Cost & Price – Definitions Matter!

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Granted, I am an analyst, so I am probably pickier about details than many. Still, it never ceases to frost me when I hear procurement professionals throw around the terms “cost” and “price” indiscriminately and interchangeably.

If you’re a mere mortal outside the field of strategic sourcing, ok, I’m inclined to let it slide. Price might be thought of as cost if you’re just a gofer turning reqs into POs and reconciling records.

Here is a scenario I use to illustrate the difference:

You buy toys for a chain of toy stores, and a new supplier calls you up and says: “I have a boat load of the latest toys in, but the original buyer has gone out of business, are you interested?” He continues: “The price per toy is $2.00 and there are 50,000 toys per container – and I’ll even include delivery to your warehouse. A great deal!”

Here’s the question: What’s the cost per container?

The transactional buyer response is – that’s easy, $100,000!

Here’s part two of the story – after you’ve sold the toys – a consumer watch group does some lab testing on the toys and finds them loaded with traces of lead, formaldehyde, and some other nasty chemicals. You read about that in the media, and now you are facing a product recall and a lawsuit, in addition to the bad press. Ouch!

So, the cost is a lot more than $100K per container – maybe 10X or more.

Price is what you pay, cost is what you incur.

This difference was drummed into me in my first econ studies years ago. Later, when I worked with John Madrid (head “Sourcerer” at Procuri) he and others there kept reinforcing this concept. We were all about Best Value sourcing, or TCO sourcing – and if you pollute your definitions, you find yourself in a hand basket headed to warmer locations.

Ok, you say, I get it, and so do my peers; we just use the terms a little loosely. Well, many outside corporate procurement – whether they are in marketing management, at the business unit level, or some other function that doesn’t report up to procurement, but is regularly involved with procurement – say that “procurement is only interested in lower prices.” Then there are your suppliers, most of whom are allergic to the word price and extremely cynical of procurement’s use of the term cost.

This perception gap (assuming you are truly interested in Best Value sourcing) can more easily be overcome with better use of definitions. Semantics seems trivial, but it so easily sets minds racing in the wrong direction. Misunderstandings can prevent adoption, sustain maverick spends, poison relationships, miss cost savings opportunities, and potentially lead to disastrous purchasing decisions.

Be mindful of this. Explain to stakeholders what your true goals and definitions are, and get everybody on the same page around the terms of the game. That should simplify working together toward common goals.

Voices (2)

  1. Thomas Kase:

    Absolutely, all cost models eventually face diminishing returns on the factors included as they increase. That said, outside trivial and purely tactical procurement, decisions are rarely made on price alone.

    As organizations mature and procurement becomes a matrix-driven function – one which users should want to leverage – I think seemingly trivial details like semantics can have a big impact.

    To transform and drive change, a good start would be to get basic terms straight!

  2. Market Dojo:

    Thanks. This is a great reminder of how important it is to get the basic concepts right.

    Clear definitions are an important foundation on which to build. For example, discussions on how you will account for all the other important factors which contribute to the cost.

    However, I think its also important to consider how far you go and which costs you account for.

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