Maximizing Product Profits Amid Purchase Price Analysis Challenges
Securing product profits despite purchase price analysis
Sellers often face significant price pressure when their products are easily comparable to those of their competitors. This is particularly true for companies involved in discrete manufacturing, where products can be clearly defined and distinguished from one another.
Buyers in this market have access to a wide range of cost analysis methods and systems, allowing them to thoroughly evaluate and scrutinize the costs associated with their suppliers' products. However, as we'll explain, just because price variances can and should be analyzed, going a step further and taking action is critical. First, let's start by explaining the concept and a bit of the background on the topic.
Methods of purchase price analysis and target price determination
Various methods of purchase price analysis and target price determination, such as "should costing," "benchmark costing," "target costing," and "cost engineering," are employed to achieve the lowest possible purchasing price for a product. Each method involves employees from the purchasing company calculating the costs of the products to be procured.
To accomplish this, they create bills of materials and routings as a theoretical basis for determining material consumption, labor costs, production expenses, and overhead rates. These calculations are typically based on idealized process data for production and logistics, which are referred to as "greenfield planning." This approach simulates optimal production conditions to minimize costs and maximize efficiency.
However, it's important to note that these ideal conditions are seldom encountered in real-world scenarios. As a result, there may be discrepancies between the theoretical cost calculations and the actual costs experienced during production. Companies must be aware of these potential differences and adapt their purchasing strategies accordingly to ensure accurate price analysis and target price determination.
Cost simulation systems- purchase price analaysis
Since the late 1990s, software systems have been available to assist with the calculation of purchase prices. These systems typically include databases containing machine hour and labor cost rates for all standard manufacturing processes. Additionally, they feature industry-standard overhead rates and process times for various production processes.
Large companies practicing "open book accounting" with their suppliers often generate this data from cost analysis tables or cost breakdowns provided by their suppliers. These breakdowns are typically completed using Excel spreadsheets or web pages, and the data is then uploaded to database tables for storage and analytical purposes.
Such software systems enable companies to efficiently track and analyze costs associated with their manufacturing processes. By collecting and organizing data from suppliers, companies can better understand the cost drivers in their supply chain and make informed decisions regarding purchasing strategies and negotiations.
These advanced software systems facilitate greater accuracy in calculating purchase prices and promote transparency between suppliers and buyers. This collaborative approach can lead to improved relationships, enhanced communication, and, ultimately, more successful business partnerships.
Strengths and weaknesses of purchase price analysis
The methods and systems mentioned above help buyers better understand the value of the products they purchase. Comparability of the costs and processes of different suppliers enables a better assessment of quality and sustainability.
Regarding the accuracy of costing, weaknesses are usually well-known. In general, cost rates are not directly comparable or interchangeable. The investment in, for example, a machine tool is determined by individual factors of the company, which are reflected in the machine equipment costs and the machine's periphery.
Thus, there is no such thing as "the" machine hourly rate for a machine type. Other cost parameters that interact are productivity, logistics, capacity utilization, and the current production program of a supplier. These are not ascertainable by external parties and are usually calculated or estimated with ideal values.
Suppose the calculator of a purchase price has no qualified expertise to assess the manufacturability of a product correctly. In that case, differences arise in determining manufacturing processes, production times, and scrap. As a result, suppliers face target costs and prices that do not allow for sufficient profit margins.
What actions can product manufacturers & sellers take to increase product profitability?
What can sellers do to achieve a sufficient profit margin under the above conditions?
First of all, it should be noted that costs do not primarily determine a sales price but a price floor.
In the case of long-term supply contracts, in addition to covering the cost of goods sold, this must guarantee a profit that ensures the maintenance of the company's substance plus the achievement of growth targets.
The sales price to be negotiated is ideally based on the market price, which results from the relationship between supply and demand. In many cases, one hears again that the order cannot be acquired if the customer's target price is not agreed to. This strategy should not sway one. Sales countermeasures should be designed for the long term.
These measures include:
Accurate full and partial cost accounting
Comparison of planned and actual costs during the year at the cost center and product level
Taking into account planned and actual capacity utilization
The examination of the routings and the parts lists
The control and management of productivity
Checking of call-off frequencies and quantities.
An exact, reliable knowledge of the origin of product costs in cause and effect forms the basis for reliably evaluating and assessing target prices. Under no circumstances should costs be arbitrarily adjusted to prices.
One often hears, "We cannot sell at these costs; therefore, we must reduce our cost rates." However, recalculating cost rates should only be done if rationalization measures are identified and implemented- otherwise, targeting lower, unrealistic costs is a sure path to unprofitability.
In such a competitive environment, sellers must adopt strategies that set their products apart and justify their pricing. In addition, below are some complementary approaches that can help sellers overcome price pressures in markets with comparable products:
Focus on product differentiation: Develop unique features, capabilities, or designs that distinguish your product. You can justify a higher price point and mitigate price pressure by offering something distinct.
Emphasize value-added services: Offer additional services, such as personalized customer support, training, or maintenance, to enhance the overall value of your product offering. This can help justify a higher price and encourage customer loyalty.
Establish a strong brand reputation: Build a reputable brand that customers associate with quality, reliability, and trust. A strong brand can command a premium price and reduce the impact of price pressure.
Leverage technological innovation: Invest in research and development to create cutting-edge products with advanced features or superior performance. Innovative products can command higher prices and differentiate your offering from competitors.
Implement cost-saving measures: Find ways to reduce production costs without sacrificing quality. You can maintain profitability even under price pressure by streamlining processes and increasing efficiency.
Enhance product customization: Offer tailored solutions that meet individual customers' specific needs and preferences. Customized products can command higher prices and help you stand out from competitors.
Build long-term customer relationships: Focus on cultivating strong relationships with your customers by understanding their needs, providing exceptional service, and maintaining open lines of communication. This can lead to repeat business and referrals, reducing the impact of price pressure.
Collaborate with suppliers: Work closely with your suppliers to identify cost-saving opportunities and negotiate better pricing. This can help you maintain profitability in the face of price pressure.
Offer strategic pricing options: Provide various pricing options, such as tiered pricing, discounts for volume purchases, or promotional offers, to cater to different customer segments and price sensitivities.
Communicate your value proposition: Clearly articulate the benefits and advantages of your product, emphasizing its unique selling points and the value it provides to customers. This can help justify your pricing and counter price pressure.
By employing these strategies, sellers can navigate the challenges of price pressure in markets with comparable products and maintain profitability while delivering value to their customers.
Maximizing Profits Amid Purchase Price Analysis Challenges- Conclusion
Regularly evaluating the customer's target prices in relation to the company's cost structure provides valuable insights into the precision of the customer's purchasing price analysis and the effectiveness and direction of their strategy. By understanding these factors, businesses can make more informed decisions when developing their pricing strategies.
Consistently assessing the customer's target prices in the context of the company's cost structure is crucial for informed decision-making and developing pricing strategies that secure long-term profitability. This proactive approach helps businesses maintain a competitive edge while ensuring the sustainable growth of their profit margins.
