Procurement Pricing Strategies Quiz

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Questions and Answers

What is the purpose of price index?

To set fixed prices for products and services

To calculate total cost increase

To compare subsequent year prices to the base year (correct)

To track supplier prices only

What does gain-share pricing involve?

Setting fixed prices for products and services

Calculating percentage increase in total cost

Sharing savings achieved through supplier performance above normal conditions (correct)

Sharing supplier costs with the buyer

What is the purpose of indexed prices for suppliers?

To track buyer prices

To calculate percentage increase in total cost

To quickly adjust to input cost changes and honor commitments made before knowing costs (correct)

To fix prices for a specific period

What is the benefit of indexed price monitoring for buyers?

To track supplier prices and input cost fluctuations Signup and view all the answers

What is the requirement for unlocking benefits in gain-share pricing?

Investment to unlock benefits, requiring clear return on investment Signup and view all the answers

What does incentive-based pricing tie the price to?

Achieving an agreed level of performance Signup and view all the answers

What is consumption-based pricing based on?

The amount of service or product consumed Signup and view all the answers

What does converting fixed costs to variable costs involve?

Entering contracts with suppliers to link costs to workforce fluctuations Signup and view all the answers

What does the shared risk-reward model involve?

The supplier sharing risks and rewards with the buyer Signup and view all the answers

What industry can benefit from the shared risk-reward model to manage workforce essentials without fixed costs?

IT industry Signup and view all the answers

What is the supplier's risk in converting fixed costs to variable costs?

Ensuring enough customers to share fixed costs within an acceptable price Signup and view all the answers

What is a pricing schedule typically used for?

Listing the main cost elements of the supplier's price Signup and view all the answers

In which category of purchases can pricing schedules be particularly useful?

Tactical acquisition Signup and view all the answers

What do fixed-pricing arrangements involve?

Entering into a contract for the supply of goods or services at a predetermined and fixed price throughout the life of the contract Signup and view all the answers

When can the price in a fixed-pricing arrangement be changed?

If the contract allows for adjustments in certain events, like a significant increase in the cost of inputs to the supplier's delivery process Signup and view all the answers

What is the advantage of fixed-pricing arrangements?

Predictability for both the buyer and seller Signup and view all the answers

What does Kraljic's portfolio analysis categorize purchases into?

Four categories Signup and view all the answers

What is the main purpose of a pricing schedule?

To list the main cost elements of the supplier's price Signup and view all the answers

When are pricing schedules commonly used?

In markets where supply and demand dictate prices Signup and view all the answers

What is the breakdown of the total price in a pricing schedule likely to include?

Staff costs, daily rates, number of days, and total cost Signup and view all the answers

What category of purchases can benefit from pricing schedules due to low spend and supply market risk?

Tactical acquisition Signup and view all the answers

What did a pricing schedule enable the buyer to negotiate in the Clean 'n' Go Services case study?

A 20% reduction in the cost of cleaning without compromising service quality Signup and view all the answers

When are fixed-price contracts usually used?

When the specification is clear, and the quantity of each type of input can be estimated with reasonable accuracy Signup and view all the answers

What is the purpose of a pricing schedule?

To provide prices for different quantities purchased and show volume discounts offered Signup and view all the answers

What is the role of the salesperson in pricing arrangements?

To get to an agreed price as near as possible to the maximum range price Signup and view all the answers

When testing whether a fair price is being offered, what is a common way to do so?

Ask suppliers to provide a pricing schedule Signup and view all the answers

What is the buyer's role in a pricing arrangement?

To agree on a price as near to the minimum as possible Signup and view all the answers

What are direct costs directly related to?

The product or service Signup and view all the answers

What are overhead costs?

Indirect costs that need to be split among all products and services Signup and view all the answers

What may allow buyers to negotiate price reductions from a supplier?

The supplier over-recovering its indirect overheads Signup and view all the answers

What does a cost-reimbursable contract reimburse?

