Procurement - How to Analyse Supplier Costs
February 5th, 2010 |
One question that all buyers are asked and ask of themselves is “am I paying too much for this item?” Price analysis is one way to answer the question. This involves comparing the price you are paying with some benchmark - essentially you are comparing the price against yardsticks of reasonableness. 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. For everything else you need to analyse your supplier’s costs.
The starting point is to gather data about the cost build up of your supplier’s product or service. This can be done at the ITT stage.
Ask potential suppliers (at least five) for the total price together with a detailed breakdown of labour, materials, capital costs of equipment and overheads. This will show you the lowest, highest and average cost for each cost category… this gives you comparative figures from at least five independent specialists and you can now begin to query costs because you have knowledge!
Note that we ask for a cost breakdown and the price. We don’t ask for the profit element as this is often refused. But by asking for the other elements you can calculate the profit anyway!
Suppose our ITT asked for the cost build up for a cleaning contract and what we got back was a range from £13 per sq m to £16 per sq m with an average of £14.89. You can use this information to question suppliers about the assumptions they have used in arriving at the cost components and challenge them. Remember, in the long run, suppliers must cover all their costs but in the short run, price is dictated by supply and demand and competition.
Most suppliers sell a range of products or services to a number of customers but don’t necessarily expect the same level of profit from each. They offset losses (or reduced profits) from one customer or product/service.
If a supplier applies an average margin to all, some will be over-priced due to:-
•Different volumes
•Different skills
•Different costs
Buyers can use this knowledge to their advantage in subsequent negotiations.
Once you have negotiated the cost components, you need to turn your attention to the amount of profit you will allow. Profit is one component of achieving good supplier relationships. They must be high enough to keep the supplier in business and motivate them to deliver and continuously improve.
What basis should you use for calculating the profit element? Using a % of costs rewards high cost suppliers but using ROI rewards suppliers who don’t invest efficiently. In the end, the final negotiated profit margin must equate risk and reward.
Do you want to learn more about gaining procurement skills?
If so, download my brand new free ebook “The 10 Best Ways to Upskill Yourself and Boost Your Job prospects” here:
http://www.SourcingStrategyWizard.com/skills_new.html.
Steve Carter is an experienced procurement practitioner and published author and runs online training and coaching courses.
Useful Links:
Take the stress out of being in debt with expert financial reporting and money management solutions.
