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Data Mining&Business Planning of Engineering/Research Projects

Data Mining&Business Planning of Engineering/Research Projects. Presentation 3 Dr. Gá bor Pauler , Associate Professor Faculty of Sciences, University of Pécs Tel:30/9015-488 E-mail: pauler@ t-online.hu. Content of the presentation. Marketing Mix 2 : For How much? P4 Pricing

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Data Mining&Business Planning of Engineering/Research Projects

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  1. Data Mining&Business Planning of Engineering/Research Projects Presentation 3 Dr. Gábor Pauler, Associate Professor Faculty of Sciences, University of Pécs Tel:30/9015-488 E-mail:pauler@t-online.hu

  2. Content of the presentation Marketing Mix 2: • For How much? P4 Pricing • Margin rate pricing • Business Planning, BusinessPlanner 2.0 Introduction • Basic business terms • Product Units, • Lower bound of pricing: Costs • Direct Unit Costs, • Direct Unit Cost, • Breakeven, • Fixed Cost • Upper bound of pricing: Demand • Demand function • Revenue • Variable Cost • Gross Profit • Pricing Range • Cash-Flow • References

  3. For How much? P4 Pricing • Even if you are 64 years old grandma selling goose in local market, you have to find out best pricing of your product. This is painful, be- cause pricing invoves the dirty words „numbers” and „mathema- tics” making most people cry. • Almost everybody knows that if Unit Price(Egységár) of a product is decreased, Demand(Kereslet) will increase and vica versa (ex- cept some special products eg. womens garment). The big question is, exactly how much it will change (D)? • This is very critical, because we already show how easy to cut your own throat with a price reduction if the following inequalty does not hold: DDemand,units × (UnitPrice,EUR/unit – Off,EUR/unit – UnitCost,EUR/unit) > Demand,units × Off,EUR/unit (3.1) • As for most people this is already difficult, the most widely used pricing method is fixed Margin Rate (Haszonkulcs) pricing, when we create the price according how much percentage of profit it should contain besides covering Unit Costs (Egység-költség). There are standards in every business and industry about these percen-tage (eg. 10% in agriculture..50% in tourism..75% in military industry): MarginRate,% = ( UnitPrice,EUR/unit – UnitCost,EUR/unit ) UnitPrice,EUR/unit (3.2) • However, this totally ignores demand: if unit price is too high, no one will pur-chase it, therefore you do not generate any Revenue (Forgalom). If you reduce unit price too low, you will sell plenty of units, but price may not even cover costs and you will make hard loss! • So, optimal pricing (Optimális árazás) is not a problem you can find out from crystall ball. Of course you can make pricing experiments on the market but in most businesses these will be bloody expensive experiments!!!

  4. Therefore you need Quantitative Business Plannning (Számszerű Üzleti Tervezés) and a specialized software to assemble it: The PaulerSoft™ BusinessPlanner 2.0: is an MS Excel-based business planner software, which – against the mainstream of business planners (eg. Business Plan Pro http://www.paloalto.com/ps/bp/ ) – stresses on the best possible statistical estimation of expected demand/ revenue/ profit of your product, fitting better to innovative products: It handles 4 type of product lifecycle (Termék-életciklus) models for better forecasting of future demand It helps to optimize pricing of your product through its whole lifecycle It helps to optimize financing your project with a requirement-based model: it does not use any standard credit construction of a commercial bank, but helps you to bargain with the bank the best payback schedule to minimize your interest costs Limitations of the system: It does not handle qualitative (Nem számszerű) business planning tools (eg. STEP, SWOT. See them in: Presentation 1) It does not optimize make-or-buy (Gyártsd vagy vedd) decisions and inventory management (Készletezés), because you can find range of enterprise resource management (ERP) systems (Integrált vállalatirányítási rendszer) on the market solving these problems Business Planning, BusinessPlanner 2.0 Introduction

  5. Basic terms:Product Unit, Direct Unit Cost, Breakeven, Fixed Cost • Before using business planner software, we have to clear some basic business terms first: • Unit price (Egységár) measured by Unit of the product (Termék Egység) can be pieces (Darab) or m, km, m2, m3, etc. • Lower bound of unit price are Costs (Költségek) of the product which have three big categories: • Direct Unit Cost (Közvetlen Egységköltségek) are proportional with product quantity sold in units (Eladott termék mennyiség, egységekben) (eg. material cost, pieceworker (Darabbéres) employees salary (Bér)). At complex products assembled from 1000s of components in 1000s of steps it is not very easy to figure out direct unit cost manually. Therefore we will use MS Excel based add-on for Business Planner 2.0, Budget Objects 1.0 to calculate it automatically. • Difference of unit price and direct unit cost is called Unit Breakeven (Egység-fedezet) of the product: UnitBreakEven,EUR/unit = UnitPrice,EUR/unit – DirectUnitCost,EUR/unit (3.3) • Fixed Costs (Fix kötségek) do not depend on quantity sold (eg. Development costs arise even if you cannot sell anything) • Time-Proportional Costs (Időarányos költségek) (eg. timeworkers salary, utility costs of your manufacturing plant, vehicles, etc.). Of course in the final balance, these costs should be also covered

