At year-end, buying groups produce their reports to members. What did joint procurement deliver this year? The answer is a number, and that number has a property that rarely comes with it.
It depends entirely on which price the calculation was made against.
Six reference bases are common in practice. They can be distinguished by whether the reported saving actually changes the company's result.
Cash-effective reference bases produce a saving that becomes visible in the profit and loss account. In English usage they are called hard savings. They include, first, the price last actually paid at the same volume and the same specification, second, the valid framework agreement price where the contract would have been renewed without the tender, and third, the previous year's price adjusted for raw material and index movements. In volatile categories the third is the only sound basis and at the same time the most laborious.
Non-cash-effective reference bases produce a figure describing avoided expense. The common term is cost avoidance, and in the key figure system of the German association for materials management, purchasing and logistics the corresponding metric is recorded as cost avoidance. They include, fourth, the first bid of the eventual winner, fifth, the average or median of all bids received, and sixth, the budget or target price.
The first bid never stood to be paid. The median reflects competitive intensity, not the change against the previous state. The target price measures the quality of planning, not that of procurement.
Both groups have their place. Mixing them is what creates the problem.
Adding cash-effective and non-cash-effective figures produces a total that is neither one nor the other. It cannot be checked, because it merges two different matters into one number.
In a buying group this has an uncomfortable consequence. The member company does not find the reported saving in its own accounts, because part of it could never have arrived there. The report devalues itself, precisely among the members whose participation is needed next year.
The clean route is simple. Report both figures, separately, each with its stated basis. The smaller number comes first, because it is the sound one.
Regardless of the basis chosen, a price comparison is only valid if the matters compared correspond. Five adjustments are required in practice.
Volume adjustment, because tiered prices vary with volume. Specification adjustment, because a changed technical requirement means a different article. Normalizing contract terms to twelve months, because otherwise commitments of different lengths are compared. Adjustment for currency and index effects. And accounting for changed payment and delivery terms, which can make up a considerable part of the price difference.
If a line item with a different volume and a different specification is set against the previous year's value, two different matters are being compared. The difference is then not a saving but an artefact of the calculation.
For buying groups, volume adjustment is the most common stumbling block, because bundled volume by definition differs from the member's previous individual volume.
When a category is tendered jointly for the first time, no reference price exists for the group. By definition there is then no cash-effective saving, regardless of how the tender went.
At the start this is not the exception but the normal case. Three statements remain possible. The gap between the winner's first bid and the awarded price describes the concession of a single bidder. The gap to the median of all bids describes the value of competitive intensity. The gap to the estimated price describes the quality of the estimate.
Of these three, the gap to the median is the most informative, because it answers the question of what involving several suppliers contributed. We treat it as an avoidance effect and report it separately from cash-effective amounts.
One note for the annual report. The cash-effective impact of these first-time tenders shows up the following year, once a reference price exists. Explaining that in the first year saves justifying it in the second.
Which basis should we use for the annual report? The price each member last actually paid, at the same volume and the same specification. That is more laborious than a group figure and holds up to questioning.
We have always calculated against the first bid. Do we have to change that? Not retroactively. For the coming report it is enough to name the basis and report both figures separately. A reported cost avoidance is nothing improper as long as it is labelled as such.
What does the auditing association say? That depends on the individual case. What holds in any case is a figure whose basis is stated and whose source data exists. It becomes laborious when the source data has to be reconstructed first.
Sections 2.3 to 2.5 of the study contain the taxonomy of the six reference bases, the five adjustments and the methodologically distinct case of a first-time tender without a reference price.
→ To the white paper
It depends entirely on which price the calculation was made against.
Six reference bases in two groups
Six reference bases are common in practice. They can be distinguished by whether the reported saving actually changes the company's result.
Cash-effective reference bases produce a saving that becomes visible in the profit and loss account. In English usage they are called hard savings. They include, first, the price last actually paid at the same volume and the same specification, second, the valid framework agreement price where the contract would have been renewed without the tender, and third, the previous year's price adjusted for raw material and index movements. In volatile categories the third is the only sound basis and at the same time the most laborious.
Non-cash-effective reference bases produce a figure describing avoided expense. The common term is cost avoidance, and in the key figure system of the German association for materials management, purchasing and logistics the corresponding metric is recorded as cost avoidance. They include, fourth, the first bid of the eventual winner, fifth, the average or median of all bids received, and sixth, the budget or target price.
The first bid never stood to be paid. The median reflects competitive intensity, not the change against the previous state. The target price measures the quality of planning, not that of procurement.
Why mixing them is the problem
Both groups have their place. Mixing them is what creates the problem.
Adding cash-effective and non-cash-effective figures produces a total that is neither one nor the other. It cannot be checked, because it merges two different matters into one number.
In a buying group this has an uncomfortable consequence. The member company does not find the reported saving in its own accounts, because part of it could never have arrived there. The report devalues itself, precisely among the members whose participation is needed next year.
The clean route is simple. Report both figures, separately, each with its stated basis. The smaller number comes first, because it is the sound one.
Five adjustments before any price comparison
Regardless of the basis chosen, a price comparison is only valid if the matters compared correspond. Five adjustments are required in practice.
Volume adjustment, because tiered prices vary with volume. Specification adjustment, because a changed technical requirement means a different article. Normalizing contract terms to twelve months, because otherwise commitments of different lengths are compared. Adjustment for currency and index effects. And accounting for changed payment and delivery terms, which can make up a considerable part of the price difference.
If a line item with a different volume and a different specification is set against the previous year's value, two different matters are being compared. The difference is then not a saving but an artefact of the calculation.
For buying groups, volume adjustment is the most common stumbling block, because bundled volume by definition differs from the member's previous individual volume.
The case buying groups regularly face at the start
When a category is tendered jointly for the first time, no reference price exists for the group. By definition there is then no cash-effective saving, regardless of how the tender went.
At the start this is not the exception but the normal case. Three statements remain possible. The gap between the winner's first bid and the awarded price describes the concession of a single bidder. The gap to the median of all bids describes the value of competitive intensity. The gap to the estimated price describes the quality of the estimate.
Of these three, the gap to the median is the most informative, because it answers the question of what involving several suppliers contributed. We treat it as an avoidance effect and report it separately from cash-effective amounts.
One note for the annual report. The cash-effective impact of these first-time tenders shows up the following year, once a reference price exists. Explaining that in the first year saves justifying it in the second.
Frequently asked questions
Which basis should we use for the annual report? The price each member last actually paid, at the same volume and the same specification. That is more laborious than a group figure and holds up to questioning.
We have always calculated against the first bid. Do we have to change that? Not retroactively. For the coming report it is enough to name the basis and report both figures separately. A reported cost avoidance is nothing improper as long as it is labelled as such.
What does the auditing association say? That depends on the individual case. What holds in any case is a figure whose basis is stated and whose source data exists. It becomes laborious when the source data has to be reconstructed first.
The next step
Sections 2.3 to 2.5 of the study contain the taxonomy of the six reference bases, the five adjustments and the methodologically distinct case of a first-time tender without a reference price.
→ To the white paper