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Price isn’t everything

August 29, 2019

In many cases, organizations continue to make purchasing decisions based on price. It has been baked into their DNA, with the mantra of ‘commoditization’ backed up by software that drives price-based competitive auctions and measurement systems that continue to monitor ‘negotiated savings’. In the public sector, this is further reinforced by public procurement rules that blithely ignore concepts of value and have failed to adapt to the nature of today’s supply requirements.

Many claim otherwise

Suggestions that procurement decisions remain focused on price are often met with howls of protest and claims that such an approach is a thing of the past. In some cases, this is true – there are Supply Management groups which have moved on and many who advocate the need for change. Yet supplier experience continues to attest that those who have actually changed are very much the exception.

Why is this a problem? 

Simply put, purchasing decisions need context and it is rarely true that price is everything. The commoditization craze that came with reverse auctions and spend management discouraged the use of economic judgment – essentially, it resulted in economic illiteracy. A great example of this was cited in a recent edition of Talking Logistics, which examined the influence of networked technologies on the logistics industry. It made the point that, during the dot com era, many believed that they could convert a traditional relationship-based industry into a spot market commodity. They were wrong. The article highlights how similar efforts are now appearing as a result of digitization. In both cases, these are driven by the hunger for lower prices, but illustrate two fundamental misjudgments:

1) creating a spot market does not necessarily alter the availability of supply and is more likely to reduce competition over time than to increase it;

2) low prices frequently do not translate to low cost. For example, reliability and quality of collection, shipping and delivery frequently has far greater importance than saving a few dollars in processing costs. A failed delivery may well catch the CEO’s attention; a nominal ‘saving’ certainly will not.

So what’s the answer?

Procurement decisions need context. They must examine impacts that stretch beyond the acquisition and explore downstream effects. I recall a great story from the public sector, where a buyer thought it would be a marvellous idea to save money in the criminal justice system by supplying gaols with fruit that had failed the supermarket tests of homogeneity. It seemed entirely logical – saving money and the environment – until it caused a prison riot due to the inequitable size of portions!

With the growth in the scale and types of acquisition, in particular the shift towards services, procurement decisions need a new and economically-based approach to sourcing decisions and supplier management. ‘Price’ must be put in its proper place – and my next blog will expand on how that should be achieved.

2 Comments
  1. Hi Tim,

    As always great article to help us think. And indeed I have worked in many areas where price is the sole focus of the procurement leading to unintended (although not unexpected) consequences for both buyer and seller.

    Fortunately, I have spent the majority of my time working in a jurisdiction (Australian Federal government) where Value for Money (VfM) is the assessment criteria, not price. Specifically, the Commonwealth [of Australia] Procurement Rules (CPRs) that all Federal Government agencies must adhere to has the following statement in the forword:

    “Achieving value for money is the core rule of the Commonwealth Procurement Rules as it is critical to ensuring that public resources are used in the most efficient, effective, ethical and economic manner. However, it is important to remember that price is not the only factor when assessing value for money, and officials are required to consider all relevant financial and non-financial costs and benefits associated with a procurement.”

    A copy of the CPRs is publicly available at https://www.finance.gov.au/commonwealth-procurement-rules/.

    Therefore, I count myself lucky to be able to focus on value rather than price.

    I look forward to seeing your next article!

    Regards
    Dr Andrew Jacopino

    • It is of course welcome when jurisdictions have enacted rules such as this since they certainly allow greater balance and encourage integrity. It appears to me that such rules are more likely to be used in defence acquisitions than elsewhere (and that’s also true outside Australia). However, it seems to me that there are still often constraints that limit the extent of VFM analysis and I’d welcome a discussion on effectiveness in practice (and more important, how it can be further improved).

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