The two most important economic objectives of any business are first survival, and then profit. Obtaining materials at the right price, therefore, is important. It literally can mean the difference between a firm’s success or failure.
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Professional buyers interpret the right price to mean a price that is fair and reasonable to both the buyer and seller. There is no magic formula for calculating precisely what constitutes a “fair and reasonable price.”
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The purchaser must carefully consider what choice he has when he embarks on a purchase-what is the availability of various purchase-what is the availability of various products, their quality and their prices.
It is the ultimate payable price that counts and therefore, he must consider all relevant factors viz., taxes, insurance, packaging, handling, transportation, etc. before arriving at the least cost.
At the same time he must take a broad, objective and overall view. A low price with erratic delivery or poor after sales service is obviously not the right price. Further, the price must be fair both to the purchaser and the seller.
Factors Affecting Right Price/Variables Considered While Reaching at Right Price:
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The right price for one vendor is not necessarily the right price for any other vendor, at either the same or at different points of time.
To determine the right price, for any specific purchase, a number of constantly changing variables and relationships must be evaluated. These variables are as follows:
1. Conditions of competition
2. Reasonable profit.
1. Conditions of Competition:
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There are three types of competition, i.e.
(a) Pure Perfect Competition
(b) Monopolistic Competition
(c) Imperfect Competition.
At the one end of the scale is pure or perfect competition and at the other imperfect competition.
(a) Pure Perfect Competition:
In this type of competition the laws of supply and demand regulate prices. The forces of supply and demand alone, not the individual actions of either buyers or seller, determine price.
(b) Monopoly Competition:
Under conditions of monopoly, one seller control the entire supply of a particular commodity, and thus is free to maximize the profits by regulating output and forcing a supply demand relationship that is most favorable to him.
(c) Imperfect Competition:
The competitive area between the extremes of pure competition and monopoly is called imperfect competition. If there are few sellers an oligopoly is said to exist as in steel, automobiles, automobile tyres, aluminum industries.
On the other hand, there may be many sellers trying to sell many products each trying to persuade the buyers that his product is superior. It is in this type of competition that a purchaser can exercise maximum influence and secure for his company prices which are really competitive.
The pricing structure of most firms is such that it possible for them to adjust their prices. There is little scope for negotiations in markets of pure competition or monopoly. But for shrewd purchasers there is considerable scope to effect price economies in the markets of imperfect competition provided they exercise their mind in analysing prices.
2. Reasonable Profit:
There are no precise formulas which can be used to help form a positive judgement concerning the right price (of which profit is one component: price = cost ± profit). There are, moreover, certain basic concepts of pricing on which scholars and practitioners do agree.
One objective of sound purchasing is to achieve good supplier relations. This objective implies that the price must be high enough to keep the supplier in business. The price must also include a profile sufficiently high to encourage the supplier to accept the business in the first place and second to motivate him to deliver the materials or services on time.
In a competitive economy, the major incentive for more efficient production is greater profit and repeat orders. A fair profit in our society therefore cannot be determined as a fixed percentage figure. Rather it is a flexible figure that should be higher for the more efficient procedure than it is for the less efficient procedure.
Low-cost procedure can price lower than their competitors, while simultaneously enjoying higher profits. Consequently, one of a buyer’s greatest challenges is constantly to seek out the efficient, low-cost procedure.
Profit calculated as a fixed percentage of cost is not realistic as it gives a greater reward to an inefficient producer. Profit calculated as a fixed percentage of capital investment is also not satisfactory as, here also, an inefficient producer reaps a higher reward.
Profit should be so flexible as to benefit an inefficient manufacturer more than a less efficient manufacturer. The purchaser must be constantly on the lookout for the efficient low cost producer.
Apart from efficiency there are other considerations too. Important among these considerations are:
1. A supplier who takes a risk in producing new products is entitled to higher profit.
2. If the size of the order is small, higher profit has to be allowed as unit cost of production will be higher. On a large order smaller profit will be adequate.
3. A supplier who takes the risk to manufacture and supply materials to his own design should be allowed higher profit than a supplier who manufacturers and supplies stores to the purchaser’s design or another company’s design.
4. Suppliers who are reliable who supply quality goods and deliver materials on time must be allowed higher profit.
5. Suppliers who offer technical assistance resulting in better design and specifications should earn more profit.
6. Profit is a reward for efficiency. A more efficient producer deserves a higher profit.
7. Materials, production of which requires highly skilled technicians are entitled to higher profit.
The profit a purchaser allows a supplier must induce him to take a contract and to perform it as efficiently as possible give good quality, deliver on time, provide satisfactory after sales service etc. If it does not induce the supplier in this manner, the profit is too low.