The Journey to Value-Based Procurement Process 4.0 [Part 1]
Procurement management is on the journey from cost-cutting to value delivery.
Naturally, Procurement started in the lowest-cost arena, where the cheapest bid wins.
As we evolved from the transactional cost-cutting tool to a more strategic role, we realized that cost is just an element of the complex equation.
Getting to measuring the TCO was a giant leap, but not anymore.
Selecting suppliers by cost-only criteria (even as sophisticated as the TCO) contradicts procurement ambition to become value contributors.
This article will map the procurement management journey from cost-cutting to value delivery on the road to Procurement 4.0.
Lowest bid
Supplier selection by the lowest bid is still the dominant approach in many companies, especially public ones.
This method is simple, logical, and easy to implement. It provides a sense of objectiveness and secures decision-makers from post-decision anxiety.
Obvious shortcomings of the lowest bid method are defined in this OECD guidance:
- qualitative considerations are not accounted for;
- innovation and innovative solutions are not considered either;
- for requirements with long operating life, it does not consider the lifecycle costs of the providers procured;
- When the lowest-price criterion is used, only the direct cost of the purchase or the initial purchase price within the set specifications can be considered.
The lowest bid approach is an excellent example of ecological rationality - an adaptive fit between the human mind and the environment.
For example, it is the easiest way to explain supplier selection decisions in a public procurement environment.
Perhaps, our colleagues understand that the nature of complex goods and services isn't only explained by the unit cost. Yet, they tend to exploit it to avoid subjectivity or personal interest accusations.
Total Landed Cost (TLC)
The first step of the procurement journey to value starts from the Total Landed Cost.
TLC adds transportation, packaging, and storage costs to the unit prices. These additions are most important when buyers consider remote locations as physical goods sources.
TLC analysis requires a deep understanding of supply chain costs - customs, duties, tariffs, and 3PL services. However, it still neglects revenue, risk, or social objectives.
Total Cost of Ownership (TCO)
TCO considers all costs associated with acquiring, operating, and maintaining goods or services.
Typically, TCO evaluations add the following lifecycle costs to the price of goods and services:
- operational costs, e.g., energy consumption, consumables;
- maintenance costs;
- dismantling and scrapping costs;
- sustainability costs (contamination, greenhouse gases, etc.)
Needless to say that all lifecycle cost elements must be objectively measured with appropriate formulas and standards.
TCO requires a deep understanding of the scope of Procurement and extends our line of sight beyond immediate price elements.
On the other hand, TCO can be difficult to calculate for complex technological objects, e.g., railway locomotives. It still avoids subjective matters of value and risks.
Most Economically Advantageous Tender (MEAT)
EU Directive 2014/24/EU on public Procurement introduced the concept of most economically advantageous tender (MEAT) criteria, which considers aspects other than the lowest price, such as security of supply, environmental investments, and long‑term sustainability.
The MEAT criterion aims to identify the tender that offers the best value for money.
Value-for-Money
This term means the optimum combination of the various cost-related and non-cost-related criteria.
The concept of value-for-money recognizes that goods, works, and services are not homogenous and may differ in quality, reliability, operability, sustainability, and other characteristics of the subject of Procurement.
MEAT criteria
The Directive contains an illustrative list of criteria, which are:
- quality,
- price,
- technical merit,
- aesthetic and functional characteristics,
- environmental characteristics,
- running cost,
- cost-effectiveness,
- after-sales service and technical assistance,
- delivery date and delivery period or period of completion.
With these criteria, a contracting party will consider qualitative, innovative, usability, and lifecycle cost attributes.
Despite all advantages of the MEAT method, it doesn't account for the revenue, risk, and customer value aspects.
Value-based Procurement vs. traditional procurement
NHS embarked on the value-based procurement (VBP) project with an ambition to "shift in emphasis from a reduction in product costs... to reduction in total costs within the patient pathway. VBP will provide... means of driving sustainable increased savings and improving patient outcomes."
The last phrase is the key to a value-based procurement process since it differentiates efficiency and effectiveness.
The efficiency establishes the correlation between inputs (cost estimates, transactional procurement costs, sourcing strategy) and outputs (actual contract conditions, compliance, and business needs.)
Meanwhile, effectiveness considers how the procurement strategy translates into achieving business goals, i.e., customer value.
For example, NHS's business goal isn't to save money on medical care but to improve the patient's experience and optimize pathways.
VBP problems with value interpretation
Despite all benefits of VBP, NHS suppliers identified some problems appearing in the course of implementation.
One of those was "interpreting value," i.e., "the existence of gaps in how the operational benefits contained in the supplier's proposal would deliver tangible and measurable financial, system, and patient benefits."
This is where the devil is. Due to the philosophical nature of the value, VBP may be accused of being subjective in selecting value factors and quantifying them.
Value quantification
To minimize claims of subjectivity, Value-Based Procurement should be mindful of a few critical rules of value quantification:
- Select a meaningful unit of measurement.
- Use multiple measures of the value experience. Don't rely on a single size.
- Estimate the difference between your product and the next best alternative when you can't measure the actual value experience.
- Be sure to document the basis for your estimate.
CJEU case: Proximus SA vs. the Council of European Union
Proximus SA lost the case, claiming that the tender award not to the lowest bidder is in breach of EU legislation and infringes the general principles of transparency, non-discrimination, and equal treatment.
This case set the precedent that MEAT tender is not necessarily synonymous with the lowest bid. A customer can award a contract to a bidder that offers better overall quality despite being more expensive in certain situations.
The value-based procurement process is a true example of transformation
While we celebrate the court case that has defeated the lowest-bid proponents, the war for procurement value is far from over.
Value-based Procurement will be continuously subjected to claims of inappropriate evaluation methods and arbitrary results.
We should apply the value quantification rules to minimize that, primarily by documenting estimates. The court case we referred to above was only successful for the contracting authority because they followed this rule.
As the court stated
- All conditions and detailed rules of the award criteria must be drawn up in a clear, precise, and unequivocal manner in the contract notice or tender specifications;
- The award criteria must be set out in the tender specifications or contract notice in such a way as to allow reasonably well-informed tenderers to interpret them in the same way.
- The criteria must be capable of guiding the discretion of the contracting entity on an objective basis and must not include elements of arbitrary choice.
- Moreover, the award criteria must be directly linked to the subject matter of the contract, have effects that can be measured objectively, and be quantifiable at the economic level.
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More information on this and other exciting topics can be found in "The Technology Procurement Handbook." It represents 23 years of experience, billions of dollars worth of successful sourcing projects, and 1000s of hours spent on research, analysis, and content creation for the most demanding professional readers.
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