Computron, Inc.

Ralph Z. Sorenson, II

 

Mr. Thomas Zimmermann, manager of the European Sales Division of Computron, Inc., trying to decide what price to submit on his bid to sell a Computron 1000X digital computer to Konig & Cie., A.G., West Germany's largest chemical company. Were Mr. Zimmermann to follow Computron's standard pricing policy of adding a 331/3 percent markup to factory costs and then including transportation costs and import duty, the bid he would submit would amount to $311,200. Mr. Zimmermann was afraid that a bid of this magnitude would not be low enough to win the contract for Computron.

Four other computer manufacturers had been invited by Konig to submit bids for the contract Mr. Zimmermann had received information from what he considered to be a "reliable trade source" which indicated that at least one of these four competitors was planning to name a price somewhere in the neighborhood of $218,000. Computron's normal price of $311,200 would be $93,200, or approximately 43 percent higher than this price. In conversations which he had had with Konig's vice president in charge of purchasing, Mr. Zimmermann had been led to believe that Computron would have a chance of winning the contract only if its bid were no more than 20 percent higher than the bid of the lowest competitor.

Inasmuch as Konig was Computron's most important German customer, Mr. Zimmermann was particularly concerned about this contract and was wondering what strategy to employ in pricing his bid.

Background on Computron and Its Products

Computron, Inc., was an American firm which had, in the winter of 1998, opened a European sales office in Paris with Mr. Zimmermann as its manager. The company's main product both in the United States and in Europe, was the 1000X computer, a medium-size digital computer designed specifically for process control applications.

In the late - 1990s, the market for digital process control computers was growing quite rapidly. These computers were substantially different from the computers used for data processing and engineering calculation. They also were generally produced by companies which specialized in digital process control computers, not by the manufacturers of office and/or calculation-oriented digital computers. The companies also were different from those companies which had produced analog process control computers-the traditional units used for process control.

Digital computers were classed as small, medium, or large, depending on their size, complexity, and cost. Small computers sold in the price range up to $80,000; medium computers in the price range $80,000 to $600,000; and large computers in the price range $1 million to $6 million.

The Computron IOOOX had been designed specifically for process control application. It was used in chemical and other process industries (oil refining, pulp and paper, food manufacture, etc.) as well. as in power plants, particularly nuclear power plants.

In addition to its IOOOX computer, Computron manufactured a small line of accessory process control computer equipment. These accessories, however, constituted a relatively insignificant share of the company's overall sales volume.

           

            During the first 6 months after its opening, the European sales office did only about $1,100,000 worth of business. In the 1999-2000 fiscal year, however, sales increased sharply, the total for the year being $5 million. Computron's total worldwide sales during that same year were roughly $44 million. Of the European countries, Germany was one of Computron's most important markets, having contributed $1,200,000, or 24 percent of the European sales total in 1999-2000. Britain and Sweden were likewise important markets, having contributed 22 percent and 18 percent respectively, to the 1999-2000 total. The remaining 36 percent of sales was spread throughout the rest of Europe.

            Computron computers sold to European customers were manufactured and assembled in the United States and shipped to Europe for installation. Because of their external manufacture these computers were subject to an import duty. The amount of this tariff varied from country to country. The German tariff on computers of this type sold by Computron was 17 1/2 percent of the United States sales price.

            Prompted primarily by a desire to reduce this importation duty, Computron was constructing a plant in Frankfurt West Germany. This plant which would serve the entire European Common Market was scheduled for opening on September 15, 2000. Initially it was to be used only for the assembly of 1000X computers. Assembly in Germany would lower the German importation duty from 171/2 percent to 15 percent. Ultimately the company planned to use the plant for the fabrication of component parts as well. Computers which were completely manufactured in Germany would be entirely free from the importation duty.

