WEBINAR Thursday, May 28. Sign-up for free!

Product Cost Management, Supply chain, Total Cost of Aquisition No Responses »

May 202020

Recently, our managing partner, Eric Hiller, published an article at aPriori’s website called:

6 STEPS TO OVERCOMING THE SUPPLY CHAIN CRISIS

The response was so good, that aPriori is having Eric teach as part of a webinar on the subject.

Webinar Description: The COVID-19 pandemic has created workforce disruptions that have paralyzed manufacturers from the top to the bottom of global supply chains. Join Eric Hiller, who will share how to keep your supply chains up and running now and in the future. This webinar will be most relevant for sourcing professionals and suppliers. If you are unable to attend the webinar, register, and we will send you a link to the recording following the event.

REGISTER FOR: Using Digital Factories to Model Supply Chain Changes

Thursday, May 28, 2020

Session 1: 9:00 AM EST | 3:00 PM CET

Session 2: 2:00 PM EST | 8:00 PM CET

Corona Supply Chain Blues — what to do about cost, when delivery is a problem

Design-to-Value, Supply chain, Total Cost of Aquisition, Total Cost of Ownership, Uncategorized No Responses »

May 062020

The old world…

So, you had a supply chain, and you thought it was pretty “optimized.”

Yeah, you could improve it here and there, but you had wrung out 95%+ of the addressable waste.

To really make progress, you would need to make MAJOR changes (new suppliers, locations, etc.), but there just is always other stuff to do.

The new world…

Then Corona happens!!!!

Your tidy and luxurious platform is now burning.

Now you have no choice but to DO SOMETHING different.

Cost was really important and you thought delivery and quality were assured.

Now delivery is a huge problem (maybe quality too.)

The future world…

What do you do short term? What do you set up in the future to stop this from happening again?

Find out in Eric Hiller’s new article over at the aPriori blog (which Eric originally started in 2007, when it was “CostCents“) It has been a long time since Eric worked at aPriori or wrote for the blog, but he has some advice now.

6 STEPS TO OVERCOMING THE SUPPLY CHAIN CRISIS

Relative Cost Power – How to not know the cost of your products and win negotiations, anyway

Product Cost Management, Product Pricing, Uncategorized 10 Responses »

Jun 052014

NEW ARTICLE in Industryweek.com by Hiller Associates

Synapsis: No matter how badly you think you are pinned down in a pricing negotiation, there are always tools for leverage that can help you improve your position. Relative should costing is one of these powerful tools.

To read the article at Industryweek.com, click here.

Or, you can read the full article below

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Relative Cost Power – How to not know the cost of your products and win negotiations, anyway

With product cost accounting for 70 to 90% of every revenue dollar on the income statement, it’s not hard to understand why cost is such a big deal to many companies. In the last decade, there has been a renewed focus on the world of Product Cost Management, including techniques like Design for Manufacturing (DFM), Should-Costing, Spend Analytics, etc. Many of these techniques are used (or are intended to be used) *before* the sourcing phase of the Product Life Cycle. While procurement professionals should be involved up front in product design, a lot of the responsibility for success with these techniques will rest on the design engineering staff.

Regardless of whether your company is best-in-class in Design-To-Cost, or whether you have the most cost-oblivious design staff in the world, your designs must be eventually made or bought. With the dominance of outsourcing, it’s more difficult than ever to know what the should-cost of a product is? Purchasing agents are told that they should know the should-cost of products before they walk into a negotiation with a supplier. However, that is not easy, and the fact is:

Your supplier will typically know more about their costs than you do.

So, how do you precede in a negotiation where your supplier has more and better information? Are you completely at their mercy? And, what if your supplier holds oligopoly, or even monopoly, supplier power? Are you just a price taker?

ANSWER: No, you don’t have to be a price taker, at least in the case of buying multiple variants of a similar spend item. Recently, I wrote a blog post about how the human brain does not like non-linearity, discontinuity, or non-monotonic functions. This is a fancy way of saying that people are very good at detecting pricing inconsistencies within multiple similar products.

This inconsistency is the key to being able to better control a negotiation, in which you really don’t know what the absolute cost of a product should be, or where you know the should-cost, but have little buyer power. Let’s explain this with an example:

Case Study in Relative Should-cost: Pick-up Truck Driveshafts

In the late nineties, I had the privilege of being the product development owner for the drivelines (axles and drive shafts) used in the full-size pick-up that was best-selling vehicle in the world for over 30 years. This truck made over 100% of the profit for my employer (making up for losses on other vehicle lines). I was very young and inexperienced at the time, so it was a great experience, but a big challenge.

