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CHAPTER 9
Price and total cost of ownership (TCO)
Objectives of this chapter
• To examine the factors influencing pricing decisions
• To compare ‘price analysis’ with ‘cost analysis’
• To analyse the ways in which major contracts might be priced
• To explain contract price adjustment clauses
• To explain the use of incentive clauses in relation to price and cost
• To explain the effect of the ‘learning curve’ on the cost of production
List of Cases, Research Boxes and Figures in this chapter
Mini Case Studies
• Eutilia
Research Boxes
Nil
Figures
• Figure 9.1 Factors affecting price decisions
• Figure 9.2 Price mechanism
• Figure 9.3 Suppliers and buyers working together to drive out unnecessary costs
• Figure 9.4 Product life cycle
• Figure 9.5 Costs associated with a manufactured item
• Figure 9.6 Break-even chart
• Figure 9.7 Main categories of supplier discounts
• Figure 9.8 Price and cost investigation tools
• Figure 9.9 IBM procurement – acquisition cost
• Figure 9.10 Buyer/seller risk in major contracts
Instructor’s Manual
When evaluating price the question may be asked, have we captured all the costs? For example,
have we allowed for lead time or capacity problems with the supplier, what about extra
resources and support we may have to devote to suppliers if problems arise and so on. What
could look like a good price from a supplier could suddenly escalate if problems occur.
Acquisition costs can be defined as all the costs involved in bringing a supplier’s product to the
buyer’s organisation. It is made up not just of price and freight cost but any other costs in
completing this activity properly, e.g. any quality or delivery problems need to be costed in.
More procurement organisations than ever are now attempting to measure these costs, which are
often considerably more than the price.
To gain a complete picture of the TCO requires a cross-functional team effort.
Here is a list of the costs associated with quantifying acquisition and ownership costs for
revenue and capital items.
General costs
Finding and evaluating supply sources to provide an informed basis for choosing, or rejecting,
suppliers. Costs of purchasing and related activity, including manpower costs, IT systems, and
facilities. Changes to purchasing processes will change the resource levels and skills
requirements.
Obsolescence costs including dismantling and disposal.
Providing IT systems.
Providing decision-making tools and manpower.
Additional costs where products are imported:
• Costs of packaging/crating.
• Transportation and handling at the seller’s port.
• Export taxes and fees assessed by the government of origin.
• Inspection certificates.
• Sea transport costs.
• Marine insurance costs.
• Port of entry handling costs.
• Customs brokerage fees and duties.
• Inland transportation costs.
• Bank and other financial charges.
• Costs associated with currency fluctuations.
• Communication costs.
• Additional inventory levels to cover long, and variable, lead times.
• Additional administrative and legal costs.
