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This is a highly concentrated presentation that addresses the differences among price, cost, and TCO; what cost reduction strategies to focus on; and an overview of various techniques, as well as when and where to use them. Faced with excruciating competitive pressures, many senior C-Level executives require maximum effort from every part of their organization to survive. Today, purchasing, acquisition, procurement, contracting, and supply management professionals must be the most progressive cost reduction oriented group in the company. For many organizations, senior C-Level executives set forth annual purchasing, acquisition, procurement, contracting, and supply management goals that mandate cost reductions. Regardless of the cost savings, avoidances, or containments achieved previously, you are faced with new cost reduction initiatives and objectives. To make the goal of cost reduction a reality, we cannot focus solely on the price. We must examine the total cost of ownership to your organization, which means moving beyond the organizational environs to include suppliers, internal customers, other allied business functional entities, and external customers. By working both internally and externally with these stakeholders, cost reduction opportunities will become visible. A typical purchasing, acquisition, procurement, contracting, or supply management professional will help reduce supplier prices and avoid incremental costs. A good purchasing, acquisition, procurement, contracting, or supply management professional will reduce costs by lowering both costs of acquisition and risks of supply. A great purchasing, acquisition, procurement, contracting, or supply management professional will reduce total costs across the board, increase service levels to the internal customer, make a significant contribution to the bottom line, seek value-added opportunities, and help to delight the organization’s customer. This type of professional also balances supply related costs and cycle time for the lowest overall cost, at the best value, while seeking risk optimization rather than risk minimization strategies.
Citation preview
Cost Reduction Strategies: Cost Reduction Strategies:
Focus and TechniquesFocus and Techniques forfor
NAPM-WichitaNAPM-Wichitapresented bypresented by
Thomas L. Tanel, C.P.M., CTL, CCAThomas L. Tanel, C.P.M., CTL, CCAPresident and CEOPresident and CEO
CATTAN Services Group, Inc.CATTAN Services Group, Inc.College Station, TXCollege Station, TX
© 2009 CATTAN Services Group, Inc.
Agenda TopicsAgenda Topics Cost Reduction Strategies and IdeasCost Reduction Strategies and Ideas Price and Cost Analysis--Applied Price and Cost Analysis--Applied Total Cost of Ownership and Total System Total Cost of Ownership and Total System
CostCost Use of “Should” Cost ModelsUse of “Should” Cost Models Innovative Thought and Ideas SolicitationInnovative Thought and Ideas Solicitation Value Analysis and EngineeringValue Analysis and Engineering Target Cost Analysis and Target PricingTarget Cost Analysis and Target Pricing Low (Best) Cost Country SourcingLow (Best) Cost Country Sourcing SummarySummary
Cost Reduction StrategiesCost Reduction Strategies
Cost SavingsCost Savings
Cost AvoidanceCost Avoidance
Cost ContainmentCost Containment
Value EnhancementValue Enhancement
Cost Reduction TerminologyCost Reduction Terminology
Product cost savingsProduct cost savings Defined as obtaining and realizing a lower unit Defined as obtaining and realizing a lower unit
price on the same item than the unit price was in price on the same item than the unit price was in the last contract period.the last contract period.
A cost saving is A cost saving is valid for as long as the valid for as long as the comparative that generated the savingcomparative that generated the saving is; but is; but it is not to exceed the end of the contract period it is not to exceed the end of the contract period in which the saving was produced. On the first in which the saving was produced. On the first day of the next contract period the old price day of the next contract period the old price becomes the baseline against which any future becomes the baseline against which any future cost savings are measured.cost savings are measured.
Cost Reduction TerminologyCost Reduction TerminologyRevenue generationRevenue generation New financial sources that can be used to leverage or New financial sources that can be used to leverage or
increase monies/resources available to an activity.increase monies/resources available to an activity. Revenue generation is a Revenue generation is a quantifiable monetary quantifiable monetary
benefit.benefit.
Non-monetary benefitNon-monetary benefit A benefit that A benefit that cannot be measuredcannot be measured in terms of finances in terms of finances
or resources, such as better quality of services; or resources, such as better quality of services; improved health, safety or quality of life; enhanced improved health, safety or quality of life; enhanced security; enterprise-wide consistency; or contribution to security; enterprise-wide consistency; or contribution to achieving supplier diversity goals.achieving supplier diversity goals.
