CIPS L4M3 Chapter 3 (3.3)

Question 1

What is Price?

Answer 1

• the amount expressed in units of currency, to be paid by the purchaser to the supplier to obtain the goods or services

Question 2

What is Cost?

Answer 2

• the total sum of amounts paid by the supplier in order to produce the goods or provide the services

Question 3

What is a Price schedule?

Answer 3

• an appendix to a contract setting out what the prices are

Question 4

What is a Schedule of rates?

Answer 4

• An itemized list of component parts within a lump-sum contract, or a list of individual products, giving a price for each unit. Note that the rate may be different for different order volumes

Question 5

What is Linear Pricing?

Answer 5

• One price for any quantity

Question 6

What is Non-linear pricing?

Answer 6

• Multiple lines for price breaks. Higher the quantity, cheaper the price

Question 7

When are hourly rates/day rates used?

Answer 7

• services, where most of the cost is for the person or people providing the service e.g. consultants, lawyers, training providers

Question 8

What are Combination rates?

Answer 8

• Where the service being provided is a mixture of goods and services (parts and labor)

Question 9

How can standard schedules be used?

Answer 9

• They can be used as reference points against which prices can be compared in tendering and negotiation

Question 10

What is a Fixed pricing arrangement?

Answer 10

• the purchaser will simply say they want ‘X’ amount of a product and will be quoted a fee for that one order. It can also be used for services.

Question 11

What is the risk in using fixed-pricing arrangements?

Answer 11

• The cost risk of fixed pricing arrangements is shared between the two parties, but it may not be shared equally. That will depend on the following -
• How accurate the specification is?
• How robustly the supplier resists post-contract change requests
• How good the original price estimation is by both parties

Question 12

What are the advantages of using fixed pricing arrangements?

Answer 12

• Budget/income certainty
• The impact of changes to the suppliers cost base is not fed through to the purchaser. If costs diminish, the supplier will benefit from this, and if cost rise, the purchaser will benefit

Question 13

What are the disadvantages of using fixed pricing arrangements?

Answer 13

• Time needed to fully specify exactly what is included and excluded in the price
• The impact of changes to the suppliers cost base is not fed through to the purchaser.
• Assumptions, e.g. on the balance of high cost/low-cost items not being met, could lead to disputes
• Potential for quality issues if the fixed price is too low - supplier will deliver down to price

Question 14

What are Fixed costs?

Answer 14

• A cost that remains constant in the short term irrespective of production volumes

Question 15

What are Variable costs?

Answer 15

• Costs that change directly in line with the output of the organization

or

• Cost that fluctuate as production increases and decreases

Question 16

Why should purchasers seek to understanding supplier mark-ups and margins?

Answer 16

• To help to determine whether they are getting a reasonable deal

Question 17

What is Mark-up?

Answer 17

• Profit as a percentage of costs

Example: Assume a product costs £1000 to make and it sells for £3000. The profit is £2000.

The Mark-up is £2000 as a percentage of £1000

£2000 / £1000 x 100 = 200%

Question 18

What is Margin?

Answer 18

• Profit as a percentage of sales value

Example: Assume a product costs £1000 to make and it sells for £3000. The profit is £2000.

The profit margin £2000 as a percentage of £3000

£2000 / £3000 x 100 = 66.67%

Question 19

What is the cost-plus pricing model?

Answer 19

• A model where the price is set based on cost, plus an agreed profit mark-up

Cost + (cost x % mark-up) = price

Example: £70 cost with 5% mark-up

£70 + (£70x5%) = £70 + £3.50 = £73.50

Question 20

What should the supplier demonstrate to the purchaser’s satisfaction for a cost-plus pricing model?

Answer 20

• Exactly what the input costs are
• Whether they are fixed or variable
• How the variables normally move
• How much control the supplier has over them and that they are exercising that control

Question 21

What are the advantages of Cost-plus pricing for the Purchaser?

