Case studies

Case 1: the hotel. This company owns and operates a hotel and a restaurant in Narva (a town in the north-eastern part of Estonia). As the company holds only 13% of the local market share and does not have a dominant position in the market, they are very focused on every customer. The company has a much diluted customer structure, where the biggest customer has brought less than 3%

of revenues. The company has been active in the market since late 2002.

In 2005 the company had turnover of 401,000 EUR and made a loss of 12,000 EUR. The company had an interest bearing liabilities ratio of 0.76, which is high, compared to the industry average. Still, the highest costs within total costs were personnel costs, accounting for 38%, followed by interest costs of 26%. The cost structure has been quite stable; the turnover and profitability have improved during 2006. Financial obligations of the company are based on 6-month EURIBOR (and small amount on fixed interest rate).

The company is managed by the owner. Financial results have been reported monthly and benchmarked mainly on the previous years’ results. Pricing issues have been studied more deeply, twice a year before seasons. Pricing issues have been discussed with the controller and marketing specialist. Due to weak profitability, management has desperately looked for profit throughout the entire period. Despite the fact that the company has had net loss on previous years, the operating profit has been positive.

The pricing discussion usually starts with the analysis of financial results – mainly the cost analysis based on activities. The cost structure and revenues of different activities have been studied carefully; what have been the results with the lease-out of some premises (the cafeteria and the health centre); with reorganisation of activities (the laundry and cleaning services have been outsourced). Another aspect, aside from costs of the company, is the analysis of competitors. The company has chosen two benchmarks from the local market, similar size and customer focus. The cost follow-up and the analysis of competitors are two pricing methods used in the company. Even though the company looks for profit, they have not increased prices during the three year period due to tough competition.

Case 2: the knitting company. This company is active in producing and selling knitted apparel. The company is located in Pärnu (a town in the western part of Estonia) and operates under the Knityard brand. Approximately half of the

production is sold domestically and the other half is exported. The company also operates two outlets: one in Pärnu and the other in Tallinn. The market share of the company is less than 5% in each segment of the market. The company states it has good personal relations with customers.

The company had turnover of 447,000 EUR in 2005, and a 19,000 EUR profit. The company has liabilities from banks and owner’s loans totalling 96%

of liabilities. The most important costs were personnel costs, accounting for 38% of total costs, followed by the raw material costs 28% and interest costs 11%. Due to the high increase in personnel costs, the company had financial losses in 2006, despite the increase in turnover.

The company is managed by one person supported by the chief-accountant and production manager. The design of the new product is outsourced. The main responsibility of the manager is customer relations including also price negotiations. Due to the seasonality of business, pricing decisions are mainly done twice a year. The price setting is accompanied with the development of new products. During that development phase they intensively discuss the price expectation of final customers, as well as middlemen’s expectations. The new product should be available at that price target, which then impacts the model design (labour optimisation) and the selection of raw materials. The production manager, together with chief-accountant, reports final raw material costs and direct labour costs for each and every product. Thereafter, prices are corrected by the coefficient, which should include all other costs and some profits. The company targets minimum costs for each and every product. The launching period ends with signing contracts, where final prices are determined. Contracts do not guarantee production volumes to the company therefore all issues, including pricing, are still up for discussion at the moment of ordering. The company practices heavy discounts on quantities as well as seasonal discounts.

Case 3: the liquor trader. This company is an importer and distributor of alcoholic and non-alcoholic beverages. The company holds exclusive selling rights of many worldwide famous brands. All products have been imported. The company rents a customs-warehouse in Tallinn. Besides the selling of the products, the company provides different kinds of marketing support to those brands in the local Estonian market. Even though the company has exclusive rights for some brands, they still have market share less than 10% in all product groups they deal with. The company operates through the distributors and direct contacts with shops and Hotels-Restorans-Cafes customers (more than 100 customers).

The company had very good results in 2005 due to increasing demand (high growth in the wine segment). The company had turnover of 11.5 mil EUR and net profit of 705,000 EUR. The main costs were purchase of goods, accounting for 83% of total costs, followed by 11% of personnel costs. The amount of interest bearing liabilities was less than 50% from total liabilities, and financial costs were insignificant. The good financial results in 2006 contributed to the increasing of sales as well as profits figures.

