Procurement Management

Chapter 8: Price
 Chapter Index

S. No Reference No Particulars Slide

From-To

1 Learning Objectives 183

2 Topic 1 Relation of Cost to Price 184−189

3 Topic 2 Government Influence on 190−191

Pricing

4 Topic 3 Contract Cancellation 192−193

5 Let’s Su m Up 194
• Explain the relation of cost to price

• Discuss the factors determining purchase price

• Describe pricing of contracts

• Explain how government influences pricing

• Discuss the concept of contract cancellation

 Relation of Cost to Price

• The Chartered Institute of Procurement and Supply (CIPS) defines price and cost as follows:
Cost is the total sum involved, including all expenditures associated with
ownership and use of a product or service, including price. Price is the amount of
consideration to be paid or given to a supplier for an article, good or service, or
for something desired, offered or purchased.
• Price is the supplier’s stated value of a product or service measured in terms of the
monetary unit of the country concerned. The customer may have a different value for the
product or service, based on the utility level assumed to be achieved from ownership of that
product or service.
 Relation of Cost to Price

• Price is the amount to be paid, in order to get

the product or service

• Cost is basically the aggregate monetary

value of the inputs used in the production of
the goods or delivery of services

• Value of a product or service is the utility or

worth of the product or service for an
individual.
What is cost?

• Fixed Cost: Costs, which remain the same

irrespective of the number of units
produced, it is called a fixed cost. For
Example, Rent, depreciation, insurance,
web hosting etc.,

• Variable Cost: The kind of costs, which

varies with the number of units produced
is called variable cost. For Example Raw
material, labour, shipping cost, etc.
Price vs cost- differences
 Relation of Cost to Price

Main factors affecting price determination of product are:

1. Product Cost
2. Supply and demand
3. Cost of production
4. The Utility and Demand
5. Extent of Competition in the Market
6. Government and Legal Regulations
7. Pricing Objectives
8. Marketing Methods Used.
 Relation of Cost to Price

Pricing of Contracts
• Repetitive and standard inventory items are purchased through long-term contracts
concluded with the supplier. Purchase orders and release orders are issued under these
contracts as and when material requirements occur.

• There are two major types of contracts: fixed price contracts and cost reimbursement
contracts. These two types represent two extremes of risk sharing.

• These two types represent two extremes of risk sharing. In the case of fixed price contracts,
the seller bears the entire risk. For the given fixed price, he/she is required to execute the
contract irrespective of any events like cost escalations that may occur during the contract
period.
Contract types

Type of
contracts

In fixed-price contracts, the contractors try

Fixed price to cut down the cost by purchasing or using
low-quality materials, whereas,

in cost-reimbursement contracts, the quality

of the resources isn’t compromised since
Cost the entire cost is reimbursed by the
reimbursement owner/company.
 Relation of Cost to Price

Pricing of Contracts
• Different types of fixed price contracts and cost reimbursement contracts are as follows:

Fixed Price Contracts

• Firm fixed price

• Fixed price with incentive
• Fixed price with economic price adjustment
• Fixed price with price redetermination
• Fixed price, level of effort

Cost Reimbursement Contracts

• Cost plus fixed fee

• Cost plus incentivefee
• Cost plus award fee
 Government Influence on Pricing

Pricing of Contracts
• An important part of the overall price is the tax liability that depends on government
regulations.

• Sale of goods is subject to various central and state taxes like excise duty, sales tax and local
taxes. Sales tax is levied on the sale of moveable goods in India. The sales tax rate depends on
the type and nature of goods and the state in which the sale has taken place. The central
sales tax deals with inter-state sales transactions. Similarly, customs duty needs to be paid on
imported goods. The basis of tax and the rate of taxes vary depending on the prevailing
government regulations of the concerned country.
Factors to influence- Pricing of contracts

•Price floors create surpluses by fixing the price above the equilibrium price. At the
price set by the floor, the quantity supplied exceeds the quantity demanded.
•In agriculture, price floors have created persistent surpluses of a wide range of
agricultural commodities. Governments typically purchase the amount of the surplus or
impose production restrictions in an attempt to reduce the surplus.
•Price ceilings create shortages by setting the price below the equilibrium. At the
ceiling price, the quantity demanded exceeds the quantity supplied.
•Rent controls are an example of a price ceiling, and thus they create shortages of rental
housing.
•It is sometimes the case that rent controls create “backdoor” arrangements, ranging
from requirements that tenants rent items that they do not want to outright bribes, that
result in rents higher than would exist in the absence of the ceiling.
 Contract Cancellation

• A buyer may enter into a long-term procurement contract with a supplier as an outcome of
the supplier evaluation, selection and negotiation process.

• A purchase order becomes a contract when it satisfies the three legal requirements of a
contract: an offer, acceptance and consideration.

• A long-term procurement contract or a purchase order contract can be cancelled by one of

the parties to the contract after it has been made. A contract cancellation can be in the
nature of ‘cancellation’ or ‘termination’. Cancellation occurs when either party ends the
contract for breach of terms by the other party.

