Jun 182012
 

To continue my thoughts from last week’s blog regarding the article  “Putting it All Together at Harley-Davidson“, I’ve put together some additional insights below.

Keep Your Product Cost Management Promises and Don’t Force Others into Promises They Can’t Keep

I am reminded of a story about, Saint Augustine of Hippo, a brilliant theologian, who meets a young boy along the Mediterranean sea sea shore  one day.  As the story goes, Augustine had gone for a walk to clear his prodigious brain, trying to fathom the Christian mystery of the Trinity.  He sees a little boy running back and forth between the sea and a hole that the boy dug on the beach.  The boy uses a little bucket to transfer water from the sea to the hole.  Augustine asks the little boy what he is doing, and the boy replies that he is draining the ocean.  Augustine laughs at him and tells him that his goal is ludicrous, and he’ll never do it.    At this, the little boy replies to the great Doctor of the Church, “I’ll accomplish MY goal before you get to yours!”

Spiritual implications aside, the secular point is that there are goals that cannot be achieved.  In the article, Schmitz talks about his time at Honda:

“Plus, at Honda we learned to never miss a target, to never make a commitment that we couldn’t keep.”

That is a subtle, but important point.  I don’t believe the bigger problem is people not keeping realistic commitments, but forcing the team for sign up to unrealistic commitments.  The culture of US business has morphed to a state where everyone must accept “stretch” goals, some of which are ridiculous.  In addition, eager managers make assumptions about the execution of projects.  Getting a project authorized is the equivalent to assuming that that the Boston Red Sox will hit 3 home runs per inning for a whole game.  Managers who accept such ludicrous targets are “inspiring leaders with a ‘can-do’ attitude;”  while those who cry foul on silly expectations are “negative” and “not team players.”   The article on Harley seems to say that Honda has at least partially overcome this problem and is a bit more realistic in goal setting and acceptance.

Reality Cannot Be Fooled Repeatedly for Very Long

There are “stretch” goals, and then there are miracles.  For example, consider the picture below.  Boiling the ocean in Product Cost Management Hiller AssociatesThis leads us to ask, how do you know if your goal is too aggressive in Product Cost Management?   I don’t have an exact answer, but I would suggest that people think of goal setting like tolerance stack up.   Managers should remember back to the days when they were engineers.  If a design is so delicate that all parts must have extremely tight tolerances and must be heated/cooled to assemble, would you say this is a design that will ever work in the real world of production?  No.  Alright, so when you are setting your product cost targets, reduction targets, or any other target, consider what intermediate goals must be reached to accomplish the overall target.   It is a lot easier to assess the chance of accomplishing the more narrow intermediate goals than the big longer term goal.  If you need flawless execution on each intermediate goal to achieve the overall goal, you may want to consider whether or not you are boiling the ocean.

Part 3 in this series is coming soon.

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Jun 112012
 

I just read the article “Putting it All Together at Harley-Davidson” in the July 2012 [July??] Blue Heron Journal.   The article is a profile on Pete Schmitz, a Honda veteran in Product Cost Management, who now works at Harley-Davidson.    According to the article,:

“[Schmitz] combines procurement, design, manufacturing and cost expertise in a unique job function. Reporting up ultimately to Harley’s CFO, Schmitz describes his ten year Finance Product Cost Manager position as ‘the cat bird’s seat…we are the neutral third party in product development – getting the whole organization to work together.”

That perked up my ears right away.  As many of our readers may know, Harley Davidson is a classic case study in the positive effects of successful Product Cost Management.  It was an exciting article to me for several reasons.  I would like to explore them in the next few days in some shorter posts.  The first insight that I gained from the article is the following:

Finance Must be Involved with Purchasing and Engineering

According to the article, Harley is at the mature stage of Product Cost Management making their efforts truly cross-functional.  Specifically, the finance (maybe accounting too?) people are involved directly with the engineering and purchasing groups.  That is impressive.  If you are familiar with Product Cost Management efforts, you know how difficult it can be just to get engineering and purchasing to work together.  However, getting finance and accounting meaningfully involved is even harder in my experience.  That is unfortunate, because often finance and accounting have so much of the existing data that the cost management team needs to make valid cost models, do spend analytics, etc.

