True Cost Versus Piece Price in the Supply Chain

Chris Harris is one of the authors of a new book titled Lean Supplier Development: Establishing Partnerships and True Costs Throughout the Supply Chain, and I recently asked him the following questions in an email: "Why shouldn't the decision of where to source a purchased component be made on piece price alone? And, just what is 'true cost' and why should it be considered?

Here is Chris Harris' concise reply:

"The piece price of an component -- the comparison of one supplier’s piece price to another’s -- is typically the driving factor for selection of one supplier over another. But unfortunately, piece price only tells us a fraction of the cost that is actually borne by your organization when sourcing a component. The piece price only takes into account the price for which the supplier is willing to sell the item -- it usually includes the supplier’s manufacturing costs and overhead costs and profit, but it may or may not include factors such as the cost to you, the customer, for transportation of the component to your location and many other concealed costs.

When you evaluate a supplier’s cost, I believe you should always use a true cost methodology. The true cost methodology does indeed consider the piece price as a part of the equation but also takes into account other costs that fall into one of three categories: change costs (the cost of switching from one supplier to another), risk costs (the cost that you can reasonably predict could occur in the course of doing business with a supplier), and ongoing costs (the costs you'll bear during the duration of time that the new supplier is providing you with product)."

What are your considerations when purchasing parts or components? Do you use any type of "true cost" model?


Supply Chain Management said...
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