N287E - Advanced Financial Management

N287E - Advanced Financial Management

Cost Management Strategies

Cost ManagementPublic vs. Private Sector

• Public Sector– Custodians of Public

Funds– Must Provide Open

Access to Business Opportunities

– Must Establish Cost Reasonableness for each Decision

– Value Propositions can only be evaluated using Cost Per Quality Point Analysis

• Private Sector– Primary Fiduciary

Responsibility is to Shareholders

– Cost Management is Focused on Bottom Line

– Strategic Alliances and Supply Chain Management

– Value Propositions evaluated using Best Value Analysis

Cost Consequence Accountability

• Public Sector– Delegations of

Authority– Discretion Limited by

Policy– Balancing Mandates

Against Available Funding

– Deficit Spending

• Private Sector– Corporate Business

Plan– Risk and Incentives

often Drive Policy– Performance is Driven

by the Bottom Line– Risk and Profitability

Drive Spending

Cost Containment Strategies

• Limit Access to Sources• Pre-Authorization vs. Post-Audit• Ensure Accurate Contract

Administration• Process Re-Engineering• Mutual Gains Incentives (Partnerships)• Risk Mgmt vs. Risk Defense/Aversion

Leveraged Purchasing

• Commit Total Spend in Exchange for Deep Long-Term Discounts (Commitments Contract)

• Seek Standardization• Adjust Requirements to Create a Market• Integrate Order-Delivery-Payment Systems • Jointly Attack Other Cost Drivers

Impacts of Integrated Financial Systems

• Upside-– Minimize Multiple Databases– Apples to Apples– Eliminate the “Back Room”

• Downside-– Pushes “Central Functions” to Frontline– Need to Re-engineer Processes– If you can’t ask for it right, you can’t get it.

E-Commerce Issues

• Cost• Back-Filling the Requisition Function• Matching Rules, Tolerances, & Returns• The Need for EDI• Content Management• Keeping Up with Innovation

Return on Capital Employed

Net Income Capital Employed

Revenue Total Expenses

Cost of Goods Sold Other Expenses

Overhead Materials+

+

_

=

=

=

Fixed AssetsWorking Capital

Accounts

Receivable Inventory Accounts Payable

=

+ _

=

=+

Return on Capital Employed

Return on Capital Employed10%

Net Income Capital Employed$10M

Revenue$15M

Total Expenses$14M

Cost of Goods Sold$9M

Other Expenses$5M

Overhead$2M

Materials$7M+

+

_

=

=

=

Fixed Assets$9M

Working Capital$1M

Accounts

Receivable$3M

Inventory $2M

Accounts Payable

$4M

=

+ _

=

=+

To IncreaseBy $1M

Either Increase By $1M

Or DecreaseBy $1M

Return on Capital Employed

Return on Capital Employed10%

Net Income Capital Employed$10M

Revenue$15M

Total Expenses$14M

Cost of Goods Sold$9M

Other Expenses$5M

Overhead$2M

Materials$7M+

+

_

=

=

=

Fixed Assets$9M

Working Capital$1M

Accounts

Receivable$3M

Inventory $2M

Accounts Payable

$4M

=

+ _

=

=+

To IncreaseBy $1M

Either Increase By $1M

Or DecreaseBy $1M

Return on Capital Employed

Return on Capital Employed10%

Net Income Capital Employed$10M

Revenue$15M

Total Expenses$14M

Cost of Goods Sold$9M

Other Expenses$5M

Overhead$2M

Materials$7M+

+

_

=

=

=

Fixed Assets$9M

Working Capital$1M

Accounts

Receivable$3M

Inventory $2M

Accounts Payable

$4M

=

+ _

=

=+

To IncreaseBy $1M

Either Increase By $1M

Or DecreaseBy $1M

Return on Capital Employed

Labor$700,000

Materials$2,300,000

Overhead$800,000

Inventories $500,000

Accounts Receivable$300,000

Cash$300,000

Sales$5,000,000

Cost of Goods Sold

$3,800,000

Other Costs$800,000

Plus

MinusNet Income

$400,000

Sales$5,000,000

Profit Margin

8%Divided By

Return OnInvestment

10%

Current Assets$1,100,000

Fixed Assets$2,900,000

Plus

Sales$5,000,000

Total Assets$4,000,000

Divided ByAsset

Turnover Rate1.25

Multiply

Ope

ratin

g C

ost E

lem

ents

Ass

ets

ROCE Example

Labor$700,000

Materials-5%

$2,185,000

Overhead$800,000

Inventories – 5%

$475,000

Accounts Receivable$300,000

Cash$300,000

Sales$5,000,000

Cost of Goods Sold

$3,685,000

Other Costs$800,000

Plus

Minus Net Income$515,000

Sales$5,000,000

Profit Margin10.3%Divided By

Return OnInvestment

13%

Current Assets$1,075,000

Fixed Assets$2,900,000

Plus

Sales$5,000,000

Total Assets$3,975,000

Divided ByAsset

Turnover Rate1.26

Multiply

Ope

ratin

g C

ost E

lem

ents

Ass

ets

Impact from 5% Price Reduction

Strategic Sourcing…

• A systematic process to reduce the total cost of purchased products and services by fully leveraging the University’s combined purchasing power, without compromising quality or service.

