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Putting the Volume-Price Myth to Rest

Out of capacity, lead times at 44 weeks, and price increases: Sounds familiar? Since my blog on volume vs. price last month, there's been a continuing discussion of what sets the pricing of electronic components, starting with the question: “If not volume, then what?” I will share here some thoughts on component pricing, starting with these observations:

  • There are significant differences in prices across industry segments. Components sold into the medical devices and military segments tend to have higher prices than components sold into consumer markets, even when there is no difference in the component, its spec, or its attached services.
  • Prices drop when second sources are brought into the picture.
  • Negotiations yield better prices. Why should this be if there is a curve that suppliers stick to?
  • There are huge price variations across geographies, more than can be explained by logistics costs and duties.
  • There are multiple channels to market, each having its own pricing profile.
  • Margin targets of manufacturers and suppliers are not fixed. They vary by market segment, product type, and customer, among other factors.

Now for some thoughts on the above.

What determines price more than anything is how badly the supplier wants your business, and that determines the margin that a company is willing to accept to clinch the sale. When shortages occur, short-term thinking companies raise prices because they have lots of alternatives to your business. Make sure you have alternatives to theirs.

Salespeople are usually given margin targets (maybe disguised through price lists) that allow local negotiation of price. These prices may be acceptable, but, if not, the pricing decision goes back to the manufacturer and its executives to decide what they want to do. This decision is not a simple one as they must consider how important the customer is to their business, the total current and future business potential, the margin dollars associated with this opportunity, how losing this business would help a competitor, and other such factors.

After deliberation, they set the pricing. They may choose to leave pricing and quotes as they are; they may base new pricing on total margin dollar contribution; or they may enter into loss territory if they see the opportunity as a must-win and believe through cost management activities they could maintain their profits. These are not easy management decisions. Margin percentage correlates with stock price, while margin dollars are linked to cash. Which is the priority in the company, and does it change with time?

A supplier may want your business because you are a recognized technology leader or early technology adopter, your total business potential may be substantial, you may represent an entry opportunity to a new market… lots of reasons. Or you may be stuck with no options or leverage and must take what is offered. The price range created by the best case and worst case imaginable in these scenarios is quite large.

The next significant factor affecting price is who else wants your business, and what they are prepared to do to win it. This puts on the table a second set of numbers driven by a different set of constraints and supplier strategies. Competition always yields better results. Industry segments where substitution is difficult pay a premium.

The third thought concerns relationships. Businesses are run by people and people-to-people relationships matter in a tangible way. When a supplier has jumped through hoops to meet your needs did you say thank you? Are you seen as thorough and fair or arrogant and arbitrary? Your behaviors influence how people feel about you and how hard they will work on your cause. Beyond this, there are executive relationships, old boys' networks, and other forms of networking that influence inter-company relationships.

At Freebenchmarking.com I don't have visibility into which mechanisms yield any company's price, but I do see the results. There is a wide variation in pricing, but there is no apparent price-volume curve.

2 comments on “Putting the Volume-Price Myth to Rest

  1. Barbara Jorgensen
    June 5, 2012

    Ken: Your first point regarding mil/medical is worth a follow-up blog at some point. As more militray and medical companies move from specialty to commercial off the shelf, this disparity should vanish. Yet it hasn't, and I expect it is becuase the market will bear more expensive components, meaning people expect to pay more so vendors charge more. That's one of the reasons counterfeiters target the militray marekt, becuase the components are considered high-value, whihc in this case means high-cost.

  2. Ken Bradley
    June 5, 2012

    Barbara, I would argue that even with the military's move towards using commercial components, the amount of time taken by the approvals processes for military and medical applications will make substitutions difficult and limit price reduction success.

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