            The new plant was to occupy 10,000 square feet and would employ 20 to 30 people in the first year. The initial yearly overhead for this plant was expected to be approximately $300,000. As of July 2000, the European sales office had no contracts on which the new plant could begin work, although it was anticipated that the training of employees and the assembly and installation of a pilot model 100OX computer in the new plant could keep the plant busy for 2 or 3 months after it opened. Mr. Zimmermann was somewhat concerned about the possible risk that the new plant might have to sit idle after these first 2 or 3 months unless Computron could win the present Konig contract

Company Pricing Policy

Computron had always concentrated on being the quality, "blue-chip" company in its segment of the digital computer industry. The company prided itself on manufacturing what it considered to be the best all-around computer of its kind in terms of precision, dependability, flexibility, and ease of operation.

Computron did not try to sell the, 100OX on the basis of price. The price charged by Computron was very often higher than that being charged for competing equipment In spite of this fact the superior quality of Computron's computers had, to date, enabled the company to compete successfully in both.the United States and Europe.

The European price for the 1000X computer was normally figured as follows:

 

United States "cost"                 (Includes factory cost and factory overhead)

Plus

Markup of 33% percent            (To Cover profit. Research and development on "cost" allowances, and selling expenses)

transportation and installation costs

Plus

Importation duty

----------------------------------

Total European price

Prices calculated by the above method tended to vary slightly because of the country-to-country difference in tariffs and the difference in components between specific computers.2 In the case of the present Konig application, Mr. Zimmermann had calculated that the "normal" price for the 100OX computer would be $311, 200. Exhibit 1 shows his calculations.

The 33 1/3 percent markup on cost used by the company was designed to provide a before tax profit margin of 15 percent, a research and development allowance of 10 percent and a selling and administrative expense allowance of 8 percent The stated policy of top management was clearly against cutting this markup in order to obtain sales. Management felt that the practice of cutting prices "not only reduced profits, but also reflected unfavorably on the company's 'quality' image." Mr. Zimmermann knew that Computron's president was especially eager not to cut prices at this particular moment inasmuch as Computron's overall profit before taxes had been only 6 percent of sales in 1999-2000 as compared with 17 percent in 1998-1999. Consequently, the president had stated that he not only wanted to try to maintain the 33 1/3 percent markup on cost; he also was eager to raise it.

In spite of Computron's policy of maintaining prices, Mr. Zimmermann was aware of a few isolated instances when the markup on cost had been dropped to the neighborhood of 25 percent in order to obtain important orders in the United States. In fact he was aware of one instance in the United States when the markup had been cut to 20 percent In the European market however, Computron had never yet deviated from the policy of maintaining a 33 1/3 percent markup on cost.

 

'Depending on the specific application in question, the components of the 1000X varied slightly so that each machine was somewhat different from the rest

EXHIBIT 1

CALCULATED "NORMAL" PPDCE FOR THE 100OX COMPUTER FOR KONIG

Factory cost                                         $192,000

33%% markup on cost                          64,000

U.S. list price                                       256,000

Import duty (15% of U.S. list price)       38,400

Transportation and Installation            16,800

Total "normal" price                            311,200

 

 

 

The Customer

Konig & Cie., A.G., was the largest manufacturer and processor of basic chemicals and chemical products in West Germany. It operated a number of chemical plants located throughout the country. To date it had purchased three digital computer process control systems, all from Computron. The three systems had been bought during 1999-2000 and had represented $1 million worth of business for Computron. Thus Konig was Computron's largest German customer and had alone accounted for over 80 percent of Computron's 1999-2000 sales to Germany.

Mr. Zimmermann felt that the primary reason Konig had purchased Computron computer systems in the past was their proven reputation for flexibility, accuracy, and overall high quality. So far, Konig officials seemed well pleased with the performance of their Computron computers.

Looking ahead, Mr. Zimmermann felt that Konig, in contrast to any other single German customer, would continue to represent more potential future business. He estimated that during the next year or two Konig would have a need for another $1 million worth of digital computer equipment.

The computer on which Konig was presently inviting bids was to be used in the training of operators for a new chemical plant The training program was to last approximately 4 to 5 years. At the end of the program the computer would be either scrapped or converted for other uses. The calculations which the computer would be called upon to perform were highly specialized and would require little machine flexablity. In the specifications which had been published along with the invitation to bid, Konig management had stated that in buying this computer Konig was primarily interested in dependability and a reasonable price. Machine flexibility and pinpoint accuracy were listed as being of very minor importance, inasmuch as the machine was to be used primarily for training purposes and not for on-fine process control.

