The Price Change Equation

The late Richard Beckhard, industrial psychologist and adjunct professor at the MIT Sloan School of Management, developed an equation for change. He called it a “change equation” when really it was its vector equivalent — progress — but as he's not a physicist, he can be forgiven.

His equation describes how to achieve change in a positive direction. Three factors are multiplied together to achieve change. Being a multiplication product, if any factor is zero, the result is zero, and change won’t occur. The three factors are a desired future state; an unsatisfactory current state; and some critical first steps to create some momentum. If the multiplication product is greater than the resistance to change, change will occur.

The formula is: (C=a.b.c>R) .

This same formula can be applied to pricing, once the appropriate factors are identified. In my previous blog, I described target pricing as a desired future state. (See: Calling the Shots in Component Pricing.) So one of these factors, current pricing, is quantifiable through benchmarking; along with target pricing and some critical first steps, this would make the Price Change Equation:

Price change = target pricing x benchmarking x critical first steps > supplier resistance.

The price change equation is a useful model to prepare for price negotiations between suppliers and customers. Being unsatisfied with current pricing and having targets to guide your suppliers makes a difference in your negotiating leverage. You will push harder for improved pricing if you know current pricing is out of line and if your targets allow salespeople to go back to the factory to try for a better deal. Often the regional salespeople are frustrated because the factory is out of touch with competitive pricing, and it uses your targets as a tool. That can be the difference between true progress and random change.

What steps can be taken to create pricing momentum and reduce supplier resistance? Benchmarking and target setting are two good first steps. Another step: Provide an annual forecast to your supplier and tell it your company's story. This will help suppliers see the long-term advantage of working with you. Both of these efforts increase momentum and reduce resistance.

Creating leverage also addresses momentum and resistance. A supplier that wants your business will be less resistant than one that doesn’t care. How you pay your bills, your payment terms, and your reputation will all play a role in how the equation plays out. Other factors such as volume or supply chain design can also work to your advantage or disadvantage.

Tools such as the gold report can help with target pricing and benchmarking, as well as other factors that can create leverage and better pricing. The report provides component-level detail for your most out-of-line components and advice on the pricing you should be getting, given what your company has achieved on its more competitive negotiations. The report also benchmarks the commodities that are your worst performing, to provide you with specific areas to focus on.

I look forward to discussing these and other factors related to price competitiveness and leverage during the EBN LiveChat scheduled for March 10.

2 comments on “The Price Change Equation

  1. Mydesign
    March 4, 2011

        Ken, many of the companies has a fair pricing policy by considering different factors like basic cost of the raw materials, employee’s wage, ROI for investment, marketing and profit. As we know companies and marketing guys are struggling too much to find out a place to sell their products. So auction, online sales and bargaining are the different options in front of the marketing people to promote a sale. In one way it’s gives a cost effective end product to the customer, who care least about the quality. Those who are really bothered about quality may get suffered. For reducing the price, the seller or company can compensate only up to certain extent in their margins. So the next option for them is to compromise in terms of quality, up to some extent and this is the usual thing happens in marketing side. 

        So it’s the hard time for companies, to come up with some cost controlling mechanism rather than compromising the quality.  In my opinion they can collect the necessary components from different countries, where they are cheap and finally assembling in another country where labour cost is less. In this way they can also have a global presence. But this may not be suitable for all cases and may vary from case to case.

  2. Ken Bradley
    March 4, 2011

    Toms, I don’t accept a compromise quality argument being tied to price negotiation. I might accept it being tied to a supplier’s corporate performance in tough financial times but, even here,  those that would compromise quality were likely not all that strong with quality in the first place.

    My comments are based on my experience in electronics component technology development, manufacturing and procurement. Companies do not change their quality policy or philosophy because of a price negotiation. I do see companies undertaking cost reduction activities through redesign or materials substitution when competitiveness dictates but these changes are put though stringent quality assessments and verifications. This is the case for any company I would want to work with or recomend.

    It is quite telling to see the range in margins that companies operate with across products and across customers. If our readers works at an OEM, check with your companies sales department and see how wide this rand is on actual custoner sales. At FREEBENCHMARKING.COM, we see this range reflected in client prices for the same items from the same suppliers.  The range is huge! I want to ensure that the EBN readership understands that my comments are based on achieving better pricing on the same components from the same suppliers using the same channel and without compromising any other attribute or aspect of the suppler relationship.

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