Oct 292012
 

Last week Hiller Associates published an article on Should-cost in one of the leading online magazines for manufacturing companies, IndustryWeek.com.   Below is a synopsis  of the article.  However, you may want to just read the article here:

Your Should-cost Number is Wrong, But It Doesn’t Matter

Should cost is not perfect, but it does not matter, because its purpose is to be a leverage tool to improve negotiated cost, regardless of the should-cost number’s absolute accuracy.

  • What is should cost?
  • Methods of should cost?
  • Uses of should cost, specifically to reduce the price of products one buys
  • No one expected Peter Lynch to achieve his absolute return predications for a stock
  • How to use should cost as pricing pressure

  12 Responses to “Your Should-cost Number is Wrong, But It Doesn’t Matter”

  1. Moderator Reposting a comment from Linked In Groups. Original here. http://www.linkedin.com/groupAnswers?viewQuestionAndAnswers=&discussionID=178939670&gid=126939&commentID=101669593&trk=view_disc&ut=2RsC1Ra35xJls1

    Joe Szpak • I would like to know where in the hell some of these larger companies ever got the idea that as vendors we should negotiate a price. When I provide a quote I provide a number that is what I need to make the part and a small profit. I do not pad quotes, there is no negotiation here if you do not like what I am charging then go some where else period.
    As if I should sacrifice even 10 cents of the small profit we make to a multi million dollar company, cold day in hell. It is bad enough some of these large companies hold payment on invoices for 75 to 90 days they also want to cut every damn nickle of profit we make.
    Some of these purchasing agents at the larger companies make me sick and I only deal with them on my terms. It is time we as small vendors stood up to these guys, remember they can not function without us so it is time they started working under our terms. When you go to the grocery store and buy something can you tell them hey I will pay in 75 days.
    Why is it then that we have to settle for the terms they dictate, 30 days used to be the norm now they are pushing 90 in some cases, screw you go find someone else to play bank for you. I have played the price game over the years and one thing I learned if you make a good product and you provide it on time then even if you tell the PA you are not going to budge on prices they will 9 times out of 10 order it anyway. If you provide a quote to a company stick by it do not let them try to nickle and dime you to death, no negotiation period it never pays off, all it does is take money out of your pocket and put it into a company that is making millions of dollars a year. In some cases the bonus check for the PA is driven by not only by how cheap they can get parts but by how long they can hold off paying for those parts. My advice quote the job at what you need to get for it and stand by it there is no reason under the sun why you should negotiate your price down, have you ever been able to negotiate it up? It is bad enough we have to compete with 3rd world countries the last thing we need is these PA’s from the huge corporations trying to bleed every last penny out of our pockets NO NEGOTIATIONS!!. my price is my price take it or leave it.

    • By Eric Arno Hiller — @Joe,

      I hear and appreciate your frustration. You bring up a ton of problems in the modern system, among them:

      * Customers assuming that the Vendor is trying to gouge them.
      * The continual drive for lower prices, even when a part is already optimized
      * The unethical behavior of a customer trying to use a vendor (even small vendors) as a bank on payment terms.
      * Purchasing organizations that bred and reward for bad behavior.

      These are all good topics for us to discuss further on our blogs and our linked in forum here.

      Eric

    • Moderator re-posting Michael Unmann from original thread.
      Michael Unmann says:

      Joe to add to your comment how to deal with a job that you have made for years and all costs, material, labor, overhead have risen but you cannot increase the price. As a matter of fact the PA wants to shave 5% off. Well you can apply all the efficiency improvements and still not make a dent in the margins.

    • Moderator re-posting Jeff Matthews from original thread
      Jeff Matthews says:

      Joe, your comments reflect lots of experience ( bad and good) in the real business world. I have been on both sides as a PA ,and as the supplier in the quotation process. In component selling from past industry we almost always face cost downs as part of the business award, but as you have done, we have held our position and negotiated a best outcome. Micheal is right saying there is a point in long term jobs, where productivity gains have been maximized and without real customer involved VA-VE improvements there is nothing but profit to give away. I will say when being on the PA side there are times it is vital to have an understanding of what the product buy “Should Cost”, so a method of cost modeling has to be utilized in negotiations. This related most as we moved from purchasing single components, to buying or selling complex assemblies. Where that assembly was comprised of many components and processes, that made up the quoted price. It does not take you long to learn how a customer or supplier is or will deal with you, when treated fairly we can work together. If not, we all have the right to fire them!

  2. Moderator Reposting a comment from Linked In Groups. Original here. http://www.linkedin.com/groupAnswers?viewQuestionAndAnswers=&discussionID=179181972&gid=3758755&commentID=101497415&trk=view_disc&ut=2PLsakaS5EJls1

    Karl Walter Keirstead • Excellent article. . .

    A must read for anyone who wants to improve their negotiation skills.

