Pricing Arrangements in Procurement Quiz

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Questions and Answers

What is a key task for procurement in terms of getting value for money on all purchases?

Negotiating the lowest possible price with suppliers

Focusing on the target level of profit for the supplier

Considering a whole range of factors that affect the actual price paid (correct)

Ensuring effective price and cost management in commercial agreements

What is the role of the salesperson in determining the price in a commercial agreement?

To negotiate the highest possible price with the buyer

To ensure effective price and cost management

To agree on a price as near to the minimum as possible

To get to an agreed price as near as possible to the maximum range price (correct)

What are some factors that can affect the actual price paid for goods or services?

The supplier's indirect costs allocation

The buyer's pricing strategy

Scarcity of materials used in the supplier's production (correct)

The target level of profit for the buyer

In the context of indexation and price adjustment, what does it mean when the index value is 112?

The total cost for the goods is 12% more than in the base year Signup and view all the answers

What is the purpose of using an index in price adjustments?

To avoid renegotiating contracts when underlying costs change Signup and view all the answers

Why is there no incentive for the supplier to work more efficiently in a price-capped contract?

Efficiency does not affect the amount of profit in a price-capped contract Signup and view all the answers

What potential risk does the supplier face in a price-capped contract?

Dispute with the buyer over reimbursement if the price cap is reached Signup and view all the answers

Why is it impractical for industries to renegotiate contracts when underlying costs change?

They have hundreds or thousands of customers Signup and view all the answers

What is the purpose of normalizing an index value?

To express every year as a percentage of the base year Signup and view all the answers

In the context of calculating an index, what does an index value of 104% in 2015 indicate?

The total cost for the goods is 4% more than in the base year Signup and view all the answers

What is the significance of selecting a base year when calculating an index?

To express every other year as a percentage of the base year Signup and view all the answers

What does a pricing schedule primarily reveal?

The relationship between price and volume Signup and view all the answers

In which type of markets is the pricing schedule commonly used?

Commodity markets, agricultural products, and utilities Signup and view all the answers

What is the main benefit of using a pricing schedule for buyers?

Gaining a better understanding of the supplier's pricing structure Signup and view all the answers

At what stage can a pricing schedule include a breakdown of the main cost components?

Tender stage Signup and view all the answers

In which procurement category is the use of pricing schedules particularly helpful?

Tactical acquisition category Signup and view all the answers

How much cost reduction was achieved in the case study example of using a pricing schedule in a cleaning services tender?

20% Signup and view all the answers

What concept does the strategic use of pricing schedules align with?

Kraljic's portfolio analysis Signup and view all the answers

What does the breakdown of the total price in a pricing schedule provide?

Transparency in the pricing structure Signup and view all the answers

What is the main purpose of a pricing schedule in procurement?

To compare prices for different quantities purchased Signup and view all the answers

What does the pricing schedule help the buyer seem like in the absence of action?

A price taker Signup and view all the answers

What should buyers understand to take action using pricing schedules?

The supply market Signup and view all the answers

For which category of purchases is the buying process expected to be efficient due to low spend and low supply market risk?

Tactical acquisition category Signup and view all the answers

What is the primary advantage of fixed-pricing arrangements?

Predictability and budgetary certainty Signup and view all the answers

In what scenarios are fixed-price arrangements particularly relevant?

Consultancy services Signup and view all the answers

What does a firm-fixed-price contract require from the supplier?

Careful cost management to ensure profitability Signup and view all the answers

What is the purpose of adding profit in the price calculation for a consultancy service?

To ensure a sustainable business model Signup and view all the answers

When is fixed price with adjustment often used?

When the price is nominally fixed, but certain elements vary in line with an agreed index Signup and view all the answers

What is the downside of fixed-pricing arrangements?

The risk for the seller and potential disappointment for either party if costs change unexpectedly Signup and view all the answers

What does a fixed-price arrangement create for both the buyer and the seller?

Certainty and predictability Signup and view all the answers

How does XYZ Consultants ensure a fixed price for implementing a software package?