  6. Content of the presentation Marketing Mix 2: • For How much? P4 Pricing • Margin rate pricing • Business Planning, BusinessPlanner 2.0 Introduction • Basic business terms • Product Units, • Lower bound of pricing: Costs • Direct Unit Costs, • Direct Unit Cost, • Breakeven, • Fixed Cost • Upper bound of pricing: Demand • Demand function • Revenue • Variable Cost • Gross Profit • Pricing Range • Cash-Flow • References

  7. Basic terms: Demand function 1 • Upper bound of unit price is influenced by Demand function (Keresleti függvény) of the product: how much units you can sell at a given unit price: Demand,units = BasketSize,EUR∕UnitUtility,EUR/unit× × Exp(1- UnitPrice,EUR/unit∕UnitUtility,EUR/unit) (3.4) Legenda: Estimation, Known data, Parameters Demand function of unit price is influenced by 2 parameters: • Unit Utility (Egység Hasznosság),EUR/unit: how big intrinsic value (Belső érték) customers asssociate to my product. It depends on: • Objective technical quality/features (Műszaki minőség/jellemzők): Eg. at Miracle Roof, it is very important to show for the customer that introducing the solution in his/her building(s) will generate reasonable savings in energy/ environmental costs to cover costs of investment and provides reasonable profit. It can be necessary to assemble a separate business plan for the customer at more complex products. • How well my product hits Customer Preferences (Vevői preferen-ciák), whether I try to sell it for the correct target market (Célpiac), for the correct market segment (Piaci Szegmens) (eg. we could try to sell Miracle Roof in wealthy suburbs (Gazdag elővárosok), they would have plenty of money to buy it. But in most cases they have sizeable garden anyway, so they won’t need it)

  8. Basic terms: Demand function 2 • Whether I try to sell it in the correct Place (Értékesítési csatorna) in the correct time (Időszak) • Whether the selected Promotion (Promóció) of the product conveys its objective benefits to the customer (Eg. you should sell Miracle Roof differently for a professional crop producer and a downtown yuppie seeking for recreational garden) • Basket Size (Kosárméret),EUR: how much money in total the target market would invest buying such a product category considering they get it at very low, Dumping price (Dömpingár). It depends on: • Population (Népesség) in the target market • Income- (Jövedelem) and Education (Képzettség) level of target market • The category of the product itself (Eg. roof carpentry business will never be even close to size of reinforced concrete structures or car industry) Of course, these parameters are unknown: We can find them out with statistic analysis of Market research (Piackutatás) data (see later). We will survey a representative sample of potential customers and ask them whether they are willing to pay given level of prices for the product. Summarizing, how much of them will, we can collect observed (UnitPrice,EUR/unit, ObservedDemand,unit) coordinate points (marked with ):

  9. Basic terms: Revenue, Variable Cost, Gross Profit EUR or unit Observed (UnitPrice, Demand)data 65,000 55,000 45,000 35,000 Revenue,EUR Variable Cost,EUR BasketSize, EUR Demand,units 25,000 15,000 Demand,unit GrossProfit,EUR 5,000 Revenue,EUR -5,000 10 20 30 40 70 60 80 90 50 -15,000 UnitPrice,EUR/unit Variable Cost,EUR DumpingPrice, EUR/unit -25,000 -35,000 ProfitMaxPrice,EUR/unit -45,000 Gross Profit,EUR -55,000 -65,000 • Then Business Planner will fit Demand function curve on observed points( ) finding its best fitting parameters. This way we can compute very important financial information: • We can compute Estimated Demand (Becsült Kereslet) at a given price: Demand,unit • We can compute Revenue (Forgalom),money inflow from retailing activity: Revenue,EUR = UnitPrice,EUR/unit × Demand,unit (3.5) • We can compute Variable Cost(Változó Költség) all costs proportional with retailing: VariableCost,EUR =DirectUnitCost,EUR/unit × Demand,unit (3.6) • Breakeven/Gross Profit(Fedezeti összeg/Bruttó profit)is difference of (3.5), (3.6): GrossProfit,EUR = Revenue,EUR - VariableCost,EUR (3.7) • BasketSize,EUR is the maximal amount of revenue can be extracted from market at… setting the price asDumpingPrice,EUR/unit = UnitUtility,EUR/unit • This is the lower bound of rational pricing:profit is very negative here.I can use dumping price to clean up competitors from market if I have enough capital to cover losses • Moreover, we can compute our Market share (Piaci részesedés): MarketShare,% = Revenue,EUR / BasketSize,EUR (3.8) • Upper bound of rational pricing: where gross profit of retail will be maximal: ProfitMaxPrice,EUR/unit = UnitUtility,EUR/unit + DirectUnitCost,EUR/unit (3.9)