Return on investmentReturn on investment Monetary benefit from an investment as a ratio or Monetary benefit from an investment as a ratio or
percentage of the amount invested.percentage of the amount invested.
Cost SavingsCost SavingsCost Savings—definitionCost Savings—definition A cost reduction that can be specifically identified A cost reduction that can be specifically identified
and will be made to a budget or program, and will be made to a budget or program, resulting from implementing a specific alternative resulting from implementing a specific alternative in lieu of continuing the present system.in lieu of continuing the present system.
The result of a The result of a planned or deliberate action planned or deliberate action taken by Purchasingtaken by Purchasing
Savings are a Savings are a quantifiable monetary benefitquantifiable monetary benefit There must be a direct activity reduction for a There must be a direct activity reduction for a
savings to occur; thus, benefits are considered as savings to occur; thus, benefits are considered as savings only if the estimate identifies benefits that savings only if the estimate identifies benefits that start accruing during the budget/activity’s fiscal start accruing during the budget/activity’s fiscal year.year.
Cost AvoidanceCost Avoidance
Cost avoidance—definitionCost avoidance—definition Financial or economic benefits that result from Financial or economic benefits that result from
an initiative but do not permit a monetary an initiative but do not permit a monetary reduction to a funded activity or budget.reduction to a funded activity or budget.
Is a quantifiable monetary benefitIs a quantifiable monetary benefit Usually addresses the Usually addresses the reduction or elimination reduction or elimination
of a future costof a future cost Does not lower the cost of materials purchased Does not lower the cost of materials purchased
when measured against historical results, but it when measured against historical results, but it does minimize or avoid entirely the negative does minimize or avoid entirely the negative impact on net income that a price increase impact on net income that a price increase would have.would have.
Cost ContainmentCost Containment
Cost containment—definitionCost containment—definition The process of The process of maintaining organizational maintaining organizational
costscosts within a specified budget; restraining within a specified budget; restraining expenditures to meet organizational or expenditures to meet organizational or project financial targets. project financial targets.
Measures taken to Measures taken to reducereduce expenditure or expenditure or the rate of growth of expenditure, or the unit the rate of growth of expenditure, or the unit cost of goods/materials/supplies/services. cost of goods/materials/supplies/services.
When an organization keeps costs low, or When an organization keeps costs low, or within a limit that has been planned. within a limit that has been planned.
Value EnhancementValue EnhancementValue enhancement—definitionValue enhancement—definition Value which affects the Value which affects the whole-lifewhole-life costs costs or or whole-life whole-life
incomeincome and its and its required functionalityrequired functionality..ValueValue For any service or offering to have For any service or offering to have financial valuefinancial value, the , the
organization must have been willing to pay for it out of organization must have been willing to pay for it out of pocket or must have already been paying for it in a pocket or must have already been paying for it in a way way that can be measured on the organization’s income that can be measured on the organization’s income statementstatement. This definition is a requirement for any . This definition is a requirement for any discussion of legitimate cost avoidances.discussion of legitimate cost avoidances.
For example, in practicing sustainable environmental For example, in practicing sustainable environmental management, we may reduce the environmental impact; management, we may reduce the environmental impact; while at the same time achieve cost reduction and create while at the same time achieve cost reduction and create environmental friendly conservation added value. environmental friendly conservation added value.
The Difference between The Difference between
Price and CostPrice and Cost
““Price”Price” . . . . . .
is a sales and purchasing concept.is a sales and purchasing concept.
““Cost”Cost” . . . . . .
is an accounting concept.is an accounting concept.
The Difference between The Difference between Price and CostPrice and Cost
Price =Cost of Material + Labor + Overhead + General & Administrative Expenses + Selling Expense + Profit
Price =Cost of Material + Labor + Overhead + General & Administrative Expenses + Selling Expense + Profit
Cost =Cost of Material + Labor + Overhead + General & Administrative Expenses + Sales Expense
Cost =Cost of Material + Labor + Overhead + General & Administrative Expenses + Sales Expense
Comparability Factors for PricesComparability Factors for Prices
Comparative price analysis involves the comparison of the current Comparative price analysis involves the comparison of the current proposed price with quotes or prices for the same or similar items. proposed price with quotes or prices for the same or similar items.