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

What are indexation and price adjustment formulae used for in cyclical industries?

Base price changes on an index Signup and view all the answers

What is an index calculated by selecting?

A base year and expressing other years as a percentage of that base year Signup and view all the answers

What is indexation practical for?

Industries with fluctuating supply and demand and numerous customers Signup and view all the answers

What does indexation allow for without the need for renegotiating contracts?

Price changes when underlying costs change Signup and view all the answers

What is the potential drawback of over-recovering indirect overheads?

Ignoring competition, potentially leading to reduced profits or loss of business Signup and view all the answers

What can wide price ranges from suppliers be due to?

Factors such as workload and profit expectations Signup and view all the answers

What is the risk limitation for the supplier in cost-reimbursable contracts?

Reimbursement of all costs plus an agreed amount for profit Signup and view all the answers

What is the potential drawback of cost-reimbursable contracts?

Lack of incentives for efficient work and disputes over cost reimbursement Signup and view all the answers

What is the role of the salesperson in pricing arrangements?

To get to an agreed price as near as possible to the maximum range price Signup and view all the answers

What is the purpose of a pricing schedule?

To give the price for different quantities purchased and show volume discounts Signup and view all the answers

What is a common means of getting to an agreed price in commercial agreements?

Negotiation or a tender Signup and view all the answers

What is the significance of the range of prices acceptable to both parties in a purchase?

It represents the potential agreed price Signup and view all the answers

What can uncertain future costs lead to in a fixed-price arrangement?

Higher prices quoted by the supplier to mitigate potential risks Signup and view all the answers

What do fixed-price arrangements provide in terms of financial commitments and revenue?

Certainty for both the buyer and the supplier Signup and view all the answers

What does a firm-fixed-price contract type mean?

The price is not varied even if the contractor spends more time or money on completing the contract Signup and view all the answers

What is the characteristic of a firm fixed price with incentive contract?

The final price can vary based on the final cost, with a ceiling to minimize the risk of cost overruns Signup and view all the answers

When is fixed price with adjustment used?

Where the price is nominally fixed but an element or elements vary in line with an agreed index Signup and view all the answers

What do cost-plus pricing arrangements involve?

Calculating the cost of components and adding a mark-up for profit Signup and view all the answers

What is one advantage of cost-plus pricing?

Its simplicity in understanding and calculating costs and profit Signup and view all the answers

What is an example of a fixed-price arrangement?

XYZ Consultants offering a software implementation for a fixed fee of $20,000 Signup and view all the answers

What is the characteristic of a fixed price with adjustment contract?

The price is nominally fixed but an element or elements vary in line with an agreed index Signup and view all the answers

What does a cost-plus pricing example demonstrate?

How a supplier arrives at a target price by adding a mark-up to the total cost of production Signup and view all the answers

What is the characteristic of a firm fixed price with incentive contract?

The final price can vary based on the final cost, with a ceiling to minimize the risk of cost overruns Signup and view all the answers

What does process efficiency measure?

The percentage of time spent 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 does waste refer to in the context of processes?

Anything that adds no value in the eyes of the customer Signup and view all the answers

How can applying Lean principles to processes increase speed and reduce costs?

By eliminating non-value-add tasks Signup and view all the answers

What does Little's Law state about lead time?

It can be reduced by decreasing work in process (WIP) or increasing the average completion rate Signup and view all the answers

What is easier and cost-effective according to the text?

To reduce WIP than to increase completion rates Signup and view all the answers

What does the example illustrate about Little's Law?

How it can be used to determine the maximum WIP for a desired turnaround time Signup and view all the answers

What can triage systems prioritize processing based on?

Factors like value, complexity, and importance to the organization Signup and view all the answers

What do Lean principles focus on eliminating to improve value for the customer?

Non-value-added activities, categorized into seven types of waste by Taiichi Ohno Signup and view all the answers

What are examples of waste in a Procurement Department?

