From the course: Purchasing Foundations

Price and cost analysis

From the course: Purchasing Foundations

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Price and cost analysis

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- When shopping, either in a store or online, most of us try to spend our money wisely. As consumers, we all want to get the best deal we possibly can. Well, purchasing professionals are trying to accomplish the same thing at work. In fact, a friend at Intel Corporation once told me that he is expected to spend Intel's money as if it were his own. Buyers are expected to find value when they spend their company's money. A good definition of value is to compare what you get for your money and the price you paid for everything you received. Getting more for a lower price provides good value for your company. To a buyer, the price you pay is the focus of your cost management efforts. Price is what it cost you to make the purchase. You can increase value in three very straight-forward ways. First, by reducing what it costs you for the purchase. Assuming of course that the quality stays the same, you are buying the same item, you're just paying less. Or you can increase value by getting more for your money at the same price. More items or a higher-quality item for the same money. But even better, you can increase value by getting more for a lower price. However, the job of the purchasing department actually is not to attain the lowest price. Purchasing's job is to ensure that the price paid is fair and reasonable. Fair to you, and fair to your suppliers. After all, you want those key suppliers to be around a long time, continuing to do business with you. So, how do you determine a fair and reasonable price? Here are some specific models to help you do that. The first approach is price analysis which compares the supplier's price to existing benchmarks. When you're buying wheat for example, a fair and reasonable price is determined by current economic conditions and the relationship between supply and demand. You look at current and projected market prices without considering what it cost your supplier to produce the wheat. Or your can do a cost analysis, in which you do specifically look at what it cost your supplier to produce the product or service. You then compare this to the supplier's asking price. From here, you may enter a negotiation and hopefully a contract for a fair and reasonable price. You also should consider a total cost analysis, which ensures you capture all the cost of the transaction. For example, if you're buying your wheat from a supplier in China, you definitely want to include things like the international transportation expenses, customs, and tariffs. You also want to include the cost of the additional transportation time. If so-called lead times are greater with a foreign supplier, and you have to hold additional days of inventory because of this, you want to include that cost in your analysis also. These analytical models provide you with tools to better understand your costs. Your job in the purchasing department is to use the correct tool in the correct manner to manage costs for your suppliers in a more strategic manner. As companies continue to increase their global sourcing, that's the key to success for professional buyers today.

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