Total Cost of Ownership Total Cost of Ownership (TCO)(TCO)
TCOTCO – the sum of all – the sum of all costs associated with any costs associated with any given supply streamgiven supply stream
Source: The Executive Guide to Supply Chain Management, David Riggs/Sharon Robbins
= Purchase Cost +
Logistics•Inland Freight•Ocean/Air Freight•Transfer charges
Customs Duties &
Fees
Taxes•VAT•Incentives
+
Other Costs•Quality•Safety Stock•Supplier Development •Currency
+ +TCO
ACQUISITION COST
OPERATING COSTS
TRAINING COSTS
MAINTENANCECOSTS
WAREHOUSINGCOSTS
ENVIRONMENTALCOSTS
SALVAGE VALUE
Trad
ition
al Su
pp
lier Co
st and
Price S
tructu
reT
raditio
nal S
up
plier C
ost an
d P
rice Stru
cture
Typical Negotiation FocusTypical Negotiation Focus
Cost Reduction Opportunities
Cost Reduction Opportunities
Cost Reduction and NegotiationCost Reduction and Negotiation
Total System Cost (TSC)Total System Cost (TSC)
Total System Cost (TSC)Total System Cost (TSC) – – the sum of the buyer’s costs, the sum of the buyer’s costs, supplier’s costs and supplier’s costs and interaction cost between the twointeraction cost between the two
Traditional Strategic
TSC SavingsTSC Savings
PricePriceSavingSaving
ss
FocusFocus
BuyerBuyerCostsCosts
InteractionInteractionCostsCosts
ProfitProfit
SupplierSupplierCostsCosts
BuyerBuyerCostsCosts
Interaction CostsInteraction Costs
ProfitProfit
SupplierSupplierCostsCosts
Total System CostTotal System Cost
Profit
General andAdministrative
Selling Expense
Overhead
Labor
Materials
Elements of CostElements of Cost
SellingPrice and
Margin
Cost of
Goods Sold
Drive Out Costs CreativelyDrive Out Costs Creatively
Considering Considering alternativealternative products, designs, concepts, products, designs, concepts, and services, or looking at different or and services, or looking at different or alternativealternative solutions to existing services, processes or solutions to existing services, processes or applications, requires a multi-disciplined approach, applications, requires a multi-disciplined approach, making use of internal customers or subject matter making use of internal customers or subject matter experts as well as first-tier suppliers or prime experts as well as first-tier suppliers or prime contractors.contractors.
Remember to create an arena that is friendly and open Remember to create an arena that is friendly and open to suggestion, change, and innovation.to suggestion, change, and innovation.
When defining the elements of cost, focus on When defining the elements of cost, focus on cost cost reduction opportunitiesreduction opportunities..
The Creativity FormulaThe Creativity Formula
Remember: Most of the opportunities to reduce costs occur during the design, SOW, or conceptual stage for products and services—not after.Remember: Most of the opportunities to reduce costs occur during the design, SOW, or conceptual stage for products and services—not after.
Should Cost TechniqueShould Cost Technique
““Should Cost” as a price challenge Should Cost” as a price challenge technique:technique: Provides cost analysis to buyers to be used Provides cost analysis to buyers to be used
for negotiations and determining price for negotiations and determining price reasonablenessreasonableness
Provides cost analysis in responding to price Provides cost analysis in responding to price challenges and pricing issues from your challenges and pricing issues from your internal customers and management internal customers and management
Should costs are independent analytical Should costs are independent analytical estimates to determine the cost forestimates to determine the cost for manufacturing an item. manufacturing an item.
Building a Total Cost ModelBuilding a Total Cost Model
Profit/Fee
Total Price of Contract
Total Cost of Contract
Costs to Meet Contract Requirements
G & A Expenses
Product CostsOther Direct Costs
Direct Costs
Indirect Costs
(Other Allocable
Costs Plus Overhead)
Direct Labor Plus Direct
Material
(Allocation of
Overhead to Labor
and Material)
Should Cost—Supplier Cost Should Cost—Supplier Cost DecompositionDecomposition
What is in a typical “Should Cost” report:What is in a typical “Should Cost” report: A detailed description of the item.A detailed description of the item. A list of references used in the analysis.A list of references used in the analysis. A break down of cost and labor burden rates.A break down of cost and labor burden rates. Estimated unit prices for specified quantities.Estimated unit prices for specified quantities. A break down of the material and associated A break down of the material and associated
cost and minimum economic buys.cost and minimum economic buys.