Over-production, unnecessary motion, waiting, transport and handling, over-processing, inventory, and defects Signup and view all the answers

What does the chapter discuss various ways buyers can influence?

Cost and price through pricing arrangements, supplier cost understanding, and payment terms Signup and view all the answers

What does it mean to increase speed and reduce costs by eliminating non-value-added activities?

To make processes faster and cheaper Signup and view all the answers

What are direct costs directly related to in procurement?

The product or service Signup and view all the answers

Why should the basis for allocating overhead costs be transparent to the buyer?

To ensure fairness and understanding Signup and view all the answers

What may over-recovering indirect overhead costs provide an opportunity for?

Price reduction Signup and view all the answers

What does the pricing arrangement aim to minimize for the supplier?

Risk Signup and view all the answers

What does the method of pricing arrangement allow the supplier to justify price increases based on?

Cost structure and cost increases Signup and view all the answers

What potential consequence can the method of pricing arrangement lead to?

Ignoring competition Signup and view all the answers

What may cause a wide price range among suppliers in procurement?

Workload, profit expectations, and market conditions Signup and view all the answers

What are cost-reimbursable pricing contracts suitable for?

Projects with unclear scope Signup and view all the answers

What does indexation and price adjustment formulae help industries manage?

Price changes due to fluctuating supply and demand Signup and view all the answers

How is an index calculated for price changes in cyclical commodity-based sectors?

Selecting a base year and expressing other years as a percentage of the base year Signup and view all the answers

What does a cost-reimbursable pricing contract limit for the supplier?

Risk Signup and view all the answers

What do industries use indexation and price adjustment formulae for particularly?

Cyclical commodity-based sectors Signup and view all the answers

What type of relationship is described in the text for buyer-supplier interactions?

Strategic Signup and view all the answers

What is the role of the supplier according to the text?

To provide mutual competitive benefit Signup and view all the answers

What is the recommended level of buyer involvement in the interaction with suppliers?

Often, from many functions Signup and view all the answers

What type of cost requirements are emphasized in the text for buyer-supplier transactions?

Target costing for reductions Signup and view all the answers

What type of relationship is characterized by strategic closeness?

Close Signup and view all the answers

What is the role of the supplier in a transactional relationship?

To supply services you don't want to have in-house Signup and view all the answers

What is the buyer involvement in a purchase characterized by?

Little or none, mainly from procurement Signup and view all the answers

What are the cost requirements in a purchase of marketing print?

Target costing for reductions 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

Which aspects guide Lean thinking?

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

What is lead time?

The time it takes to deliver a product or service once the order has been placed Signup and view all the answers

What is the formula that shows the relationship between lead time and its drivers?

Little's Law Signup and view all the answers

What does WIP (work in process) apply to?

Service-based activities as well as manufacturing processes Signup and view all the answers

What is the purpose of Lean thinking concepts and terminology such as lead time, WIP, delays, and value-add/non-value-add?

Applying Lean principles to open-book costing Signup and view all the answers

What is the five-step process for applying Lean thinking?

Specify value, identify value stream steps, arrange value-adding steps, let customers pull value, and repeat until maximum value with minimum waste Signup and view all the answers

What is the main difference between value-add work and non-value-add work?

Value-add work is what a customer would willingly pay for, while non-value-add work is a candidate for elimination Signup and view all the answers

What are the specific characteristics and examples involved in each stage of open-book costing?

Briefing suppliers and stabilizing current performance Signup and view all the answers

What is the process of implementing open-book costing?

Involves cost transparency in the total supply chain and with suppliers Signup and view all the answers

What is the significance of understanding Lean thinking concepts for open-book costing?

Crucial for applying Lean principles to open-book costing and identifying areas for cost reduction Signup and view all the answers

What is the role of Lean thinking in finding solutions in open-book costing?

