What is the cost of money? Does the Purchasing Department that is threatening to switch suppliers know the cost?

The cost of money refers not just to the interest rate charged by a bank. The cost of money also is the return on investment, such as inventory, opportunity cost, and payment terms. How does the Purchasing Department calculate the cost of opportunity? If you are facing a Purchasing Department that insinuates they will switch suppliers to “save money,” be sure to do your homework so you are prepared to respond. Truth is, the Purchasing Department likely has not thought it through. Here is why:

Many Purchasing Departments are assigned a cost of money equal to what the same funds would return to the company if they were used by another department to help make money. An example of this is the borrowing rate of funds might be 7%, but the company expects a reasonable rate of return on the money they borrow; therefore, the rate the Purchasing Department is charged is 14%. This means any money they invest into inventory has to create at least a 14% return or they’re losing money. Looking at funds in this manner can impact significantly how much the purchasing agent is willing to invest into inventory.

Knowing the cost of money to the PA can also help in dealing with lead-times and order patterns. A PA who has a high cost of money is going to be far less likely to invest in items they have to inventory, which will mean they will be more receptive to longer-performance items. Using this approach can help a PA see how a higher priced item you may be selling can be cheaper to them than one that has a lower list price.

I know this may sound confusing, but you need to really understand that a comment from a Purchasing Department about “switching suppliers to save money” may not have any feet under it. You as the sales representative can be the one to show the reality that switching suppliers actually could cost your customer more.

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