Material—Terms & DefinitionsMaterial—Terms & Definitions
TermTerm DefinitionDefinition
Raw materialsRaw materials Materials in a form or state requiring further processing Materials in a form or state requiring further processing before they can be usedbefore they can be used
PartsParts Items that, when joined with other items, are not subject Items that, when joined with other items, are not subject to disassembly without destruction or impairment of to disassembly without destruction or impairment of useuse
SubassembliesSubassemblies Self-contained units of an assembly that can be Self-contained units of an assembly that can be removed, replaced, and repaired separatelyremoved, replaced, and repaired separately
ComponentsComponents Relatively simple hardware items which are listed in the Relatively simple hardware items which are listed in the specifications for an assembly, subassembly, or end specifications for an assembly, subassembly, or end itemitem
Manufacturing Manufacturing suppliessupplies
Items that are required by or in support of the Items that are required by or in support of the manufacturing processmanufacturing process
Inbound Inbound transportation andtransportation and
in-transit insurancein-transit insurance
Freight, express, cartage, insurance, and postage for Freight, express, cartage, insurance, and postage for goods purchased, in process, or delivered, which goods purchased, in process, or delivered, which can be added to the cost of an item or as an Other can be added to the cost of an item or as an Other Direct Cost (ODC)Direct Cost (ODC)
Direct Labor—Terms & DefinitionsDirect Labor—Terms & DefinitionsTermTerm DefinitionDefinition
Direct LaborDirect Labor Work performed by individuals which is directly related to a specific Work performed by individuals which is directly related to a specific cost objective. This work is readily identifiable with a particular cost objective. This work is readily identifiable with a particular product or service.product or service.
Indirect LaborIndirect Labor Work performed by individuals which is not identifiable with a single Work performed by individuals which is not identifiable with a single final cost objective but is identified with two or more final cost final cost objective but is identified with two or more final cost objectives or an intermediate cost objective. One example of objectives or an intermediate cost objective. One example of indirect labor is the work expended by the Controller of a indirect labor is the work expended by the Controller of a company. The Controller’s work is not directly identifiable in company. The Controller’s work is not directly identifiable in the production of a specific product or service, since his or her the production of a specific product or service, since his or her work includes several projects or tasks.work includes several projects or tasks.
Labor HourLabor Hour The unit of time by which direct labor activity is measured.The unit of time by which direct labor activity is measured.
Labor RateLabor Rate The dollar amount paid to an individual per a given amount of time The dollar amount paid to an individual per a given amount of time in consideration of work accomplished.in consideration of work accomplished.
Labor CostLabor Cost The product (i.e., result) of multiplying labor hours by appropriate The product (i.e., result) of multiplying labor hours by appropriate labor rates.labor rates.
Labor CategoryLabor Category A grouping of workers with similar skills or expertise or trade A grouping of workers with similar skills or expertise or trade classification.classification.
Labor MixLabor Mix The combination of functional skills and levels of worker experience The combination of functional skills and levels of worker experience required to accomplish a given task.required to accomplish a given task.
Basis of Estimate (BOE)Basis of Estimate (BOE) A statement of the rationale used by a supplier/contractor to A statement of the rationale used by a supplier/contractor to generate a cost estimate for a specific task or item to be generate a cost estimate for a specific task or item to be produced.produced.
Indirect Costs—Terms & DefinitionsIndirect Costs—Terms & Definitions TermTerm DefinitionDefinition
Indirect CostsIndirect Costs Any cost that cannot be directly identified with a single final cost objective Any cost that cannot be directly identified with a single final cost objective but can be identified with two or more final cost objectives or an but can be identified with two or more final cost objectives or an intermediate cost objectiveintermediate cost objective
OverheadOverhead Indirect costs related to specific operations, such as general product Indirect costs related to specific operations, such as general product lines, organizational groups, and groups of contracts. Overhead is a lines, organizational groups, and groups of contracts. Overhead is a type of indirect cost pool that is related to the specific operations of type of indirect cost pool that is related to the specific operations of the firm. The three major types of overhead are material, labor, and the firm. The three major types of overhead are material, labor, and fringe benefit (if not included in labor overhead). The three fringe benefit (if not included in labor overhead). The three overheads differ in regard to which costs they include and how they overheads differ in regard to which costs they include and how they are allocated.are allocated.