Answer 21

• Value for money demonstrated by fixed profit mark-up - knowledge that the supplier is not making excess profit
• Risk of supplier collapse is reduced, particularly if the purchaser is a major customer of the supplier

Question 22

What are the disadvantages of Cost-plus pricing for the Purchaser?

Answer 22

• Lack of certainty over supplier cost base: how ‘real’ is the data sharing? Needs accurate data and a strong degree of trust between the parties
• Changes in the supplier cost base feed directly into the price paid, with no room for negotiation
• Supplier has no incentive to manage costs

Question 23

What are the advantages of Cost-plus pricing for the Supplier?

Answer 23

• All costs are covered - it cannot make a loss
• Guaranteed profit levels aid forward planning and may assist small companies in accessing cheaper credit
• Easy to justify price increases

Question 24

What are the disadvantages of Cost-plus pricing for the Supplier?

Answer 24

• Profit is limited, cannot gain from cost efficiencies
• Cannot leverage market advantage to charge a higher price
• Cannot refuse price reductions in response to input cost reduction

Question 25

What is Indexation?

Answer 25

• the linking of a payment (be it a price, a salary, or some other due payment) to an index and the adjustment of the payment in line with the movements of the index

Question 26

What is Price Index?

Answer 26

• A way of showing the percentage change in prices over a given period, based on a starting year (the base) which is taken to be equivalent to 100%. Indices above 100 indicate a rise; indices below 100 indicate a fall

Question 27

What is a Base year?

Answer 27

• The starting point for an index, at which point the index is set at 100

Question 28

What are the two most widely used indices in the UK?

Answer 28

• The Retail Price Index (RPI)
• The Consumer Price Index (CPI)

Question 29

What is the difference between RPI and CPI?

Answer 29

• RPI includes VAT and other taxes and mortgage interest payments, all of which are excluded from CPI

Question 30

Why is Indexation useful?

Answer 30

• It is a way of predetermining price adjustments by reference to an externally validated source of input cost changes.

Question 31

What does Automatic indexation reduce?

Answer 31

• the incentive for a supplier to reduce or control cost

Question 32

What is a Target fee?

Answer 32

• the fee or profit element which will be paid if actual costs equal target costs in a cost-plus incentive contract

Question 33

What is Sharing Ratio?

Answer 33

• the proportion of the cost/benefit which is allocated to the purchaser and the supplier within a cost-plus incentive contract

Question 34

What is a Cost-plus incentive contract?

Answer 34

• A contract type that requires the buyer to pay a cost for the procured work, plus an incentive fee, or a bonus, for the work if terms and conditions are met. Also known as target cost contract or gain-share/pain-share arrangement

Question 35

How to calculate Target Cost?

Answer 35

Assume: Target cost = £1000 Target fee = £100

Sharing ratio for cost overruns: 80% purchaser: 20% supplier

Sharing ratio for cost savings: 60% purchaser: 40% supplier

If the actual cost is £1100 (above target), then the final fee is: £100+((£1000-£1000) x20%) = £80

And the final price is: £1000+£80 = £1180

If the actual cost is £900 (below target), then the final fee is: £100+((1000-900)) x 40%) = £140

And the final price is: £900 + £140 = £1040

Question 36

What is a key aspect of contract performance for the purchaser?

Answer 36

• the speed of delivery

Question 37

What other incentives can be used in contracts?

Answer 37

• Contract extensions
• Accelerated payments

Question 38

When should incentives be used?

Answer 38

• For financial benefit (over and above the cost of the incentive) to the purchaser. Examples are controlling costs and speedier delivery

Question 39

What does Payment terms clauses look at?

Answer 39

• when and how payment is to be made through: Documentation required, VAT and other taxes, Payment period and how it is calculated, Disputed invoices and pay-less notices, Treatment of retentions, Remedies for late payment

Question 40

What is a Pay-less notice?

Answer 40

• A formal notice under a contract stating that an invoice will only be paid in part and giving the reasons why the lower amount is being paid

Question 41

What is Retention?

Answer 41

• A sum of money withheld from payment for a fixed period to be used to cover any costs associated with remedying defects that are not corrected by the supplier