The following article was prepared by
Mike Taylor, C.P.M., for distribution to ISM affiliate newsletters. January 2007
Weíve spoken several times about the value of
understanding the costs associated with the items and services we are buying.
[Read Cost CountsÖ] 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
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; itís 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 arenít in
any particular order and may or may not be applicable to your specific
situation. Iíd 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.
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, Iím
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
I love to go on factory tours, attend trade shows and
chatter with sales people every chance I get.
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
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 Iím thinking a priced spare parts list would be nice
along with a hint about alternative sources of supply
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.
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.
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 havenít heard of before. At best Iíll hear about
attributes that can be either added or removed to improve the
cost-effectiveness of my acquisition.
What advantages do you have over the competition?
Do you have special permits, one-of-a-kind tools, trucking fleets, exclusive
How/Why do you package the product like that? Are
there alternatives or constraints in how the products are packaged, stored
What value added services are included with the
purchase or available? [If there are additional services available for free
Ė Iím losing money on the purchase if I donít take advantage of them. [Read
Indirectly Beneficial Ö.]
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.
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?
Gievn all of that information, can we start to build a simplified cost breakdown?
I think so.
Direct material costs Ė either dollars or a
percentage of the total?
Components & parts
Direct labor to machine, build, assemble,
Direct packaging, handling & storage costs
Manufacturing overhead estimates for the
industry or the local area. Use actual or refine the estimate as more
detailed information is obtained.
General and Administrative expenses. Either
actual or an estimate for the industry or local area.
Typical profit or fee or the commodity or
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 Ė 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 donít 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.