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The Art of Pricing

Buyers want to get good value for their money, and sellers want a good return on what is sold. Coming to agreement on what price satisfies both parties involves a process of negotiation.

When someone buys, it is a cost; when someone sells, it is a price. Supply chain professionals are on the buy side so they are concerned about cost: Are their costs competitive, are there cost reduction opportunities, and are they getting good value for their spending?

If pricing is an art, it follows that there is no fixed formula that determines what a supplier will charge. If it were a science then there would be a formula that would predict price from a set of variables. I believe there is no such formula. I believe this because of the multivariate analysis that I do on FreeBenchmarking.com's pricing database where we attempt to correlate pricing with numerous factors that influence price.

The bottom line is that the price paid for an item is mostly set by the relative leverages of the buyer and the supplier. In other words, how badly do you want the supplier’s item and how badly do they want you to buy it? This means that one’s ability to get better pricing is directly tied to the ability to create leverage. It is interesting that premier athletes get their equipment for free (a really good price) as do famous rock musicians their instruments.

From the supplier side, leverage can be created to keep prices up through brand (for example, Gucci or Rolex), by technology differentiation (application-specific standard product silicon), or by creating end market pull (Intel Inside). All of these and other techniques have the impact of keeping prices high.

From the procurement side, leverage can also be created. There are the obvious means like consolidating volume, creating competition through multi-supplier sourcing, and long-term supply agreements, but there are many other factors that can be equally or more effective. One surprise from our multivariate analysis was that the volume relationship did not always lead to the best or even a better price; other factors dominate. These other factors align your purchase with what a supplier wants.

Let’s consider three things a company can do to create leverage with a supplier: 1) Agree to favorable payment days; 2) Link new design win awards to price considerations on production materials; and 3) Sell your company’s success path to the supplier.

Many companies have extended their payment terms with suppliers. They did not see a price increase when they did this, but they have also not seen subsequent price reductions that their competitors are getting. After all, cash is not free. Think about it: A supplier that has to meet payroll most likely values cash over margin. Paying in fewer days will not only improve price, but will most likely also improve access to constrained supply.

Linking new design wins to production price concessions requires coordination across R&D and operations organizations, but the results can be remarkable.

Selling your company’s success story to suppliers is an underused strategy. Get the supplier excited about the opportunity you are creating. If your company's story is compelling enough to have you continue to work there, it should be strong enough to get a supplier excited. Get them wanting to participate in your success.

10 comments on “The Art of Pricing

  1. Ariella
    February 3, 2011

    Is the old standard of net 30 no longer used? It was common to add on a discount for payment within 10 days for that.   

  2. Ken Bradley
    February 3, 2011

    Ariella, net 30 days is still used but I wouldn’t call it a standard.

    Many companies, particularly OEMs in telecommunications, have been pushed by their customers to longer and longer payment terms. In telecommunications it is   to help offset the high cost burden of deploying networks. These OEM have likewise pushed longer terms to their suppliers. Terms of 120 days are not uncommon.

    Astute companies take advantage of early payment discounts as well as reasonable payment days to get better pricing. Many companies, however, get cash constrained by their customers and lose out.

  3. Ariella
    February 3, 2011

    120 days is a very long time to wait for payment.  I would rather have the payment in earlier — even at a discount of 5- 10%.

  4. Anand
    February 3, 2011

    Ken Bradle,

     Dont you think Apple has started using the third stratergy (Sell your company’s success path to the supplier) recently? 

    http://www.ebnonline.com/author.asp?section_id=1071&doc_id=203635&

     

     

  5. Ken Bradley
    February 3, 2011

    Anandvy, it is hard not to be impressed by what Apple has achieved.

    I agree that any supplier aware of Apples story would want to be on their vendor list assuming that they can come to agreement on price.

    Apple is a great company and uses many effective approaches in their supply chain. Apple is an excellent example of a company with both differentiation and cost control.

  6. Barbara Jorgensen
    February 3, 2011

    I don't think a lot of folks in the industry appreciate the costs associated with waiting for payment. Distributors–which extended credit to customers during the downturn when no one else would–have long complained that terms vary from 30 days to 160 days. It costs money to lend money and in the electronics supply chian it doesn't seem like there is a mechanism built in to account for that. How about an incentive to pay in 30 days or less? Does anyone offer that?

  7. prabhakar_deosthali
    February 4, 2011

    For any company when it asks for credit from its suppliers, it has to extend similar credit to its dealers or distributors. If a fine balance is struck between your creditors and debtors then the duration of the credit does not matter , whetehr it is 30 days or 120 days. Many companies try to charge interest on delayed receipts but are unwilling to pay interest on delayed payments to their vendors. This creates a skew in their financial policy and long term it harms the company's business. Hence the supply chain professionals of any company should work hand in hand with their sales people to match the  Credit given vs the credit asked for. The top managment must play the middleman's role to strike this balance of payments.

  8. Mydesign
    February 4, 2011

        Ken, that’s purely depends up on the pricing policy of companies and negotiation power of customers. I know some companies which have a fair pricing policy with the vendors. That means if you are going for ready cash purchase, then only you can avail the negotiated price, otherwise they will start the discussion on MRP pricing policy. If the vendors are agreeing for MRP, they have time till 125 days without interest components.  Even some companies are offering guarantees against the credit notes of vendors.

        One way it’s good for both the companies and vendors, they will get enough time for rolling and arranging the money. At the same time, one side (companies or vendors) are increasing their profit with others cost. It’s all marketing strategy and a chain process and may continue still they have faith and trust on each other.

  9. mfbertozzi
    February 4, 2011

    I agree with positions telling about extra-costs in delaying payment and two way credit. The art of pricing found pragmatic applications by firms which have tried to setup a pervasive negotiation process within the whole ecosystem involved in their business instead of a limited one-to-one process with each one supplier or buyer. Since the beginning Apple applied exactly that strategy.
    Then the question is: it is a path still valid abroad take in consideration how is uncertainty financial and political situation in such regions?

  10. Ken Bradley
    February 4, 2011

    I have two thoughts on credit balancing. The first is that, as a supplier, one is lending on price whereas, as a customer, one is borrowing on cost. Depending on a company’s margin this could be a 3X difference making balancing difficult. The second thought is that attempts at balancing may work in the middle of a supply chain but not at the end. In the telecom example, operating companies are not extending credit to customers but they are demanding long payment terms from suppliers. Try getting 120 day payment terms on your phone bill! The balance equation falls apart here.

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