I am not sure why finance and accounting often shy away from participating in PCM efforts.  My own experience is that the finance and accounting people are uncomfortable with the very physical world that includes the Bill of Material (BOM) and purchasing commodities.  Moreover, the PCM team often needs to recalculate overhead and other financial rates to be RELEVANT for cost management analyses.  This recalculation is is very different from the RELIABILITY focused, acceptable financial accounting viewpoint with which the accounting team is comfortable.  That is just a general guess from my experience over the years, but maybe a reader can provide more insight.  Regardless, I would urge more finance and accounting folks to step out of their comfort zone in the financial world to participate in the physical world with engineering, purchasing, and manufacturing.

Translating from the Physical World to the Financial

At the end of the day, isn’t translating the physical into the financial what Product Cost Management is about?   I actually wrote one of my first blog posts in 2007 about this concept for Jason Busch at SpendMatters.Translating Features to Cost in Product Cost Management Hiller Associates  The article is called What’s The Language of Your Business?   It’s very helpful to ensuring a good translation when experts in all languages are present during the translation work.  Ergo, both the people that speak physical (features, functions, BOM, machines, and supplier) and people who speak financial (dollars, overhead rates, internal rate of return, net present value) need to be around the table to make sure nothing is lost in translation.

See you again soon with part 2.

 

 

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May 292012
 

One thing that is interesting about Product Cost Management is that people have different thoughts as to what is included in the product cost.  Is the product cost the raw material, labor, and direct  labor?  What about the capital tooling?  What about logistics and shipping?  Oh, and what about warranty cost or end of life disposal fees for which your firm is responsible?

The short answer is E. All of the above.

In a product and manufacturing firm, everything on the income statement is included in the product cost.  However, the income statement does not easily present a direct association between a particular cost with a certain product.  Hence, accounting came up the concept of “indirect,” “period,” or “burden” costs.  This is accounting speak for, “We’re not really sure how to reliably split this bucket of cost and assign it to an individual product.”  Later, academics and consultants made a lot of money, and caused great pain and suffering, with Activity Based Costing.   This method was invented to try to reasonably amortize indirect costs in a logical way, so that people could call them direct costs.  ABC was a good idea, but in most companies, it was badly implemented in an impractical way that made everyone lose interest in it.

So, what IS in Product Cost?  That’s a tricky question that we may be talking about for a long time.  However, I would like to address one particular cost that is a perennial burr in my bell bottoms.

Grand Theft Auto — Yes Virginia, Capital is a Real Cost

Imagine you were selling your car and put a “For Sale” sign on it in the parking lot of your company.  Over lunch one day, one of the engineers in your firm walks up to your desk and says he’d like to buy your car.  You might say, “Great!  I’ll make you a deal. It’s $5,000.”   But the engineer looks at you in a confused manner and said, “Oh no, you see, I’m only responsible for the ‘variable’ costs of the car such as gas, insurance, those little pine tree air fresheners, etc.  The capital cost of the car is not my problem.  It comes out of ‘another budget,’ for which I am not responsible.  Can I have the keys now?”  You would not give him your car and might actually ask his supervisor to have the guy checked out for behaving in such an irrational way.

That’s a bizarre story, and no engineer that I know would say something like that… unless they are talking about Product Cost.  I wish I had a dollar for every time an engineer or his manager told me that capital tooling “didn’t matter because that comes out of a different budget.”  Capital Investment and Capital Tooling are real things that cost real money.  However, most organizations treat them as if they are totally different than the variable product costs (e.g. raw material, labor, direct overhead, etc.).    No, capital is not different, in the sense that the design team’s decisions will determine how much capital is needed, just as their decisions affect variable costs.  However, at best, engineering teams will only consider capital as completely separate from the “Piece Part Price.”  Many engineering departments do not consider capital in any serious manner at all.

This leads to perverse decision making.  Why?  Typically, investment in capital will reduce the variable cost of a part, and there are often multiple ways to make a part.  For example, let’s say that you are Joey Bag O’Donuts design engineer, who has been given challenging cost targets for Piece Part Cost.  You design a part and your purchasing guy comes back with quotes from 3 suppliers:

Supplier  Piece Part Cost Capital Tooling Cost
Louie’s Laser Library $15.10 $1,000
Pete’s Press Emporium $12.50 $15,000
Chuck’s Casting Shack $10.50* $13,000
Capital breakeven in Product Cost Management Hiller Associates

Click to Enlarge!