The company is managed by three owners, each responsible for certain types of products. Due to volatile prices and currency exchange rates, selling prices are settled on an ongoing basis. The method mainly in use is the simple cost-plus pricing, even though the company has very good knowledge about the competitors’ prices. Additional margin that is included to cover overall costs and give some profits is discussed four to five times per year. The setup of margin is mainly influenced by the overall competition and comparison of competitive products’ prices. From time-to-time the company carries out the research on pricing of competitive brands.

The company heavily uses different kinds of seasonal and promotional discounts. These mainly seasonal discounts are initiated by shops or restaurants-bars and have already become a kind of tradition in the market.

Case 4: the construction company. The company is active in the building industry, which has grown very fast during the years 2003–2007. The company is located in Tartu even though it has been active all around Estonia (and has built a few buildings also in Riga, Latvia). The company has approximately 40 employees plus subcontractors. In the building industry the company is a middle-sized company with market share less than 2%, based on the industry and the company’s turnover. The company has been in the market for more than eight years.

2005 was an excellent year for the company with turnover of 3.8 mil EUR and net profit of 578,000 EUR. The biggest costs were material costs ac-counting for 41% of total costs, followed by personnel costs 27% and costs re-lated to subcontractors 22%. The company had low interest bearing liabilities – only loans from owners. The company has avoided the increase in prices for materials by contracting material purchases at the beginning of construction contracts. The company expected for 2006 the same good year, even though the salary levels increased by around 30%.

The company is owned and managed by two persons. Even though the company has been active with many clients from different locations, the main customer structure has remained the same. The manager states that the extra-value is created for the company by working with the same customers, namely, there are fewer communication problems and less financial fraud.

The pricing practice in the company has been based on contracts/proposals.

Before proposing, they calculate all direct costs related to the work (material costs, labour costs, logistics, costs for subcontractors, etc). Thereafter, some amount is added, where the main component are the possible price-increases, miscalculations, etc. This also includes all indirect costs, interest expenditures and expected profit. This added amount can be from 20% to 50% from final contract price. One important component on pricing has been the benchmarking of the market. The manager admits that in recent years, benchmarking has worked quite often in the opposite way, to avoid too low pricing. Quite often the company has practiced “refusal offering,” deliberately proposing very high

prices. A few times these “refusal offerings” have been accepted, creating long overtime, but also some extra profit.

Case 5: the recycling company. This company is active in the recycling business, buying and recycling different types of industrial waste. The company has a network all over Estonia and has a processing plant nearby in Tallinn.

Total assets on the balance sheet are over 12 mil EUR, where some assets such as land have much higher market value than book value. The company had loans in the amount of 7 mil EUR from the mother company, with a fixed interest rate.

Due to the high demand for recycling products in the world market, the company reached turnover of 64 mil EUR, and profit of 3.2 mil EUR in 2005.

The biggest expenditures were the raw material costs, accounting 77% of total costs, followed by personnel costs, 9%, and logistic costs, 8%. The company has interest bearing liabilities in the amount of 8 mil EUR, still, the interest costs to the total costs are less than 3%. The company expects strong financial performance also in 2006.

Due to the small size of the Estonian recycling market, the company has the dominant position in the market counting its market share to be close to 50%.

After the enlargement of the European Union, the boundaries of the market have enlarged, as well as creating additional competition. In the last two years there have appeared more competitors, some of them already well-known in the Baltic Sea region. Most of the recycled products are exported. Recycling products are traded in a liquid global market, therefore, the company is strongly exposured to international price risk together with currency risk. To fight with growing competition the company recently launched different logistics service packages to provide additional value-added to customers. Also, there was introduced price discrimination to different customers.

Due to the high fluctuation of prices in the world market, the company is forced to correct prices weekly. With many customers with whom the company has signed cooperation agreements with, it was agreed a pricing formula, in-cluding weekly pricing corrections based on international price-levels. Other-wise, the company follows competitor behaviour and its own purchase volumes.

If the world market prices are growing or dropping, but competitors do not react, the company keeps the price level. Other costs, like salaries, fuel costs, maintenance and etc., are included in pricing through the mark-up calculated as the cost per sold ton. If these costs increase, they raise the mark-up. Interest costs are not directly influencing prices; the company internally reports the EBIT.