Materials Management BUS 3

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Materials ManagementBUS 3 141 Cost
Management, Discounts, Negotiation October
22, 2007
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Agenda

• Cost Types
• Total Cost of Ownership
• Target Pricing
• Learning Curve and Discounts
• Negotiation

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Case 2 Sedgman Steel (p. 176) Due Oct 29,
2007
Approx. 20 of Total Effort / Grade
Approx. 20 of Total Effort / Grade
Approx. 25 of Total Effort / Grade
Approx. 35 of Total Effort / Grade
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Comparison of Fixed Variable Costs with Volume
Understanding Supplier Fixed and Variable costs
is CRITICAL to any Negotiation
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Cost Types
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Labor and Material Costs
Labor

• Direct hours worked X Hourly Rates
• Often charged based on Standard Hours per job

Material

• Taken from Bill Of Material (if provided)
• When purchasing manufactured items, some supplier
  material costs can be reasonably estimated
• Raw material cost is openly available
• Component cost can be obtained from catalogues
  and the internet

There should be little or no Supplier
Markup on material used to make the Purchased Item
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Examples of Overhead and General Administrative
Costs
Overhead

• Indirect facilities and personnel costs incurred
  in
• Manufacturing
• Research
• Engineering
• Equipment depreciation
• Other

General Administrative (GA)

• Selling
• Promotion
• Advertising
• Executive Salaries
• Legal
• Other

Overhead and GA are a major factor in
calculating Standard Cost at expected overall
volumes, but less relevant for calculating the
cost of incremental units for unexpected orders
or additional volumes
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Labor, Material, and Overhead Small Business
Example
Since you were traveling earlier while we spoke
on the phone, and I was talking quickly, I
thought it would be useful to list my concerns
regarding the price of the booster pump and the
fee for installation. Your charge of 305.00 for
the Letro Booster Pump is higher than is
apparently available from many sources. A simple
Google search yielded several suppliers selling
the item for well under 200.00. I also checked
the Leslie's pool site and there was a Hayward
Booster Pump on sale for 224.99, reduced from
259.99. I would expect that as a contractor, you
would have access to even better pricing, since
you are likely paying wholesale, rather than the
Retail prices I was able to find. I would also
expect that since Pam and I have been solid
customers for many years, you would charge little
to no additional mark up on parts. I have two
concerns regarding the Installation. One is based
on the underlying hourly rate you charge. Please
explain the Rate and Time that resulted in the
125.00 charge. My second concern regarding the
Installation fee is based on my assumption that
there is some amount of "non-routine" service
that is already included in your 100.00 monthly
charge. When you provide the standard weekly
service, and you are in and out in minutes, I am
pleased to pay you the 100.00. I don't feel a
need for you to "justify" your fee by spending a
lot of time. In reality, I am paying you to worry
about my pool for me. And if you can do that
quickly and move on, it is good for both of us.
However, if you have to do a little extra, I
would assume that you have already accounted for
some amount of that effort in your rates. What do
you consider as included in the "standard"
service, and what do you consider as incremental,
and thus would require an additional charge?
Based on these concerns, please adjust your
charges for the Booster Pump and its
installation. Either reply to this email or call
me at xxx-xxx-xxxx, so that we can agree on a
revised total that is reasonable for both of us.
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Additional Cost Items

• Understanding cost helps you negotiate Price
• Previous estimates when analyzing make / buy
  decisions become a basis for understanding
  supplier cost
• Co-workers who were previously employed at
  suppliers often understand supplier cost
  structure
• Start-up costs and Setup costs are frequently
  separated from future unit costs
• Common in printing business
• Common in subcontract manufacturing
• In New Product Development, it is recommended to
  separate research and start-up costs from
  production unit costs
• Nonrecurring Engineering as a separate line item
• Tooling as a separate line item
• Units produced as a separate line item

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Total Cost of Ownership
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Total Cost of Ownership
ALL costs associated with the item

• Acquisition (purchase)
• Administration
• Follow-up
• Expediting
• Transportation
• Inspection Test
• Rework

• Storage
• Scrap
• Warranty
• Service
• Downtime
• Customer Returns
• Lost Sales

Understanding total costs is a good early step
in identifying Improvement opportunity
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The Components of Total Cost of Ownership
Pre-transaction
Transaction
Post-transaction

• Identifying need
• Investigating sources
• Qualifying sources
• Adding supplier to internal systems
• Educating
• Supplier in firms operations
• Firm in suppliers operations

• Price
• Order placement/preparation
• Delivery/transportation
• Tariffs/duties
• Billing/payment
• Inspection
• Return of parts
• Follow-up correction