* Redesign will be required to use Chuck as a supplier

Of course, capital is “considered” by Joey’s engineering team, but it’s hard to comprehend because it is considered separately from variable costs.  Joey would likely choose Pete as a supplier because Pete is cheaper on Piece Part Cost.  Joey won’t have to redesign as he would if Chuck was Joey’s supplier.  Joey’s Cost Target is based on Piece Part Cost.  Sure, his supervisor tells him to “watch the capital,” but the capital budget is this big amorphous pot of money that everyone shares, so Joey is not personally penalized for using it.

However, using a bit of eighth-grade math, we can graph the real cost to the company, including the capital amortized over the life the tool.  We see that the right decision for maximum product profit depends on the volume of products we will sell before more capital needs to be spent to refurbish or replace the tool.

Capital is Different… It’s MORE Important Than Piece Part Cost

The attitue of most product development teams towards capital shows that they implicitly believe capital is LESS important than the Piece Part Cost.  However, I would argue that the opposite is true for at least 3 reasons:

  1. Time Value of Money — You have to buy capital up front, spending the dollars earlier.  Using sophomore math and a proper cost of capital for the organization, you can calculate how much more expensive capital is than variable costs.
  2. Risk of Change — Capital Tooling is often called “hard tooling” because it is made for a specific part.  Often out of hardened steels that are expensive to manufacture and machine. But, the tooling is ‘hard’ in another way:  it’s hard to change.  Let’s say that Joey’s part failed in the field and needed to be modified.  It’s likely that the tooling will need to be to be modified, and tooling modifications are expensive.  So, how do we account for the risk of changes in calculations of tooling cost?  I will have to look into that, or perhaps, one of our readers can suggest a method.  One  method would be to ask the following questions:  What percentage of parts are modified after tooling is created and what is the average cost of tool modification as a percentage of the original tooling cost?  Using these two numbers, we could create a reasonable risk multiplier for capital.
  3. Return on Assets — Since the 1980’s, Wall Street has been obsessed with “asset light” companies.  Some of this is just Wall Street codifying reasons 1 & 2 in the stock price.  However, a lot of this has to do with leveraged buyouts and other financial “engineering” voodoo.  Regardless of whether assets light strategy really adds or subtracts value from the firm, Wall Street thinks it does.

These are just three reasons why capital is an expensive cost that should be considered as part of product cost and considered together with piece part cost.  There may be others, too, but at the end of the day remember:

Cars are not free and neither is the capital tooling for your product.

This advice may help keep you out of jail and/or the world of unprofitable products.

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May 212012
 

In last week’s post “Do you hear the voices? (Voices Series, Part 1) ” we talked about the different voices that speak throughout the product life cycle and how they relate to Product Cost Management. This week, we’ll talk about some voices give bad advice and expectations. As the diagram to the left shows (click to enlarge), there are at least two typical conversations happening in the product life cycle. The conversation at the top shows the voices that are beneficial to Product Cost Management and help lead to a profitable product. The conversation at the bottom has some of the same voices, but also replaces some of the voices with new, discordant voices, who more often than not, lead to an unprofitable product.

Voices in Product Cost Management Hiller Associates

CLICK TO ENLARGE Good and Bad Product Cost Conversations

Hope is Not a Strategy

Organizations have a variety of excuses for why they don’t let the Voice of Reason limit the finance team’s desires for product cost or profit. The same is true for not listening to the Voice of Intent (seriously evaluating alternatives in concept design and costing them), and for having no Voice of Engineering (not doing product cost management in engineering or being lax on cost roll-ups). These voices are replaced by a new voice:  the Voice of Hope!
“Hope” — that sounds pretty positive, doesn’t it? However, as Rick Page taught us in his book, if hope is not a strategy for sales, why would a company think it is a good strategy for its Product Cost Management? The difference between a conversation on product cost with the Voices of Reason / Intent / Engineering vs. a conversation with only the Voice of Hope is the difference between a profitable and unprofitable product.

The Voice of Resignation (…or Eeyore)

Eeyore Voices in Product Cost Management Hiller Associates

Voice of Resignation

This brings us to the Voice of Partners and the Market, i.e. your suppliers and factory who have to actually deliver your new product. The supplier or plant will determine the price at which they are willing to sell to you.

