Understanding COST – why Procurement should care

The terms “cost” and “price” are often interchanged when used in Procurement circles but they have fundamental differences when they are being reviewed as part of a supply offer.

In terms of definition, “Cost” is the amount that has to be paid to get something. However, in business, cost is usually a monetary valuation of (1) effort, (2) material, (3) resources, (4) time and utilities consumed, (5) risks incurred, and (6) opportunity forgone in production and delivery of goods and or services.

“Price” on the other hand is the value that will purchase a finite quantity, weight, or other measure of the goods or services required. The differences may seem trivial but are actually very far reaching.

“If you don’t understand the cost, it is like being a buyer in a Middle Eastern bazaar, the price that will be offered is the one the trader thinks he can get away with”

Marketing spend

With spend categories like Marketing, which can be highly complex, Procurement teams are often only able to assess the value of goods or services on the basis of the prices provided.

As an example, Procurement runs a tender and they receive different price offers from the participating suppliers. By comparing the prices of the different offers, they are able to ascertain which offers are more competitive. However, this does not provide any real indication of what a fair price should be, based on the associated costs for providing those goods or services. This is because the prices are only reflective of the suppliers who participated.

“Relying on suppliers to help you identify the market price is like asking a second-hand car salesperson if their proposed price represents good value.”

Retail investment

One of the areas of marketing spend where this is a common challenge is in the area of retail fixtures and permanent Point of Purchase materials.

The industry is very fragmented with thousands of suppliers, a very complex supply chain, many different production techniques and substrates and suppliers who use a combination of in-house, near-shore and offshore manufacturing.

The suppliers in this industry only provide a price with no indication or transparency on underlying costs across the supply chain. This means that Procurement has its hands tied behind its back, as it has no benchmark against which to compare the prices received. These suppliers will often propose a price which they believe the client will accept or is in-line with the budget price originally provided. This clearly opens on the opportunity for suppliers to apply a significant profit margin to their offered price. It also means that they are not under internal pressure to secure the best possible price from their suppliers.

All Procurement can try and do, in these situations, is to negotiate a lower price via margin reduction, without having the evidence or data to validate why that reduction should be provided.

“Understanding cost provides an objective benchmark against which offered prices can be compared and negotiated against.”

Supply Chain Management versus Procurement

So, how do you achieve a true understanding of cost when there are complex supply chains involved? Very simply you need to change your approach from one of sourcing to one of Supply Chain Management SCM). Here is an article that provides more colour around this topic and why it really makes sense.

“It is a capital mistake to theorize before one has data.” Sherlock Holmes, “A Study in Scarlett” (Arthur Conan Doyle).

In summary, you need to work with suppliers who are willing to be open about their costs and the costs that they incur. Suppliers who see value in partnership where by working together, both parties can identify areas of waste and remove them for the benefit of all stakeholders. This requires a culture of trust, transparency, openness and fairness. It requires sharing of data and through that building insights that can lead to more informed and more insightful decisions.

“The goal is to turn data into information, and information into insight.” – Carly Fiorina, former executive, president, and chair of Hewlett-Packard Co.

We, at LeanPie, have embedded this philosophy into our offering. We believe that by building our client’s understanding of costs, we can collectively work towards a better solution for everyone. The benefits of this approach are significant:

  • Knowing the fair market price offers a benchmark against which you can identify real cost savings
  • If prices come in above the benchmark, you know the suppliers are either inefficient or taking excessive margin
  • If prices are below the benchmark, it prompts you to ask how they achieve these prices and to make sure that quality and other value aspects are robust
  • Identifying specific costs across the supply chain helps identify waste that can be removed to the benefit of all stakeholders
  • It enables a fair market price to be accepted leading to stable and sustainable relationships with your suppliers
  • A transparent supply chain enables you to ensure that all parties involved adhere to your CSR, environmental and ethical sourcing standards

It also means that your suppliers have to really understand cost, based on labour, utilities, substrate, tooling, conversion/production and margin etc. So, the next time a supplier walks in the door, isn’t this now a good place to start the conversation?

If you would like more information on how LG&P and LeanPie can transform your shopper marketing supply chain, please feel free to contact David at david.newberry@leanpie.com