Jul 092012
 

It’s been a couple of weeks, since we discussed the Voices series, so if this post is interesting to you, you may want to go back and read the first two:

In these first two articles we introduced several of the voices that are always present in the Product Cost Management conversation, including:

  • The Voice of Hopefulness – the Pollyanna voice that assumes product cost will just work itself out in the end.  It is a voice of justification to ignore Product Cost Management, because the team is just too busy at XYZ point in the development process to seriously consider product cost.  Hope is NOT a strategy.
  • The Voice of Resignation – the nihilist voice that assumes that you have to accept high prices because the three suppliers that purchasing quoted gave you pricing far higher than what seems reasonable
  • The Voice of Bullying – the seemingly unreasonable scream of the customer telling you what your product should cost — not based on reality, but based on the customer’s own financial targets.

However, there is another voice in the conversation that can bring some reason to the cacophony.  It is a voices of reason — the Voice of  Should-cost.

Buck-up Cowboy. The Voice of Should-cost Can Help

Should-cost is just what it sounds like, using one or more techniques to provide an independent estimate of what the cost of a part or product “should” be.  The question is, what does “should” really mean?  For many, the definition depends on the type of cost being calculated, as well as personal should-cost calculation preferences.   I will provide my own definition here, mostly targeted at providing a should-cost for a discretely manufactured part.

Should-Cost – The process of providing an independent estimate of cost for a part, assembly, component, etc.  The should-cost is based on a specific design, that is made with a specific manufacturing process, and at a supplier with a specific financial structure.  Or, the should-cost is calculated assuming a fictitious supplier in a given region of the world that uses the best manufacturing technology, efficiency operating at maximum sustainable capacity.

I realize that this is a broad definition, but as I said, it depends what you want to estimate.  For instance, do you know the supplier’s exact manufacturing routing, overhead and labor rates, machine types, etc.?  In this case, do you want to estimate what it “should” cost to manufacture the part under these conditions?  OR… do you want to know what the cost “should” be for a new supplier who is well-suited to manufacture your design and has a healthy but not overheated order book?  Although you could make many other assumptions, the point is:   KNOW YOUR ASSUMPTIONS.  You will note that I said nothing about margin.  Some people call this a “Should-Price,” while others call it a “Should-Cost” referring to what they will pay vs. what the part costs the supplier to make.  The only difference is that you will also make an assumption for a “reasonable” margin for a Should-Price.

The important point is that the team relying on the should-cost information must define the scenario for which they want a should-cost estimate.  There is nothing wrong with wanting an answer for all these scenarios. In fact, it’s preferable. Run the calculation / estimate more than once.

Should-cost, Should Be a Choir, not a Solo Act

Manufacturing cost is a very tricky thing to calculate.  I often say that the true cost of the economic resources to make a part or product is a number known but to God.  Put statistically, you can’t know the true meaning or standard deviation of a population, you can only estimate it from the samples that you take.  People take two common approaches to should-cost.

The Pop Star Solo Act

The popular solution that too many people pursue is the solution pictured at the right.

No Easy Button in Product Cost Hiller Associates

There’s no easy button to should-cost

They want the easy button — the single source of truth.  They want the plasticized overproduced solo pop star version of should cost, i.e. the easy button tool.  There’s nothing wrong with this and there are some really good should-cost solutions available, but none of them are infallible.  In addition, it is not appropriate to put the same should-cost effort into each part or assembly in a problem.  One should focus where the money is.  However, too many people, especially cost management experts, become sycophants of one particular tool to the exclusion of others.

Single estimates in Product Cost Hiller Associates

The Lonely World of a Solo Should-cost Voice

 

Looking at the diagram to the left, you can see what the landscape looks like when you make your comparisons to one point in cost space. It is an uncertain, scary world when you only have one point of reference.  In this case, all one can do is try to force a supplier to match the should-cost output of your favorite tool.

 

 

The Andrews Sisters, Competitive Trio Quoting

The other very popular approach comes from the purchasing department:  three competitive quotes.  If the auto-tuned single pop star should-cost is too uncertain, purchasing will listen to a trio instead.  Why three quotes?

Supplier quotes in Product Cost Hiller Associates

The Trio of Should-cost Quoting

No one seems to know, but in EVERY purchasing department with which I have ever worked, three shall be the number of the quoting, and the number of the quoting shall be three.  [If you are an engineer, you know my allusion.  If not, watch the video to the left!]   The trio of quotes in the diagram to the right do help clarify the picture a little better, but there is still too much uncertainty and what I call “commercial noise” to really believe that the quotes alone bound what the should-cost plus a reasonable margin is in reality.

An Ensemble of Should-Cost Estimates

Returning to our statistics example, one of the first things you learn in statistics is that it takes about 33 samples to characterize a bell curve distribution.  At 33 samples, you can start to approximate the true mean and standard deviation of the actual population.  I am not saying that one needs 33 estimates of should-cost to triangulate on the true cost, but you should get as many as you can within a reasonable time frame.  Have a look at the diagram at the right to see this illustrated.    Instead of the single pop star approach or the Andrews Sisters trio of quotes, hopefully what you get is a well-tuned small chorus of voices who start to drown out the Voices of Resignation, Hope, and Bullying.  The chorus of should-cost estimates start to bound the “true” should-cost of the part or product and can give the team a lot more confidence.

Triangulating on Product Cost Hiller Associates

Chorus of Should Cost [CLICK TO ENLARGE!]

Sometimes the team does not have time to assemble all the voices of should-cost.  Not all parts or products are worth assembling the full choir.  More often than not, the organization is either unaware of the should-cost voices at its disposal, or are just too lazy to assemble them.

Don’t let your organization be lazy or sloppy with respect to should-cost, and remember that the best music is made when groups of instruments and voices work together, not when one person sings in isolation.

 

p.s. Bonus PCM points if you can guess what a cappella group is pictured in the thumb nail to the post

  4 Responses to “The Voice of Should-Cost (Voices Series, Part 3)”

  1. Nice series on PCM issues, particularly with using multiple tools (or concepts) to provide a better understanding of the cost structure.

  2. Thank you, Mike. Glad to know that people are listening and enjoying the discussion.

  3. Moderator re-posting from Linked-in

    http://www.linkedin.com/groupAnswers?viewQuestionAndAnswers=&discussionID=132163726&gid=126939&commentID=87404001&trk=view_disc&ut=39iJGKfbARhBk1

    Jeff Matthews • Eric ..this is a great series of information, knowledge and real experience….thanks

  4. Thank you for the interest Jeff. Glad that people are finding value in the efforts.

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