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.