The Preferential Procurement Premium

The Concept:

The Preferential Procurement element of the B-BBEE scorecard incentivizes companies to purchase goods and services from suppliers with strong B-BBEE credentials. The higher a supplier’s B-BBEE level, the greater the percentage of spend with that supplier a company can count towards its own Preferential Procurement target.

The “premium” arises because, in many cases, achieving high levels of B-BBEE-compliant procurement may involve some additional costs compared to sourcing solely from the cheapest possible suppliers (who might have low or no B-BBEE recognition). This isn’t always the case, but it’s a common enough reality to be a significant factor. It’s a potential inefficiency that propagates through the economy – from government spending all the way down, via the BEE scorecards.

Why a Premium Might Exist:

Several factors can contribute to a potential Preferential Procurement premium:

1. Supplier Base: Smaller, Black-owned businesses (which often have higher B-BBEE levels) may have higher operating costs than larger, established (and potentially non-B-BBEE compliant) companies. This could be due to economies of scale, access to financing, or other factors. These higher costs might be reflected in their pricing.
2. Limited Supply: In some sectors, there may be a limited number of suppliers with very high B-BBEE levels (e.g., Level 1 or Level 2). This limited supply can create a higher demand, potentially leading to higher prices. (Note the the corollary to this is that BEE ownership deals that get you to a level 1 or 2 can be potentially lucrative).
3. Administrative Costs: Finding, vetting, and managing a diverse supplier base that meets B-BBEE requirements can involve additional administrative time and resources for the procuring company. This includes:
   • Supplier Identification: Searching for and identifying suitable B-BBEE compliant suppliers.
   • Verification: Verifying the B-BBEE status of potential suppliers (checking certificates, etc.).
   • Supplier Development: In some cases, companies may invest in developing their suppliers’ capabilities to help them improve their B-BBEE levels, which is a direct cost.
   • Contract Negotiation: Negotiating contracts with new suppliers.
   • Relationship Management: Managing relationships with a potentially larger and more diverse supplier base.
4. Switching Costs: Moving from existing, long-term suppliers (who may not be B-BBEE compliant) to new B-BBEE suppliers can involve disruption and costs, such as:
   • Retraining staff: Employees may need training to work with new products or services.
   • System changes: Integrating new suppliers into existing procurement systems.
   • Potential quality issues: There’s always a risk of initial quality issues when switching suppliers.

How We Estimated the Premium in the article on the relative costs of scorecard points:

Because the Preferential Procurement premium is difficult to quantify precisely (it varies greatly by industry, company, and specific procurement categories), we used a simplifying assumption in the article:

• Assumption: We assumed a 2% cost premium on 50% of the Total Measured Procurement Spend (TMPS).
• Rationale:
  • Not All Procurement: We didn’t assume a premium on all procurement, as many goods and services can be sourced from B-BBEE compliant suppliers without any significant price difference. The 50% figure acknowledges that a portion of spend is likely to be more price-sensitive or involve specialized goods/services where finding high B-BBEE level suppliers is more challenging.
  • 2% Premium: The 2% figure is a conservative estimate. In some cases, the premium could be higher; in others, it might be negligible. This represents a reasonable “average” cost increase that a company might face when actively pursuing high B-BBEE procurement. It’s meant to be illustrative, not definitive.
• Calculation Example (Company A):
  • TMPS: R10,000,000
  • Portion of TMPS subject to premium: R10,000,000 * 50% = R5,000,000
  • Estimated Premium: R5,000,000 * 2% = R100,000

Important Considerations:

• Industry Variation: The actual premium will vary significantly depending on the industry. Some sectors have a readily available pool of high B-BBEE level suppliers, while others face greater challenges.
• Long-Term Benefits: While there may be a short-term premium, building relationships with B-BBEE compliant suppliers can offer long-term benefits, such as:
  • Improved B-BBEE Score: This is the primary driver.
  • Access to new markets: Some B-BBEE suppliers may have access to niche markets or government contracts.
  • Innovation: Working with smaller, more agile suppliers can foster innovation.
  • Social Impact: Contributing to the growth of Black-owned businesses.
• Strategic Sourcing: Companies can mitigate the premium through strategic sourcing practices, such as:
  • Long-term contracts: Offering longer-term contracts to B-BBEE suppliers can give them greater certainty and potentially lead to better pricing.
  • Supplier development: Investing in the development of suppliers can improve their efficiency and competitiveness.
  • Early engagement: Engaging with potential B-BBEE suppliers early in the procurement process.

In summary: The Preferential Procurement premium represents the potential additional costs a company might incur to achieve high levels of B-BBEE-compliant procurement. It’s a complex factor influenced by market dynamics, supplier availability, and the company’s own procurement strategies. The 2% premium on 50% of TMPS used in the article is a simplifying assumption to illustrate this often-hidden cost, but the actual premium will vary. It’s crucial for companies to strategically manage their procurement to minimize this premium while maximizing their B-BBEE score and contributing to economic transformation.