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Deere Case
The gatherer chain is selling for less and costing more, putting a squeeze on the margins at Deere. The supplier, Saunders, is likely increasing prices to Deere to help cover fixed costs in the face of declining demand, as revenue to Saunders from Deere has declined 16.3% even with the price increases.
For Saunders, variable costs of production are $12.43 per unit based on last year's figures; indirect labor is $1.36 and overhead allocation is $4.52, with profit of $4.29 per unit. If Deere wants to stick to a 50/50 split, it needs to buy from Saunders at $15. This would leave Saunders with $2.57 (profit margin = 20.67%) once direct costs are excluded, and that would go towards Saunders' profit but not indirect cost and overhead allocations. It is reasonable to argue that overhead allocations and indirect costs should be incorporated into the profit margin that Saunders takes anyway.
According to the estimates of raw material that Deere has, 13.92 lbs...
Thus, material costs that Saunders faces are likely to be significantly lower than the $9.50 estimated based on the manufacturer's survey. Again, this points to the excess cost going to Saunders' profit margin or to allocated overhead.
There are a number of business issues at play in this situation. Deere at this point only has one supplier -- the competition is using a cheaper one but Deere does not have a cheaper one. The competition is leveraging their cheaper supplier to undercut Deere, stealing market share in the process. By matching prices, Deere is unlikely to win back lost market share -- it would need to undercut the competition. This is not a scenario that will work for Deere in the long-run. Deere needs to find a better solution to this problem. Saunders' lack of transparency is an issue -- if his firm was public Deere would know what…
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