Price vs Cost, any Difference?
One of the major woes in effective decision making in the built environment is the lack of understanding of the difference between Price & Cost. The two terms are mostly used erroneously, thus preventing leaders to make informed decisions thereby running down their assets.
Price is the initial investment inputted or required to acquire an asset. Here, most uniformed top managements are very interested in discussing with the lowest bidder or the vendor whose price is the lowest. They leap for joy and unknowingly jump into trouble of cost management and the liabilities that comes with it in no distant time. Cost, on the other hand is the complete or total financial responsibility of ownership. It considers the initial investments and other associated cost with acquiring or owning an asset until it is disposed. It is also the investment inputted in the asset throughout the cradle to grave journey. With this background, we can see the difference between the two most important terms in the procurement of service in the built environment.
I was fortunate to be part of a particular procurement committee at the tail end of the selection process for the renovation of seven primary schools in Lagos. I was later told by one of the committee members that the Chairman insisted that I was invited to give my own thoughts on the entire process. This experience I am about to share happened many years ago. Here, they were reviewing the submissions of several contractors that bided for this project.
I asked the team lead of the project to provide the budget for the project and all other metrics which will serve as the criteria for the selection process. I was shocked to hear that what they are after is the lowest bidder, and this is the right thing to do since the remaining fourteen company’s have all passed the technical stage. Unfortunately, the Chairman did not considered my recommendations. Your guess is as good mine because just last week I visited the seven schools for re-evaluation and these buildings were all in a sorry state.
The aforementioned scenario described above necessitated this article as it is obvious that the procurement team couldn’t differentiate between ‘’Price & Cost’’ and their focus was solely on price which is immediate and not futuristic. This may also be the same experience with so many decision makers takes actions on a daily basis because they only consider how much they can save now to get a handshake from the top management, but the repercussion of such actions are never rewarded.
Let us further discuss the term “Price” and “Cost”, to gain more insight. These terms are frequently mentioned in the context of sales. They are often used interchangeably in normal conversation, but in business & economics, each term takes on a different meaning and must not be confused with the other. Technically, “price” is defined as the actual amount of money that a client or consumer is willing to pay to acquire a certain product or service. “Price” involves the future acquisition of the product or service if the consumer pays the said amount of money. On the other hand, “cost” is known as the amount paid to produce a product or service before it is marketed or sold to its intended consumers. Looking at it in this context, “cost” implies the amount of money involved in production/operations, workforce development, marketing, and distribution. The term can also refer to the amount of money needed to maintain a product or a service. This is getting more interesting to me as an advocate for managing the built environment because largely, service providers or consultants encounter price and cost related issues with prospective clients. To maintain a productive or service effectively, clear understanding of cost will help not just the service providers but the business owners to enable them have a closer look into the future of their business. Learn now to avoid regrets!
Both “price” and “cost” involve the element of money, but the context where it is used is not at all the same.
“Price” refers to the money given to the seller for the product while “cost” involves the seller’s money to produce values which may be comfort, accessibility to peace of mind. Cost can include labour, capital, materials, bills, salaries and wages of workers, and other transactions like marketing and distribution and shipping. In the whole business process, “cost” comes first before “price.” In fact, the costs of putting up a product and the seller’s calculated profit can be added to determine the price of a product or service. In economics, “price” is the point where the supply and demand meet. It also exemplifies the worth or value of the product or the service itself.
Both “price” and ‘’cost’’ have different kinds and classifications. Price can be further classified as the selling price, transaction price, bid price, or buying price. On the other hand, “cost” can be classified as fixed cost, variable cost, or opportunity cost. The first two types of cost refer to operation costs in a production. Opportunity costs, meanwhile, do not necessarily refer to money but to opportunity for a business to profit.
In terms of value, costs are often lower compared to the price. As mentioned before, “price” is a combination of production costs and added profits for the seller. This means that the profit element adds some value into the price.
