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Cost Management and Total Cost of Ownership Analysis

This chapter explores the concepts of direct and indirect costs, variable and fixed costs, as well as portfolio analysis, cost analysis challenges, and the benefits of total cost of ownership analysis. It also covers target pricing, negotiation strategies, and the negotiation process.

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Cost Management and Total Cost of Ownership Analysis

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  1. Chapter 11 Cost Management

  2. 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 Indirect Costs: Costs incurred that normally cannot be related directly to any given unit of production of a product or service When evaluating costs as either direct or indirect, the issue is the ability to trace the costs directly to a unit of production

  3. 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

  4. Portfolio Analysis High bottleneck items strategic items Risk non-critical items leverage items Low High Low Value

  5. 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 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

  6. Advantages of TCO Highlight cost reduction opportunities Aid supplier evaluation and selection Provide data for negotiations Focus suppliers on cost reduction opportunities Highlight the advantage of expensive, high-quality items Clarify and define supplier performance expectations Create a long-term supply perspective Forecast future performance

  7. 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 Total Cost of Ownership • 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 Source: Lisa Ellram, “Total Cost of Ownership: Elements and Implementation,” International Journal of Purchasing and Materials Management, Winter 1993.

  8. Target Pricing Example > Future Market Price – Desired Profit = Target Cost Adjust for Spec. Differences Current Profit Desired Profit Internal Costs Model-to-Model Change Current Cost C Part/System Price Target Cost Purchased Component Part Level Costs B A Current Price Verified By Cost Standards Component Target Costs

  9. Example of the 90 Percent Learning Curve

  10. The 90 Percent Learning Curve – Logarithmic Plot

  11. 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

  12. Any Aspect of the Purchase Agreement is Subject to Negotiation 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 • Price • purchase order price • discounts (cash, quantity and trade) • escalation provisions • exchange terms • import duties • payment of taxes • countertrade credits

  13. 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

  14. Model of the Negotiation Process

  15. The Basic Steps in Developing and 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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