Current Event Assignments 2
INeal
MGT533Chapter111.pptxChapter 11
Cost Management
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Key Questions Addressed in Chapter 11
How can cost management and negotiation tools help identify opportunities and assure value?
How can we determine:
the supplier’s costs?
delivery cost?
our own use costs?
disposal costs?
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Strategic Cost Management
An externally focused process of analyzing costs in terms of the overall supply chain
Measure and improve specific cost elements.
Tools and techniques to sustain cost savings year over year.
Cost culture versus a price culture with internal stakeholders and suppliers.
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Direct and Indirect Costs
Direct Costs: Costs that can be specifically and accurately assigned to a given unit of production of a product or service
e.g., materials and labor
Indirect Costs: Costs incurred that normally cannot be related directly to any given unit of production of a product or service
e.g., administrative expenses and plant overhead
When evaluating costs as either direct or indirect,
the issue is the ability to trace the costs directly
to a unit of production
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Variable and Fixed Costs
Variable Costs: Vary directly and proportionally with the number of units produced
Fixed Costs: Remain the same regardless of volume produced (over the relevant range)
Semivariable Costs: Partly variable and partly fixed
When evaluating costs as either variable or fixed,
the issue is how costs change as volume of production changes
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ABC or Pareto Analysis
Assign items to A (high-dollar), B (medium-dollar), or C (low-dollar) spend categories
A items = greatest percent of annual spend
Cost management approach for A items:
More time and managerial attention
Understand supplier’s cost structure
Identify opportunities for supplier or joint buyer-supplier initiative to eliminate, reduce, or avoid costs in any cost elements (materials, services, labor, and overhead)
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Pareto Analysis and Supplier’s Strategic Positioning
A items: differentiated products or services (customized) or low cost commodity-type items with high volumes:
Cost reduction opportunities:
Custom: changing specification or design
Commodity-type items: come from inside the supplier’s organization and be from its supply chain, production process, service delivery system, or distribution network
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Portfolio Analysis
non-critical
items
bottleneck
items
strategic
items
leverage
items
Value
Risk
Low
High
High
Low
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Portfolio Analysis and Cost Reduction Opportunities
Non-critical Items
Acquisition process costs
Market competition and price analysis
Bottleneck Items
Process costs
Carrying costs
Value analysis
Strategic Items
Internal cost structure
Supplier’s cost structure
Leverage Items
Acquisition process costs
Price per unit
Total cost of ownership
Value
Risk
Low
High
High
Low
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Total Cost of Ownership (TCO)
The acquisition price plus all associated cost elements
Identify opportunities for each cost element
cost reduction
cost avoidance
Work with internal stakeholders and external suppliers to achieve cost reductions/avoidance
Life-cycle costing (LCC) = TCO for capital acquisitions
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Challenges in Using TCO
Difficult to:
Identify and track cost elements
Achieve changes internally to reduce/avoid costs
Achieve changes externally with suppliers
Use the information appropriately to compare suppliers
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TCO Applications
Highlight cost reduction and continuous improvement opportunities
Aid supplier evaluation and selection
Provide data for negotiations
Focus suppliers on cost reduction opportunities
Highlight advantage of expensive, high-quality items
Clarify and define supplier performance expectations
Create a long-term supply perspective
Forecast future performance
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Excuses for Not Using Cost Analysis
Suppliers may not know their costs
Interpretation of cost calls for an exercise of judgment
Some suppliers are not willing to divulge cost information
Some buyers have limited knowledge in cost estimating
The seller’s costs do not determine the market prices
The buyer is not interested in the supplier’s costs, the primary concern is getting the best price
If a supplier offers a price that does not cover its costs, the matter is the supplier’s problem and not the buyer’s
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Major Categories for the Components of Total Cost of Ownership
Pretransaction Components
Identifying need
Investigating sources
Qualifying sources
Adding supplier to internal systems
Educating:
Supplier ins firm’s operations
Firm in supplier’s operations
Transaction Components
Price
Order placement/preparation
Delivery/transportation
Tariffs/duties
Billing/payment
Inspection
Return of parts
Follow-up and correction
Posttransaction Components
Line fallout
Defective finished goods rejected before sale
Field failures
Repair/replacement in field
Customer goodwill/reputation of firm
Cost of repair parts
Cost of maintenance and repairs
Total Cost of Ownership
Source: Lisa Ellram, “Total Cost of Ownership: Elements and Implementation,” International Journal of Purchasing
and Materials Management, Winter 1993.