    Having a “should – cost” number allows you to decide “when to hold, when to fold”

  3. Moderator re-posting comment from Linked-in Group, original here: http://www.linkedin.com/groupAnswers?viewQuestionAndAnswers=&discussionID=178939670&gid=126939&commentID=102272662&trk=view_disc&ut=1lAvbVZVC7NBs1

    Jorge Sousa says

    Eric
    The correct cost for everything does matter but a large number of suppliers with deep pockets now use the low price as a way of getting the business in the door and them renegotiate the price.
    How would you like to sign a contract to purchase a new car for 20k but when you take delivery there is another invoice for additional 10k, would you ever deal with this entity again?
    In the last four years I lost a lot of work to this unethical behavior, at the time as far as my customers were concerned I was gauging them.
    Unfortunately for my competition I have kept a good relation with the PA and have checked in on the progress, performance and costs of the new supplier on all these parts, I’m pleased to say that most of them are now back on my floor.
    The upside is that my competition lost their pants, my customers got a temporary cost break and I came out of this smelling like a rose because price is not to high after all.

    Joe
    I agree with you it is frustrating as hell most days trying to profitably run a business.
    But just a piece of advice the rigid pole breaks easily, one that flexes just a little will last a long time.

    • Eric Arno Hiller •

      To Jorge’s comment a couple of days ago to me,

      I agree with what you are say about the arbitrary changes of cost. It’s not right, or good business in the long term. What you describe with the behavior of large suppliers is disgusting. This sort of undercutting, if it could be proven, would be clear abuse of monopoly (or oligopoly) power, and likely punishable under anti-trust laws.

      I do believe knowing the right cost is very important. If you know my background (http://www.hillerassociates.com/about/leadership/) , a large part of my career has been dedicated to making the software to help people calculate an ‘accurate’ cost. I wrote this article, some purposely to be contentious, in the sense that I wanted to shake up the purchasing people and others in OEMs who are obsessed with ‘accuracy’ in a cost estimate, but who have no clue what accuracy means. I wanted them to understand that even if they have a beef with accuracy of should-costs, it has other important uses.

    • Moderator re-posting comment from Linked-in Group, original here: http://www.linkedin.com/groupAnswers?viewQuestionAndAnswers=&discussionID=178939670&gid=126939&commentID=102272662&trk=view_disc&ut=1lAvbVZVC7NBs1

      FROM: Joe Szpak

      Jorge, I used to do things like reduced prices or quoting an order of 50 parts only to get 20 and then caving in and doing them for the same price. It never and I mean never works out, the PA may be happy with it at the time but soon they forget they always forget. All they do remember is when you screw up so now it is my terms and my terms only. I have not lost a single customer since I started standing up for myself I have not lost a single job where I was asked to reduce price and refused to do it. My record of quality and on time delivery wins out every time over the few dollars they may have saved. I understand that the job of the PA is to get things as cheap as possible and trust me a lot of them go by price only, those are weeded out right from the start now. I refuse to waste my time quoting for companies that work that way, the only jobs you get from them are the jobs you made a mistake on I have had my share of them over the years.

      My customers all know that when I quote a job I give them my best price right up front I am not a damn used car salesman so there is no haggling over price. .There are certainly times where they can get parts made cheaper somewhere else this is mostly on the very simple low volume stuff and I will tell my customer right up front take it over here this guy can make it cheaper I can not be competitive on it. I am honest right from the get go I can look at a part and know if I can compete on it or not if I can not I wont spend the time to even quote it. Where I have saved them money is through design for production methods, many times we will re design a part to make it less expensive to produce. This is huge part of what we do here and because of it we are able to make the part “cheaper” not through just cutting my quote but by actually reducing labor or material costs which in the end is much better for the customer.

      It is bad enough these huge companies expect us to wait 60 to 90 days to get paid the last thing I am going to do is just arbitrarily cut my cost because they ask me to. If they are open to sitting down with me and looking at cost reduction methods through design changes or different manufacturing methods I am more than happy to do that.
      In the long run that is the best way for all of us involved to get the product to market with a cost they can live with and NOT go to China to get that cost. I can tell you that in a lot of cases the PA has no clue what the part “should cost” they just have an idea what they want to pay and it is based only on the other quotes they have sent out.

      So Jorge my flexing days are long over, if you give your best price up front and are on target with your quote there is no reason to flex. How many times as a PA did you flex the other way, say a vendor made a mistake on a quote missed something or found out the material was something from hell? As a vendor I can tell you that almost never happens you are simply stuck with making the parts for what you quoted or they toss a small offering your way to make it look like an attempt to help. I have had that happen as well and I no longer will even quote work for the companies that have done that to me. My customer base now is great I never have issues like this in fact I do not even quote jobs anymore for a lot of them I make it and charge them what it took. That kind of trust took years to build up and in fact it is the cheapest possible way for a customer to get his parts and I don’t get burned if I missed something or made a mistake. One good thing about the kind of work we do here is I can be a lot more picky with who I do work for and what terms I will do it under. No one company will ever have a thumb on me again I don’t care how big they are.Diversification is what has kept us alive over the years, never put so many eggs in one basket that it will hurt you if you have to make that basket go away.