A popular method for finding solutions Signup and view all the answers

Study Notes

Pricing Index and Incentivised Gain-Share Pricing

Price index is calculated by comparing subsequent year prices to the base year
Normalizing process involves reflecting the percentage increase in total cost compared to the base year
Suppliers use indexed prices to quickly adjust to input cost changes and honor commitments made before knowing costs
Indexed price monitoring can be useful for buyers to track supplier prices and input cost fluctuations
Gain-share pricing involves sharing savings achieved through supplier performance above normal conditions
Investment may be required to unlock benefits in gain-share pricing, requiring clear return on investment
Incentive-based pricing ties price to achieving an agreed level of performance, often with quantitative or qualitative targets
Consumption-based pricing is based on the amount of service or product consumed, useful for changing usage over time
Converting fixed costs to variable costs involves entering contracts with suppliers to link costs to workforce fluctuations
Shared risk-reward model involves the supplier sharing risks and rewards with the buyer
This model is beneficial for IT industry to manage workforce essentials without fixed costs
Supplier's risk in converting fixed costs to variable costs is in ensuring enough customers to share fixed costs within an acceptable price

Pricing Schedules and Fixed-pricing Arrangements in Procurement

Pricing schedules are commonly used in markets where supply and demand dictate prices, such as commodity markets, agricultural products, and utilities.
They are also utilized in other categories like office stationery, computer hardware and software, and mobile phones.
Despite the perception of limited influence, there are strategies for buyers to take action, such as understanding the supply market and monitoring market trends.
A pricing schedule typically lists the main cost elements of the supplier's price and is often provided at the tender stage of a bidding process.
The breakdown of the total price in a pricing schedule may include staff costs, daily rates, number of days, and total cost.
The Kraljic's portfolio analysis categorizes purchases into four categories, with tactical acquisition being one of them, where the buying process should be made efficient.
Pricing schedules can be particularly useful in the tactical acquisition category due to the low level of spend and low supply market risk.
A case study of Clean 'n' Go Services demonstrates how a pricing schedule enabled the buyer to negotiate a 20% reduction in the cost of cleaning without compromising service quality.
Fixed-pricing arrangements involve entering into a contract for the supply of goods or services at a predetermined and fixed price throughout the life of the contract.
The price in a fixed-pricing arrangement can only be changed if the contract allows for adjustments in certain events, like a significant increase in the cost of inputs to the supplier's delivery process.
Advantages of fixed-pricing arrangements include predictability for both the buyer and seller, making it easier to get approval for the purchase.
Fixed-price contracts are usually used when the specification is clear, and the quantity of each type of input can be estimated with reasonable accuracy.

Fixed-Price and Cost-Plus Pricing Arrangements

Fixed-price contracts can lead to reduced profits for the seller in case of unexpected cost rises, unless provisions for price recalculation are included in the contract
Uncertain future costs can lead to higher prices quoted by the supplier to mitigate potential risks
Fixed-price arrangements without provisions for price recalculation can lead to one party receiving less benefit than expected when input costs change
Changes in the market can impact the supplier's profits significantly in a fixed-price arrangement
Fixed-price arrangements provide certainty for both the buyer and the supplier in terms of financial commitments and revenue
An example of a fixed-price arrangement is showcased through XYZ Consultants offering a software implementation for a fixed fee of $20,000
The firm-fixed-price contract type means the price is not varied even if the contractor spends more time or money on completing the contract
Firm fixed price with incentive allows the final price to vary based on the final cost, with a ceiling to minimize the risk of cost overruns
Fixed price with adjustment is used where the price is nominally fixed but an element or elements vary in line with an agreed index
Cost-plus pricing arrangements involve calculating the cost of components and adding a mark-up for profit
A cost-plus pricing example demonstrates how a supplier arrives at a target price by adding a mark-up to the total cost of production
One advantage of cost-plus pricing is its simplicity in understanding and calculating costs and profit

