Methods of Costing Facilities & Labour

1. Methods of Costing Facilities & Labour …technology & work-centre specific. By David Reuss

2. So where is the case that demands the need for ‘Work-Centre specific’ cost rates? • Why should a Customer care about such detail? • Surely a Customer just wants to pay the cheapest price, whilst getting the right product or service in return? • Why should a Supplier need anything other than a wrap-rate for a facility? • So long as he gets back his ‘costs’ over a year and makes at least a satisfactory profit, what does he care?

3. Lets not forget... • Of course, some Suppliers involved with military customer work (e.g. DoD) are already required to agree facility cost rates (wrap rates) inclusive of engineering and fabrication overheads, • and where a Supplier is involved in both military & civil work – conflicts need to be managed. • So, in the same spirit as on military work, why shouldn’t the civil Customer get a handle on a Supplier’s Costs? • Especially if customer work-load is significant to the Supplier. • And of course, the Supplier may want better resolution of costs for themselves, e.g.: • For helping to identify which machines are more profitable than others, or • Where the waste is in the business.

4. Profits being pulled Customer Supplier The situation: • Customers & Suppliers suffering ever reducing margins. • This calls-for an Ability to predict Fair & Reasonable Cost-Rates. • For the Supplier, this means: • Ensuring that true costs are accounted for and that profit margins are demonstrable and fair. • Access to a more effective business analysis tool – assisting future business strategy development and capital purchases. • And for the Customer, ensuring that: • they have a view as to what the market should be paying, and • that which is viewed to be fair, reasonable & affordable.

5. A Case in point... From a Supplier's perspective • Assume a supplier has a wrap rate of £50/hr • Then invests in a state-of the art machine, which should rightly have a cost rate for itself of say £300/hr. • However, the supplier prefers to maintain a wrap-rate business, and due to load, forecasts a revised wrap rate of say £65/hr as a result. • This may then burden jobs with cost from the new investment that it may never benefit from – and hence may cause the supplier to appear uncompetitive for such products. • Wrap rates tend to also disguise in-efficiencies and poorly loaded capital. • Hence, if investment was correct for business (especially in cases where investment was high), then it makes sense for the supplier to charge rates according to ‘True’ costs. • Having a transparent relationship with important customers makes it easier to persuade when they come looking for price reductions too. • Regrettably, some suppliers even apply wrap rates that are perceived necessary in order to win the business... And remain blind to the mounting losses that can sometimes follow.

6. A Case in point... From a Customer's perspective • Having sight to the construction used by a main supplier, in the build up of the rates, will: • assist appreciation of the difficulties experienced by that business and • will assist in the long term planning of sourcing strategies. • It is also highly desirable when comparing suppliers from pan global locations: • where risks associated with sourcing in presently low cost labour countries (e.g. India and China) can be better analysed and • impact risk assessments made.

7. Making predictions of Work-Centre specific Cost Rates – the ingredients. • Whilst taking it from a Cost Engineer’s perspective, rather than a purist financial controller. • A dive into the deep end… • With emphasis on • Direct Labour • Indirect costs, & • Work-Centre costs.

8. Purchased Parts, Consumables and Material Cost • External spend • Purchase Burden (if not in Indirect Costs) • Cost of Money (due to stock burn-off) • Process Related Scrap impact on lost purchases. Manuf. Cost Work-Center Specific cost rates * Process Costs Process Operation Times (Cycle Run Times and Set-Up) Batch Lead-Time cost-of-money Logistics Cost paid by Supplier Tooling Costs & other NRC Margin/Profit * SEE FURTHER SLIDES FOR BREAK-DOWN Price Modelling Map Estimated Recurring Piece Price

9. Direct Labour Cost Rate Rates applied to Set-Up & Run Operations Indirect – Shop Labour Indirect Cost Rate Indirect – Office Labour Indirect – Buildings & Other costs Equipment cost rate Recovering Fixed & Variable costs Cost Rate Map Work-Centre specific Cost Rate

10. Direct Labour Cost Rate Cost Rate Map - elements Basic Pay (per hour) – work-centre skill level specific. Operator Quantity – normal operation (Work-Centre specific, can be < or > 1). Shift premium Allowances Fringe costs (Holiday, Sick Pay & Training costs - as lost time to business) Co. National Insurance contributions (Gov. / State Taxes) Pension Contributions

11. Shop Indirect Labour • Shop Indirect & Tech Support resources, Covering either: • Whole Factory / business • Cell • Work-Centre Pay & Benefits (p.a.) For ALL resources (as per Direct Operative) Divided by corresponding factory Hours for area covered Office Indirect Labour Office Indirect Resources (rest of business) - Non specific to area or Work-Centre (e.g. S.G&A) Pay & Benefits (p.a.) For ALL resources (as per Direct Operative) Divided by total annual factory Hours for business Other Indirect Operating Business Budgets (not Labour) including: Admin.; Marketing; Travel; Training; Insurance; Telephone & postage; Non-specific Transportation; Consultancy; etc. Equipment Costs including: Office Equipment; I.T.; Shop Equipment Misc.; Stores Equipment (if not recovered via separate purchasing overhead). Divided by total annual factory Hours for business • Costs p.a. per square metre, covering: • Local Gov. Taxes (incl. Rates); • Building rental Costs (as applicable); & • Space Heat, Light, Utilities and Maintenance. Office Area (plus stores and all other indirect areas) Divided by total annual factory Hours for business X Buildings – Indirect Cost Rate Map - elements Indirect Cost Rate