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Target Costing Example
Future Market Price – Desired Profit = Target Cost
Current Price
Part/System Price
Verified By
Cost Standards
Target
Cost
Desired Profit
Current
Cost
Component
Target Costs
A
B
C
Purchased Component Part Level Costs
Internal Costs
>
Current Profit
Model-to-Model
Change
Adjust for Spec. Differences
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Goals of Target Costing
Organization-wide cost reductions in:
Design to cost, on the part of design engineering
Manufacture to cost, on the part of production
Purchase to cost, on the part of supply
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Target Costing Implications for Supply
Target costing provides supply with:
a measurable target for supply performance
a yardstick for measuring cost reductions
a means of measuring the supplier’s efficiency
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Example of the 90 Percent Learning Curve
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The 90 Percent Learning Curve – Logarithmic Plot
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Value Engineering (VE) and Value Analysis (VA)
Value methodology is
a systematic approach to analyzing the functions of a product, part, service, or process
to satisfy all needed quality and user requirements
at optimum total cost of ownership
Value engineering (VE): in product or service design
Value analysis (VA) in product or service redesign
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Value Expression
Value can be expressed as:
VALUE = Function
Cost
Function = a noun-verb combination (e.g., holds liquid)
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Goal of VE and VA
Perform a function at the same or an improved level while reducing costs
Eliminate or avoid unnecessary costs:
do not provide quality
do not extend product or service life
do not provide features desired by customers
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Activity-Based Costing
Tries to turn indirect costs into direct costs by tracking the cost drivers behind indirect costs
Overhead is divided into:
costs that change in response to unit-level activities
batch-level activities
product-level activities
the remainder are true fixed costs and are allocated according to traditional cost accounting
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Activity-Based Costing Implications for Supply
Purchasers can use activity-based costing as a tool to reduce supplier costs by:
eliminating nonvalue-adding activities
reducing activity occurrences
reducing the cost driver rate
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Supply Chain Financing
Emergence of financial technology, or “FinTech” companies
Offer procure-to-pay technology solutions – cloud based
Early payments to suppliers include a small discount based on buyer’s low credit risk
FinTech firms collect account receivable from buyer based on normal payment terms
Allows suppliers access to accounts receivable promptly—providing greater liquidity and cash flow certainty
Can represent an important source of capital for small- and medium-sized enterprises (SMEs)
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https://www.youtube.com/watch?v=-EoNrg_DR3s
CNBC FinTech
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Negotiation
The most sophisticated and most expensive means of price determination
A difficult art requiring judgment and tact
An attempt to find an agreement that allows both parties to realize their objectives
Requires the buyer and supplier, through discussion, to arrive at a common understanding on the essentials of an issue
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Any Aspect of the Purchase Agreement is Subject to Negotiation
Quality
specification compliance
performance compliance
test criteria
rejection procedures
liability
reliability
design changes
Support
technical assistance
product research, development, and/or design
warranty
spare parts
training
tooling
packaging
data sharing, including technical data
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Any Aspect of the Purchase Agreement is Subject to Negotiation (cont’d)
Price
purchase order price
discounts (cash, quantity and trade)
escalation provisions
exchange terms
import duties
payment of taxes
countertrade credits
Transportation
FOB terms
carrier
commodity classification
freight allowance/equalization
multiple delivery points
Supply
lead times
delivery schedule
consignment stocks
expansion options
supplier inventories
cancellation options
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Situations Where Negotiation May Provide Value
Any written contract covering price, specifications, terms of delivery and quality standards
The purchase of items made to the buyer’s standards
When changes are made to drawings or specifications
Following an unsuccessful bidding process
When problems of tooling or packaging occur
When changing economic or market conditions require changes in quantities or prices
When problems of termination of a contract involve disposal of equipment, materials or tooling
When problems arise under the various type of contracts used in defense and governmental contracting
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Model of the Negotiation Process
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The Basic Steps in Developing a Negotiation Strategy
Develop the specific objectives (outcomes) desired from the negotiation
Gather pertinent data
Determine the facts of the situation
Determine the issues
Analyze the positions of strength for both (or all) parties
Set the buyer’s position on each issue, and estimate the seller’s position on each issue based on your research
Plan the negotiation strategy
Brief all persons on the negotiation team
Conduct a dress rehearsal
Conduct the actual negotiations with an impersonal calmness
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The Zone of Negotiation
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