People often add pernicious voices to the conversation that are manic depressive opposites.   The first is the Voice of Resignation.  If you have kids, or if you ever were a kid, you may know this as the Voice of Eeyore.   Eeyore is the lovable, but chronically dejected donkey in Winnie the Pooh.    This voice says, “I don’t care what your ‘should-cost’ says.  This is what the market will sell for, so I guess that I have to buy at that price.”

The Voice of the Bullying (…800 lbs and growing)

The manic brother of the Voice of Resignation is the Voice of Bullying.  However, instead of Tigger as the opposite of Eeyore, we have another mascot for this voice — the 800 pound gorilla.  After all, Tigger is more of an annoyance than a bully.    The Voice of Bullying

Gorillas in Product Cost Management Hiller Associates

The 800 Lbs Customer Purchaser

says:  “We’re the 800 pound gorilla customer, and we’ll use our weight to force some cost reductions with the supplier.”  Is the price requested reasonable?  The 800 pound gorilla doesn’t care, because he needs the price to be what he wants it to be for one of several reasons that are beyond explanation in this post.  I plan to discuss the reasons more fully in a subsequent post, but for now we’ll just list them as the following:

  1. Cost was never targeted properly in the first place (a.k.a. the Voice of Hope was listened to over the Voice of Reason)
  2. Engineering let things get out of control (a.k.a. the Voice of Sound Cost Engineering was replaced with the Voice of Hope… or apathy)
  3. The Voice of the Ghost-of-Product-Costs-Past haunts purchasing (a.k.a. the demand for post-launch cost reductions)
So, how do we silence, or better yet, learn from the Voice of Resignation and the Voice of Bullying, while keeping them in control?  I’ll leave that for next time.
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May 142012
 

Lately, it’s become popular to talk about “voices” in business, e.g. the “Voice of the Customer.”  With all the voices, it is difficult not to wonder if one is listening in on a business meeting, or a group of choral composers arguing over the score’s balance, psychologists trying to diagnose a patient, or a kitschy show with karaoke singers trying to go pro.    I believe that the “voice” nomenclature is the new new way to say “stakeholders,” a term that was the new way to describe the groups of people and forces of the universe that prioritize your product decisions and limit its possibilities.

All frivolity aside, the Voices framework is not a bad one. Instead of arguing over what we call the rose, I’d like to focus on WHO and WHAT those voices are with respect to Product Cost Management. Click on the diagram to the right. In this graphic, I show three categories across the product development cycle:

Voices in Product Cost Management Hiller Associates

Click to Enlarge! Voices in Product Cost Management

  1. What are the ‘Voices’ in the discussion of product cost and profit
  2. What are the target costs or cost statuses that the voices dictate or influence
  3. What are the ways that people can estimate the cost target or cost

The First Voices in the Discussion Had Better Be Balanced

The first two voices are the Voice of the Customer and the Voice of the Business.  The Voice of the Customer is supposed to tell you what consumers will pay for a certain bucket of product features and attributes based on perceived customer value.  Understanding the weird customer dialects isn’t so easy because customers won’t give you an exact number for the price they expect, such as $44.85.  If customers do give you an exact number, the number should still be considered fuzzy because customers have a hard time conceiving the value of your intended offer.   It is traditionally marketing’s job to read these tea leaves in order to decipher the Voice of the Customer.
The second voice, the Voice of the Business, gives us the Product Target Price and Product (System) Level Cost Target.  To illustrate, the CEO or Group VP comes in and says, “We need X total revenue and Y market share,” and the VP of Finance comes in and says “We need to have Z profit margin on the product.”   Great! Right?  Well, yes, but this is a TOP-DOWN cost target, or as the EE‘s in the room would say, an “open loop” control.  Normal people refer to this as an “estimate” or a “guess” (a.k.a. a hope).
Trade-offs in Product Cost Management Hiller Associates

Click to Enlarge! Product Fiscal Planning Triangle

The hopeful nature of the top-down product cost target is why the next voice in the discussion is so important:  the Voice of Reason.  What modern businesses don’t like to think about (or have been taught not to by consultants) is that there is a fairly rigid triangle (see the figure to the left) linking the price you must charge (or the customer will pay), the feature set (value) you will deliver in the product, and the product’s cost (margin).  If you set two of the corners of the triangle, the third will move to compensate.  I am not saying that people cannot do better on their product cost, but there are limits.

