WORKSHEET #20C: Setting Company Pricing Objectives and Guidelines
Step 1:
Determine the minimum Price at which the Company will serve a Non-core customer:
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Determine the cash cost per unit of sale of producing the Standard Leader product. The source for this information should be the financial department of the organization.
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Determine how these cash costs might vary as the Company serves customers of varying sizes (i.e. Very Large, Large, Medium and Small customers). Note here that the size of the customer for this calculation would be the purchases actually made from the Company. The source of this information is also the financial department of the organization supported, where necessary, by the operations groups.
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Develop a graph of the minimum price that the Company would accept to serve a customer who annually purchases a given amount of product from the Company. On the vertical axis would be the price per unit for the Standard Leader product. On the horizontal axis would be the size of the customer's annual purchases from the Company. The graph would be a line or a series of lines for the minimum acceptable price.
Step 2:
Determine whether the Company has sufficient capacity to serve all Core customer needs over the next two years. If it does not have sufficient capacity:
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Rank each Non-core customer according to the annual contribution dollars the customer makes to the Company's fixed costs and overhead.
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Estimate the capacity likely to be freed up as these Non-core customers leave us for other suppliers.
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If the Company still needs additional capacity, rank all Near-core customers according to the annual profit margin percentages they offer the Company, with the lowest profit margin percentage listed first and the highest listed last. If figures for profit margins are not available, you may start this analysis with gross margin figures, in percentage terms. Plan to raise prices to these customers in the order in which they provide profit margin percentages to the Company. Raise prices first on the Near-core customers who provide the lowest margin and last on the customers who provide the highest margins.
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If the Company still needs capacity in order to serve its Core customer needs, evaluate the possibility of purchasing product from other suppliers in order to keep Core customer demand satisfied.
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If the Company must eliminate some Core customer volume in order to support its most important Core customers, list all Core customers in the order in which they purchase from the Company with the customer purchasing the least amount from the Company ranked first and the company purchasing the greatest amount ranked last.
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If the Company believes that it might be successful with an allocation program with the Core customers, then plan an allocation program which provides a greater allocation to the larger customers than it does to the smaller customers.
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If the Company is unlikely to succeed with an allocation program, then raise prices to the Core customer purchasing the least amount from the Company first and proceed through the list by raising prices to each succeeding Core customer purchaser, ranked in order of purchases, until the needs of the largest Core customers are met.
Step 3:
If the Company has any control over pricing in a rising price environment, consider limitations on the degree to which prices rise, as follows:
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Evaluate the threat from substitute products by comparing the price of the Standard Leader product today to the substitute product. Make the same comparison in relative prices three years ago. If the substitute product has become cheaper, compared to the present Standard Leader product, this substitute product may be a threat.
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Evaluate the industry's return on investment at the new pricing level compared to average returns for all industries (see Tools/Benchmarks/Quartile Ranking Reports). If returns are high, consider whether these returns will attract competitors who are not in the market today.
Step 4:
Adjust the objectives for each Very Large and Large customer by considering the competitors who are in these customer relationships with us:
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If the market price is tending to fall, gather, on a regular basis, pricing initiatives for each competitor, and adjust the speed and degree of the Company's response to each competitor according to our prediction of the way the competitor will price in their relationship.
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If prices are rising in the market, the Company has little need to track individual competitor pricing tactics until price based competition re-emerges.
Step 5:
Establish guidelines for the use with all Medium and Small customers by setting minimum price and volume targets that the Company must reach to serve each of those customers. Use the conclusions from Step 1 to establish minimum prices for all customers in a declining price environment. In a rising price environment, the Company would choose to serve new Small and Medium customers only to the extent that it is likely to have capacity available to do so.