The following article was prepared by Mike Taylor, C.P.M., for distribution to ISM affiliate newsletters. January  2007

   Question Cost

November 2008

We’ve spoken several times about the value of understanding the costs associated with the items and services we are buying. [Read Cost Counts…] Manufacturing costs, direct costs, indirect costs, distributor costs or other costs associated with the supply chain all become part of the price and are all therefore opportunities to improve our negotiated acquisition. Once we understand all of the cost elements that contribute to the final price, then we can be creative about eliminating, reducing or improving the net value to the transaction. So how do we achieve that understanding?

In the Federal acquisition process, obtaining a cost breakdown is mandated by regulation for certain types of transactions. Buyers require and sellers provide certified cost and pricing data. But if you are not the government or if you are buying standard commercial products, what options do we have to get cost information? I think we have a lot of options; it’s just a matter of being creative and accumulating data over long period of time.

Here are some ideas about how to be proactive in obtaining cost information that can be useful in negotiations. These aren’t in any particular order and may or may not be applicable to your specific situation. I’d suggest treating this list like a checklist to be reviewed and data gathered for each significant item or service you are now or might eventually become in involved with.

  1. The most important ting to do is to make  a commitment to do the homework up front ona regular basis and store the data for future use. Commodity or topical files at a high level are much more useful than vendor files. That is, I’m going to store everything I learn about HVAC systems in one place so I can use it whenever I get involved with obtaining HVAC equipment or HVAC services again.
  2. I love to go on factory tours, attend trade shows and chatter with sales people every chance I get.
  3. I like to see the types and quantities of materials being used in the product. "Why those, why not others, where do the materials come from, how are they obtained, what are the challenges in obtaining those materials, etc." Giving me a facory tour is no piece of cake.   Manufacturers are proud of what they have been able to accomplish and during informal plant tours or trade shows they would love to explain it to you. Keep your eyes and ears open for possible material substitutions, processes which are not needed and places where the supply chain could be affected by material shortages
  4. What are the parts and components being used in the product? Where do they come from? Is there a parts list available? How costly are those parts to obtain? Are there supply concerns or multiple sources. Of course I’m thinking a priced spare parts list would be nice along with a hint about alternative sources of supply
  5. What are the manufacturing challenges to producing these products? How much of the final value is represented by which materials or components and how much is added by manufacturing or assembly.
  6. What kinds of manufacturing overhead and extra costs are associated with the product? Are there duties, import fees, certification costs, environmental taxes, special permits or safety regulations which affect the process and add costs or difficulties.
  7. What makes your product different than the competition? I definitely want to hear the answer to this question when we are not in the middle of an acquisition process. At the least I might get a lead on a competitor I haven’t heard of before. At best I’ll hear about attributes that can be either added or removed to improve the cost-effectiveness of my acquisition.
  8. What advantages do you have over the competition? Do you have special permits, one-of-a-kind tools, trucking fleets, exclusive licenses, etc.?
  9. How/Why do you package the product like that? Are there alternatives or constraints in how the products are packaged, stored and shipped?
  10. What value added services are included with the purchase or available? [If there are additional services available for free – I’m losing money on the purchase if I don’t take advantage of them. [Read Indirectly Beneficial ….]
  11. Do you have stocking distributors or alternate storage locations? Are there other customers that use this product? If I ever need one in a hurry maybe I can get one from another customer.
  12. What percentage of your business do these products represent? How do I compare to your other customers in terms of the amount of business we do? How do I compare in terms of buying smart? Are there simplified methods, cost reducing strategies or alternative approaches I should be learning from? Are my requirements causing me to pay more or see an increased risk of nonavailability?
  13. Gievn all of that information, can we start to build a simplified cost breakdown? I think so.
    1. Direct material costs – either dollars or a percentage of the total?
    2. Raw materials
    3. Components & parts
    4. Direct labor to machine, build, assemble, test, etc.
    5. Direct packaging, handling & storage costs
    6. Manufacturing overhead estimates for the industry or the local area. Use actual or refine the estimate as more detailed information is obtained.
    7. General and Administrative expenses. Either actual or an estimate for the industry or local area.
    8. Typical profit or fee or the commodity or service
    9. Supply chain costs and adders

Once we have started gathering information and answers to these questions we can start making inferences and checking facts.

Example: I can roughly estimate the cost of storing, shipping and handling a valve. Taking those out of the price, reducing the remaining cost by some reasonable estimates for overhead and indirect expenses, I can then get a guess at the actual raw material costs. Thus I can use that rough estimate to see what the actual impact of an announced 20% commodity increase in the price of brass should be to my brass valve purchases. So far we have been addressing this subject primarily as it relates to purchasing equipment and materials, but the principles are the same for services.

For example: If I know that the typical diesel engine overhaul takes about $5000 in parts, then I can guess that the $15,000 proposed service price includes about $8000 in labor. (leaving about $2000 for overheads, fees, and indirect costs.) Thus when I ask for a rush job, I know that the primary change should only be to the $8000 labor cost – not the whole price.

Another opportunity might appear when purchasing telephone, internet or computer equipment or services. Does the supplier have training information, educational programs and/or customer service specialists that can be utilized during to make the transition easier? If so, knowing that those services are available and already priced in the total costs of acquisition means we are losing value if we don’t take full advantage of them.

Experienced buyers understand that the overall cost of a product or service is where the big money savings hide. Happy hunting.

Mt

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