Chapter 11
Strategic Cost Management Qualities
- A continuous improvement process - Measure and improve specific cost elements - Tools and techniques to sustain cost savings year over year - Strategic partnering to achieve competitive advantage - An opportunity for strong supply leadership to develop a cost culture rather than a price culture with multiple internal stakeholders and suppliers
A items: differentiated products (customized):
- Cost reductions by changing specification or design - A items: low-cost commodity type or standard off-the-shelf goods or services with substitutes available: - Cost reductions from within the supplier's supply chain, production process, or distribution network
Standard Economic Indexes
- LME/AMM for metals - BLS for Labor & Overhead - Others for various materials
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)
• 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
Manufacturing 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
The Basic Steps in Developing a Negotiation Strategy
1. Develop the specific objectives (outcomes) desired from the negotiation 2. Gather pertinent data 3. Determine the facts of the situation 4. Determine the issues 5. Analyze the positions of strength for both (or all) parties 6. Set the buyer's position on each issue, and estimate the seller's position on each issue based on your research 7. Plan the negotiation strategy 8. Brief all persons on the negotiation team 9. Conduct a dress rehearsal 10. Conduct the actual negotiations with an impersonal calmness
Value methodology:
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 where value can be expressed as: Value = Function/Cost.
Total cost of ownership (TCO) can used to:
All of the Below A) highlight cost reduction opportunities. B) compare suppliers in a supplier selection decision. C) prepare for a negotiation. D) assess the reasonableness of a supplier's prices. Feedback: (The concept of TCO acknowledges that acquisition price is merely one part of the costs associated with owning a good or procuring a service. While the most obvious reason for using TCO is to identify the actual cost of the supply decision, the cost data can be used in each action listed above.)
When developing a negotiation strategy, the negotiator should assess the positions of strength of both (all) parties to:
All of the below A) decide if negotiation makes sense. B) establish negotiation points. C) avoid setting unrealistic expectations. Feedback: (The list of things that give each party (buyer and seller) strength can be used to determine (a) if there is enough overlap in interests to make negotiation worth the cost, (b) generate likely talking points that each side will probably use in the negotiation, and (c) help each party face reality when it comes to likely outcomes.)
Negotiation:
An attempt to find an agreement that allows both parties to realize their objectives.
ABC analysis or the Pareto curve:
Assigns items to either the A, B or C category where A items are high dollar items, B are medium dollar and C are low dollar items.
Portfolio Analysis
Bottleneck items Strategic items Non-Critical Items Leverage Items
Transportation aspects up for negociation
FOB terms carrier commodity classification freight allowance/equalization multiple delivery points
Total cost of ownership (TCO):
For non-capital goods acquisition, the acquisition price plus all other associated costs becomes the total cost of ownership; this includes all relevant costs, such as administration, follow-up, expediting, inbound transportation, inspection and testing, rework, storage, scrap, warranty, service,
Strategic Items and cost reduction
High Risk High Value can reduce internal cost structure suppliers cost structure
Bottleneck items and cost reduction opportunites
High Risk Low Value Can reduce Process costs Carrying costs Value Analysis
General and administrative expense
Includes items such as selling, promotion, advertising, executive salaries, and legal expense.
Supply aspects up for negociation
Lead Times Delivery schedule consignment stocks expansion options supplier inventories cancellation options
Leverage Items
Low Risk High Value can reduce acquisition costs Price per unit Total cost of Ownership
Non-Critical Items and cost reduction
Low Risk Low Value can reduce acquistion process costs Market competition and price analysis
Learning curve
Provides an analytical framework for quantifying the commonly recognized principle that one becomes more proficient with experience.
Price aspects up for negociation
Purchase order price discounts(cash, quantity, trade) escalation provisions exchange terms import duties payment of taxes countertrade credits
Aspects Subject to Negotitation
Quality Support Price Transportation Supply
Quality aspects up for negociation
Specification compliance performance compliace test criteria rejection procedures liability reliability design changes
Support aspects up for negociation
Technical assistance product research, development, and or design warranty spare parts training tooling packaging data sharing, including technical data
Life cycle costing (LCC):
The term for total cost of ownership used in capital acquisitions
Value can be expressed as
VALUE = Function/ Cost - Function = a noun-verb combination (e.g., holds liquid)
Activity-based costing (ABC):
an attempt to turn indirect costs into direct costs by tracking the cost drivers behind indirect costs.
Strategic cost management
an externally focused process of analyzing costs in terms of the overall value chain.
Overhead
costs generally consist of indirect costs incurred in the manufacturing, research, or engineering facilities of the company.
When a supplier offers a lower price for a larger quantity, the buyer should:
determine the return on investment. Feedback: (Price savings from taking a quantity discount must be compared to additional costs from higher inventory levels to determine if the return on investing those extra dollars in those specific goods is worth it.)