    • Moderator re-posting comment from Linked-in Group, original here: http://www.linkedin.com/groupAnswers?viewQuestionAndAnswers=&discussionID=178939670&gid=126939&commentID=102272662&trk=view_disc&ut=1lAvbVZVC7N

      FROM: Jorge Sousa •

      Joe I agree with you, I run a business not a flee market or auction.

      I have literally kicked out customers and their over seas parts where thrown out on to the parking lot before he was able to pick himself up, I refused to do work for others that believe I’m here to work for free and be their bank at the same time (HELL NO).

      My smart customers know that I’m not the cheapest supplier monetarily but they also know that their goods will be delivered on time and it will meet all of their requirements and this is the only upper hand I have as supplier.

      I will not quote on any thing that is not a good fit for us and we can make at a reasonable price, it is a waist of my time and my customers No customer will ever be more than 10 to 15% of our business, 2012 is not over but is our best year ever and during a recession to boot, simply because we have kept our quality, delivery and reputation, also said no to about 90% plus of haggling over price.
      This is where you and I seem to differ, I will throw the PA a bone on a small amount but make no mistake I keep the steak.

      My experience by throwing in a little and I do mean little bone at the PA here and there makes them feel like they are in control and in the long run easier to deal with. I have had competitors in the past that where very firm on their ways and had about the same quality and delivery but are no longer in business mostly because they did not have any flex and proved difficult to deal with.

      The work we temporarily lost was not by just a few bucks but 30 to 70% less, I knew there was no way they could supply product or quality at this price. I notified my customers of this, one of them finally realized how true my warning was when they had their assembly line idle for four days and had to pay hefty penalties for delivering late.

    • Moderator re-posting comment from Linked-in Group, original here: http://www.linkedin.com/groupAnswers?viewQuestionAndAnswers=&discussionID=178939670&gid=126939&commentID=102272662&trk=view_disc&ut=1lAvbVZVC7N

      FROM Joe Szpak •

      Jorge,

      don’t get me wrong I have done it in the past, way too much of it now that I look back and I can say that without a doubt it did not pay off. The customers that I did that most for are no longer customers I have tossed them out one by one, my choice not theirs. Once you have a good working relationship with a customer they will never ask you to lower a price at least not without sitting down and trying to get it lower through design changes or alternate manufacturing methods. I just recently did that with one customer and reduced a part price from $25.00 each to $9.00 each and it was on a part we did not even make for them, that price reduction came from switching from wire EDM to creep feed grinding on a part they require. That kind of help I am more than willing to offer even though there is no direct monetary gain in it for me at all. The gain comes from making the customer more profitable allowing more resources to be freed up which in tern allows them to move on to more new projects. Yes I did have a few hours of research involved but that is part of the over all service we offer to every customer and I consider it to be much different than just dropping a price on a part with out any justification except that the PA wants it cheaper. So there are ways to help your customer without losing any money in the deal and that is the way it should be. The long term customers will not play those kinds of games with me I am honest about which jobs I feel I can offer a competitive price on and I will even help them to source those parts elsewhere from time to time. A good customer/vendor relationship is a team effort if one side of that team starts to get too demanding then the whole thing falls apart and you lose the competitive edge. Both sides need to be motivated to do what is best for the over all goal I don’t know about you but I lose motivation when the first thing a customer says to me is the guy down the street quoted that at 50% less. Well why are you talking to me then go talk to the guy down the street. In the end I guess I have weeded out the customers that tried to pull the price game with me and stuck to the customers that know what we offer and know we can do it for good price. We may be a little higher in some cases but they also know that the parts will be there on time and right and they also know I pay close attention to everything that comes through the door I am always looking for ways to reduce part cost. They know that even if I was a few cents high on the last job that the next one coming through could be a few dollars cheaper if I see a way to make that happen. What matters to them is in the end the overall costs have come down or at least not gone up due to the cost of everything else going up.

  4. Jeff, Joe, Michael, Jorge… and everyone else who have been reading and are interested,

    I have to say I am delighted at the amount and depth of discussion that the article sparked. I just wish people were commenting directly on my my site (www.ProductProfitAndRisk.com) to increase my Google foo! Hahaha!

    I also wish some current Purchasing Agents would weigh in on the discussion, too.

    But, what it has convinced me is that I should write an article on all the things that can cause a should-cost to “appear” wrong to the OEM when the should-cost is likely correct. And, as mentioned in the comments above, most of the time, the PA’s don’t even have a should-cost. They have 3 quotes, one or more of which may be junk from people trying to buy the business.

    If you guys have any subjects that you would like to have addressed, please let me know.

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