By offering a fixed fee of $20,000 regardless of the complexity or additional time required Signup and view all the answers

What is the purpose of creating work packages for each task in the price calculation for a consultancy service?

To estimate time and costs for each task Signup and view all the answers

What do different types of fixed-price contracts offer for managing cost variations?

Varying mechanisms, including firm-fixed-price, firm-fixed-price with incentive, and fixed price with adjustment Signup and view all the answers

What is an example of fixed pricing in bookkeeping services?

A fixed price quoted based on an estimation of the work involved, with potential for profit from more complex work offsetting any additional effort Signup and view all the answers

What is a potential variation of a firm-fixed-price contract?

Firm-fixed-price with incentive Signup and view all the answers

What is the formula for cost-plus price?

Total cost + Target profit Signup and view all the answers

What is a disadvantage of cost-plus pricing for the buyer?

No incentive for the supplier to manage costs properly Signup and view all the answers

What is the formula for direct material costs in the example of cost-plus pricing?

$50 Signup and view all the answers

What is the advantage of cost-reimbursable pricing for the supplier?

Being reimbursed all costs plus an agreed amount for profit Signup and view all the answers

What is the buyer's challenge with cost-plus pricing?

Supplier over-recovering indirect overheads Signup and view all the answers

What is the disadvantage for the supplier with cost-plus pricing?

Ignoring competition can lead to potential profit reduction or loss of business Signup and view all the answers

What is the formula for cost-reimbursable pricing?

Total costs + Agreed profit Signup and view all the answers

What is the buyer's dilemma with wide price range in procurement tender?

Wide price range complicates decision-making Signup and view all the answers

What does cost-reimbursable pricing commonly apply to?

Projects with unclear initial scope Signup and view all the answers

What is the risk management feature of cost-reimbursable contracts?

Ceiling on the price to avoid unaffordable cost escalation Signup and view all the answers

What is the advantage of cost-plus pricing for the supplier?

Assurance of recovering all costs and making a profit Signup and view all the answers

What is the disadvantage of cost-plus pricing for the supplier?

Ignoring competition can lead to potential profit reduction or loss of business Signup and view all the answers

What is one of the main reasons a supplier might want to use an indexed price?

To quickly reflect rising input prices and stay competitive Signup and view all the answers

Why might a sudden and unanticipated rise in costs make a contract unprofitable for a supplier?

The supplier has entered into a commitment before knowing its costs Signup and view all the answers

In what way can indexed price arrangements be useful for buyers?

To monitor supplier prices and gain valuable insights Signup and view all the answers

What does comparing the rise or fall of a steel price index with the price index of items purchased from a supplier help buyers with?

Gaining valuable insight into supplier pricing Signup and view all the answers

Which pricing model encourages collaboration between buyer and seller, requiring a high degree of trust and fair risk allocation?

Gain-share pricing Signup and view all the answers

Which pricing model ties the price to the achievement of an agreed level of performance, often stated in quantitative or qualitative targets?

Incentive-based pricing Signup and view all the answers

Which pricing model is based on the amount of a service consumed, commonly used in IT, serviced offices, and utilities?

Consumption-based pricing Signup and view all the answers

What does converting fixed costs to variable costs involve?

Making costs rise and fall with the number of people working at any one time Signup and view all the answers

What is crucial for cash flow and includes price, payment method, and when the payment is due, ensuring no misunderstandings or disputes?

Terms of sale Signup and view all the answers

What is made before the goods or services are delivered, ensuring that the supplier receives sufficient payment to cover initial expenses?

Advance payment Signup and view all the answers

When does immediate payment occur?

As soon as the goods or services have been delivered and an invoice received Signup and view all the answers

What does net x days payment term mean?

Payment is expected in x days after the invoice date Signup and view all the answers

What does shared risk-reward model encourage suppliers to do?

Find ways of improving the buyer's business Signup and view all the answers

What do payment terms ensure?

