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NIGP Consulting


How Do You Measure Cost Effectiveness?

As referenced in Purchasing and Supply Management by Monczka, Trent, and Handfield, a key performance metric for procurement organizations is cost-effectiveness.  Cost effectiveness may be defined as a measure of cost reduction, cost avoidance, or return-on-investment.  A cost reduction measure compares the actual cost of an item over a period of time, while cost avoidance represents the difference between a price paid and a potentially higher price (without procurement’s involvement).  As cost avoidance is not based on “actual” costs paid, a procurement organization that strives to document tangible cost improvements should focus on the use of cost reduction metrics to provide a representation of tangible savings and cost-effectiveness for the organization.

When Procurement Cuts May Cost You Money

Procurement officials always remain focused on obtainment of the best pricing for any needed product or service being procured. Although, procurement officials need to remember that saving a $1 today may not necessarily save a dollar tomorrow.  Many of us can recall an example of when the lower cost item was not necessarily the best solution.  One example I recall was for the purchase of an ambulance.  The low bid was approximately 25% than the next lowest bidder. When conducting due diligence for responsibility it was discovered that the supplier had several unhappy customers based on poor product, specifically leaking/open-air floors.  Can you imagine being a patient in an ambulance and having water flood the bottom while on the way to the hospital or feel the “natural” fresh air across your face and toes? Customer experience aside, it will cost more money in the long run to replace low-quality or poor-performing equipment. Consistently, we have to remember that we need to maximize each  dollar we spend and ensure we achieve full value for each dollar. For more information on accountability in procurement, read the NIGP’s Values and Guiding Principles of Public Procurement.

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