Price each clause per unit, probability-weighted, add it to the headline, and solve for the price at which the cheaper bid would really be cheaper.
Compare bids by converting every clause that differs into an expected cost per unit and adding it to the quoted price. In the worked tender below, a bid 1.50 cheaper at 50.50 costs 52.87 a unit once its shorter payment terms, shorter warranty, take-or-pay commitment and freight are priced, 0.87 more than the dearer bid. To win on total cost it would have to quote 49.63.
Worked in full in Contract Management by Julian R. Sterling, with every figure reproduced in a free workbook.See the book on Amazon →
Price is the only term of a supply contract that arrives already expressed as a number. The others, payment days, warranty months, a minimum volume, an Incoterm, arrive as words, and words lose to numbers in an award meeting. The fix is not a scoring matrix with weights; it is to put every term in the same currency per unit as the price, and add.
| Term | Bid A | Bid B |
|---|---|---|
| Unit price | 52.00 | 50.50 |
| Payment terms | 60 days | 30 days |
| Delivery | Delivered to site | Ex works carrier, freight 0.85 a unit |
| Warranty | 24 months | 12 months |
| Volume commitment | None | 90,000 units a year, 6.00 a unit short |
Operational inputs: cost of funds 7 per cent; 1.5 per cent of units fail in the field over their life, 40 per cent of those failures in months 13 to 24; a failure costs 180 to repair; a 25 per cent chance that volume comes in at the low case of 80,000 units.
Price each difference against the better term, so Bid A carries zero on every line and Bid B carries what its weaker clause costs.
=B2*Funds*(A3-B3)/365| Per unit | Bid A | Bid B |
|---|---|---|
| Quoted price | 52.00 | 50.50 |
| Payment terms | 0.00 | 0.29 |
| Warranty months 13 to 24 | 0.00 | 1.08 |
| Take-or-pay, expected | 0.00 | 0.15 |
| Freight | 0.00 | 0.85 |
| Total cost per unit | 52.00 | 52.87 |
The headline saving of 1.50, 2.9 per cent, turns into a premium of 0.87. On 100,000 units that is 5,287,055 a year for Bid B against 5,200,000 for Bid A: an award to the cheaper bid would cost 87,055 a year while the procurement report booked a saving of 150,000.
The useful output is not the ranking but the equivalence price: the price at which Bid B, with its own clauses, would cost the same as Bid A. Because the payment-terms cost scales with price, solve rather than subtract:
Peq = (52.00 − 1.08 − 0.15 − 0.85) ÷ (1 + 7% × 30 ÷ 365) = 49.63
That is the number to take back to supplier B: a further 0.87, 1.7 per cent, or the clauses improved until the gap closes. Most suppliers find it cheaper to extend a warranty they rarely pay out on than to cut price.
The warranty line is the largest and the least certain, so test it.
| Field failure rate | Repair 90 | Repair 180 | Repair 300 |
|---|---|---|---|
| 0.5% | −0.03 | 0.15 | 0.39 |
| 1.0% | 0.15 | 0.51 | 0.99 |
| 1.5% | 0.33 | 0.87 | 1.59 |
| 2.5% | 0.69 | 1.59 | 2.79 |
Bid B is cheaper in only one cell: a very reliable part that is cheap to repair. At the base repair cost of 180 it ties at a failure rate of 0.29 per cent, so the award to Bid B is defensible only if the buyer believes the part almost never fails. That is a quality-engineering question, and the table turns it into one the engineers can answer.
Pricing the worst case instead of the expected case. Charging Bid B the full shortfall fee, 10,000 × 6.00 ÷ 100,000 = 0.60 a unit, puts its total at 53.32 and overstates the clause four times. A volume commitment costs its fee multiplied by the probability of falling short, not the fee.
Applying the annual cost of funds to price. 50.50 × 7% = 3.54 is the cost of paying a year early, not 30 days. Prorate by days over 365.
Counting a clause twice. If Bid A's price already includes delivery, adding a freight line to it as well inflates A. Price each difference once, against the better term, and leave identical terms out entirely. The same applies to indexation: when one bid is firm and the other indexed, the indexation already sits inside the price path, so model it there, as in when an indexed price overtakes a dearer firm bid, and do not add it again as a clause.
The free workbooks on the Contract Management companion page price eight clauses of a signed supply agreement against the bid that was rejected, and return the equivalence price for a contract of your own. Two of the clauses are worked on their own in what a minimum volume surcharge costs per unit short and whether a longer warranty is worth more than a better remedy.
Every term that differs between the bids and has a cash consequence: payment days, freight and Incoterms, warranty length, volume commitments, currency, liquidated damages and change pricing. Terms that are identical in both bids can be left out. In the worked case four differences add 2.37 a unit to the cheaper bid and reverse a 1.50 price advantage.
Multiply the price by your cost of funds and by the difference in days over 365. Paying a 50.50 invoice 30 days earlier at a 7 per cent cost of funds costs 0.29 a unit. Use the cost of the money that actually funds working capital, not the deposit rate, and never the annual rate unprorated, which would give 3.54.
Weight the shortfall fee by the probability that volume falls below the commitment. A 90,000 unit commitment with a 6.00 fee, against a 25 per cent chance of only 80,000 units, costs 15,000 a year in expectation, 0.15 a unit. Charging the full low-case fee instead would add 0.60 a unit and overstate the clause four times.
This article is one calculation from Contract Management. The book takes the same case from first principles to the decision, chapter by chapter, and every figure it prints is a live formula in the free companion workbooks.
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