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The Hedging Corner: Pricing choices for sales and profits
As discussed in last week's Hedging Corner, reliability, quality, and service have gone from being 'game changers' to 'admission tickets' for manufacturers to compete for new business, and hold on to what they have.
Tom Langan
July 12, 2011
3 Min Read
.svg?width=850&auto=webp&quality=95&format=jpg&disable=upscale "The Hedging Corner: Pricing choices for sales and profits")
, reliability, quality, and service have gone from being 'game changers' to 'admission tickets' for manufacturers to compete for new business, and hold on to what they have. It's not fair, but the evidence for this "unfairness" is clear; the latest provided by this study on a plastics processing, "Utilization of injection molding machinery is very low, averaging under 40% on a 24/7 basis" and "many companies routinely low-ball quotes to keep the presses running."
So product price is critical to new business, but must it be "low-balled"? That is, must manufacturers sacrifice profit for utilization? Not if they offer pricing choices that give customers cost certainty and price protection while providing reliability, quality, and service. Three such choices, common in energy markets, are:
Fixed price with no cost adder. The customer isn't exposed to higher commodities costs and you don't have to worry about passing them along.
Fixed price with no adder plus a floor, where the floor price limits or eliminates potential "buyer's remorse" for the customer at time of delivery.
Capped price. The customer pays the lower of the capped price vs. the market price at time of delivery.
Manufacturers may offer these choices (and others) alongside the Standard - a fixed price plus an "adder" to cover higher raw materials costs as they may occur over the life of a contract. The Standard protects the manufacturer but does nothing for the customer, a fact made known to many customers over the last six months.
Example: The House
Two reliable, reputable, and friendly contractors (A and B) want to sell you a house. The house will be constructed with special raw materials and be ready for occupancy in one year. Both contractors offer to 'deliver' the house for $200,000. Contractor A has a clause in his contract that allows him to pass along potential cost increases in raw materials during construction that, based on history and price volatility, may increase the cost of the house to $250,000. (Similarly, raw materials prices could fall and bring the price of the house down to $170,000, but $200,000 is the contract price.) Contractor B offers the same deal and three other choices:
$200,000 with no cost increases regardless of what happens with raw materials costs by the time the house is ready. You must take delivery.
$203,000 with a floor price of $190,000 in case the housing market collapses when the house is completed. If the market price of the house is less than $190,000 at delivery (e.g. $170,000), you are compensated the difference between the market price and $190,000. You must pay the incremental $3000 up front, and you must take delivery.
$5000 for a capped price of $210,000. Upon completion of the house, you pay the lower of $210,000 or the market price. You must pay the incremental $5000 up front, but you do not have to take delivery of the house.
As the customer in this case, which price choice do you prefer? More to the point, which contractor are you likely to work with? Most important, if you offered pricing choices to your prospective customers, wouldn't you capture more business?
Try It
Can resins suppliers offer pricing choices to processors? Yes. Can processors offer pricing choices to new and existing customers? Yes. Can suppliers or processors who offer pricing choices maintain profit margins? Most assuredly, if they use the right hedging tools.
Understand pricing choices; then test the market. If prospective customers are interested in pricing choices, offer them. You truly have nothing to lose; you've probably already lost customers to low-ballers and cheap offshore competitors. With pricing choices, you may just get some of them back - and capture a few new ones.
To learn more about pricing choices and how to implement them to benefit you and your customers, email me at [email protected].
Tom Langan is a risk management consultant who operates WTL Trading. His focus is commodity cost control, margin improvement, and revenue development for manufacturers and their customers.
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