General & General & AdministrativeAdministrative
Any management, financial, and/or other expense incurred by or Any management, financial, and/or other expense incurred by or allocated to a business unit for the general management and allocated to a business unit for the general management and administration of the business unit as a wholeadministration of the business unit as a whole
Business UnitBusiness Unit Any segment of an organization, or an entire business not further divided Any segment of an organization, or an entire business not further divided into segmentsinto segments
Home Office ExpenseHome Office Expense The expenses of an office responsible for directing or managing two or The expenses of an office responsible for directing or managing two or more, but not necessarily all, segments of an organizationmore, but not necessarily all, segments of an organization
Indirect Cost PoolIndirect Cost Pool A logical grouping of incurred costs identified with two or more objectives A logical grouping of incurred costs identified with two or more objectives but not specifically with any final cost objectivebut not specifically with any final cost objective
Cost ObjectiveCost Objective A function, organizational subdivision, contract, or other work unit for A function, organizational subdivision, contract, or other work unit for which cost data are desired and for which provision is made to which cost data are desired and for which provision is made to accumulate and measure the cost of processes, products, jobs, accumulate and measure the cost of processes, products, jobs, capitalized projects, etc.capitalized projects, etc.
Profit—Terms & DefinitionsProfit—Terms & Definitions
TermTerm DefinitionDefinition
ProfitProfit Represents the excess of revenue over applicable costs of Represents the excess of revenue over applicable costs of performance and is associated with fixed-price type performance and is associated with fixed-price type contractscontracts
FeeFee Represents a flat charge paid as compensation for services or Represents a flat charge paid as compensation for services or supplies provided and is associated with cost supplies provided and is associated with cost reimbursement contractsreimbursement contracts
RiskRisk The level of uncertainty associated with specific factors The level of uncertainty associated with specific factors regarding contract performanceregarding contract performance
SUPPLIER PART COST BREAKDOWN WORKSHEET—Part ASUPPLIER PART COST BREAKDOWN WORKSHEET—Part ASUPPLIER NAME:SUPPLIER NAME: CONTACT:CONTACT: E-MAIL:E-MAIL:
PART NUMBER:PART NUMBER: VOLUME QUOTED:VOLUME QUOTED: QUOTE NO:QUOTE NO:
DESCRIPTION:DESCRIPTION: EST. TOOL LIFE:EST. TOOL LIFE: DATE:DATE:
DRAWING ISSUE:DRAWING ISSUE: TOOLING CAPACITYTOOLING CAPACITY@ Hrs/day:@ Hrs/day:@ Days/Week:@ Days/Week:
EXCHANGE RATE:EXCHANGE RATE:
RAW MATERIALS & PURCHASED COMPONENTSRAW MATERIALS & PURCHASED COMPONENTS CURRENCY:CURRENCY:
## Item Descriptions (1)Item Descriptions (1) Item ID (2)Item ID (2) Unit of Measure (3)Unit of Measure (3) Unit Cost (4)Unit Cost (4) Total Cost (5)Total Cost (5)
11
22
33
44
55
66
77
Total Material Cost Total Material Cost
SUPPLIER PART COST BREAKDOWN WORKSHEET—Part BSUPPLIER PART COST BREAKDOWN WORKSHEET—Part B
LABOR AND OVERHEADLABOR AND OVERHEAD
Labor Labor DetailsDetails Machine DataMachine Data Overhead DetailOverhead Detail
## Operations Process Descriptions (6)Operations Process Descriptions (6)LaborLabor Rate Rate (7)(7)
Std Std Hrs Hrs (8)(8)
Labor Labor Cost (9)Cost (9)
Op. Op. (10)(10)
Mach. Mach. Size (11)Size (11)
Mach. Type Mach. Type (12)(12)
Var. Cost Var. Cost (13)(13)
Fixed Cost Fixed Cost (14)(14)
Total Cost (15)Total Cost (15)
11
22
33
44
Total Total Labor Labor CostCost Total Overhead CosTotal Overhead Costt
Total Manufacturing Cost (material + labor + burden) (16)Total Manufacturing Cost (material + labor + burden) (16)
Selling, General and Administration Expenses (17)Selling, General and Administration Expenses (17)
Selling PriceSelling Price
FROM TOOLING COST BREAKDOWN—TOTAL TOOLING COST QUOTEDFROM TOOLING COST BREAKDOWN—TOTAL TOOLING COST QUOTED
Meeting the Competitive Demands of Meeting the Competitive Demands of Supply Management through Supply Management through
Supplier Ideas SolicitationSupplier Ideas Solicitation
Meeting the Cost Reduction Mandate Meeting the Cost Reduction Mandate through Innovative Thought and through Innovative Thought and
Supplier Ideas SolicitationSupplier Ideas Solicitation
EPI and Concurrent EPI and Concurrent engineeringengineering
VMI/SMI/SOMI/ISMVMI/SMI/SOMI/ISM Cycle or lead time Cycle or lead time
reductionreduction Addition or elimination Addition or elimination
