Why “Last Price Paid” Is A Dangerous Metric
What Makes Purchasing Savings Claims Believable?
PurchTips Edition #331 Click here for the printer-friendly version
Why do I prefer “last fiscal year’s average price” over “last price paid” as the baseline against which new prices are compared in cost savings calculations? The answer is simple: Purchasing should measure performance like CEO’s do.
One of the most important metrics for CEO’s and finance executives is profit growth. Profit growth is often an outcome of expense reduction. They determine year-to-year change in expenses and profit by comparing annual profit and loss statements (P&L’s). If the expense reduction that they observe from P&L’s doesn’t reconcile with purchasing savings claims, your credibility can take a hit. Let’s explore why “last price paid” is such a bad baseline through an example…
Let’s say you bought an item four times last fiscal year. The prices you paid were (i) $10, (ii) $10, (iii) $10, and (iv) $14. Let’s say you bought that same item four times this fiscal year. The prices you paid were (i) $9, (ii) $9, (iii) $9, and (iv) $9.
Using last fiscal year’s last price paid as your baseline, the baseline would be $14. This ill-advised method would mean that you saved $5 each time you bought the item this year for a total annual savings of $20. If that baseline didn’t take fiscal year change into account, then you’d only claim savings on this year’s first purchase, for a total of $5 for the year.
If your calculation instead aimed to better align purchasing savings claims with year-to-year changes on the P&L, then you’d note that your total spent on four purchases last year was $44. You’d also note that your total spent on the same quantity this year was $36, an $8 difference. Last fiscal year’s average price paid was $11 and this fiscal year’s average price paid was $9 – a difference of $2 per purchase and a total savings of $8 for the fiscal year.
If these were the only expenses that showed up on the P&L, you would see a change in total P&L expenses that exactly matched your purchasing savings claim of $8. That should be a goal – measuring financial performance like CEO’s do.
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