Improving Process Efficiency and Reducing Waste in Procurement

Process efficiency measures the percentage of time spent in value-adding activities, calculated as value-add time divided by total lead time.
A process efficiency of less than 10% indicates significant waste in the process.
Waste refers to anything that adds no value in the eyes of the customer, often caused by workarounds and delays in the process.
Applying Lean principles to processes can increase speed by eliminating non-value-add tasks, reducing costs.
Little's Law states that lead time can be reduced by decreasing work in process (WIP) or increasing the average completion rate.
It is easier and cost-effective to reduce WIP than to increase completion rates.
The example illustrates how Little's Law can be used to determine the maximum WIP for a desired turnaround time.
Triage systems, similar to those in hospitals, can prioritize processing based on factors like value, complexity, and importance to the organization.
Lean aims to make processes faster and cheaper by eliminating non-value-added activities, categorized into seven types of waste by Taiichi Ohno.
Examples of waste in a Procurement Department include over-production, unnecessary motion, waiting, transport and handling, over-processing, inventory, and defects.
Lean principles focus on eliminating these types of waste to improve value for the customer.
The chapter discusses various ways buyers can influence cost and price through pricing arrangements, supplier cost understanding, and payment terms.

Pricing Arrangements and Considerations in Procurement

Direct costs directly relate to the product or service, such as consultant fees, while overhead costs are incurred in running operations and are allocated among all products and services.
Allocated overhead costs must be split among products and services, and the basis for this allocation should be transparent to the buyer.
Over-recovering indirect overhead costs can be a challenge for the buyer, and it may provide an opportunity for price reduction.
The pricing arrangement ensures the supplier recovers all costs and makes a profit, minimizing risk for the supplier.
The arrangement allows the supplier to justify price increases based on cost structure and cost increases.
The method can lead to ignoring competition, potentially resulting in reduced profit or loss of business.
Wide price range among suppliers may be due to factors such as workload, profit expectations, and market conditions.
Cost-reimbursable pricing contracts entail reimbursing all costs plus an agreed amount for profit and are suitable for projects with unclear scope.
This pricing arrangement limits the supplier's risk and provides certainty of profit but may not incentivize efficiency.
Industries use indexation and price adjustment formulae, particularly in cyclical commodity-based sectors, to base price changes on an index.
An index is calculated by selecting a base year, making its value 100, and expressing other years as a percentage of the base year.
This approach helps industries manage price changes due to fluctuating supply and demand without renegotiating individual contracts.

Open-Book Costing and Lean Thinking

Open-book costing involves cost transparency in the total supply chain and with suppliers
The process of implementing open-book costing includes four stages: exploring, testing, scaling, and embedding
Each stage of open-book costing involves specific characteristics and examples, such as briefing suppliers and stabilizing current performance
Lean thinking, a popular method for finding solutions in open-book costing, is guided by three basic aspects: purpose, process, and people
Lean thinking is applied using a five-step process: specify value, identify value stream steps, arrange value-adding steps, let customers pull value, and repeat until maximum value with minimum waste
Lean thinking concepts and terminology, such as lead time, WIP (work in process), delays, and value-add/non-value-add, are important for applying Lean principles to open-book costing
Lead time is the time it takes to deliver a product or service once the order has been placed
Little's Law is a formula that shows the relationship between lead time and the drivers of that lead time
WIP applies to service-based activities as well as manufacturing processes
Delays, or queue time, occur when there is work waiting to be done
Value-add work is what a customer would willingly pay for, while non-value-add work is a candidate for elimination
Understanding Lean thinking concepts is crucial for applying Lean principles to open-book costing and identifying areas for cost reduction.

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Test your knowledge of procurement pricing strategies with this quiz. Explore topics such as pricing index, gain-share pricing, pricing schedules, fixed-pricing arrangements, cost allocation, and indexation. Sharpen your understanding of key concepts and strategies used in procurement pricing.

