How Important Is Price?
Brought to you compliments of the Presidents of Next Level Purchasing and American Certification Institute.
The President of Next Level Purchasing recently had the enriching opportunity of speaking to a group of sales professionals. He asked them to tell him about the experiences they've had with purchasing groups that have frustrated them the most. He got some interesting responses!
One phrase that was repeated often was, "It's all about price!" These sellers felt that many purchasers do not seek the supplier that will best serve their organization, but instead always seek the cheapest supplier.
(The first opinion below is that of the President of Next Level Purchasing).
I assured them that this was not the case in most progressive purchasing and supply management departments. However, that is not to say that their perspective did not have merit. It does.
I summed up why they had the experiences that they had in this blurb: "It all comes down to what can be quantified in financial terms. When price is the only thing that appears to be quantifiable then, yes, it does all come down to price. However, when paying a higher price can yield a quantifiable return (e.g., minimizations of other costs), a well-trained purchaser will make the decision that has the most favorable net impact on the bottom line."
There are many other aspects of doing business that affect the bottom line. Are you considering them? If not, consider evaluating how these costs differ between competing suppliers:
- The cost of acquiring a product or service
- The cost of using a product or service
- The cost of supporting a product or service
- The cost of maintaining a product or service
- The cost of disposing of a product or service
- The cost of poor performance
From here on down, we have the opinion of Dr. LeRoy H. Graw, President of the American Certification Institute.
Those of you who have been around a while will recognize the above approach as the “Total Cost of Ownership”. Whenever and wherever feasible purchasers need to consider the “Total Cost of Ownership”. Another term for this is “Total Life Cycle Costing”. In my military procurement days (I started my career in Federal (Military) Procurement and actually taught it before it “did it”), we used the example of aircraft tires to illustrate the point. We suggested that instead of buying a tire on a lowest price basis we should buy tires on the “lowest price per aircraft landing”. This assumes of course that we can test tires and derive such a figure. Another example we used was for refrigerators. Instead of buying “bottom line price”, we suggested the purchaser buy on lowest price per kilowatt hour of operation. In another (real world) example, I awarded a multi-function service contract for “Base Operating Services” on a “Total Cost Per Quality Point” basis.
This involved evaluation of Technical Proposals to derive a total score for quality (max of 1,000) and then dividing that into the Total Price in the Price Proposal. The contract was awarded on a lowest “Cost per quality point” basis. This technique has certain merit, as long as all offerors bid to the actual scope of work. If they bid below what they believe to be the value of the work scope, results can be less than optimal. A more satisfactory approach can be derived by evaluating separate Technical and Price/Cost Proposals and adding the respective scores for each. In many of my procurements, I used a 50 point score for Technical Proposals and a 50 point score for Price/Cost Proposals. Of course there is no “magic” to this point distribution.
When I was growing up, I heard many times that “Money isn't everything----it's just way ahead of whatever comes in second place. The analogy relates to this topic as well. As author of “Cost/Price Analysis: Tools to Improve Profit Margins” (Van Nostrand, 1994), I placed great emphasis on price (and if necessary, cost) to justify a purchase. I also pointed out that there are many ways to reduce “cost”, with most of these techniques falling within what I call “Strategic Cost Analysis”.
This is a very fertile ground for cost-savings. Potential redesign efforts should address not only the materials and components used in manufacturing the final product or service but also the manufacturing processes themselves and the incoming and outgoing packaging of the materials and products. Potential cost saving efforts could include specification of lower grade material or more durable material; use of standardized or simpler materials; standardization or simplification of the manufacturing processes used; or redesign of the packaging containers or even the labeling system for the containers.
Changes In Delivery And Order Quantity Requirements.
This activity is second only to quality and design changes in offering substantial cost savings opportunities. Through the analysis of the "bottom line cost" or "landed cost" of materials, the user organization (assisted by purchasing) can favorably impact the cost of purchasing. Potential cost saving efforts could include "packaging" material requirements so as to deliver in larger quantities (consistent with whatever Just-In-Time and inventory minimization goals the organization has); use of "make-or-buy" analysis of the transportation component of the incoming materials prices in order to get the best "bang for the buck"; and/or changing modes of transportation (truck to rail or rail to barge/boat, etc.). When considering the packaging of requirements, the user organization should consider use of local off-site storage; increase in storage capacity of in-house facilities; and/or use of sur rail to barge/boat, etc.). When considering the packaging of requirements, the user organization should consider use of local off-site storage; increase in storage capacity of in-house facilities; and/or use of supplier storage capacity.
Changes In Supplier Base.
This is where the purchasing manager can shine. Supplier base management should present numerous opportunities for savings. Through a careful analysis of the production and MRO materials purchased by the organization, the purchasing manager can arrive at decisions on whether to expand or contract the supplier base for specific materials and services; change suppliers because of quality or other deficiencies; or even to relocate certain operations in order to effect closer integration with supplier partners.
Changes In Procurement And Buying Methods.
This is another area where the purchasing manager should be able to work his/her magic. In this area, the purchasing manager should try to think "strategically". This type of broad thinking may discover opportunities for the company to practice "vertical integration". Rather than partnering with a supplier, the organization may find it beneficial to acquire the supplier's operation, either through outright purchase or through effective financial control. Another broad-based method goes to the heart of the source selection decision: "Should an individual item be purchased or produced in-house?" A very aggressive make-or-buy program can pay most organizations big dividends. Very closely allied with make-or-buy is the lease-purchase decision process. This type of economic/financial analysis can uncover hidden opportunities to effect cost savings through the simple decision of whether or not to own a particular item of equipment or property. Less broad sweeping but often equally effective is the use of long-term contracts, systems contracts, requirements contracts, and indefinite quantity-indefinite delivery contracts.
Changes In Inventory And Materials Management.
Although these activities come later in the purchasing cycle after most of the more potent decisions have been made, these cost savings measures should not be overlooked by the organization. Potential cost saving efforts include all the various ways the inventory manager can reduce inventory investment and improve management procedures, including use of "ABC Analysis"; use (and frequent update) of "EOQ" procedures; reduction in safety stock; efficient and effective use or disposition of obsolete stock; and use of computerized perpetual inventory procedures, if appropriate.