The Optimal Price used in sourcing decision
The 90% of Government and private sector sourcing or purchasing decision on products is made based on Least pricing method, A business quoting least pricing gets the Purchase Order or contracts. In most cases the Qualification of a Suppliers Business system, Quality System and capacity is determined after a supplier is short listed due to the least pricing offered.
As Most buyers do not even proceed with suppliers who have better product quality and services, if their pricing is at the median of all the solicited quotes.
Least pricing method has lot of disadvantages, the can be listed in the following order
1.No pricing outliers are considered
Example: If 6 quotes from 6 suppliers are received from the same Geographical area, 4 quotes are deemed to be clustered in the median, while 1 quote is a distant low pricing and 1 quote is a distant highly priced, the buyer simply chooses the supplier who has presented a distant low price.
2.The low-priced supplier’s quality and business system supplied to larger companies are evaluated by its Auditors. In most cases the Quality systems are least developed to match the supply requirements and a Huge Quality System Development is engaged
3.Supplies from an outlier low cost supplier are very less reliable and are subject repeated rejections, reworks, supply delays and Spot buys from a Very expensive source.
There are several points which we can list as a cost disadvantage in using Least pricing method, however to focus on the solution which is Optimal pricing method, we must limit the disadvantages to the above 3 points.
Optimal Pricing method
The header clearly states what we are about to discuss, which is Optimal Means Right price for Right commodity at a given Geographical location.Optimal pricing considers a median price range of all the quotes obtained from various suppliers of a commodity at a given geographical region.
To properly depict the methodology here is a practical example:
Supplier’s A TO Z are requested to Quote a commodity item and all suppliers are in the same geographical region. Quotes are received by supplier A, B, C, D, E, F and G the rest of the suppliers do not quote or may not be interested in quoting at that time.
Following are the value of quotes per part in US$
Supplier A = 0.25$, B= 0.26$, C=0.26$, D= 0.24$, E=0.29, F=0.45$ and G = 0.15$
In least Pricing method, a Buyer would have simply decided on sourcing the commodity with supplier G.
In Optimal Pricing Method involves a little more screening and computation, It eliminates Supplier G an F as outliers (Supplier F would be automatically eliminated in Least Pricing method).
Pricing range for Suppliers A-E will be 0.24$ to 0.29$
Median Price will be 0.26$
Mean price will be 0.26$
In the Mathematics, The Mean has various definitions depending upon the context of the situation.
For a Data Set, the terms Arithmetic mean and average are exactly used to refer a central value value of a different set of numbers. Generally, The sum of the values divided by the number of values.
For Example, The Arithmetic mean of 5 values 10, 20, 30, 40, 50 is
10+20+30+40+50/5= 30. So, The Arithmetic mean is 30.
The Median is nothing but a value separating from the higher half of the data group to the lower half. In General Terms, it may be considered as the middle value of the data group. For example, in the data group 1, 3, 4, 6, 7, 8, 9, the median is 6. The fourth number in the sample. The median is a normally used to measure the properties of the data group in statistics.
For Example: The median of a finite list of numbers can be found by arranging all the numbers from smaller to bigger.
1. If there is an odd number of numbers the middle one is picked. For example, consider the following group of numbers:
1, 3, 4, 6, 7, 8, 9
This set contains seven numbers. The median is the fourth of them, which is 6.
2. If there are an even number of numbers then there is no single middle value; the median is then usually defined to be a mean of the two middle values.For example, in the data group:
1, 2, 3, 4, 5, 6, 8, 9
The median in this data group is the mean of the middle two numbers: this is (4 + 5) ÷ 2 = 9/2= 4.5. The Median is 4.5
The Mean price or Average price is same as median price in this case, however if mean price is lower than the Median price then a Buyer will use the mean price to negotiate with the suppliers at the median (will also consider other suppliers within the range for negotiation).
The Supplier’s short listed based on the Mean pricing can be short listed and requested for samples, in this case Suppliers A-D will be requested for samples as their prices are clustered around the Median, while Supplier E is out of the Cluster.
This Methodology considers all the Hidden Factors such as Good Manufacturing Practices, Quality and Business systems of the suppliers in deriving a Common Acceptable pricing. This also eliminates Supplier Development costs and Significantly reduces the risk of rejections. Optimal pricing methodology may be slightly time consuming to a buyer,but adds lot strategic value in Sourcing and Reduces Strategic sourcing costs.
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