• 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

Source Lisa Ellram, Total Cost of Ownership
Elements and Implementation, International
Journal of Purchasing and Materials Management,
Winter 1993.
From Leenders, Johnson, Flynn, and Fearon,
Purchasing and Supply Management, Thirteenth
Edition, McGraw Hill Irwin
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Target Pricing
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Target Pricing
Instead of adding profit and cost to establish a
selling price, the organization starts with the
market price and required profit to establish a
target cost to achieve the necessary profit. The
Supply function becomes responsible for working
internally and with suppliers to achieve the
target
Traditional
Cost
Profit
Sales Price


Target Pricing
Sales Price (Market)
Profit
Cost
-

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Target Pricing drives cost reduction beyond
Purchasing

• 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

The targets also drive cross-functional communicat
ion and shared problem-solving
You get what you EXPECT and what you MEASURE
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Target Pricing is key in Defining Product
Specifications
The Initial Development Design is the biggest
factor in Life Cycle spend
100
90
80
70
60
of Dollars COMMITED to the Item
50
40
30
20
While volume buying takes place to support full
scale production
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0
0
1
2
3
4
5
6
7
8
of Dollars SPENT on the Item over Time
For illustration only numbers are
approximations
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Other Cost ItemsLearning Curve Discounts
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Learning Curve
With practice and repetition, performance
improves. Expected improvement can be calculated
and incorporated into future cost projections
The Learning Curve is a calculation that
estimates the rate of improvement as output
doubles. It implies that improvement NEVER stops.
The relevance to Supply is lower price targets
for future deliveries
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Discounts
Discounts are a LEGITIMATE and effective means of
reducing prices. They may offered by Suppliers or
negotiated by Buyers
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Negotiation
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How this Course supports Supply Chain Objective
Process
The Right PRICE
The Right SERVICE
paying
The Right SUPPLIER
and
The Right PLACE
with the
The Right TIME
at the
The Right QUANTITY
at the
The Right QUALITY
with the
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Background

• Not the same as haggling
• Honest
• Professional
• Fact based
• Data driven
• Different approaches for different situations
• One-time purchase with a non-partner supplier
  (buying a car)
• Recurring purchases with an ongoing partner
  supplier
• Initial purchase with a potential partner
  supplier
• Different approaches for different Purchase Types
• Less leverage for most raw materials, standard,
  and low-value items
• More leverage in special items and Capital Goods
• ABC classification is key
• Get EVERYTHING in WRITING

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Relationship between ABC Classification and
Negotiation

• Highest dollar items need to also have the
  highest value
• Cross-functional teams contribute input
• Significant time commitment from many people
• Significant fixed cost that should be recovered
  in better pricing

Focus negotiating efforts on the BIGGEST
PAYBACK for the time and cost invested
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Different approaches for different Purchase Types
Raw Materials
Standard Production
Items of Small Value
Special Items
Services
Capital Goods
Resale
Best Opportunity to Negotiate
Special Items

• Global sources of Supply
• Potential for design and specification
  modifications

Capital Goods

• Very high dollar purchases
• Many non-price items can be included

Services

• Can often be A items, especially with
  outsourcing relationships
• Often very competitive market, with many
  alternative sources of supply

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Non-price Negotiation

• Support
• Technical assistance
• Product research, development, and/or design
• Warranty
• Spare parts
• Training
• Tooling
• Packaging
• Data sharing, including technical data

• Quality
• Specification compliance
• Performance compliance
• Test criteria
• Rejection procedures
• Liability
• Reliability
• Design changes

• Supply
• Lead times
• Delivery schedule
• Consignment stocks
• Expansion options
• Supplier inventories
• Cancellation options

• Transportation
• FOB terms
• Carrier
• Commodity classification
• Freight allowance/equalization
• Multiple delivery points

From Leenders, Johnson, Flynn, and Fearon,
Purchasing and Supply Management, Thirteenth
Edition, McGraw Hill Irwin
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NegotiationPlanning and Execution
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The Basic Steps in Developing and 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 buyers position on each issue, and
   estimate the sellers 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

From Leenders, Johnson, Flynn, and Fearon,
Purchasing and Supply Management, Thirteenth
Edition, McGraw Hill Irwin
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Game plan for Negotiation
From Leenders, Johnson, Flynn, and Fearon,
Purchasing and Supply Management, Thirteenth
Edition, McGraw Hill Irwin
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The Zone of Negotiation
The overlap between what the Buyer will pay and
what the Seller will accept defines the Zone of
Negotiation
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The Zone of Negotiation
There is a gap between what the Buyer will pay
and what the Seller will accept. There is NO
DEAL without Creativity or Compromise