Price vs. Total Cost vs. Value
PurchTips edition #316
Do You Know The Difference Between Price And Cost?
Once focused strictly on price, today's leading procurement departments also focus on total cost and value. In this edition of PurchTips, we'll explore the difference between price, total cost, and value.
Price Price is simply the amount of money an organization pays to a supplier for a product or service. When price is the focus, procurement departments work intensely to pay less than they had in the past for goods and services. If particular goods or services were not purchased in the past, procurement departments will work intensely to pay lower prices than initially proposed by suppliers. When price-oriented procurement departments report their performance, they only take into account the effect they had on prices paid.
Total Cost While seeking lower prices is noble, it shouldn't be done without considering factors that could make costs go up. For example, let's say that you've begun buying a lower-priced component for a manufactured item. The price reduction has caused your company to spend $10,000 less per year for that component. However, the lower-priced component is of a lower quality than the previously purchased component. As a result of a higher defect rate, your company has incurred $20,000 per year in new costs for repairs, tech support, etc. That's obviously a bad outcome.A total cost focus assesses expenses that a price-only focus ignores. Total cost includes all expenses associated with the acquisition, receipt, storage, use, maintenance, and disposal of purchased products and services. When total cost-oriented procurement departments report their performance, they take into account all components of cost.
Value Simplified, improving business performance means increasing revenues and/or reducing costs. Historically, the procurement function has been associated exclusively with cost reduction. But modern procurement departments can also help to increase revenues. For example, imagine that you implemented a program with a supplier that gave your company a unique advantage over competitors and, as a result, increased your company's market share and revenue. You may not have reduced the price or cost of the product purchased. But your work delivered a financial benefit to thecompany in the form of higher sales. "Value" is the word used to describe any type of financial benefit, whether it is a reduction in price, reduction in total cost, or an increase in revenue.
Do You Want a More Rewarding Procurement Career?
Are you tired of not getting enough opportunities, respect, and money out of your procurement career? Well, guess what? Nothing will change unless you take action towards becoming a world-class procurement professional.
Earning your SPSM® Certification is the action to take if you want to bring the most modern procurement practices into your organization and achieve your career potential. Download the SPSM® Certification Guide today to learn how to get started on your journey to a more rewarding procurement career!
Need Better Performance From Your Procurement Team?
Are you a procurement leader whose team isn't achieving the results you know are possible? Maybe it's not enough cost savings. Or frustrating performance from the supply base. Or dissatisfied internal customers.
You need a performance improvement plan that's easy to implement and quick to produce results. The NLPA can help.
Download our whitepaper "The Procurement Leader's Guide To A More Successful Team." You'll learn the 7 steps for transforming your staff into a results-producing, world-class procurement team.
Are You Getting The Most Out of Your NLPA Membership?
Members of the NLPA get more than just articles like this by email. As a member, you also get access to:
- The Procurement Training & Certification Starter Kit
- The latest Purchasing & Supply Management Salaries Report
- Leading-Edge Supply Management™ magazine
- Members-only webinars 10x per year
- And more!
If you haven't been taking advantage of these benefits, why not log in and start now?
Copyright 2014. This article is the property of Next Level Purchasing and may not be copied or republished in any form without the express written consent of Next Level Purchasing.
Click here to request republishing permission.
By Charles Dominick, SPSM, SPSM2, SPSM3
Other Editions of PurchTips:
|« 315 Why iPhone Cost Savings Matter Less||317 A Buyer's 11-Point Contract Review Checklist »|