The key is to ALSO estimate what is theoretically possible for product cost in a BOTTOMS UP way — given REASONABLE assumptions.
The bottoms-up estimate moves you from an open loop control to a closed loop control (with feedback for adjustment), as the EE’s would say.  If the top-down and the bottoms-up costs are too far apart, somebody needs to throw a flag.  The first figure above shows the methods one can use to get an early bottoms-up product cost estimate.  Another voice that is often not heard is the Voice of Intent.  People often just assume a design alternative and immediately launch into full scale engineering.  But the old DARPA study told us that 80% of cost is decided in the first 20% of decision making.  So, the solution is pretty obvious.
Spend significant effort and time in the concept design stage seriously generating, considering, and costing a series of alternatives with your cross-functional team of design, manufacturing, purchasing, etc.
Spend the money needed on comparative teardowns of carryover systems you plan to cost reduce and systems with new features you plan to design versus similar systems of your competitors’ products.  Spend time together in a workshop evaluating your design alternatives and estimating your costs (raw material, manufacturing, shipping, etc.).  You do not need triple point precision — you only need a good enough estimate to allow you to compare one alternative to another.   Then you should give a REVISED Product Cost Target to management and marketing.   Very little cost has been spent up to this point, so if a program needs to be stopped or modified, now is the time!

Keep the Conversation Going

The next voice that should be in the product cost discussion is the Voice of Engineering.  Often, the discussion on product cost just stops for months or years until suppliers send in the first quotes at the end of the detailed design phase.  However, the conversation should continue.  Where is the engineering team in their cost roll-ups?  Have they discovered problems and barriers that will force costly changes, or have they found clever ways to beat the cost target?

Shrink the Triangle with Should-Cost and Spend Analytics

The Voice of Partners and the Market refers to the price your suppliers (or your internal plant) will charge you to produce your design.  If you want to get the best prices, it is important to understand another triangle:  the Purchased Cost Triangle (to the right).   The corners of this triangle are the price the supplier or plant quotes, the final cost you negotiate with the supplier/plant, and your should-cost calculations.  Here’s the secret:  this triangle is much more flexible and stretchy than the product fiscal planning triangle above.   Powered by the number and quality of your should-cost and spend analytics estimates, you want to drive all three vertexes together and converge.   Product cost is a difficult and fuzzy world; it’s even fuzzier when you have no facts (or even well-reasoned estimates) to rely upon.

Triangulating in Product Cost Management Hiller Associates

Click to Enlarge! Purchased Cost Triangle

If you want your Negotiated Costs to reflect the actual costs of manufacturing plus a reasonable supplier margin, invest heavily in good Should Cost and Spend Analytics.

If that’s too hard or too expensive… well, it’s only your product’s profit anyway, right?

Time to Pay the Piper

For the most part, the final voices settle things.  The Voice of Realization happens when you actually start to make the product and do the formal accounting to see what the product actually costs.  Sadly, this is where most companies spend the lion share of their product cost management effort. This is not to say that there are not opportunities to reduce costs after launch.  However, this is not where companies should be spending a lot of Product Cost Management effort.  Cost is pretty much set at this point, and companies should be working on the NEXT product.

The last voice is the Voice of Regulation / Responsibility.  In general, the Voice of Regulation should be known up front, in regards to disposal fees or other government penalties and taxes for which the company is responsible.  On the other hand, the Voice of Responsibility is trickier. The company should take its warranty predictions very seriously.  Most products, though, tend to have surprises, and they are typically not positive surprises.  Sometimes, the Voice of Responsibility speaks with legal authority (e.g. contractual warranty), but it should also speak to the corporate conscience to do the right thing for the customer, even when the company is not legally bound.

Next week….

This week we talked about how things SHOULD work.  However, the framework and solutions presented are not how many companies DO work.  Next week, we’ll talk the ad hoc and emergent system by which most companies operate, and what problems this causes.

 

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Apr 302012
 

Michelle Boucher from Aberdeen Research just put out another nice piece of research on Product Cost Management.  (Actually, it’s not about PCM specifically.)  It’s called Product Development Single Source of Truth:  Integrating PLM and ERP.   The report delves into perennial topic of Enterprise Resource Planning (ERP) and (or versus) Product Lifecycle Management (PLM).