Procurement Pricing Strategies Quiz

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Questions and Answers

What is the purpose of price index?

What does gain-share pricing involve?

What is the purpose of indexed prices for suppliers?

What is the benefit of indexed price monitoring for buyers?

What is the requirement for unlocking benefits in gain-share pricing?

What does incentive-based pricing tie the price to?

What is consumption-based pricing based on?

What does converting fixed costs to variable costs involve?

What does the shared risk-reward model involve?

What industry can benefit from the shared risk-reward model to manage workforce essentials without fixed costs?

What is the supplier's risk in converting fixed costs to variable costs?

What is a pricing schedule typically used for?

In which category of purchases can pricing schedules be particularly useful?

What do fixed-pricing arrangements involve?

When can the price in a fixed-pricing arrangement be changed?

What is the advantage of fixed-pricing arrangements?

What does Kraljic's portfolio analysis categorize purchases into?

What is the main purpose of a pricing schedule?

When are pricing schedules commonly used?

What is the breakdown of the total price in a pricing schedule likely to include?

What category of purchases can benefit from pricing schedules due to low spend and supply market risk?

What did a pricing schedule enable the buyer to negotiate in the Clean 'n' Go Services case study?

When are fixed-price contracts usually used?

What is the purpose of a pricing schedule?

What is the role of the salesperson in pricing arrangements?

When testing whether a fair price is being offered, what is a common way to do so?

What is the buyer's role in a pricing arrangement?

What are direct costs directly related to?

What are overhead costs?

What may allow buyers to negotiate price reductions from a supplier?

What does a cost-reimbursable contract reimburse?

What are indexation and price adjustment formulae used for in cyclical industries?

What is an index calculated by selecting?

What is indexation practical for?

What does indexation allow for without the need for renegotiating contracts?

What is the potential drawback of over-recovering indirect overheads?

What can wide price ranges from suppliers be due to?

What is the risk limitation for the supplier in cost-reimbursable contracts?

What is the potential drawback of cost-reimbursable contracts?

What is the role of the salesperson in pricing arrangements?

What is the purpose of a pricing schedule?

What is a common means of getting to an agreed price in commercial agreements?

What is the significance of the range of prices acceptable to both parties in a purchase?

What can uncertain future costs lead to in a fixed-price arrangement?

What do fixed-price arrangements provide in terms of financial commitments and revenue?

What does a firm-fixed-price contract type mean?

What is the characteristic of a firm fixed price with incentive contract?

When is fixed price with adjustment used?

What do cost-plus pricing arrangements involve?

What is one advantage of cost-plus pricing?

What is an example of a fixed-price arrangement?

What is the characteristic of a fixed price with adjustment contract?

What does a cost-plus pricing example demonstrate?

What is the characteristic of a firm fixed price with incentive contract?

What does process efficiency measure?

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

What does waste refer to in the context of processes?

How can applying Lean principles to processes increase speed and reduce costs?

What does Little's Law state about lead time?

What is easier and cost-effective according to the text?

What does the example illustrate about Little's Law?

What can triage systems prioritize processing based on?

What do Lean principles focus on eliminating to improve value for the customer?

What are examples of waste in a Procurement Department?

What does the chapter discuss various ways buyers can influence?

What does it mean to increase speed and reduce costs by eliminating non-value-added activities?

What are direct costs directly related to in procurement?

Why should the basis for allocating overhead costs be transparent to the buyer?

What may over-recovering indirect overhead costs provide an opportunity for?

What does the pricing arrangement aim to minimize for the supplier?

What does the method of pricing arrangement allow the supplier to justify price increases based on?

What potential consequence can the method of pricing arrangement lead to?

What may cause a wide price range among suppliers in procurement?

What are cost-reimbursable pricing contracts suitable for?

What does indexation and price adjustment formulae help industries manage?

How is an index calculated for price changes in cyclical commodity-based sectors?