12. Variable Cost Rate p.Hr Total Energy and Utility costs per hour Divided by Accounting policy Depreciation years. Divided by total Worked* Equipment Hours p.a. Acquisition Costs (inclusive of Installation) Capital Depreciation Costs p. Hr Divided by total Worked* Equipment Hours p.a. Acquisition Costs (with installation cost) / 2 Loan interest rate Cost of Money – shown as a rate p.Hr. Current Year Valuation OR X • Costs p.a. per square metre, covering: • Local Gov. Taxes (incl. Rates); • Building rental Costs (as applicable); & • Space Heat, Light, Utilities and Maintenance. Equipment Foot Print Area (inclusive of gang-ways allowance) -1 Shop Floor effective Utilisation Divided by total Worked* Equipment Hours p.a. Shop-Floor Cost Rate p.Hr X X * ‘Worked Equipment Hours p.a.’ makes allowances for planned and unplanned down-time and equipment Utilisation within year. Cost Rate Map - elements Equipment cost rate

13. Methods for Costing Facilities & LabourSummary • Analysing costs in more detail can be of benefit to both Suppliers and Customers. • As profit margins become ever more stretched, by endeavours from both sides of a negotiation, and as safety-nets get thinned out by: • classical price reductions, • design optimisation and • lean manufacturing process improvement initiatives, … so we need to be prepared to make use of such magnifying glasses upon our businesses. • Today’s Integrated Teams (from the customer and supplier)are working together – with the intent of mutual benefit. • Assisting this process then is making available better quality representation and understanding of what the ‘true costs’ are, and by sharing them with your supply-chain partners.

14. Important points for consideration • Cost Apportionment • Depreciation of Work-Centre acquisition costs: • Straight-Line or Current year valuation? • Fixed period depreciation or over Equipment Useful Life? • Building costs (space heat, light & other general utilities): • Charged to: specific Work-Centres, Cells, or Factories? • And then apportioned by: Floor area or factory hours? • Purchase handling costs, charged by: • Fixed fee per transaction, or • Flat rate % for all purchases, against purchase order value? or • Charging actual costs back to specific order or commodity group? • Overheads (Engineering or ‘Sales General & Admin’): • Charged by factory hours? Or • Should costs be weighted to programmes, or other areas of business?

15. Important points for consideration • Virtual Factories • Where a customer is trying to predict costs as seen by a specific type of supplier, within a commodity group or sector of the manufacturing industry, they can create what are called ‘Virtual Suppliers and Virtual Factories’. • Behind such would lie a generic financial representation of such an entity. • Utilisation – Equipment, Buildings, Labour • All fixed costs to the business need to be effectively utilised. • But the cost of under-utilisation needs to recovered too. • Plus, assuming equipment use is reasonably optimised (e.g. set-up or maintenance down-time) then these ‘non-added value’ costs shouldn’t be forgotten either. • What’s a Direct Operation? • Whilst using Work-Centre specific cost rates, one has to be sure that all ‘True Costs’ are recovered within direct operation identifications and time generations.

16. Important points for consideration • Accounting for direct operatives doing indirect duties • Not all direct operatives work on 100% directly chargeable duties, they do indirect duties too. • Such indirect duties need to be recovered within corresponding indirect shop accounts, without double-accounting. • Dealing with automation vs man-hours for apportionment • Clearly, where factory hours are used for apportionment purposes, one needs to account for all hours that can be sold. • Hence, automated equipment need to be charged. • Clearly most firms will have a mixture of pure labour and automated processes. • Over-time • Over-time, although paid at a premium to the Operative, can have cheaper rates applied to their working, in comparison to normal time. • This logic is based on how all fixed costs within the business should be recovered within the ‘normal time’ factory hours expected to be worked within a financial year.

17. Important points for consideration • Lead-time cost of money, and Inventory holding costs. • Capital investment normally brings with it a Loan. • The cost of the loan (arrangement and interest charged by the lender) is cost-of-money. • This real cost is recurring too, and so proportional to Product lead-times. • Inventory holding costs, however, are a non-recurring saving where reductions are made. • The act of eliminating waste within a manufacturing process may, if no quality improvements are made: • make significant lead-time improvement, but • yield only modest recurring cost savings – due to the ‘cost of money’ savings on interest costs… • These impressive lead-time improvements can some-times be confused as being proportional to product cost reduction too.