I have worked closely around these enterprise categories for the last 10 years, but I admit I may not be an expert of Michelle’s level.  However, from my seat in the ballpark, it feels like the open warfare between PLM and ERP has now morphed into a cold war or maybe cautious Glasnost and the realization of each other’s right to exist.    Michelle’s report doesn’t focus on the war between the software categories but on the end customers.  The end customers know that both ERP and PLM must exist in a corporation, but they have the problem of figuring out how ERP and PLM should best work together.

The general interoperability of ERP and PLM is beyond my interest in this post.  What is interesting is that there is research in the report on Product Cost Management, even if the report does not call it out specifically.   Here’s a few pieces of data that I have surgically excised from much larger tables from a much larger report.

How important is Product Cost Versus Other Pressures?

Top Pressures Driving Improvements to How Products Are Developed Hiller Associates

CLICK to Enlarge: Top Pressures Driving Improvements to How Products Are Developed

Readers of Jim Brown’s blog on PLM may remember that I did a post on this very topic a few months ago.  You can read it here.  Take a look at the figure to the right.  It appears that my intuition was right, at least with the preeminence of time-to-market as the number one priority to product development.  However, I was surprised to see that Product Cost Management came in number two in importance, albeit 25% less important than time-to-market (using time-to-market as a base).  Regardless, that is encouraging.  So, one wonders again why more companies don’t have stronger PCM efforts?

Does PLM and/or ERP Help with Product Cost Management?

One of the tables in Michelle’s report shows the effect of a company having PLM and the effect of PLM’s level of integration with ERP on many different performance metrics.  One of those metrics is whether a company meets its product cost targets or not.   Take a look at the chart to the right.  This is very interesting for two reasons.

ERP and PLM Hiller Associates

CLICK to Enlarge: Performance Benefits of Integrating PLM and ERP

First, we see a range of meeting product cost targets of 65%-72%.  Really?  In my own research on about 40 operational companies in many different industries, the mean percent of time that companies meet product cost targets at launch is 20-30% — HALF of what Aberdeen is seeing.  I wonder what the disconnect is in my data versus theirs?

Second, the report shows mean (average) of the respondents that fell in each category on the chart (having ERP but no PLM system, having PLM and ERP but unintegrated, and having both in some level of integration).  As expected, the companies with some level of integration do better, but is this statistically relevant?  What is the standard deviation on this data?  I ask this because the range of answers I get when I ask companies how often they meet product cost targets is from 0-100% of the time.

Is PLM or ERP is Storing Product Cost Data?

ERP and PLM Hiller Associates

CLICK to Enlarge: Data sent from ERP to PLM

Looking at the graph to the right, notice that none of the couple hundred Aberdeen respondents were pushing any cost data from PLM to ERP.  They were pushing some data from ERP to PLM.  I have shown the pieces that they are storing in ERP and pushing to PLM.  One could argue that the “Sourcing Data” that they pushing to PLM may be quite relevant in Product Cost

Management.  However, I wonder how relevant the “Costs / Actual Costs” are to PCM, given that ‘actual’ costs imply old carryover costs, which are fairly irrelevant to new designs or re-designs.

According to Aberdeen, 77% of companies do store “Item Costs” in ERP.  This left me wondering, where are the other 23% of companies storing cost information?  An excel spreadsheet? (have mercy!)

 

There’s a lot more in Michelle’s report than this narrow slice of data on PCM.  So, if you don’t subscribe to Aberdeen’s research, you can sign up or just buy the report.  Great data, though, Michelle.  Thanks.

 

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Apr 232012
 

 

Today, I’d like to talk about when it is prudent to poke the tiger, so to speak. During a client visit a few weeks ago, I learned of two situations the company had experienced involving re-quoting parts with the supplier. Although the situations were similar, they resulted in two exactly opposite outcomes – one happy, one sad. The happy situation went like this:

 

We had the big casting on a housing of our product. One day we were talking in passing about how this casting cost us $500. One of our machinists overheard us and his eyes popped open. He exclaimed, ‘$500! That is only about a $100 casting!’ So, we made a very gentle inquiry of the supplier about this casting’s cost, and before we even mentioned shopping the part, they had dropped the part price to $150. On one hand, we were happy, but on the other, we wondered, were these guys cheating us? How many other parts like this were in our bills of materials?

Later that day, I found out about the sad re-quoting situation:

We were trying to find savings on a bucket of parts and thought we had an interesting design change that could lower cost. Our supplier was happy to recalculate based on the design change as time had played a role in the price of parts. He said, “I think that there will be a $14 per part savings for the design change, but this part was quoted five years ago and the material cost and our costs are now higher. The increase is over $20 on old design and $15 on the new design. I’m sorry for this, but we have to ask for a price increase, because we are upside down on this part.”

