Pricing is an important pedal for increasing supply chain profits through a more concerted effort of matching supply and demand. Tied to pricing, for better or for worse, is revenue management. Together they can increase the profit generated from a limited supply of assets. Revenue management suggests using pricing to gain a semblance of balance between the supply and the demand. Once this balance is acquired or met then can invest in or reduce assets – capacity and inventory.
Pricing has a significant impact on the supply chain profits when one or more of the following conditions are met:
- The value of the product varies in different market segments
- The product is perishable or waste occurs
- Demand has seasonal and other peaks
- The product is sold in two ways – bulk and or sole item
To debate and analyze pricing we will discuss tow strategic pricing strategies – Everyday Low Pricing and Hi-Low Pricing – from this point forward known as EDLP and HLP. There remains a large difference of opinion concerning the effectiveness of these strategies. EDLP charge a consistenly low price ignoring price discounts. This strategy avoids risk while simplifying forecasting, allowing for better customer service and reduces labor costs.
HLP sets prices that discount selected items to clear slow moving inventory. It can be argued that manufacturers with a single ordering decision with the option to reduce initial prices are more profitable than those manufacturers who keep a fixed price.
However, there are two major drawbacks to both of these strategies. Most if not all HLP research is focused on the retail industry. This assumes that item costs are independent of demand. The manufacturing level of the supply chain and the cost adjustments – overtime, hiring, training, subcontracting and inventory carrying costs - have been largely ignored. EDLP studies have been based upon items with fairly steady demand. Items such as clothing, toys and sporting goods are based upon seasonal patterns and EDLP will fail to stabilize those demands.
My goal is to address identify operating conditions – demand patterns, demand amplitude, customer price sensitivity, production change cost structure and promotional cost structure – which favors pricing strategies in manufacturing supply chains.
There may be other environmental factors favoring one pricing strategy over another but that assumes performance criterion is complete supply chain profitability. Here, I will introduce a three level supply chain model for a single product. This model will allow us to compare alternative pricing methods in the supply chain.
The proposed model spans manufacturing sectors, multiple periods and can be constrained to simulate a variety of operating environments. Key limits are manufacturing level costs such as labor costs, production change costs, limitations and production rates. Some variables are replenishment orders to the manufacturer and the manufacturers’ short term capacity to meet those orders.
The model has several assumptions. Let us assume an open market with seasonal and price-sensitive demand. The role of the manufacturer is to set a sell price for each product and to order nough to satisfy forecasted and customer demand. These forecasted decisions will influence demand, revenue, and inventory costs. Secondly, EDLPis chosen to maximize profut throughout the entire supply chain.
A manufacturer with short term capacity constraints, should produce sufficient quantities to satisfy the chronological demand in the replenishment plan. The manufacturer can use a combination of production planning strategies – overtime/undertime, workforce level changes, inventory – to fill orders at minimum cost. Since the interest should be with total supply chain profitability transfer pricing between the manufacturer and supplier are at cost.