Notesale: Turn your study into money

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Possibilities for evaluating
suppliers’ offers
Lowest price
Lowest total cost
of ownership
Weighted scoring

?

Value
judgement
ITC

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...
Lowest price
 Suppliers’ offers are tested for compliance
against minimum requirements, e
...
:
Does the offer meet your specifications?
Can the supplier deliver on schedule?
 If they meet or exceed these criteria, they are evaluated on the
basis of their offered price, e
...
:
Evaluating offers for supply of office PCs

ITC

Supplier

Registered
supplier?

A
B
C
D
E
F
G

Yes
Yes
Yes
No
Yes
Yes
Yes

Meets minimum:
Delivery
Specification
schedule

Price

Selected:

Yes
Yes
Yes

No
Yes
Yes

$ 42,300
$ 47,500

No
No

No
Yes
No

Yes

$ 38,900

Yes
M6:U4:4
...
2-1

Evaluation based on lowest price
The following table shows a tabulation of offers from Suppliers X, Y, and
Z together with the minimum requirements of the buying company
...
2-2

2
...
3-1

Features of the TCO approach
...
e
...
3-2

TCO components:
Purchase cost
Operating costs
Preventive maintenance costs
Repair costs
Cost of disposal
Capital costs
Other costs, e
...
insurance
Other considerations, e
...
: output levels
ITC

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...
3-1

Elements of total cost of ownership
Consider the case of a delivery vehicle to be purchased
...


ITC

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...
3-5

Quantifying each cost
You need to quantify each of the
component costs and tabulate them over
the lifetime of the equipment
In most cases, it is sufficient to look at
total annual costs
You may exclude certain costs if:
 The cost is very small compared with other costs
 The cost can be expected to be similar
for all offers

ITC

M6:U4:4
...
3-7

The importance of the timing of costs
 Different suppliers’ offers are likely to
result in different levels and patterns
 Thus, although the sum of all costs
of two offers is similar, one offer
might involve higher costs in early years
while the other might involve higher
costs in later years, e
...
:
Purchase of production machinery: Summary of costs over time
Offers

ITC

Year 1

Year 2

Year 3

Year 4

Total cost

Supplier X

Purchase
price:

$5,000

$20,000

$5,000

$90,000

Supplier Y

Purchase
price:

$3,000

$3,000

$4,000

$90,000

$60,000

$80,000
M6:U4:4
...

Cost of using Supplier X taking interest payments into account
Year 1

Year 1 cost
Interest payments
associated with Year 1

Year 2 cost
Interest payments
associated with Year 2

Year 3 cost
Interest payments
associated with Year 3

Year 4 cost
Interest payments
associated with Year 4

Total
ITC

Year 2

Year 3

Year 4

$60,000
$6,000

Total
$60,000

$6,600

$7,260

$7,986

$5,000
$500

$27,846
$5,000

$550

$605

$20,000
$2,000

$1,655
$20,000

$2,200

$4,200

$5,000

$5,000

$500

$500
$124,201
M6:U4:4
...

Cost of using Supplier

Y taking interest payments into account
Year 1

Year 1 cost
Interest payments
associated with Year 1

Year 2 cost
Interest payments
associated with Year 2

Year 3 cost
Interest payments
associated with Year 3

Year 4 cost
Interest payments
associated with Year 4

Total
ITC

Year 2

Year 3

Year 4

$80,000
$8,000

Total
$80,000

$8,800

$9,680

$10,648

$3,000
$300

$37,128
$3,000

$330

$363

$3,000
$300

$993
$3,000

$330

$630

$4,000

$4,000

$400

$400
$129,151
M6:U4:4
...
3-2

Calculation of financing costs
A company is paying $20,000 for a new delivery vehicle from its
overdraft, on which it pays an annual interest charge of 15%
...
3-11

Calculating the TCO using the Net
Present Value (NPV) approach
NPV takes the time-value of
money into account in calculating
the total cost of ownership

12
3

9
6

=

It re-states all costs in terms of
the equivalent cost today, i
...
the
“present-day equivalent cost”
E
...
at a 15% interest rate, a cost of $23,000 in
one year’s time = a present-day cost of $20,000
Future costs are thus “discounted” back to the present!
ITC

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...
g
...
The funding can include…






Bank account in credit
Bank overdraft
Bank loan
Issue of shares
Issue of bonds

5
X

2

When various sources are used, the discount rate
is the weighted average cost
ITC

