PurchTips edition #320

A commonly-used term is “best value procurement.” In most cases where “best value procurement” is used, people use it to describe purchasing decisions where factors other than price are given “points” and used in determining the supplier to select.

That’s a fine methodology, which I refer to as “weighted average supplier scoring.” But, I argue that “best value procurement” should mean something more.

I believe that “value” is something that can be measured in financial terms. Value might be increased revenue. Value might be reduced cost. Or value might be a combination of the two. Regardless, “value” can and should be expressed in units of currency.

So, if one machine (Machine A) can help a company reduce its labor force by 10 people and, thus, its payroll by $500,000 per year for 10 years, then that machine has a value of $5,000,000. If a competing machine (Machine B) can help the same company reduce its labor force by 15 people and, thus, its payroll by $750,000 per year for 10 years, then that machine has a value of $7,500,000.

But those numbers alone wouldn’t tell you the “best value.” Because true “best value” factors in cost as well.

If, on a total cost basis, Machine A costs $2,000,000, then it has a value-to-cost ratio of 2.5 ($5,000,000 / $2,000,000 = 2.5). If Machine B costs $5,000,000, then it has a value-to-cost ratio of 1.5 ($7,500,000 / $5,000,000 = 1.5). Additionally, net value subtracts cost from value.

Both a higher value-to-cost ratio and higher net value are more attractive, so on a purely “best value” procurement decision, Machine A would be chosen. For best value procurement decisions to work well, all suppliers considered must meet minimum supplier qualification criteria, which may include factors like financial stability, service capability, quality requirements, etc. Those criteria are not subjectively ranked and scored – they are evaluated to ensure that they meet the high standards of the buying organization as a prerequisite to consideration.

Both true best value procurement and weighted average supplier scoring are legitimate procurement decision methods. So are decision-making methods based on low bids, reverse auction outcomes, lowest total cost of ownership analysis, and sourcing optimization.

The key is using the right method in the appropriate situation.

Recommended Reading

• Procurement Value Creation Workbook
• Incorporating Value-Driven Procurement Into Negotiations

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