When using the terms “cost” and “price” in everyday conversation, most people probably use them somewhat interchangeably. Even in a place of business, these terms may be used to mean the same thing. For instance, the phrase “what is the cost?” means the same as “what is the price?” when you are talking to a sales associate. However, in higher-level business dealings, there is a difference between price and cost analysis, and both are essential to the smooth operation of your company.
TL;DR (Too Long; Didn't Read)
A price analysis is a method for evaluating similar products. In a cost analysis, you attempt to evaluate the fair market value of a product without comparing it to another.
What Is Price Analysis?
The method for evaluating similar products is called price analysis. You likely conduct a small-scale version of this activity when you go to the fresh produce section of your local grocery store. Before purchasing strawberries, you will typically lift the container to observe the quality of the fruit. Depending on the grocery store, you may even have different brands of strawberries from which to choose.
In order to determine which strawberries to purchase, you will conduct a price analysis. The price of one brand is compared to the competition’s cost, and you select the product with the best value. This value is subjective and can be based on price alone or on perceived value based on quality, available deals and more.
In the business world, price analysis is used to select everything from staplers to contractors, and the more complex the item, the more in depth the price analysis. For example, if you have three contractors submitting bids on a project, you start with the price proposed and then look over what each individual contractor offers for that price. The contractor you choose will be the one who you believe provides the most benefits or value relative to the price of the work.
What Is Cost Analysis?
In comparison, a cost analysis is a more complicated approach. When performing a cost analysis, your results are not as black and white as they are during a price analysis. A cost analysis should include a review of itemized services and products against their separate costs. You will need to examine each and every estimated or actual cost as outlined to determine the likely overall cost to your company.
While a price analysis can give anyone an idea of value against competitors, a cost analysis is typically done by a purchasing agent or manager. Your purchasing department is aware of historical data from your company, any relevant market trends and the costs of each individual part of a project. They can then make an educated choice based upon the merits of a solution alone.
Cost analysis is often used when price analysis is not feasible, like when there is no alternative solution for your project. When an engineer is replacing part of a machine, he may be locked into working with one company due to policy. Cost analysis is challenging because you are not comparing similar solutions; rather, you are attempting to figure out the fair market value of something (a good or service) without comparing it to anything.
How to Complete a Cost Analysis
When no price analysis can be performed, performing a cost analysis is typically the solution. You or your purchasing department will review and evaluate the separate cost elements of the proposed scope of work against the profit margin for the project. Once completed, a cost analysis should inform your opinion on what the final costs of a project will be. Doing a cost analysis in this manner takes projected profit into consideration along with the expenses.
For instance, a cost analysis might be conducted when the product or service has no competing proposals, when change orders are issued pursuant to an existing and binding contract or when only one proposal is solicited.
To properly conduct a cost analysis, you should start with a detailed overview of the work to be performed. Consider the elements individually, ideally by outlining each and determining their value to the overall project. Evaluate these against your total profit margins as well.
How to Complete a Price Analysis
Conversely, when you are performing a price analysis, you are comparing two like products or solutions against each other. You cannot perform a price analysis of goods that are not available in the general commercial marketplace. As such, when you are considering two competing offers, the prices offered to you should be the same as those that are available to the general public.
There are certain other conditions that must be met to perform a price analysis. The process cannot be accurately conducted for any items that are one-of-a-kind or are in the research and development phase since there would be no means for comparison.
It is not required that comparable products be identical to those you are considering, but you should be able to consider the capabilities of the products or services and their respective prices with relative ease. In doing so, you can make value judgments about which products or services compel higher or lower prices.
What Is a Cost/Price Analysis?
Depending on the scale and scope of your project, you could conduct both price and cost analyses that work together to help you make a determination. These analyses do not always have the same results. Your costs could look very different from your pricing depending on the solutions that your supply chain has developed. Both cost and price analyses begin with a CPU, or cost per unit.
However you begin, your price analysis should have four key components.
Component 1: Analysis of Price History
Have you ordered from this particular vendor before, and what did it cost the last time that you did so? By checking any history that you have with the company, you can figure out if the costs are rising too much to be of value to your company. If there is no existing price history, you can proceed by assuming that the history is a nonissue.
Component 2: Comparisons of Price to Projections
What will your business earn from this project? Will your profit margins be large enough? Understanding the final goals of a project is essential in this step of the process. It goes without saying that if your project is going to cost your company more than you will be making, there needs to be proper justification for continuing.
Component 3: Comparing Bids
Unless you are contractually obligated to use one specific vendor or contractor, you should be carefully examining their bids. This should be done with an in-depth, side-by-side comparison.
What does contractor A offer? Does it compare with the offerings of contractor B? Your goal here is not to take the lowest bid on a project; it is to ascertain what is the best value to your company.
Component 4: Check General Pricing
Checking either a catalog or governmental pricing for all parts of your project is a necessity. If you cannot check prices against a readily available market, you cannot do a price analysis. At this point, you can see the real difference between a price analysis and a cost analysis.
Unless there is a fair market value for a good or service, you cannot be expected to know that good or service’s baseline value. These general prices can go up or down depending on many variables, including the stock market or import fees.
Core Cost Analysis Considerations
When dealing with your cost analysis, there are five core considerations:
- Working hours
- Indirect costs
Consideration 1: Personnel
What is the general cost of the staff that you will have working on this project? Large-scale construction jobs can have hundreds of employees to track. Smaller businesses may only have a handful. Regardless of how many employees you have, you will need to keep track of them and their base expenses.
Consideration 2: Working Hours
When you know how many people the project requires and their pay rates, you can then calculate the full cost of having all the personnel on hand that you will need. If you have more than one pay bracket, it is easiest to sort the personnel list organized by that pay rate.
Consideration 3: Sourcing
How much do your raw materials cost? What is the machine usage that you will need? This step may need to include a price analysis to assure that you are getting the best value for your company. When you are working with vendors, you may also need to loop back and include maintenance for equipment or even training hours.
Consideration 4: Indirect Costs
Taxes, fees, electricity and more all fall into the category of indirect costs. These costs typically can not be mitigated, and all can add up to a significant part of your budget. When discussing indirect expenses, you are basically talking about the tools and services that are supporting your project.
Consideration 5: Evaluation
Once you have all of the numbers, you must evaluate them to figure out what will work best for your company. If any costs are not necessary and reasonable, you should go back in an attempt to find a better solution to your problem. Depending on your prices, you could save money by either contracting work to other people or moving a part of the project in house.
Cost Price Analysis Template
There are plenty of templates available for project managers to help them set up their cost and price analysis worksheets. A skilled project manager should be able to perform both of those projections in tandem by using one set of figures to help inform the other.
When you are working with price analysis vs. cost analysis, you must always keep value in mind. Your job as a project manager is to provide the best value possible for your business. Your company’s quality expectations should not be compromised, as they have a lasting effect on how your customers view your company and your products. This type of quality assurance means that the lowest cost may not always be the best option.
While price analysis and cost analysis need to work together, they are also very different processes. Your cost analysis informs your price analysis by keeping your expenses at the forefront of your mind. Your price analysis is a crucial part of completing your cost analysis by assuring that you are sourcing all of your materials for your project.
Danielle Smyth is a writer and content marketer from upstate New York. She has been writing on business-related topics for nearly 10 years. She owns her own content marketing agency, Wordsmyth Creative Content Marketing (www.wordsmythcontent.com) and she works with a number of small businesses to develop B2B content for their websites, social media accounts, and marketing materials. In addition to this content, she has written business-related articles for sites like Sweet Frivolity, Alliance Worldwide Investigative Group, Bloom Co and Spent.