M6:U4:4
...
9709
0
...
9524
0
...
9346
0
...
9174
0
...
9009
0
...
8850
0
...
8696

Year
2
0
...
9246
0
...
8900
0
...
8573
0
...
8264
0
...
7972
0
...
7695
0
...
9151
0
...
8638
0
...
8163
0
...
7722
0
...
7312
0
...
6931
0
...
6575

Year
4
0
...
8548
0
...
7921
0
...
7350
0
...
6830
0
...
6355
0
...
5921
0
...
8626
0
...
7835
0
...
7130
0
...
6499
0
...
5935
0
...
5428
0
...
4972

Year
6
0
...
7903
0
...
7050
0
...
6302
0
...
5645
0
...
5066
0
...
4556
0
...
8131
0
...
7107
0
...
6227
0
...
5470
0
...
4817
0
...
4251
0
...
3759

Or
...
7894
0
...
6768
0
...
5820
0
...
5019
0
...
4339
0
...
3762
0
...
3269

Year
9
0
...
7026
0
...
5919
0
...
5002
0
...
4241
0
...
3606
0
...
3075
0
...
of years
r = the discount rate

Year
10
0
...
6756
0
...
5584
0
...
4632
0
...
3855
0
...
3220
0
...
2697
0
...
3-14

Action Point

4
...


Now, use formulas to calculate the net present value of
$75,300 payable four years from now, assuming a discount
rate of 13%
...
3-15

An example
...
9259

0
...
7938

0
...
3-16

The result for
...
9259

5,000 x 0
...
8573

7,000 x 0
...
7938

7,000 x 0
...
7350

-5,000 x 0
...
3-17

The result for
...
9259

2,778

Year 2

3,000

0
...
7938

2,381

Year 4

-1,000

0
...
3-18

Action Point

4
...
The average cost of capital is 12%
...
3-19

NPV - some issues to consider…
The impact of errors in cost estimates
 Difficult to forecast far into the future
...
3-20

When to use TCO
Appropriate to use when:
 There are relatively significant ongoing costs after the
purchase has been made
...

 The value for money is important
...

TCO is usually associated with major capital purchases, but is
generally relevant for a significant proportion of all purchases

ITC

M6:U4:4
...
Weighted scoring models
Suppliers are scored against criteria that have been
“weighted” to reflect their relative importance
The supplier with the highest overall score is
awarded the contract / order
Cost is treated in the same way as all other criteria
If the supplier with the highest overall score is not
the lowest cost, you may be tempted to ignore the
scores and select the lowest cost supplier anyway
The supplier must be selected on the overall
assessment of many relevant criteria, of which cost
will be just one
ITC

M6:U4:4
...
Identify which criteria are important
in selecting a supplier’s offer
...
Give a numeric weighting to each criterion to reflect its relative
importance in the supplier selection decision
...
Identify minimum requirements for certain of the criteria
- to be used to screen-out unsuitable /
less-suitable suppliers
...
Develop a range of scores to apply to the remaining suppliers’
offers in relation to each of these criteria
...
4-2

The process of weighted scoring:
5
...


6
...


7
...


ITC

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4-4

Scoring capability: some criteria…
Ability to meet essential and desirable requirements
(specifications, quantity, lead-time…)
Quality assurance
Customer service
Supply capacity
Past performance
Strategic issues (location, distribution network…)
Supplier innovation
Financial strength
Risk management (including insurance)
Compliance with conditions of contract
ITC

M6:U4:4
...
Technical performance
 Precision in measurement

10

(10)

2
...
Lead-time to delivery
 Delivery of the main equipment

9

(9)

4
...
4-6

An example:

(Continued…)

5
...
Life-cycle cost
 Purchase price (2)
 Cost of spare parts (2)
 Cost of staff training (1)
 Cost of maintenance support

10
(3)

7
(2)

TOTAL:

ITC

56

M6:U4:4
...
less than
100 days
between failures

Avge
...
120-129
days between
failures

Supplier A
Supplier B
Supplier C

ITC

Avge
...
150 or
more days
between failures

X
X
X

M6:U4:4
...
Score Wtd
...

Score Score
Score
Score

1
...
Reliability
 Low meantime between failures
 Low outage rate (3)
 Durability of the equipment (4)

(3)

3
...
Supply horizon – continuity of spares




ITC

(1)
Offer of continuity of supply
(3)
Financial stability
(3)
Core product for supplier
(3)
Sustainable market position

M6:U4:4
...
Score Wtd
...