No misunderstandings or disputes regarding payment Signup and view all the answers

What is the primary purpose of incentive-based pricing?

Tie the price to the achievement of an agreed level of performance Signup and view all the answers

What is the main characteristic of consumption-based pricing?

Based on the amount of a service consumed Signup and view all the answers

What is the purpose of a line of credit in payment terms?

To permit buyers to spread payments over an agreed period Signup and view all the answers

What is the primary function of a letter of credit from a bank?

To guarantee full payment on the due date Signup and view all the answers

What is the key characteristic of bills of exchange?

To obligate one party to pay a fixed sum on demand Signup and view all the answers

What is the primary aim of open-book costing?

To reduce costs and improve service for mutual benefit Signup and view all the answers

In what context is open-book costing most effective?

When the buyer and supplier view each other as strategic to their business Signup and view all the answers

What is the purpose of contra payments in financial arrangements?

To deduct what buyers owe to a supplier from the amount owed to them Signup and view all the answers

What is the calculation basis for interest invoices for late payments?

Based on the number of days the payment is overdue and an annualized interest rate Signup and view all the answers

What is the primary characteristic of payment terms specified as 'net x days with y% discount'?

Allow buyers to receive a discount for early payment Signup and view all the answers

What is the primary aim of applying open-book costing in the public sector for engineering design and construction?

To reduce costs and improve service for mutual benefit Signup and view all the answers

What is the purpose of a payment term specified as 'net x days'?

To guarantee full payment on the due date Signup and view all the answers

Which stage of implementing open-book costing involves improving current performance?

Scaling Signup and view all the answers

In the context of open-book costing, what is the primary purpose of the 'Testing' stage?

Stabilizing current performance Signup and view all the answers

What is the main focus of Lean thinking according to Womack and Jones?

Customer satisfaction Signup and view all the answers

What is the first step in the five-step process of applying Lean thinking?

Specify value from the standpoint of the customer Signup and view all the answers

What does the 'Embedding' stage of open-book costing aim to achieve?

Embedding the open-book culture in the Ways of Working of both parties Signup and view all the answers

What is the primary focus of the 'Exploring' stage in open-book costing?

Briefing suppliers and testing their willingness to participate Signup and view all the answers

According to Womack and Jones, what is the second basic aspect that guides Lean thinking?

Process optimization Signup and view all the answers

What is the key characteristic of the 'Transactional' type of relationship?

Joint aim with no additional value to be gained Signup and view all the answers

What is the role of the supplier in the 'Interdependent' type of relationship?

To provide mutual competitive benefit Signup and view all the answers

In the context of buyer involvement, which type of relationship involves frequent involvement from many functions?

Strategic Signup and view all the answers

What is the main characteristic of the 'Cooperative' type of relationship?

Long-term commitment with continuous benefit generation Signup and view all the answers

What is the primary selection criteria for the 'Transactional' type of relationship?

Lowest price Signup and view all the answers

What are the four stages involved in implementing open-book costing?

Exploring, testing, scaling, and embedding Signup and view all the answers

What are the three basic aspects of Lean thinking?

Purpose, process, and people Signup and view all the answers

How many types of relationships are there in supply chain management?

Three: interdependent, cooperative, and transactional Signup and view all the answers

What are the stages involved in applying Lean thinking?

Specify value, identify steps, arrange value-adding steps, let customers pull value, and repeat Signup and view all the answers

What is the primary aim of open-book costing?

To create transparency and collaboration Signup and view all the answers

What tools can be used to find solutions for reducing costs in open-book costing?

Lean thinking Signup and view all the answers

What are the different types of relationships in supply chain management based on?

Selection criteria, roles of suppliers, relationship lengths, and buyer involvement Signup and view all the answers

What are the stages involved in implementing open-book costing based on?

Specific characteristics and examples for each stage Signup and view all the answers

What is the role of Lean thinking in reducing costs?

Finding solutions for reducing costs Signup and view all the answers

What is the purpose of the three basic aspects of Lean thinking?