These situations highlight a lot of latent problems, forcing me to ask:

  • How did a $150 part get through quoting at $500?
  • Why was material cost not indexed on these parts, so that the OEM and the supplier were protected and unsurprised by raw material price changes?
  • Is the spend reviewed on a regular basis by a spend analytics tool that looks for outliers (positive and negative)?
  • Etc. etc.

These answers to these questions are beyond the time that we have today. What this company needed in both situations was a good, speedy, should-cost process and a tool to support their quoting, re-quoting, and re-design processes. However, there are a few things that this company could have asked immediately (without a should-cost tool)? The following five questions are a powerful and fast filter to determine were a company should look deeper into re-quoting or not.

  1. What is the change in raw material price from the time the part was quoted – You know when the part was last quoted, its composition, and mass. It’s even better if you know the portion of the Piece Part Cost that comes from raw material, but you don’t really need it. There are paid sites such as American Metals Market, MetalMiner, London Metal Exchange, and Plastics News that calculate materials pricing. You can also access free data  from the US government at the Bureau of Labor Statistics. Look up the price of the materials on the date you last quoted and today. Take the part mass and calculate what the difference would be. Then you will be able to avoid poking the tiger of asking for a re-quote when the cost of the raw material has risen significantly (as we see in the second situation above).
  2. Was the part quoted in a bundle or individually? Parts that are quoted in packages and bundles typically have less precise pricing from the supplier than individual parts. The supplier will want to make money on the bundle and may not put in that much effort to see that they are making appropriate profit (not too high or low) on an individual part. There may be more opportunity on a bundled part than on an individually quoted part. But, beware, you risk ‘cherry picking’ the part with the supplier and damaging your relationship with them. Also, you should check whether your contract on a bundled part even allows you to re-quote an individual part, or only the entire bundle.
  3. What is your buyers relationship with the supplier? – Although business is business, people still buy from people and make decisions in a way that is not always wholly rational, i.e. goodwill and bad will matter. If you are dealing with a supplier whose relationship is rocky with your company, make sure that the amount of money you think you will save on your part is worth potentially souring the relationship. Conversely, your part may become a battlefield where the buyer and the supplier fight out an existing cold war that has been brewing between them. Your part may get punished for reasons that have nothing to do with the situation at hand.

    Cost per mass in Product Cost Management Hiller Associates

    Click to Enlarge: Cost per Mass Analysis

  4.  Do a simple cost/mass spend analysis on Piece Part Cost of that commodity – Pricing and cost are not precise sciences, but they do follow general trends. You don’t have to do a full and fancy spend analysis, but you can do a back of the envelop spend analysis that will point out the big opportunities and risks. All you have to do is ask for the costs and masses of 30 -50 parts of same type of commodity that you are interested in re-quoting (e.g. castings, forgings, sheet metal, etc.). You should be able to export this info from your company’s ERP, MRP, SRM, etc. system. Just graph the cost versus mass and graphically consider if there “looks” like there might be an opportunity. This simple method would have prevented the first situation described above.
  5. Do a simple cost/mass spend analysis on the non-raw material costs portion of Piece Part Costs of that commodity– This method is a little more fancy but can highlight outliers a little more accurately. Remember that you already have a raw material cost approximation from the first question. Just calculate the Non_raw Material_Cost = Piece_part_cost – (CostCurrent_Raw_material_price * Part_Mass). Graph the Non_raw Material_Cost versus part mass (like we did in 4). Once again, look to see if your part of interest is or is not an outlier.

    Outliers Product Cost Management Hiller Associates

    Click to Enlarge: Non-Material Cost per Mass Analysis

The great thing about suggestion 4 and 5 is that once you have done the mini-analysis for a commodity, other parts in the that commodity can be compared quickly.

To re-quote or not to re-quote – that is the question. Hopefully, the five considerations explain here today will help you answer that question a little more confidently.

 

 

As an aside… I was having trouble when researching this subject beyond my knowledge on the web. I.E. I could not find other articles on things to consider before asking for a re-quote. Does anyone know of articles that are relevant on the net, or is this only covered in books, or the tribal knowledge of gray haired purchasing agents?

 

 

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