• Cancellation can be differentiated from ‘Rescission’ which refers to the act of rescinding (i.e.
undoing or unmaking) a contract.
 5 Ways to Terminate a Contract

Impossibility Completion
Breach of Prior Rescission of
of of the
contract agreement the contract
performance contract
Chapter 9: Purchasing Law
and Ethics
 Purchasing Ethics

Ethical procurement refers to a wide range of issues that can impact the ethical and sustainability
goals of a business.
Examples include the monitoring of unethical or illegal supplier business procedures and practices
that can impact your organization’s procurement efficiency and reputation.
A bribery scandal, for example, may cost the business heavy fines and lasting reputational
damage.
Negotiating with WalMart buyers- A case study
Purchasing department’s duties Benefits of purchase department

1.Following the state, local, and 1. Cost optimization

federal procurement laws
2.Working with government agencies
for subsidies and other benefits
3.Acquiring goods at competitive rates
4.Maintaining long-term exclusive
partnerships with top vendors
5.Placing best bids and acquiring
orders before business competitors
6.Sending lucrative proposals to
acquire vendors in advance
2. Risk control and supply security
3. Strong vendor relationship
management
4. Business quality improvement
5. Leveraging innovation and
technology
How would you deal with the following situations in
procurement?
• You are responsible for the procurement of janitorial supplies for your mid-sized
company. A potential supplier sends you its catalogue together with a gift of an
expensive-looking ballpoint pen with the supplier’s logo on it.
• You have agreed to a two-year supply contract with a small, foreign supplier, but a
drop in demand for your own company’s products is seriously depressing its
profitability. Another supplier guarantees lower supply prices that would re-establish
the margins your company needs to meet its objectives. That would mean breaking
the contract with the first supplier without just cause. Legal action by that supplier
would be unlikely, because of its small size.
• Your Italian company is negotiating the supply of aerospace products to a
government in Asia. Your contacts in that government insist that in return for a
successful negotiation, your company buys goods/services from a supplier in the
Asian country.
• Your American company is competing with the Italian company above for the same
contract. The government client insists on the same conditions. Will your American
company’s procurement policy differ from that of your Italian competitor, and if so,
how?
 Purchasing Ethics

Ethical Concepts in Purchasing

• Institute for Supply Management (ISM) is the largest not-for-profit professional supply
management organisation in the world.

• ISM has also developed a professional code of ethics for the purchase and supply
professionals.

• This document is formally known as the Principles and Standards of Ethical

Supply Management Conduct.

• There are three major principles and ten standards described by the ISM.
 Purchasing Ethics

Ethical Concepts in Purchasing

ISM Principles ISM Standards

Integrity in Your Decisions and Actions Impropriety

Value for Your Employer•• Conflict of interest

Loyalty to Your Profession Influence

Responsibilities to the employer

Supplier and customer relationships

Sustainability and social responsibility

Confidential and proprietary information

Reciprocity

Applicable laws, regulations, and trade

agreements
Professional competence
 Purchasing Ethics

International Buying Ethics

• An international purchase refers to an activity wherein a buyer in one country procures goods
from a seller in another country.

• When different countries are involved in one procurement deal, the buyers and suppliers
have to take care of the cultural aspects of all the countries involved. This gives rise to the
concept of international ethics.

• International ethics are those ethics or guidelines that can possibly keep a buyer away from
ethical troubles related to any culture of the world that may be involved in a transaction.
 Purchasing Ethics

International Buying Ethics

• There are no standard set of guidelines for international ethics. However, some key points can
be followed:

– Try to adjust according to the local custom of the supplier.

– Establish a limit till which the buyer will adjust home-country standards in the case of
conflict with foreign standards.

– Create a code of ethics applicable in the home country so that the buyers may establish
how much adjustment they can and should not make.

– Share experience and encourage others to do the same.

 Legal Authority and Personal Liability of the
Purchasing Manager

Legal Issues for Purchasing Management

• Authority limits
• Awareness of contract law
• Quality and safety
• Monitoring supply contracts
• Letters of intent/Memorandum of understanding
• Tenders
 Contract Law

• A purchase order or PO is considered as a binding contract between a supplier and the buyer.
This is a general practice followed across the world.
• After a contract has been made, the buyer and the supplier must adhere to the terms of
agreement. Most of the times, one party approaches to cancel the contract. However,
cancellation is a serious matter and is a concern for the supplier due to the monetary aspects
associated.

• In cases, when a supplier wants to change the terms of the contract or wants to terminate it,
the buyer’s may take the appropriate legal remedy against the supplier depending on the
conditions related to the transaction.

• If the buyer wants to change the terms of the contract, the supplier has the right to reject
such contracts or in extreme cases, he may accept such changes without incurring any liability
caused due to delay in the delivery of the stated goods.
 Let’s Sum Up

• Ethics refer to moral principles that govern or influence the conduct or behaviour of an
individual or an activity or a process. ‰

• When different countries are involved in a trade deal, buyers and suppliers have to take care
of cultural aspects of all the countries involved. This gives rise to the concept of international
ethics.

• Purchase professionals assume the role of a buyer/agent and buy goods on behalf
of the organisation.
• The term contract has been defined under Section 2(h) of the Indian Contract Act, 1872. It
defines a contract as an agreement enforceable by law.

• A purchase order or PO is considered to be a binding contract between a supplier

and the buyer.
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