To create value with minimum waste Signup and view all the answers

What is the significance of the relationship lengths in supply chain management?

It determines the duration and depth of collaboration Signup and view all the answers

What are the characteristics of the three types of relationships in supply chain management?

Different selection criteria, roles of suppliers, and buyer involvement Signup and view all the answers

What is Little's Law used to calculate in Lean thinking?

Lead time for a process Signup and view all the answers

In Lean thinking, what does the term 'WIP' refer to?

Amount of work waiting to be completed Signup and view all the answers

What is the relationship between WIP and lead time in Lean thinking?

Directly proportional Signup and view all the answers

In Lean thinking, what does the term 'queue time' refer to?

Delays in the process Signup and view all the answers

What is the primary aim of applying Little's Law in process improvement?

To reduce lead time by reducing the amount of work in process (WIP) or by increasing the average completion rate Signup and view all the answers

What is the key measure of process efficiency according to Lean principles?

Percentage of time work spends in value-adding activities Signup and view all the answers

What does a process efficiency of less than 10% indicate?

Significant waste in the process Signup and view all the answers

What is the primary purpose of a triage system in the context of Lean principles?

To prioritize work based on urgency and importance factors Signup and view all the answers

What did Taiichi Ohno categorize in Lean, which are identifiable for manufacturing processes and service-based organizations?

Seven types of waste Signup and view all the answers

What is the primary focus of applying Lean principles to processes?

Increase process speed, eliminate non-value-add tasks, and reduce costs Signup and view all the answers

What is the significance of Little's Law example in the context of Lean principles?

Reducing work in process (WIP) is easier and costs nothing, while increasing completion rate requires investment Signup and view all the answers

What is the primary impact of waste in a process according to Lean principles?

Adds no value in the eyes of the customer, including time, cost, or work Signup and view all the answers

What is the primary aim of using a triage system in Lean principles?

To prioritize work based on urgency and importance factors Signup and view all the answers

What is the primary focus of applying Lean principles to a Procurement Department?

Eliminating the seven types of waste for improved value for the customer Signup and view all the answers

What is the primary concept emphasized in applying Lean principles to processes?

Increase process speed, eliminate non-value-add tasks, and reduce costs Signup and view all the answers

Study Notes

Pricing Arrangements in Procurement

Cost-plus pricing involves detailed examination of product or service costs and adding a profit margin to determine the price.
Example of cost-plus pricing: Direct material costs = $50, Direct labour costs = $20, Allocated overheads = $10, Total cost = $80, Target profit of $24, Cost-plus price = $104.
Advantages of cost-plus pricing include simplicity, but allocated overheads can be complex and need clear explanation to the buyer.
Buyer challenge: Supplier over-recovering indirect overheads, providing opportunity for price reduction negotiation.
Supplier assurance: Cost-plus pricing assures the supplier of recovering all costs and making a profit, with little or no risk.
Supplier justification: Cost structure and cost increases can be used to justify price increases.
Disadvantage for supplier: Ignoring competition can lead to potential profit reduction or loss of business.
Wide price range in procurement tender: Suppliers' pricing strategies may be influenced by current workload and profit objectives.
Buyer's dilemma: Wide price range complicates decision-making, making it challenging to choose the best supplier.
Disadvantages of cost-plus pricing for the buyer: Provides no incentive for the supplier to design customer-oriented products, manage costs properly, or seek alternative, more efficient methods.
Cost-reimbursable pricing: Supplier is reimbursed all costs plus an agreed amount for profit, commonly used for projects with unclear initial scope.
Risk management: Cost-reimbursable contracts may have a ceiling on the price to avoid unaffordable cost escalation.