From a seller’s viewpoint, a cost is already money spent while the price is anticipated income as a method to regain back the costs made in production.
At this point, it is important to also explain two key terminologies that I have identified to be very useful especially for professionals in the built environment. These are Total Cost of Ownership (TCO) & Life Cycle Costing (LCC). Total Cost of Ownership (TCO) refers to the sum of all costs incurred throughout the lifetime of owning or using an asset; they typically go beyond the original purchase price. TCO enables decision makers to look at asset procurement in a more strategic way (beyond the lowest bidder) and to level the playing field when choosing among competitive bids where the lowest priced bid may or may not be the least costly asset to procure.
Life Cycle Costing (LCC) is a technique to establish the total cost of ownership. It is a structured approach that can assist the C-suite in the selection process. It can take into account any costs that the selection team feels are appropriate. Maintenance, cost of recruitment, asset disposal, training, cost of upgrades, energy consumption, resources used in manufacture and cost of duplicate service during installation are all examples of costs that could be included in an LCC analysis. This Life Cycle Costing Tool have been developed to assist asset managers in decision making based on performing a systematic assessment of the life cycle costs of selected water and wastewater assets.
Owners, users and managers need to make decisions on the acquisition and ongoing use of many different assets including items of equipment and the facilities to house them. The initial capital outlay cost is usually clearly defined and is often a key factor influencing the choice of asset given a number of alternatives from which to select. The initial capital outlay cost is, however, only a portion of the costs over an asset’s life cycle that needs to be considered in making the right choice for asset investment. The process of identifying and documenting all the costs involved over the life of an asset is known as Life Cycle Costing (LCC).
The total cost of ownership of an asset is often far greater than the initial capital outlay cost and can vary significantly between different alternative solutions to a given operational need. Consideration of the costs over the whole life of an asset provides a sound basis for decision-making. With this information, it is possible to:
- Assess future resource requirements (through projection of projected itemized line item costs for relevant assets);
- Assess comparative costs of potential acquisitions (investment evaluation or appraisal);
- Decide between sources of supply (source selection);
- Account for resources used now or in the past (reporting and auditing);
- Improve system design (through improved understanding of input trends such as manpower and utilities over the expected life cycle);
- Optimize operational and maintenance support; through more detailed understanding of input requirements over the expected life cycle)
- Assess when assets reach the end of their economic life and if renewal is required (through understanding of changes in input requirements such as manpower, chemicals, and utilities as the asset ages).
The Life Cycle Costing process can be as simple as a table of expected annual costs or it can be a complex (computerized) model that allows for the creation of scenarios based on assumptions about future cost drivers. The scope and complexity of the life cycle cost analysis should generally reflect the complexity of the assets under investigation, the ability to predict future costs and the significance of the future costs to the decision being made by the organization.
A life cycle cost analysis involves the analysis of the costs of a system or a component over its entire life span. Typical costs for a system may include:
- Acquisition costs (or design and development costs).
- Operating costs:
- Cost of failures
- Cost of repairs
- Cost for spares
- Downtime costs
- Loss of production
- Maintenance costs:
- Cost of corrective maintenance
- Cost of preventive maintenance
- Cost for predictive maintenance
- Disposal costs.
A complete life cycle cost projection (LCCP) analysis may also include other costs, as well as other accounting/financial elements (such as, interest rates, depreciation, present value of money/discount rates, etc.).
For the purpose of this Tool, it is sufficient to say that if one has all the required cost values (inputs), then a complete LCCP analysis can be performed readily in a spreadsheet, since it really involves summations of costs for several options and computations involving discount rates. With respect to the cost inputs for such an analysis, the costs involved are either deterministic (such as acquisition costs, disposal costs, etc.) or probabilistic (such as cost of failures, repairs, spares, downtime, etc.). Most of the probabilistic costs are directly related to the reliability and maintainability characteristics of the system.
This is an opportunity for professionals in the facilities management industry to imbibe appropriate industry best practice in order to raise the profile of this profession of choice.