I hope that you have enjoyed the article, “Price vs. Total Cost vs. Value.”
When I first entered the procurement workforce in the mid-1990’s, the concept of total cost (sometimes called total cost of ownership or lifecycle cost) was foreign to most procurement professionals. Today, a good number of procurement professionals understand and can calculate total cost. However, the concept of value is as elusive today is the concept of total cost was “back in the day.”
And even though calculating total cost has its challenges, value just may be even harder to estimate. Let me demonstrate this through an example.
In this example, let’s say that you’ve been given the responsibility for purchasing a company car for your company’s new vice president of sales.
If you were buying based on price, you’d pretty much look at the window stickers on a bunch of cars and simply select the cheapest one.
Would that be the best decision?
Of course not!
If you took a total cost approach, you’d compare the gas mileage of several vehicle models, estimate the average cost of gasoline during the time the car would be used, estimate the number of miles the VP would drive, compare prices of replacement tires among several vehicle models, look into maintenance histories of the vehicles, estimate maintenance costs for each model, and so on. You’d add up all of your costs for each model to come up with a total cost for each model.
Under 1990’s procurement theory, you’d simply select the model with the lowest total cost of ownership.
But would something like the Chevrolet Spark be the right decision?
The Chevrolet Spark is a nice car. Sometimes when I’m struggling to squeeze into a city parking space, I wish I had a car like the Spark.
But would it be the best car for the situation?
If your company’s CEO had the objective of motivating this new sales VP, if she wanted to build a sense of loyalty that would keep this star performer with the company for years, if she wanted the car to impress the VP’s clients and make them feel like the company must be a successful and stable company, would the Spark achieve those objectives?
So that’s where value comes in.
Now, the tough part is distilling these benefits of a more expensive car into quantifiable financial benefit. What’s the return on investment of a Chevy Spark versus the return on investment of a BMW 5 Series?
It’s hard to say.
It might be impossible to say.
And it may be unnecessary to say.
But that’s one of the challenges today’s procurement professionals must deal with. Some decisions will be based on price. Some will be based on total cost. And some based on value.
Knowing the difference between price, total cost, and value is the first step in making the right decision each time. And I have the faith that, a couple of decades from now (and hopefully much sooner), future procurement professionals will master value-based decisions the way today’s procurement professionals have mastered total cost-based decisions. I promise to help you along the way through this blog, future editions of PurchTips, and our online procurement courses.