Payment Terms and Financial Arrangements in Business

Payment terms such as "net x days" specify the number of days a buyer has to make payment after the invoice date.
"Net x days with y% discount" allows buyers to receive a discount if they pay earlier than the specified time frame.
A line of credit permits buyers to spread payments over an agreed period, common in large organizations with robust financial resources.
Interest invoices can be applied for late payments, calculated based on the number of days the payment is overdue and an annualized interest rate.
A letter of credit from a bank guarantees full payment on the due date, particularly useful in international trading.
Bills of exchange, primarily used in international trade, obligate one party to pay a fixed sum to another party on demand or at a predetermined date.
Contra payments allow buyers to deduct what they owe to a supplier from the amount owed to them, facilitating payment for goods or services.
Open-book costing involves identifying actual costs incurred by a supplier and aims to encourage collaborative behavior between the buyer and supplier.
Open-book costing promotes transparency and aims to reduce costs and improve service for mutual benefit.
Applying open-book costing in the public sector for engineering design and construction resulted in various benefits, including service, commercial, people, and process benefits.
Table 2.4 illustrates the key characteristics of suppliers using open-book costing and other types of suppliers, highlighting 12 features of the buyer-supplier relationship.
Open-book costing is most effective when both the supplier and buyer view each other as strategic to their business, fostering high trust and openness between the parties.

Open-Book Costing and Lean Thinking in Supply Chain Management

Open-book costing involves a relationship between parties working closely together without additional value to be gained that justifies an open-book arrangement, as in a consortium of suppliers.
There are three types of relationships in supply chain management: interdependent, cooperative, and transactional, each with different selection criteria, roles of suppliers, relationship lengths, and buyer involvement.
Implementing open-book costing involves four stages: exploring, testing, scaling, and embedding, with specific characteristics and examples for each stage.
Tools such as Lean thinking can be used to find solutions for reducing costs in open-book costing, with three basic aspects of Lean thinking: purpose, process, and people.
Lean thinking can be applied using a five-step process: specify value from the customer's standpoint, identify all steps in the value stream, arrange value-adding steps in sequence, let customers pull value from activities, and repeat steps until maximum value is created with minimum waste.

Lean Principles and Process Efficiency

Lean work in queue is called queue time, representing the time it sits waiting to be worked on.
Value-add work is what customers would willingly pay for, while non-value-add work is a candidate for elimination.
Process efficiency measures the percentage of time work spends in value-adding activities and is a key measure of any process.
A process efficiency of less than 10% usually indicates significant waste in the process.
Waste in a process is anything that adds no value in the eyes of the customer, including time, cost, or work.
Little's Law, which states that lead time can be reduced by reducing the amount of work in process (WIP) or by increasing the average completion rate, is a key concept.
Little's Law example: reducing WIP is easier and costs nothing, while increasing completion rate requires investment.
A triage system, similar to hospitals, can be used to prioritize work based on urgency and importance factors.
Taiichi Ohno categorized seven types of waste in Lean, which are identifiable for manufacturing processes and service-based organizations.
Examples of the seven types of waste and their impact on a Procurement Department are provided, emphasizing the importance of eliminating them for improved value for the customer.
The chapter discusses ways in which a buyer can influence cost and price by using a particular pricing arrangement.
The text emphasizes the importance of applying Lean principles to processes to increase process speed, eliminate non-value-add tasks, and reduce costs.

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Test your knowledge of pricing arrangements in procurement with this quiz. Explore cost-plus pricing, cost-reimbursable pricing, and their advantages and disadvantages for both buyers and suppliers. Sharpen your understanding of pricing strategies and their impact on procurement decisions.

Pricing Arrangements in Procurement Quiz

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Questions and Answers

What is a key task for procurement in terms of getting value for money on all purchases?

What is the role of the salesperson in determining the price in a commercial agreement?

What are some factors that can affect the actual price paid for goods or services?

In the context of indexation and price adjustment, what does it mean when the index value is 112?

What is the purpose of using an index in price adjustments?

Why is there no incentive for the supplier to work more efficiently in a price-capped contract?

What potential risk does the supplier face in a price-capped contract?

Why is it impractical for industries to renegotiate contracts when underlying costs change?

What is the purpose of normalizing an index value?

In the context of calculating an index, what does an index value of 104% in 2015 indicate?

