Strategic Sourcing – Why Do Price and Cost Analysis?

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A key question that all procurement professionals face is… am I paying the right price? The purpose in analysing prices and costs is to satisfy ourselves that the amount we are paying is fair.

One way to do this is by analysing the price without investigating the costs used by the supplier in arriving at the price. Essentially you are comparing the price against yardsticks of reasonableness.

Cost analysis, on the other hand, looks at the individual components that make up the price and asks if they are a reasonable reflection of the cost of an efficient process for producing those goods or service.

Generally speaking, price analysis will only ever give you an indication of fairness for simple procurements for which there is ample evidence of similar procurements in the public domain.

On the other hand, cost analysis can rarely be sufficient without price analysis being done in support. For example, suppose you are buying a bespoke laptop computer and your supplier has provided the following cost components:

Materials 160

Labour 80

Overheads 80

Development costs 1,000,000

Profit 40

Price 1,000,360

All of the cost components and the profit look reasonable. Even the £1 million development cost could be justified on the basis of the set up costs for the supplier. But a simple price comparison using any number of publicly available sources would quickly demonstrate that a price of more than £1m for a laptop.

So how about cost analysis. Take the example of a cleaning contract. You may have arrived at the conclusion by using price analysis that the price you are paying is fair. But what you really want is to get the best value for money for every pound or dollar spent. If you want to be world class your costs will have to be the best obtainable consistent with the quality and service required.

So, here are some additional things you can do to test the components in your cost analysis. Check the specification to ensure that you are not asking for too much… more than you actually need. For example, you may clean everywhere once a day. Why do you clean daily? For example, why clean archive rooms to the same frequency as busy open plan offices?

You could reduce your labour costs in this way by, say, 20% which means a saving of 20% of 80% (the total cost of the labour content) or 16% overall!

Don’t forget to ask for the material costs to go down when you reduced the frequency of cleaning – cleaning less often uses less cleaning materials. If you don’t do this, the extra profit goes to your cleaning supplier.

Finally, you can work with your supplier to eliminate any “waste” left in the system and share the cost savings. For example:-

o you can extend the contract to enable the purchase of better equipment

o you can map the entire process and find and eliminate the sources of variability (service or quality)

o you can make the process leaner by, for example, teaching our staff to be tidier and make them responsible for areas

o you can extend the range of services they provide (e.g. waste management) to spread their overheads and make savings in other areas.

Your chosen supplier ends up by being even more professional and probably gets more work from your recommendation – a true partnership.

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Source by Stephen C Carter