Activity based costing can be used by the buyer to::
eliminate nonvalue-adding activities; reduce activity occurrences, and reduce the cost driver rate. Feedback: (By definition, activity based costing is an attempt to turn indirect cost into direct cost so they can be properly assigned to cost drivers rather than allocated according to standard cost accounting. Buyers can use this information to Buyers can use activity-based costing as a tool to reduce supplier costs by eliminating nonvalue-adding activities, reducing activity occurrences, and reducing the cost driver rate.)
Portfolio analysis:
enables a supply management team to place each major spend category on a spend map based on the risks to acquire in the marketplace and the value of the category to the organization.
Difficulty using TCO
iT IS HARD 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
Value analysis (VA)
in product or service REdesign
Value engineering (VE):
in product or service design
The zone of negotiation
indicates the feasibility of negotiation and the likelihood of an agreement. Feedback: (The assessment of positions of strength, if done well, allows the negotiator to prepare arguments and counterarguments. By estimating the range of acceptable results for both buyer and seller, the negotiator can determine, first, if there is a zone of overlap, meaning negotiation is feasible and likely to result in an agreement, or if there is a gap, and if it can be closed during negotiation.)
In portfolio analysis, the goal when purchasing non-critical or routine spend is to:
minimize acquisition time and cost. Feedback: (Non-critical or routine spend is in the lower left-hand quadrant meaning it is low to medium value to the organization and low to medium risk to acquire. The goal when acquiring routine items is to minimize acquisition time and cost (process cost) not price whichis low to being with and kept in check by multiple suppliers selling commodity-type items in a competitive marketplace.)
In portfolio analysis, the goal when purchasing bottleneck items is:
reduce or eliminate customization. Feedback: (Bottleneck items are in the upper left-hand quadrant meaning they are low to medium value to the organization and medium to high risk to acquire, typically because of the level of customization. The goal when acquiring them is to lower the risk by reducing or eliminating unnecessary --non-value-adding to the customers-- customization.)
Value engineering (VE):
refers to the application of value methodology to the design stage of a product or service.
Value analysis (VA):
refers to the application of value methodology to the redesign of a product or service.
Which tool will focus everyone in the organization on cost management:
target pricing. Feedback: (The purpose of target pricing is to focus everyone on cost management so that management can execute the pricing strategy and achieve profit targets. Subtracting the profit target from the selling price reveals the target cost. All costs --- design, purchase and manufacture—must not exceed this target.)
The learning curve is based on:
the commonly recognized principle that one becomes more proficient with experience. Feedback: (The learning curve provides an analytical framework for quantifying the commonly recognized principle that one becomes more proficient with experience. It has been empirically determined that labor time declines dramatically as volume increases. Although conceptually most closely identified with direct labor, most experts believe the learning curve or manufacturing progress function is actually brought about by a combination of factors.)
Target pricing
the organization establishes the price at which it plans to sell its finished product, then subtracts out its normal operating profit, leaving the target cost that the organization seeks.
The process of attempting to determine all cost elements such as acquisition price, purchasing administration, follow-up, expediting, inspection and testing, rework, scrap, downtime, lost sales and customer returns is called:
total cost of ownership. Feedback: (By definition, total cost of ownership is the acquisition price plus all other associated costs often called inhouse costs or pre- and post-transaction costs.).
A items - ABC
• A items = greatest percent of annual spend
Strategic Cost Management
• An externally focused process of analyzing costs in terms of the overall value chain
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 in 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 facilities, materials or tooling • When problems arise under the various type of contracts used in defense and governmental contracting
ABC or Pareto Analysis and Cost Management
• Assign items to A (high-dollar), B (medium-dollar), or C (low-dollar) category
Economic Forecast
• Driven by Standard Economic Indexes • Calculates Exposure by Economic Contributors - Material content - Labor content - Overhead content - Requires knowledge of elemental price detail • Drives net productivity calculations
Commodity Cycle Plan
• Forward looking spend analysis • Part level detail • Accounts for volume adjustments • Drives commodity & productivity detail • Cornerstone of supply base optimization efforts
Uses for TCO Data
• Highlight cost reduction 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
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
Supply and Target Costing
• Overall, 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
Goal of VE and VA
• Perform a function at the same or an improved level while reducing costs • Eliminate or avoid unnecessary costs that: - do not provide quality - do not extend product or service life - do not provide features desired by customers
Reasons 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
Total Cost of Ownership
• 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
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
Activity Based Costing
• Tries to turn indirect costs into direct costs by tracking the cost drivers behind indirect costs
Direct and Indirect Costs
• When evaluating costs as either direct or indirect, the issue is the ability to trace the costs directly to a unit of production
Variable and Fixed Costs
• When evaluating costs as either variable or fixed, the issue is how costs change as volume of production changes