What is the significance of selecting a base year when calculating an index?

What does a pricing schedule primarily reveal?

In which type of markets is the pricing schedule commonly used?

What is the main benefit of using a pricing schedule for buyers?

At what stage can a pricing schedule include a breakdown of the main cost components?

In which procurement category is the use of pricing schedules particularly helpful?

How much cost reduction was achieved in the case study example of using a pricing schedule in a cleaning services tender?

What concept does the strategic use of pricing schedules align with?

What does the breakdown of the total price in a pricing schedule provide?

What is the main purpose of a pricing schedule in procurement?

What does the pricing schedule help the buyer seem like in the absence of action?

What should buyers understand to take action using pricing schedules?

For which category of purchases is the buying process expected to be efficient due to low spend and low supply market risk?

What is the primary advantage of fixed-pricing arrangements?

In what scenarios are fixed-price arrangements particularly relevant?

What does a firm-fixed-price contract require from the supplier?

What is the purpose of adding profit in the price calculation for a consultancy service?

When is fixed price with adjustment often used?

What is the downside of fixed-pricing arrangements?

What does a fixed-price arrangement create for both the buyer and the seller?

How does XYZ Consultants ensure a fixed price for implementing a software package?

What is the purpose of creating work packages for each task in the price calculation for a consultancy service?

What do different types of fixed-price contracts offer for managing cost variations?

What is an example of fixed pricing in bookkeeping services?

What is a potential variation of a firm-fixed-price contract?

What is the formula for cost-plus price?

What is a disadvantage of cost-plus pricing for the buyer?

What is the formula for direct material costs in the example of cost-plus pricing?

What is the advantage of cost-reimbursable pricing for the supplier?

What is the buyer's challenge with cost-plus pricing?

What is the disadvantage for the supplier with cost-plus pricing?

What is the formula for cost-reimbursable pricing?

What is the buyer's dilemma with wide price range in procurement tender?

What does cost-reimbursable pricing commonly apply to?

What is the risk management feature of cost-reimbursable contracts?

What is the advantage of cost-plus pricing for the supplier?

What is the disadvantage of cost-plus pricing for the supplier?

What is one of the main reasons a supplier might want to use an indexed price?

Why might a sudden and unanticipated rise in costs make a contract unprofitable for a supplier?

In what way can indexed price arrangements be useful for buyers?

What does comparing the rise or fall of a steel price index with the price index of items purchased from a supplier help buyers with?

Which pricing model encourages collaboration between buyer and seller, requiring a high degree of trust and fair risk allocation?

Which pricing model ties the price to the achievement of an agreed level of performance, often stated in quantitative or qualitative targets?

Which pricing model is based on the amount of a service consumed, commonly used in IT, serviced offices, and utilities?

What does converting fixed costs to variable costs involve?

What is crucial for cash flow and includes price, payment method, and when the payment is due, ensuring no misunderstandings or disputes?

What is made before the goods or services are delivered, ensuring that the supplier receives sufficient payment to cover initial expenses?

When does immediate payment occur?

What does net x days payment term mean?

What does shared risk-reward model encourage suppliers to do?

What do payment terms ensure?

What is the primary purpose of incentive-based pricing?

What is the main characteristic of consumption-based pricing?

What is the purpose of a line of credit in payment terms?

What is the primary function of a letter of credit from a bank?

What is the key characteristic of bills of exchange?

What is the primary aim of open-book costing?

In what context is open-book costing most effective?

What is the purpose of contra payments in financial arrangements?

What is the calculation basis for interest invoices for late payments?

What is the primary characteristic of payment terms specified as 'net x days with y% discount'?

What is the primary aim of applying open-book costing in the public sector for engineering design and construction?

What is the purpose of a payment term specified as 'net x days'?

Which stage of implementing open-book costing involves improving current performance?

In the context of open-book costing, what is the primary purpose of the 'Testing' stage?

What is the main focus of Lean thinking according to Womack and Jones?