How Can Your Purchasing Department Better Balance Cost and Value?
BY Jeff Thull
In the current economic climate, rising costs are affecting virtually every industry. As companies struggle to hold the line on their overall costs of goods sold, purchasing departments are under greater pressure than ever to focus on price in selecting vendors and contracting for products and services. While there may be some consideration of quality, availability, and overall value, price weighs ever more heavily in the decision process.
As a result, companies are in danger of falling into the "penny wise and pound foolish" trap -- saving dollars up front, but incurring more cost down the line. Inexpensive products can offer significantly less value, regardless of immediate cost benefits. When any product is selected primarily on price, there are high risks of passing inferior performance and quality issues on to the buyer's customers, resulting in erosion of confidence in a company's brand. These and other problems can ultimately cost far more than the dollars originally saved at the time of purchase.
There are two major concerns with certain purchasing department practices. First, purchasing departments may be given strong incentives to focus on dollars in terms of cost, a mandate that often means no one is thinking in terms of dollars of value. The other problem, related to the first, is that purchasing may operate according to obsolete and counter-productive rules. Examples of the latter include the frequent requirement that a specified number of bids must be considered, or that vendors should be pitted against each other with the sole purpose of driving down the price. These tactics tend to work, from the perspective of reducing prices in vendors' proposals. The effect of this "level playing field," however, is that solutions offering the highest value are systematically eliminated from consideration.
So how can a company ensure that the purchasing department is not undermining profitability through an overzealous focus on price over value? The following guidelines can help make sure purchasing is helping the other business units by buying goods and solutions that meet requirements for value as well as cost savings.
Align procurement incentives with other functional interests. To begin with, purchasing departments should not make unilateral decisions about complex solutions. Instead, purchasing should orchestrate a quality decision process that ensures a complete value impact is reviewed with the departments who will be living with the outcome of the purchasing decision.
Buy complex solutions differently from raw materials. In the case of purchasing common commodities such as sand or concrete, it is usually safe to select the least expensive option from among competing bids. But when quality and capability vary significantly, that same process loses effectiveness and begins to impinge on the opportunity to obtain value. This is especially true when vendor support is a critical component of successful implementation.
Avoid the "five bids" charade. Requiring a certain number of bids may lower the price but it will likely lower value at the same time. Many companies insist on multiple bids even when they already know which vendor they want to use. By forcing their preferred vendor to compete with others, they can indeed often drive the price downward. This "victory" may backfire, however, in the form of reduced capabilities, poorer service, lower quality, and other issues that come back to haunt the departments forced to deal with the consequences. This bidding process can also delay projects, squandering time and money.
Don't try to "fix" vendor relationships that aren't broken. Companies should hang on tight to relationships with vendors who understand their business, are well equipped to do the job, and have an established track record of success. Bidding out a project to a competitor who might be a few dollars cheaper, or asking an incumbent vendor to lower the price, may result in the loss of an important business partner. Or it may have the consequence of diluting the very value that has been crucial to past successes.
Certainly, many vendors could do a better job of helping customers understand the value their solutions provide. A purchasing agent can hardly be blamed for buying on price if that's how the sales representative is selling. The key to purchasing success, however, is for companies and vendors to work together to discover where processes and products are falling short and design solutions that optimize business performance. This approach makes purchasing a strategic resource while partnering with vendors and suppliers for true competitive advantage.