Management & Marketing Kamran on 14 Apr 2008 04:42 pm
Cost vs. Price
Though the two words are often used interchangeably, there is a significant difference between an item’s “cost” and it’s “price”. In the strictest sense, an item’s “price” is the amount that the customer pays directly to the supplier, whereas the “cost” is the total amount expended to find, buy and use the item.
For instance, imagine a hypothetical manufacturer in Los Angeles that produces medical devices. While looking for a special type of bolt for one of their devices, they narrow their decision down to two options:
Option 1: $0.55/unit, 1,000 unit minimum, 10 day lead-time required for delivery
Option 2: $0.65/unit, 200 unit minimum, 5 day lead-time required for delivery
On the face of it, it appears that Option 1 is the better of the two. The lower per-unit cost is significant and the minimum purchase amount is reasonable. Option 2 has a shorter lead time and a lower unit minimum, but those two factors, even combined, are not likely enough to compete with the lower per-unit cost.
Clever purchasing manager and executives, however, would have a clear answer to the dilemma: “We don’t have enough information to make an informed choice”. The quality, return rate, customizability, inventory management capabilities and customer service of the two companies offering the bolts are undefined. These factors all comprise the true “cost” of a purchase.
Imagine, for instance, if the company offering Option 2 could also include outsourced inventory management for the purchasing company, automatic stock replacement, warehousing facilities, custom spec parts and >99% reliability rating for the parts themselves. In that case, the extra $0.10 per unit would be a bargain! Imagine the savings if the purchasing company didn’t have to monitor or warehouse their bolt inventory! If bolt inventory took two hours per week and the labor cost was $16/hour (approx $10/hour plus benefits and insurance) then the upfront savings is $1664. Factor in the cost of capital to warehouse and maintain the supply and the wages required to order, inspect and replace parts, and the purchasing company could well save >$20,000 on a simple bolt purchasing decision.
As such, the true “cost” of the second option may be dramatically lower than the first, “low price”, option.