• Up to 41 Business Units10 Campuses 5 Medical Centers 3 National Laboratories23 California State Universities

What is strategic sourcing?

Total Cost ApproachAchieve Best Value

Tip of the IcebergPurchase Price

Total CostTotal Cost• Transaction / Admin Cost

• Delivery, Freight, Handling, Set-Up

• Implementation Cost

• Communication/Marketing

• Training

• Cost of Non-Conformance (Quality)

• Maintenance, Warranty, Parts

• Yield, Useful Life, Consumables

• Inventory, Shelf-life, Waste

• Disposal, Scrap

• Risk, Liability

Strategic Sourcing is a process rather than a series of activities

Focus on tasks Function isolated Reactive Insular, static Unit price based Adversarial supplier

relationship Win/lose Corrective Measures Undefined standards Lowest price - price driven

Focus on process performance Alignment with stakeholders Proactive Total cost framework Diverse sourcing strategies Create collaboration, trust Suppliers as a key resource Preventive measures Fit for purpose Value driven (e.g. lowest cost per

quality point)

Traditional Purchasing Strategic Sourcing

Strategic Sourcing Process

Strategic Sourcing Methodology

Launch Sourcing

Team

DevelopSpend

Analysis

DetermineUC

Requirements

DevelopCategoryStrategy

ConductMarket

Analysis

Implement Solution and begin SRM

NegotiateAgreements

Evaluate &Select

Suppliers

• Project Plan and Scope determined

• Resource Commitment Obtained (people, dollars, etc..)

• Kick-Off Meeting Conducted

• Team members identified

• Stakeholder Requirement sessions conducted

• Existing contracts summary produced

• Requirements weighting sessions conducted

• UC requirements published

• Sourcing strategy developed and communicated

• User adoption strategy and implementation plan developed

• Initial cost/benefit analysis developed

• Negotiation strategy document developed

• Meetings/Negotiations with finalists

• Agreements signed

• Analyze total spend by Category and Location and determine percent that is “sourceable”

• Document historical purchases

• Develop current TCO for each Location

• “Quick Hits” identified

• Complete pre-bid industry analysis

• RFI developed / distributed (if needed)

• Supplier responses to RFI evaluated

• Final market analysis published

• RFP developed / distributed

• RFP responses evaluated and scored

• “Short list” of finalists selected

• Implementation team assigned

• Implementation plan finalized

• Implementation completed

• Ongoing SRM plan created and implemented

This must be a joint effort between purchasing departments across the UC system and our internal stakeholders

Strategic Sourcing Opportunity• University of California

– $7.0 Billion paid invoices– $2.5 Billion construction– $4.5 Billion of opportunities

• $100 Million Commodities– Office Equipment and Supplies– Laboratory Supplies– IT Hardware / Software

Strategic Sourcing Goals• Maintain or increase product and service quality• Leverage UC buying power through strategic

alliances • Create more efficient procurement processes• Educate the UC community• Determine the appropriate product distribution

system• Demonstrate significant on-going cost savings• Meet our service and community standards

(Sustainability, Small/Disadvantaged businesses, etc.)

Channeling• VWR Implementation YTD January to July 2005

Campus YTD 2005 YTD 2004 ∆%Berkeley $ 581,295 $ 418,962 38.7%Los Angeles $1,628,382 $1,088,067 49.7%San Diego $ 993,908 $ 723,884 37.3%

Average Growth: 41.9%

San Francisco $ 891,566 $ 783,345 13.8%

Automate Payment

• UCSF processes ~ ½ million vouchers– Federal Express: 27,815– Arrowhead: 6,256– Verizon: 8,983

Labor$700,000

Materials$2,300,000

Overhead$800,000

Inventories $500,000

Accounts Receivable$300,000

Cash$300,000

Sales$5,000,000

Cost of Goods Sold

$3,800,000

Other Costs$800,000

Plus

MinusNet Income

$400,000

Sales$5,000,000

Profit Margin

8%Divided By

Return OnInvestment

10%

Current Assets$1,100,000

Fixed Assets$2,900,000

Plus

Sales$5,000,000

Total Assets$4,000,000

Divided ByAsset

Turnover Rate1.25

Multiply

Ope

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g C

ost E

lem

ents

Ass

ets

ROCE Example