of value-added of value-added servicesservices
StandardizationStandardization
Change procurement Change procurement method/instrumentmethod/instrument
Volume and forecastsVolume and forecasts Inbound freight and Inbound freight and
packagingpackaging Relaxed specification, Relaxed specification,
material substitution, material substitution, or service level or service level improvementsimprovements
Competitive Bidding—Competitive Bidding—Use Use Ceteris ParibusCeteris Paribus
Buyers normally look at the price (total cost) as Buyers normally look at the price (total cost) as stated on each bid to determine which supplier stated on each bid to determine which supplier should be awarded the PO or contract.should be awarded the PO or contract.
If there are any differences, for a fair evaluation, then If there are any differences, for a fair evaluation, then allowances must be made for the differences in allowances must be made for the differences in performance and pricing.performance and pricing.
When comparing performanceWhen comparing performanceor prices the buyer should use or prices the buyer should use Ceteris ParibusCeteris Paribus assumptions assumptions (everything else held constant) (everything else held constant) so you compare so you compare “an apple to an “an apple to an apple, not an apple to an orange.”apple, not an apple to an orange.”
ValueValue
What Is Value?—Four Distinct KindsWhat Is Value?—Four Distinct Kinds
Exchange ValueExchange Value
Cost ValueCost Value
Esteem ValueEsteem Value
Use ValueUse Value
Value Analysis and Value Analysis and Engineering (VA/VE)Engineering (VA/VE)
1. An organized creative
approach to cost reduction
2. Emphasis on function or use
3. Identifies areas of excessive
or unnecessary costs
4. Eliminates non-value added
activities
VA/VE Job Plan—Philips ExampleVA/VE Job Plan—Philips Example
ValueValue EquationEquation
ValueValue =
Quality/Worth
Cost
How To Get Started in VA/VEHow To Get Started in VA/VE
Identify what is it and what Identify what is it and what does it do?does it do?
Obtain and review all available Obtain and review all available cost informationcost information
Try to anticipate roadblocksTry to anticipate roadblocks Promote cooperation with Promote cooperation with
VA/VE effortVA/VE effort Seek guidance from those in Seek guidance from those in
management that assigned management that assigned studystudy
VA Is the Way—Ten Ways to VA Is the Way—Ten Ways to
Reduce CoReduce Co$$t t 1.1. Use it to reduce cost in Use it to reduce cost in
design, concept, or SOWdesign, concept, or SOW2.2. Use cross-functional teams to Use cross-functional teams to
approve product or service approve product or service offering changesoffering changes
3.3. Consolidate supplier base Consolidate supplier base using full service partnersusing full service partners
4.4. Reduce paperwork with Reduce paperwork with supply base by using more supply base by using more EDI/E-ComEDI/E-Com
5.5. Bundle any engineering Bundle any engineering changes or project scope changes or project scope changes quarterlychanges quarterly
6.6. Move towards common, simple Move towards common, simple methods and standard items or methods and standard items or services used at multiple sites services used at multiple sites or facilitiesor facilities
7.7. Use returnable dunnage or Use returnable dunnage or containers instead of non-containers instead of non-returnablereturnable
8.8. Identify and eliminate Identify and eliminate unnecessary testing, measuring unnecessary testing, measuring and diagnosticsand diagnostics
9.9. Reduce the number of Reduce the number of prototypes or modelsprototypes or models
10.10.Consolidate “A” type purchases Consolidate “A” type purchases with suppliers’ if possiblewith suppliers’ if possible
Process of Determining Process of Determining Target CostsTarget Costs
Target
Costs=
Cost subject to
cost reductionactivities
+
Costs not subject to
cost reduction activities
TargetTarget CostingCosting ProcessProcess
Target Cost Breakdown Target Cost Breakdown and Impactand Impact
Target Cost Breakdown Target Cost Breakdown and Impactand Impact
Target PricingTarget Pricing
A reduction in the direct A reduction in the direct costs of a supplier’s cost costs of a supplier’s cost profile has more impact on profile has more impact on your bottom line than a your bottom line than a major percentage discount major percentage discount in the supplier’s price. in the supplier’s price. Negotiation based on cost Negotiation based on cost allows you to challenge the allows you to challenge the logic of each element of the logic of each element of the price.price.