 

Competition

In West Germany, approximately nine companies were competing with Computron in the sale of medium-priced digital process control computers. Exhibit 2 shows a breakdown of sales among these companies for 1 year. As can be seen from this exhibit four companies accounted for 80 percent of industry wide sales in 1999-2000.

Mr. Zimmermann was primarily concerned with the competition offered by the following companies:

Ruhr Machinenfabrik, A.G. A very aggressive German company which was trying hard to expand its share of the market Ruhr sold a

Exhibit 2

1997-1998 MARKET SHARES FOR

COMPANIES SELLING

MEDIUM-PRICED DIGITAL

COMPUTERS TO THE WEST

GERMAN MARKET

                                                                                                Dollars             %        

Computron, Inc.                                                                       1,200,000         30.0

Ruhr Machinenfabrik, A.G.                                                       800,000           20.0

Elektronische Datenverarbeitungsanlagen, A-G.                       500,000           12.5

Digitex, G.m.b.H.                                                                     700,000            17.5

Six other companies-(combined)                                               800,000           20.0

Total                                                                                        4,000,000          100.0

medium-quality, general-purpose digital computer at a price which was roughly 22 1/2 percent lower than the price which Computron charged for its 1000X computer. Seventeen and one-half percentage points of this price differential was attributable to the fact that there was no import duty on the Ruhr machine, inasmuch as it was manufactured entirely in Germany. Though to date Ruhr had sold only general-purpose computers, reliable trade source dictated that the company was presently developing a special computer in an effort to win the Konig bid. The price which Ruhr was planning to place on the special-purpose computer was reported to be in the neighborhood of $218,000. Elektronische Datenverarbeitungsaniagen, A.G.

A relatively new company which had recently developed a general-purpose computer of a quality comparable to that of the Computron 1000X. Mr. Zimmermann felt that Elektronische Datenverarbeitungsanlagen presented a real long-range threat to Computron's position as the "blue-chip" company in the industry. In order to get a foothold in the industry it had sold its first computer "almost at cost" Since that time, however, it had undersold Computron only by the amount of the import duty to which Computron's computers were subject.

Digitex,G.m.b.H. A subsidiary of an American firm, this company had complete manufacturing facilities in Germany and produced a wide line of computer equipment. The Digitex computer which competed with the Computron 1000X was only of fair quality. Digitex often engaged in price-cutting tactics, and the price which it charged for its computer had sometimes, in the past, been as much as 50 percent lower than that charged by Computron for its 1000X. In spite of this difference, Computron had usually been able to compete successfully against Digitex because of the technical superiority of the Computron 1000X.

Mr. Zimmermann was not overly concerned about the remaining competitors, inasmuch as he did not consider them significant factors in Computron's segment of the computer industry.

 

The West German Market for

Medium-Priced Digital

Computers

The total estimated West German market for medium-priced digital process control computers of the type manufactured by Computron was presently running at about $4 million per year, Mr. Zimmermann thought that this market could be expected to increase at an annual rate of about 25 percent for the next several years. For 2000-2001 he already had positive knowledge of about $1,300,000 worth of specific new business. This new business was broken down as follows:

Kdnig & Cie., A.G.

Frankfurt plant                                                 $ 300,000

Dusseldorf plant                                                 250,000

Mannheim plant                                                 150,000

Central German Power Commission                   440,000

Deutsche Autowerke                                          160,000

        $1,300,000

The above business was in addition to the computer which Konig was presently seeking for its new experimental pilot plant None of this already known business was expected to materialize until late spring or early summer.

 

 

Deadline for Bids

In the light of the various facts and considerations discussed above, Mr. Zimmermann was wondering what price to bid on the Konig contract. The deadline for the submission of bids to Konig was August 1, 2000. Since this was less than 2 weeks away, he knew he would have to reach a decision sometime during the next few days.