Let’s start by defining the cost element for which purchases will be proposed.
Direct Material encompass two kinds of purchases, those items that will become incorporated into the deliverable “thing,” and those items that will be expended (i.e., use up) during the creation/preparation of the deliverable “thing.” Both can be Direct Material. The quantities of incorporated components can typically be estimated and presented in a straight-forward way. The unit price times the quantity equals the extended price.
Waste (such as unusable pieces), scrap, rework and similar losses use a Loss Factor built from and supported by Company-wide history. These are included as Direct Material by increasing the quantity purchased.
In a manufacturing or assembling process, the cost of shop rags, machine oil, gloves, masks, and similar material used for multiple projects – are typically included in Material Overhead. These are not included as direct purchases.
Purchased goods include all costs to get the goods in the form for intended use at the location of use. Unless a related cost – such as Freight – is consistently charged as an indirect cost, these costs are part of the direct cost for the purchased goods.
Subcontracts or Direct Subcontracts are purchases of goods and services from other companies. This can be a pre-defined segment of the Statement of Work or Performance Work Statement. This can be the building and delivery of a subassembly or component of the finished deliverable. This can be purchased labor that supplements (employee) Direct Labor. These subcontracts are only for direct work on one particular project (at a time).
Subcontracts for the management and administration, or for (the repair, maintenance, or build of) the facilities, of the Company as a whole are not included, here.
Subcontracts that are Inter-divisional Work Authorizations are purchases from “sister” companies with less than an “arm’s length” relationship (typically due to some or all owners in the contractor having ownership in the “sister” company). These can be proposed either at (“sister” company) cost with no profit or fee – or at market, supported by pricing from “arm’s length” suppliers.
Proposing Direct Travel, which is purchased, is discussed elsewhere.
Other Direct Costs are purchases other than Material, Subcontracts, and Travel that are used for one particular project. These can be services, but more likely are products outside the normal Bill of Material. They might include a special measuring or writing device needed for the particular project, a component occasionally incorporated into the deliverables or used only on rare occasions (but required to be available), or services of a special tester or examiner anticipated for irregular circumstances.
If available, the easiest (to build) support for proposed cost is historical cost. Use a printout from general ledger or other software, listing at least three purchases of the same – or a similar – item. Based on historical purchases (each less than one year old), show all anticipated differences between the historical and future (proposed) unit price. This can include:
- Escalation, either at four percent (4%) or less or at a rate supported by a specific source (such as the Consumer Price Index, or other index published by the federal government or by an objective and authoritative organization, such as a professional organization)
- Quantity discounts, supported by unit-price comparisons in the historical prices
- Trend analysis, showing consistent decreases or consistent increases in prices historically paid
Instead of historical purchases, use current (less than one year old) competitive (two or more – but preferably at least three) supplier quotes.
The Request for Quote (RFQ) must allow the same chance for each supplier to respond. The RFQ is issued to each supplier with the same number of days (or hours) to respond and asks for the same item or items. The RFQ can be a formal writing or a telephone request. The lowest (all-inclusive) cost quoted by two or more qualified suppliers is the competitive cost.
Each quote must be for exactly the same item – or support and calculations shown for slight differences. Each quote must be for the same quantity as proposed – or support and calculations shown for differences. Each quote used must be from a qualified supplier. Do not include the quote, if the supplier would not be used (due to poor, past performance or quality; not likely to be a going concern throughout the required period of purchases; or any other reason). Support the proposed unit price with a comparison showing “apples to apples,” including the cost (such as freight) to get the item to the location, in the timeframe, where it will be used.
For example, a one-hundred-dollar item might cost two-hundred dollars in shipping, while a two-hundred-dollar item ships free. The two-hundred-dollar item has the lowest, competitive cost.
Use the lowest price quoted, unless the lowest price comes in much lower than the next-highest priced competitor. If the lowest price is unreasonably low, default to dissimilar items (i.e., not “apples to apples”) unless this difference can be adequately explained in the supporting documentation. Use this same test of the next-lowest price, and so on. After excluding quotes for dissimilar items and unqualified suppliers, competition requires at least two (but preferably three or more) valid quotes.
Reasonable Market Price
Often, other sources can support the proposed cost. Note that the “price” is what the supplier sells for, while the “cost” is what the buyer pays. The cost is the ultimate goal for a proposal, typically based upon the price quoted by the supplier. Examples of other support that demonstrate a reasonable market price are:
- Results of a very-well-defined (computer) search for a commercial item, with those results sorted from low to high, and the lowest unit (or comparable-quantity) price used as the basis for proposed cost (e.g., facial tissues on Amazon.com)
- A listing for a specific item, sold to the public in substantial quantities, at an advertised price (e.g., Kleenex on Walmart.com), and a comparable quantity used as the basis for proposed cost
- A price list with the supplier’s (dated and signed) certification that, substantial quantities are sold to the general public (not just to the Government), at the list price
- Comparable listings (such as for rental property) showing current (less than one year old) prices for similar (in location or quality as applicable) items
- A “should cost” build-up created in-house, with details for each component and quality required, plus supporting cost history and quotes for significant pieces
Purchases are proposed at reasonable costs for the time of the anticipated buy. We build and support them based on supplier market-prices.
Purchases encompass Direct Material, Direct Subcontracts, Direct Travel, and Other Direct Costs. The strongest support for supplier pricing is evidence of competition. Competitive prices are at least two, but preferably three or more, suppliers’ prices for the same goods and services. The suppliers must be qualified to provide the goods and services. Similar goods and services can be considered, if the differences are separately shown and explained.