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Spot Purchasing

4 Jul 2013 - 16:48 by Nigel Rose

Spot purchasing is a new and strange idea to many voluntary organisations but is becoming more common as public bodies seek to reduce costs. It can be a far riskier form of funding if it contributes significantly to the financial viability of an organisation, as there are usually no guarantees of income, unlike grants or fixed contracts. This article examines a few of the considerations that need to be taken into account when developing a pricing plan. Some of the key concepts are emboldened. This article does not attempt to deal with the ethical issues arising for voluntary organisations raising income through spot purchasing.

Let’s take an example. An organisation “Listen” offers a free counselling service paid for by grants and donations. The local council wants to spot purchase counselling services from them.

Packaging Services
The first issue is always determining exactly what is being offered, how is the service packaged? Is it one service or is it many services? The first stage of counselling is an assessment to judge whether or not a client is suitable. Is this a separate service that is charged separately? If the person goes on to the main service is the cost incorporated into the overall costs? Are counselling services packaged up as a set of 6 sessions or a course of treatment? What happens if the client fails to attend every session, is there a discount or is full price charged? What is included in the cost: travel expenses; literature; phone calls; referrals?

Listen also offers group therapy. In order a run a group a minimum of 6 clients are required, but the group can run with up to 12. In order to offer the service the pricing plan may state that a minimum of 6 referrals is required. The pricing plan may state a price for running a group or per individual or one price for the first 6 referrals and a different price for the next 6.

A package of service is always accompanied by a guarantee of a certain standard of quality. The Local Authority may be requiring a different standard of quality than the one that the counselling service already offers, which will increase both set-up costs and unit cost. Similarly they may be asking for different monitoring information from the monitoring information that is routinely collected which will require time to set up and time to maintain.

Flow
The second issue is flow, how many clients are likely to be referred. For widgets, cost usually goes down with number of widgets ordered, for services it’s not so straightforward. The existing services may not be working up to capacity or there may be relatively simple ways of increasing capacity e.g. offering extra hours to one of the counsellors. The cost of providing for a few extra clients is marginal and the pricing can reflect this.

On the other hand it might be that the existing services are working at capacity and there is no headroom. In this case the pricing would have to reflect start-up costs. The first tranche of clients would be charged at a significantly higher rate than the following tranche.

The pricing plan also depends on the variability in flow. If it is known that there are going to be 3 new clients every month then it is easy to forecast costs. It is different however if there is one client one month and 5 the next. If the purchaser is asking for a minimum response time then enough counsellors have to be employed to meet peak demand. Demand, even for personal services, is often seasonal.

The purchaser may offer a guaranteed minimum flow but this is unusual. More often the purchaser may provide indicative flows, based on previous experience. The most difficult situation to price is where the purchaser does not give any indication of flow and also has full control of flow.

The final important element of spot purchasing is overall time frame. If the time frame is over a number of years then set-up costs and winding-up costs may form a relatively small element of the overall pricing, however if there is a short time-frame then they can become very significant. It’s important to remember that for Listen the time frame only ends when the last client receives their last service which might be well after the final payment has been made.

Invoicing and Payment
Spot purchasing usually demands a much higher level of accounting administration than grant funding. Separate invoices have to be issued and followed up and it may be that the invoice can only be issued once the service has been completed. Unfortunately this local council is relatively slow to pay out on invoices as there are several levels of authorisation before the invoice can go forward for payment. It is not unusual for there to be a delay of up to 4 months. This may cause cash flow problems for Listen at medium or high flow rates which will need to either be funded out of reserves or from a bank loan and either way pose a risk.

Pricing, Risk and Competition
I hope it is clear from the previous paragraphs that setting out a pricing plan is not straightforward, especially when there is no guaranteed flow. All spot purchasing even where there is some guarantee of work poses a risk and this risk has to be reflected in the price offered. Organisations that fail to include a factor for risk in their pricing would be failing in their duty to ensure organisational continuity.

The level of the risk factor usually depends on competition on type of service, area of operation and client group. Where competition is low then the risk factor can be set high. Conversely if there is significant competition then organisations will tend to cut their risk factor in order to put in a lower price. However if it is set too low then it puts the organisation at risk.

One way of developing a pricing plan and in some ways the best is to find out how much another successful organisation is charging for a similar service. The most dependable way of developing a solid pricing plan is basing it on previous experience, yours or some else’s. Another option is to develop a spreadsheet model and analyse what happens at different flows. A common modelling methodology is to look at fixed and variable costs and calculate the minimum flow needed for break-even point given different pricing plans. If in doubt then it’s usually wise to price high and include a significant risk factor unless the service you are offering is at such a low flow that it poses no financial or other risk to the organisation.
 

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