, the supplier will always have alternative buyers to work with and potentially orders of “larger volumes”.

    Also, as far as I am aware, one would have to go for single source agreement if the product has specialised or unique characteristics that do not have readily available alternatives. This already puts the buyer in a difficult position and the supplier is probably aware of that and can negotiate accordingly.

    I think it all depends on how the supplier sees the the implications of single source agreement and how ethical the supplier is to some extent.


  4. Ken Bradley
    July 9, 2012

    The comments that I am getting on single source premiums are interesting and relevant. I want to clarify a couple of points and provide some additional thinking.

    First, I am talking about single source situations, not sole sourced ones. The difference is that in a sole source situation, there are no alternatives whereas in a single sourced situation there are. Sole source pricing is interesting in that I have found few companies happy with their sole source pricing. On sole source devices, pricing is high because of the intellectual property content and, once an initial price is set, the sole source suppliers tend to maintain high margins without much cost reduction being passed on. Sole source pricing usually only changes when a company has some extra leverage with the supplier, like awarding a new design win for a major product, and when the company can connect the on-going supply negotiations with the new design award.   Cost reduction on sole sourced devices is often achieved through technology refresh to the next generation product.

    While it is possible for a supplier to have a strategic relationship where companies get excellent pricing on single sourced components, I would question how often this occurs? What evidence does a company have that this is occurring? How do they know? Is it what the salesman tells them?

    Finally, there is a relationship between cost and volume. Onetime costs such as set up time or order management fees must be amortized over volume giving a clear cost vs. volume relationship but this does not appear to extend to price. Cost and price are related through an elastic parameter called margin that destroys the price vs. volume curve. As the supply channel gets longer (Manufacturer, Distributor, Contract Manufacturer) this margin elasticity stacks up causing more variability in price.

    One thing is clear; the answer is not simple which is why I am reverting to data. My database has information from many corporations around the globe. These are some of the largest, most respected and sought after companies as well as many medium and small businesses.  The data comes from OEM, EMS and distribution companies. Through data mining, I am finding a number of surprising relationships that I will report on over time. My current project is looking at the cost of being single sourced. I plan to publish these results through EBN in a few weeks when my analysis is complete. In the meantime, what is your opinion on single sourced premiums?

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