10.4 Tools: Price Analysis
Many commodities are sold in highly volatile markets. Prices go up and down—sometimes dramatically. In such a market, you might wonder, "Are you doing a good job of keeping costs down and avoiding risks?" To answer these questions, you want to perform a price analysis. Price analysis compares the actual price you pay to a general market price index. To conduct a price analysis, you simply compare your historical price—i.e., what you have paid suppliers over time—to market Data used to evaluate or compare to actual data reported in one of the following data sources.
-
Public databases like the Producers Price Index.
-
Commodity-specific indices such as the Global Wood Index.
-
Private industry databases, for which you typically need to subscribe (e.g., RISI, which is a leading database for the forest industry).1
Your goal is to assess whether you are lowering your costs vis-à-vis the market index. Your big challenge in conducting a price analysis is that your key data are expressed in different units of measure. For example, you might buy guava on a per pound basis whereas the benchmark is a compilation of market prices. To get around this measurement challenge, you simply convert both sets of numbers—actual price paid and market benchmark—to a percent of change over a specific period of time. Let's work through an example.
Scenario: Imagine you are a buyer of diesel fuel for your company's private delivery fleet. Your annual spend on the fuel is about $100 million dollars. Although you've had responsibility for the diesel buy since 2008, recent price volatility concerns you. In 2012, you locked in a three-year agreement with your current supplier. That contract is about to expire. Further, your annual review is coming up and you want to show your boss that you are doing a great job. Despite limited supply options, the market is very competitive. So, you can negotiate.
Step 1: Find a Benchmark
Find the benchmark market information—in this case, from the producer's price index (see Table 10.1).
Step 2: Obtain Internal Data
Download historical pricing information for all current suppliers from your firm's purchasing management system. Make sure the information is the same time period as your benchmark data (see Table 10.2).
Step 3: Make the Comparison
Calculate the year over year percent change for both historical and market information (see table 10.3).
Now that you've run the numbers, what is the story you are going to tell your boss? Don't forget, you took over in the middle of 2008 and entered a three-year contract in January of 2012, which is about to expire. Over the 10 years, your firm has performed well: Your prices have increased 153.3% compared to a 182.3% increase in market prices. Simply put, your prices increased 16% slower than the market. Since 2008, your prices increased by 44.6% compared to 86.6% for the market (i.e., 49% slower). Moreover, your three-year contract protected your firm from wild price swings (good job!). But, as market prices decreased the past two years, maybe you should have asked your supplier for a price reduction. You will want to keep this in mind as you negotiate your next contract. The question is, "With the market trending downward, should you lock-in another long-term contract?" Keeping your price analyses current can help you answer this type of question. However, one thing a price analysis doesn't help you do is dig deeper into individual cost elements. You need different tools—cost breakdown analysis and target costing—to do that.
Want to try our built-in assessments?
Use the Request Full Access button to gain access to this assessment.