VendorVendor Preferred SupplierPreferred Supplier
Marketing, Purchase Orders, Marketing, Purchase Orders, Proposals, Variations in QualityProposals, Variations in Quality
Partner/AlliancePartner/AllianceRedundant Capabilities in Systems, Redundant Capabilities in Systems,
Activities that Add No Value,Activities that Add No Value,Approval Processes, Contracts, Approval Processes, Contracts, Excessive Communications and Excessive Communications and
Controls, etc.Controls, etc.
Cost to ServeCost to Serve Cost to ServeCost to Serve Cost to ServeCost to Serve
ProfitProfit ProfitProfit ProfitProfit
Competitive Bidding Competitive Bidding Based upon Variable ProfitBased upon Variable Profit
Redefined (Streamlined) Process Redefined (Streamlined) Process Reduces Cost and Yields Reduces Cost and Yields
Acceptable ProfitAcceptable Profit
Reengineered Process through Reengineered Process through Close Relationship; Maintains Close Relationship; Maintains
Profit and Greater Cost Profit and Greater Cost ReductionReduction
Target Pricing Perspective—Target Pricing Perspective—An ExampleAn Example
For a service contract, the For a service contract, the total quoted price was total quoted price was $260,565$260,565. .
A A 1%1% reduction on the price is reduction on the price is one thing, but reducing each one thing, but reducing each of the cost elements by of the cost elements by 1%1% yields an actual price yields an actual price reduction of more than reduction of more than 2.5%2.5%..
Individual cost elements are more vulnerable to argument than the price as a wholeIndividual cost elements are more vulnerable to argument than the price as a whole
Elements of Cost-ServicesElements of Cost-Services
Profit and MarginProfit and Margin
Other Services/OverheadOther Services/Overhead
Service LaborService Labor
Materials and SuppliesMaterials and Supplies
OccupancyOccupancy
Equipment and TechnologyEquipment and Technology
COSP
Opportunity KnocksOpportunity Knocks
Sometimes the buyer has a chance to gain the upper hand. This occurs when the supplying industry’s margins are healthy because selling prices rose faster than their costs escalated.
The ultimate objective is to maximizeThe ultimate objective is to maximizethe value of each purchase spendthe value of each purchase spend
dollar.dollar.
Low (Best) Cost Country SourcingLow (Best) Cost Country Sourcing(LCCS)(LCCS)
Near Sourcing Near Sourcing DomesticallyDomestically
Outsourcing Outsourcing OverseasOverseas
Indigenous Indigenous LocalizationLocalization
Transfer business Transfer business to provide materials to provide materials
or services by or services by swapping out swapping out
overseas suppliers overseas suppliers for closer proximity for closer proximity
to home countryto home country
Transfer internal Transfer internal dept,activity or dept,activity or
process to more process to more capable suppliers or capable suppliers or contractors to lower contractors to lower cost of ownershipcost of ownership
Find and develop Find and develop local indigenous local indigenous
sources to support sources to support country markets for country markets for
low cost country low cost country plants and plants and
distribution facilitiesdistribution facilitiesAdapted in part from Ariba’s Executive Overview on this subject
LCCS and Supply Chain RiskLCCS and Supply Chain Risk
Although significant cost savings opportunities exist , the risk may
be greater when dealing with unfamiliarsuppliers, different business protocols,
language barriers and new cultures.
Landed CostLanded Cost
LC = TSC LC = TSC SU SU
Note: Total Selling Cost (TSC) and Selling Unit (SU)
SUMMARY and THANKSSUMMARY and THANKS
© 2009 CATTAN Services Group, Inc.