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Are Your Prices Right?

Dec. 10, 2008
Adjusting pricing strategies could help manufacturers survive the economic crisis.

Playing the role of both buyer and seller, manufacturers live on both sides of the transaction. And what is perceived as a good price isn't always clearly defined. Now caught in the middle of a financial meltdown, many companies are finding out that determining the best price for their end products is just as important as what it costs to put them together.

Over the past year, the sliding economy has taken pricing in two distinct directions. When fuel and commodities prices soared, a significant number of manufacturers raised prices in order to offset the costs. As things have gotten worse, others have chosen to slash prices to retain a growing group of customers who were having trouble squeezing enough out of their budgets to still be considered customers.

Each of these decisions is usually made with the best information at hand, but it also depends on an executive's ability to reliably predict the future. In lieu of clairvoyance, Greg Cudahy, global managing partner of Accenture's supply chain strategy practice, suggests that companies start trending away from a long-practiced method called cost-plus pricing in favor of one that can better withstand increasingly volatile markets.

In cost-plus pricing manufacturers determine what it costs to make a product, then decide whether a specific price can be justified. In the new model, referred to as price-led costing, market price is determined during the earliest possible stages through a collaboration of sales and marketing, product development, plant management, and even procurement.

"If procurement can get involved early enough to determine whether you can produce at a profit, then the company can make better decisions when going to market, and ensure profitability," Cudahy explains. "Once market price is understood, procurement needs to respond quickly to the marketing side, to determine whether a product can be manufactured profitably."

Cause and Effect

"Manufacturers often have to endure price increases from suppliers, but buyers need to ask enough questions to understand how things like commodity spikes might influence a supplier's need to raise prices
in the future."

-- Len Prokopets, principal and leader of the sourcing and procurement practice for Archstone Consulting.

Of course, approaches differ slightly between new and existing product lines. If the price point is dropping on an existing product, procurement's role is usually to cut raw material costs and determine how to improve profit points. This starts with the marketing side of the organization and understanding where price points are trending.

"The organization as a whole might also need to decide whether taking a loss leader is acceptable," notes Cudahy. "Even then, procurement will need to provide answers on how to reduce the total delivery cost of a given product."

Procurement's role in setting prices for new products is particularly important in the current economy as well. Normally, once demand for a new product is established, it gets designed and procurement ensures that a reasonable cost point exists. The company eventually tries to sell the product at a high enough price to generate a reasonable margin. These days, however, normal rules might not apply.

"Now, rather than betting that you will get to the right price point, a marketing team will find out exactly how much customers are willing to pay for a specific product in the current economy," Cudahy says. "With that information, procurement can work with planning and design to determine how to manufacture the new product at the most cost-effective price."

But regardless of whether a company chooses to raise or lower prices to deal with economic instability, decisions can only be made with the information available at the time. So according to Cudahy, it's the thinking behind those decisions that might need to change. And when it does, companies will be armed with the flexibility to adapt.

"That means new levels of responsiveness, integration and collaboration for procurement that only a few companies have right now," he says. "And during this economic downturn, every company is going to need to develop those capabilities in order to survive."

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