Tuesday, March 18, 2008


Where is real value?

What is more important, price or cost?


Retailer A always has the lowest prices. Customers flock there to make purchases because they have the lowest prices.

Retailers B, C, D, E ... are closer, faster, more conveniently located, and provide higher service levels.

Example transaction - Printer Cartridge

Retailer A has the lowest price

Retailer B has a higher price

Difference of $2

The Low Price Theory says go to Retailer A.

That is the wrong decision in this case and in many cases. There are a few other factors not specifically mentioned above. Retailer A is 13 miles away and Retailer B is 1 mile away.
Round trip miles, Retailer A 26 miles Retailer B 2 miles. Differential cost of 24 miles.

Average car gets 25 Miles Per Gallon
Average price of 87 Unleaded $3.009
Cost Per Mile = $3.009 / 25 = $.12036 or 12 Cents per mile
Our travel differential was 24 miles at 12 cents per mile = $2.88

True Cost [product + variable fuel costs only]

Retailer A
$19.99 + $3.12 = $23.11

Retailer B
$21.99 + $ $.24 = $22.23

ANSWER: Purchase at Retailer B since the true cost is less. Doing business with Retailer A clearly costs more.

The Lowest Cost Theory requires that we allocate real costs that can be calculated to determine the best value.

This example leaves out depreciation, wear and tear costs and buyer time to travel.
The advantage of Retailer B becomes even more dramatic if all variable transportation expenses are allocated [tires, oil changes, vehicle depreciation etc].

Lowest cost is what matters when buying commodity products [products that are not differentiated and the supplier adds nothing of value to increase profits of the buyer].

What are your thoughts?

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