Multimedia Marketing/Marketing.iso/market/chapter8.7p

Text File | 1996-08-22 | 18KB | 388 lines

SECTION 8.7  Transportation Cost

INSTRUCTIONS Attempt to envision all of the factors that determine who pays
for transportation costs of products--the buyer or the seller?

EXAMPLE

A cement producer located in the Rocky Mountain area experienced
considerable difficulty for many years in penetrating markets in
the Pacific coast area. The producer required that its customers
pay the full cost of transporting the cement from the plant to
the customers' sites. This meant that the producer was price
competitive in a region within approximately 300 miles from the
plant, but was not competitive in the Pacific coast area.

Management decided that the market in the Pacific coast area was
growing at too fast a rate to be ignored. Accordingly, the company
agreed to pay for half of the freight for items shipped into this
region. According to management's calculations, this would make
the company price competitive. On the other hand, it was somewhat
of a gamble, because it would drive up the firm's costs. After six
months the cement company decided that it was a gamble worth taking.
The delivered price reductions enabled the firm to gain a strong
position in the market and the net effect was a gain in company
profits.

DETAILS

An important question for management to answer is "How should
transportation costs be treated when pricing a product?" Should
the company expect a buyer to pay for shipping costs as a separate
item? Perhaps buyers should be left to worry about arranging and
paying for transportation entirely. Yet, an important way to
increase an item's worth to buyers is for management to provide
this service to customers and set prices to cover the additional costs.
For many companies the answer to these questions is an integral part
of establishing marketing strategy and determining the pricing
component of the marketing mix.

There are various ways of treating transportation costs. This section
examines the major ones.

A frequently encountered term in marketing is F.O.B., which means
"free on board". Because quoted prices may or may not include
transportation charges (especially for institutional sales), it is
often necessary to state the price at a given location.

To avoid confusion, companies use the term F.O.B. to clarify who is
responsible for which portions of the transportation costs. F.O.B.
identifies the location where the seller's responsibility to cover
transportation costs end. Thus, to make F.O.B. meaningful, one must
also name a place. There are several possibilities. Assuming that
the seller is located in Kansas City:

1. The seller assumes no responsibility for freight. The term "F.O.B.
   factory" would be appropriate.
2. The seller pays for loading onto railroad cars, but no more. Terms
   such as "F.O.B. railhead" or "F.O.B. Kansas City" would describe
   this situation.
3. The seller assumes freight responsibility up to the nearest
   large city to the buyer. A term such as "F.O.B. Chicago" or
   "F.O.B. Los Angeles" would be used.

4. The seller pays for all freight and unloading at the nearest
   major transportation center, but no more. A term such as "F.O.B.
   unloaded Atlanta" would be appropriate.

5. The seller pays full freight charges to the buyer's location.
   Then terms such as "F.O.B. delivered" and "F.O.B. buyer's
   warehouse" are descriptive.

There are many such possibilities. Clearly, the specific terms have
an effect on the total price that a buyer pays. "F.O.B. factory"
for example, means that the buyer also must do the work to arrange
transportation and insurance during transit.  If the goods are
damaged in transit, the loss falls upon the buyer. It is clear that
transportation costs and terms definitely play a significant role
in affecting the price of a product offering.

PROBLEM 1

An industrial purchasing agent is ordering a shipment of chemical
supplies. Which of the following terms would be most favorable to
this buyer?

A. F.O.B. factory.
B. F.O.B. delivered
C. F.O.B. railhead.
D. F.O.B. seller's warehouse

WORKED

If an industrial purchasing agent is ordering a shipment of chemical
supplies, the most favorable terms would be F.O.B. delivered. In
this case the seller pays full freight charges to the buyer's location.
In addition, the seller would have to do the work to arrange
transportation and insurance during transit. In the case of F.O.B.
factory, the buyer would have full responsibility for transportation
and insurance. If the terms are F.O.B. railhead, the seller would
pay for loading onto railroad cars, but no more. For F.O.B. sellers
warehouse the buyer would have responsibility for transportation
from the seller's warehouse onward to the buyer's destination.

ANSWER  B
INSTRUCTIONS Attempt to envision all of the factors that determine who pays
for transportation costs of products--the buyer or the seller?

EXAMPLE

A cement producer located in the Rocky Mountain area experienced
considerable difficulty for many years in penetrating markets in
the Pacific coast area. The producer required that its customers
pay the full cost of transporting the cement from the plant to
the customers' sites. This meant that the producer was price
competitive in a region within approximately 300 miles from the
plant, but was not competitive in the Pacific coast area.