  10. Content of the presentation Marketing Mix 2: • For How much? P4 Pricing • Margin rate pricing • Business Planning, BusinessPlanner 2.0 Introduction • Basic business terms • Product Units, • Lower bound of pricing: Costs • Direct Unit Costs, • Direct Unit Cost, • Breakeven, • Fixed Cost • Upper bound of pricing: Demand • Demand function • Revenue • Variable Cost • Gross Profit • Pricing Range • Cash-Flow • References

  11. Basic terms: Pricing Range The most suprising consequence of using demand function: there is no such a thing „optimal price”! Depending on what we are planning to do, we can move continuosly in rational pricing range (Racionális ártartomány): • If we have plenty of capital and our priority is to acquire market share quickly, we move toward dumping price (Eg. the Chinese try to push out anybody else from market with cheap, low quality copied stuff sold at dumping price. After eliminating competition they will raise price, harvest the market, and make profit from initial loss) In this case: DumpingPrice,EUR/unit=UnitUtility,EUR/unit (3.10) MaxRevenue,EUR = BasketSize,EUR (3.11) • If our priority is profit, we move towards profit maximizing price, however in this case our market share is often remains limited. (eg. Porsche sells luxury-priced high-tech sportcars and SUVs, while the 20-times bigger VW is a mass car manufacturer. But the profits they produce are in the same magnitude, and at the end of 2008 they battled (lead by Wiedking vs. Piech) about taking over (Felvásárol) each other: VW won only with minor difference) In this case: ProfitMaxPrice,EUR/unit = UnitUtility,EUR/unit + DirectUnitCost,EUR/unit (3.12) MaxGrossProfit,EUR = BasketSize,EUR × × Exp( -DirectUnitCost,EUR/unit ∕ UnitUtility,EUR/unit ) (3.13)

  12. Basic terms: Cash-Flow • Following strictly profit-maximizing pricing is effective if: • We financed the research&development (R&D) (Kutatás-fejlesztés K+F) cost of a groundbrea- king new innovation in the industry. Selling the new stuff at profit-maximizing price means har- vesting the high in-come+high expectations segment of the market before copiers step in. Then price of the stuff spectacularly goes down (eg. think about price of PC projectors at their market introduction and now…) • We would like to demonstrate our maximal abi- lity to make money towards the bank applying for loan (Hitel). • This ability is measured with Cash-Flow (CF) (Működési pénzáram): CashFlow, EUR = Gross Profit, EUR - Fixed Cost, EUR - Taxes, EUR - - Inventory Stuck, EUR - Investment Cost, EUR (3.14) Where: • Gross Profit, EUR: this is what we can get at profit maximizing pricing • Fixed Cost, EUR: to produce anything, we need to run plant, pay utilities • Taxes, EUR: we have to pay sales tax (ÁFA), corporate tax (VÁNYA) • Inventory Stuck, EUR: if we cannot sell inventory long time, thats our loss • Investment Cost, EUR:we need to invest new machinery, buildings, R&D

  13. References Demand functions: • Theory: http://www.sbe.csuhayward.edu/~clee/l2/http://www.econ.iastate.edu/classes/econ437/hayes/spring97/feb20/sld002.htm • Demand estimation in geoinformatics: http://www.gisdevelopment.net/application/Utility/transport/ma03085abs.htm Cash-flow analysis: • Theory: http://www.cash-flow-analysis.com/ • Wheatworks CF-analyzer: http://www.wheatworks.com/cashflowcalculator.htm Business planner software: • Business Plan Pro: http://www.paloalto.com/ps/bp/ • Hyperion: http://www.hyperion.com/products/applications/modeling_optimization/business_modeling/ • Silverrun: http://www.silverrun.com/bpm.html • Computer associates: http://www3.ca.com/Solutions/SubSolution.asp?ID=3819

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