Score Score
Score
Score

5
...
Life-cycle cost





List price (2)
Cost of spare parts (2)
Cost of staff training (1)
Cost of maintenance support

224 Total weighted score:

160

148

129

Scores (as % of 224) =

71%

66%

58%

Max
...
4-10

Action Point
Weighted scoring: suppliers’ capabilities

4
...

 List the evaluation criteria, and allocate a weight to each
...

 Calculate the total weighted scores and capability ratings for each
supplier
...


Technical performance

2
...


Lead-time to delivery

4
...


Technical support

6
...

Score

Supplier
Y
Score

Wtd
...

Score

Total weighted score:
Supplier capability rating:

M6:U4:4
...
g
...
4-12

Scoring motivation: two elements
The Supplier Perception Model:
getting to an overall rating

B

H

M

Level of
attractiveness

N

M

E

L

C

D

L

A

N
N

H

F
L

M

H

Value of
business
ITC

M6:U4:4
...
4-2

 List your criteria for scoring the two dimensions of motivation (value of
business and level of attractiveness) for the three suppliers of the
item reviewed in the previous Action Point
...

 Plot the overall motivation ratings for each supplier in the chart below
...
4-14

Combining the scores
...

100%

4

E
C

50%

Capability

A

D

F
N

L

B

M

H

Motivation
ITC

M6:U4:4
...
4-3

Weighted scoring: supplier ratings for capability & motivation

 In the chart below, plot the positions of the three suppliers, as a
result of the capability and motivation ratings that you arrived at in
the previous two Action Points
...

100%

50%

Capability

N

L

M

H

Motivation
ITC

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It is just
weighted amongst all the other factors
ITC

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5-1

An example
...

ITC

M6:U4:4
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5-1

Value judgement

 Take the three suppliers’ positions in the previous Action Point
...

100%

50%

Capability

N

L

M

H

Motivation
ITC

M6:U4:4
...

Summary of different approaches to evaluating offers
Lowest price
 Suppliers are

tested against
minimum
criteria

Description

 Evaluation based

on purchase price

Lowest total
cost of
ownership
 Suppliers are

tested against
minimum
criteria

Weighted
scoring
 Suppliers are

tested against
weighted
criteria

 Evaluation

supplier gets
the order

ITC

 A weighted

Scoring
approach
excluding cost

 The overall

based on TCO
 The supplier with

 The lowest price

Value
judgement

the highest
overall score
gets the order

score is
compared
against cost,
and judgement
is made

M6:U4:4
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Complexity
/ effort

Lowest price

Lowest total
cost of
ownership

Simple / low
effort

Complex / high
effort

 For standard

products

 Where post-

When
appropriate?

ITC

purchase costs
are small, or
when low price
is the main
supply target

 When post-

purchase costs
are significant

 When low TOC

is the main
supply target

Weighted
scoring
Complex / high
effort
 Where cost is

not a dominant
consideration

 Where a pass /

fail approach to
evaluation is
insufficient
...
6-2

Method & depth of evaluation in the
context of the Supply Positioning Model
H

Value judgement
(based on TCO)

Weighted
scoring

Impact/
supply
opportunity/
risk rating

As risk
increases

M

L
Lowest
price

N

Weighted scoring
w/ high weight
given to costs

As expenditure
increases Lowest total cost of
ownership (TCO)

80% of items = 20% of value

20% of items = 80% of value

Expenditure
ITC

M6:U4:4
...

Bid evaluations criteria should be
consistent with the relevant supply
objectives
If the focus is on financial accounts, you should
evaluate offers based on their impact on the
profit & loss account and balance sheet
Cash flow - as determined by the timing of
payments - may be important
Economy will generally be the essential test
The purchase price is only one of several
considerations when selecting a supplier
ITC

M6:U4:4
...


(continued)

Meeting user requirements such as timely delivery,
quality and service is critical and usually more
important than price
The financial analysis should be conducted as
thoroughly as needed, and include everything
that can be costed - using, e
...
, the NPV method
Weighting scoring focuses on supply risk; value
judgement combines weighted scoring with comparison
of costs
All offers should be compared and assessed
against the evaluation criteria
Alternative products to those
specified should be considered if they
meet the requirements
...
7-2



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