What Does a Product Really Cost?
Updated: Sep 24, 2022
Purchasing departments often have a reputation for pushing for buying the lowest-priced products while sacrificing quality. I’ve been told by internal customers that purchasing departments don’t fully appreciate the form/fit/function of the products they are sourcing. Since I entered the workforce, this perception of picking the cheapest vendor has not been the philosophy of procurement practitioners.
Pricing is one of the first things a person sees when considering a purchase. For a commodity (a product where specifications are standardized and sold in a competitive market), you may not have to look too much deeper than the purchase price. In these cases, you should not find a huge price difference between vendors. You may consider transportation, payment terms, lead time, and strategic relationships in addition to price. However, for differentiated products, big-ticket items, or products from an off-shore market, it is very important to look past the purchase price. If you have multiple options, you should be comparing the lifetime cost of the products. A ‘cheaper’ product may have higher operating and maintenance costs, energy consumption, and lower salvage value among other things. The method of considering these costs is called the Total Cost of Ownership (TCO).
Another consideration is the value per dollar provided by the product. From this perspective, you need to understand what is valued and how is it provided. For example, a capital asset with a higher price or even with a higher TCO may not be the best choice if you look at it from a performance perspective. A piece of equipment could have a TCO that is 5% higher than its competition but also has a production rate that is 20% higher. To make sure you are comparing apples to apples, you may want to focus on performance specifications over technical specifications. Technical specifications may restrict your options in unnecessary ways and skew negotiations to meeting specifications rather than meeting business goals.