Management decided that the market in the Pacific coast area was
growing at too fast a rate to be ignored. Accordingly, the company
agreed to pay for half of the freight for items shipped into this
region. According to management's calculations, this would make
the company price competitive. On the other hand, it was somewhat
of a gamble, because it would drive up the firm's costs. After six
months the cement company decided that it was a gamble worth taking.
The delivered price reductions enabled the firm to gain a strong
position in the market and the net effect was a gain in company
profits.

DETAILS

The term "uniform delivered price" means that the seller charges
one final price to all buyers, regardless of their location. The
seller assumes all costs for transportation. Firms whose shipping
costs are relatively insignificant often use uniform delivered prices,
which also permits national advertisements to include a product's
price since it is the same for everyone.

"Zone prices" are charged when the seller divides the total market
area into separate zones. A uniform delivered price is charged to
all customers within each zone, but the prices vary between zones,
depending on each one's average shipping costs. Many mail order firms
use this technique. They believe that assessing shipping costs by
zone makes the calculation of transportation charges by buyers
relatively uncomplicated.

The term "freight absorption" means that the seller pays (or absorbs)
some of the transportation costs that customers would otherwise have
to assume. With freight absorption, sellers are able to compete on
the basis of delivered price in distant locations where competitors
are located.

In some industries such as automobiles and steel, a somewhat unusual
pricing method has been used at various times. It is called "base-
point" or "basing point". With this system, one or more competitors
recognize a particular set of locations as shipping points or base
points.

A seller charges each customer for freight under this system, but
the charge is from the nearest base point, regardless of the
shipment's origin. The number of base points varies from industry
to industry.

In the case of a single base-point arrangement, sellers recognize
only one location as a common origin. Historically, auto manufacturers
have used such a system, with those headquartered in Detroit choosing
that location as the base point; even if a car was built in San Jose,
a California customer would pay freight from Detroit. Generally the
Federal Trade Commission has ruled that most single base-point systems
are illegal, because they involve collusion between competitors.

In the case of a multiple base-point system, two or more base points
are identified. Such systems are generally legal because they
encourage competition between different manufacturers. However,
management must be careful to avoid "phantom freight", which refers
to charging for freight that exceeds actual transportation costs.
This process is illegal. Phantom freight can occur when customers
are far from base points but relatively close to actual points of
origin for shipments.

PROBLEM 2

A  mail order book company regularly charges uniform delivered
prices to all customers. The reasons for doing this probably include:

A. National advertisements can include the book company's price.
B. This will allow the company to be competitive in areas near
   its warehouse.
C. This will ensure that all transportation costs are paid for by
   book buyers.
D. This is less expensive to the book company than would be F.O.B.
   factory.

WORKED

A  mail order book company regularly charges uniform delivered
prices to all customers. The reasons for this probably include
that national advertisements can include the book company's price.
Book purchasers are price conscious and many like to know what
will be the total cost delivered to them, without having to make
detailed calculations to find out what delivery charges will be
levied. This can be avoided by simply advertising the delivered
price. This facilitates comparison, by consumers, of the cost of
ordering through the mail order house as contrasted to buying
books in a bookstore or through another mail order house.

ANSWER  A
INSTRUCTIONS Attempt to envision all of the factors that determine who pays
for transportation costs of products--the buyer or the seller?

EXAMPLE

A cement producer located in the Rocky Mountain area experienced
considerable difficulty for many years in penetrating markets in
the Pacific coast area. The producer required that its customers
pay the full cost of transporting the cement from the plant to
the customers' sites. This meant that the producer was price
competitive in a region within approximately 300 miles from the
plant, but was not competitive in the Pacific coast area.

Management decided that the market in the Pacific coast area was
growing at too fast a rate to be ignored. Accordingly, the company
agreed to pay for half of the freight for items shipped into this
region. According to management's calculations, this would make
the company price competitive. On the other hand, it was somewhat
of a gamble, because it would drive up the firm's costs. After six
months the cement company decided that it was a gamble worth taking.
The delivered price reductions enabled the firm to gain a strong
position in the market and the net effect was a gain in company
profits.

DETAILS

Generally, marketers of most consumer goods assess one price to cover
all marketing and production costs, including the necessary
transportation to the place of purchase. Notable exceptions include
motor vehicles, where management levies a separate charge for
transportation.

In some instances, separate transportation charges are imposed for
consumer items requiring home delivery and setup, such as washers
and dyers, depending upon the services mix of the selling retailer.
But in general, shipping charges are absorbed in the retail price
paid by consumers for most of the items they buy.

In contrast, many items sold to producers, governmental units, and
to channel members for resale do  include transportation charges.
Manufacturers frequently assess separate charges for shipping,
and this charge can represent a major portion of an item's total
cost. Therefore, management must be certain to specify which services
a price is to cover.

Whether or not prices include transportation usually depends upon
several factors, including the prevailing competitive practices,
how sizeable shipping costs are in relation to total product costs,
and the length of the distribution channel. Normally prices do not
include transportation if this is the norm in the industry, if
shipping costs are small relative to total product costs, and if
the channel is short.

In general, lengthy channels include transportation as one of the
functions intermediaries perform to earn their margins. Accordingly
prices tend to include transportation in such cases. Conversely,
short channels often involve separate charges for shipping,
although shipping is usually negotiable when sizeable orders are
involved.

Also, including transportation is often dependent on the desires
of major customers. Some buyers have extensive transportation
departments and sometimes prefer to arrange their own shipping,
whereas other firms would rather have the seller assume the tasks.

PROBLEM 3

A producer of electric motors to be installed in garage door openers
does not include transportation costs in prices. A likely reason for
this is:

A. The channel of distribution is short.
B. Other major competitors of the producer include transportation
   costs in prices.
C. Shipping costs are large relative to the product's value.
D. The producer is large and has a large transportation department.

WORKED

A producer of electric motors to be installed in garage door openers
does not include transportation costs in prices. A likely reason for
this is that shipping costs are large relative to the product's value.
Electric motors tend to be relatively heavy items and their shipping
cost can be substantial. The products must be packed and handled with
care or damage to them can easily occur. Damage can come from
mishandling, moisture, excessive pressure and other causes. Hence,
shipping tends to be expensive. Conversely, the value of the motors
is not great--they tend to be almost commodity-type items. For these
reasons transportation costs probably would not be included in
prices.

ANSWER  C
INSTRUCTIONS Attempt to envision all of the factors that determine who pays
for transportation costs of products--the buyer or the seller?

EXAMPLE

A cement producer located in the Rocky Mountain area experienced
considerable difficulty for many years in penetrating markets in
the Pacific coast area. The producer required that its customers
pay the full cost of transporting the cement from the plant to
the customers' sites. This meant that the producer was price
competitive in a region within approximately 300 miles from the
plant, but was not competitive in the Pacific coast area.

Management decided that the market in the Pacific coast area was
growing at too fast a rate to be ignored. Accordingly, the company
agreed to pay for half of the freight for items shipped into this
region. According to management's calculations, this would make
the company price competitive. On the other hand, it was somewhat
of a gamble, because it would drive up the firm's costs. After six
months the cement company decided that it was a gamble worth taking.
The delivered price reductions enabled the firm to gain a strong
position in the market and the net effect was a gain in company
profits.

DETAILS

How can a marketer best determine what method is best in handling
transportation costs? The answer is not simple, but basically it
involves assessing demand, competition, cost, and the law.

Demand is an important factor. It may be necessary to absorb freight
or to use F.O.B. buyer's warehouse because buyers demand this. They
may prefer to stay out of the freight and insurance business and let
the seller worry about this. Many retailers, for instance, are so
absorbed in buying, operating their stores, and in promoting their
goods that they have little time left to devote to transportation
problems.

Demand is probably the most important factor in determining who will
cover these costs. Companies are in business to satisfy customers,
and demand measures what these customers want. If they are not
especially worried about having to pay these costs, then the producer
may pass them on down the channel. But if the target customer objects,
this probably should not be done.

Cost is another factor. If the cost is substantial, producers prefer
to require intermediaries to bear the burden of freight. Buyers
often feel that this is justified because it does involve a substantial
expense item. It is common for  buyers to pay the transportation costs
for items that are heavy and bulky and that incur high freight
bills relative to their value . Examples are bulk cement, lumber,
and grain.

Competition should be considered. If competitors are carrying much
of the freight burden, the company may have to do likewise, in
order to be a contender for business. Or, if rivals assess buyers for
these expenses, the firm may decide to pay them, as a means of
attaining competitive advantage. Freight absorption is a strategy
that is based primarily upon competition.

Finally, the law is a consideration. Base point systems are often
illegal. If the company enters into agreements with rivals to charge
identical transportation charges or even to use the same methods to
determine these charges, federal authorities may bring charges of
price collusion.

PROBLEM 4

An importer of tea from Asia is developing policies for who in the
channel of distribution will handle transportation costs. Probably
the most important determinant of this decision is:

A. Cost.
B. Demand.
C. Competition.
D. The government.

WORKED

An importer of tea from Asia is developing policies for who in the
channel of distribution will handle transportation costs. Probably
the most important determinant of this decision is demand. The
firm is in business to satisfy customers and demand is a measure of
this performance. If customers object strongly to paying for the
freight, the producer may have to absorb it. If customers are not
heavily concerned about this expense item, the liklihood is that it
will be passed on to them.

ANSWER  B