Within the first few weeks in the assignment, I was told that it was time to negotiate the contract for the driveline commodity (over $450 million annually) for the upcoming 2004 vehicle. I was told that this was a very complex process, but that the purchasing group would lead it. However, my first meeting with our purchasing team lasted about 10 minutes… long enough for the purchasing team to say: “Oh, your supplier is *that* supplier? We don’t get involved with them. Have a nice day.” And, they walked out of the room.

After the shell shock of the experience wore off, my manager explained that our supplier was the former components division of our employer (the OEM) and that our CEO had desperately wanted to spin-off the component divisions from the OEM. To do this, our CEO had negotiated a deal with the powerful automotive union, agreeing that the union members would technically work for us (the OEM), but be leased to the newly spun-off supplier. If the OEM did not give enough business to the components supplier to keep the union members employed, the OEM was responsible for paying them a large portion of their wages, while they waited to be deployed somewhere else.

Effectively, this removed almost all negotiation power from us, the OEM. Therefore, our purchasing team had made a decision at the executive level to not participate in negotiations with this particular supplier. Instead, these negotiations were dumped into the laps of the product development team, with some support from finance.

Suppliers with Complete Supplier Power

The product development team had its own problems already. The marketing team were demanding much better performance and quality out of our parts. But, the finance team demanded that those parts be cheaper than the previous generation of parts! And now, we had an AWOL purchasing team. In terms of the old Porter’s Five Forces framework, our supplier had tremendous supplier power! What to do?

I certainly was not an expert in drivelines yet, but I had just completed a master’s thesis focused on product cost. So, I first reached out to the cost estimation team within the OEM. They helped us understand what the absolute cost might be for a driveshaft. We were also able to negotiate with the purchasing to do an “unofficial” price study with other driveline suppliers.

Our first negotiation with our supplier (the OEM’s former component divisions) was pleasant, but utterly futile. I excitedly explained what we thought the absolute part cost of these driveshaft parts should be, and hinted that we had quotes from other suppliers to prove it. Our supplier, being quite shrewd, politely explained why their product was, obviously, so much more valuable, combined with a tangible undercurrent of, “Well that’s nice that you have should-costs and quotes from other suppliers, but we really don’t care, because you have to use as a supplier regardless.”

Relative Should-Cost to the Rescue

Now what were we going to do? These lines of argumentation (absolute should-cost and competitive quoting) were not prevailing on the supplier. So I tried something different: Relative Should-Costing.

A driveshaft is complex in many ways, but in reality, it is a modular part design. It’s constructed mostly of the end yokes coupled with an extruded or seam-welded tube between those yolks. If we had a longer truck we simply extended a tube. (For technical safety reasons, we had three variants: a 1-piece steel driveshaft, 1-piece aluminum, and a 2-piece steel.) In total, we had over 70 part numbers of these three designs, and we knew the price quote for each variant.

Using a spreadsheet, I simply estimated a reasonable cost for one driveshaft tube for each of the 3 variants. With this estimate, it was easy to calculate a per-inch cost of that tube. By subtracting, I knew what all the other parts in the driveshaft (e.g. end yokes) approximately cost. That was all I needed. I didn’t need to know what the absolute cost of each driveshaft should be.

I just needed to know what each similar part should cost RELATIVE to another part.

In the second negotiation, we politely questioned the supplier on their confidence in their pricing ability. They professed with great certainty that they knew how to price and stood by those prices. Then we coyly pulled out the part numbers for the three drive shafts for which I had estimated the absolute, and asked if they stood by those prices. They eagerly declared they stood by those prices. Gotcha!

At that point, we started asking how Part B that was 5 inches longer of extruded tube than Part A could cost $10.00 more than Part A, when the tube extension was only worth $0.30. The supplier was not sure and asked for time to investigate. We had several more meetings on the topic, but in the end, the supplier could not give any logical reason why their pricing for similar drive shafts varied in bizarrely non-linear ways.

The supplier reduced the cost of the entire driveshaft commodity by about 8%, resulting in about $35 million a year, straight to the bottom line of my employer, the OEM.

Should the discount have been bigger? Yes. Did my calculations show that the supplier should have given us more money? Yes. But, did we get a significant concession from a supplier who held every card in this negotiation? Yes we did!

In reality, the supplier still could have refused to reduce their costs. However, the point of these Relative Should-Cost negotiation techniques is to bring logic and facts to bear to increase leverage in a situation where you seemingly have no leverage.

The win occurred when the supplier just couldn’t answer why their own pricing was internally inconsistent with itself.

This is a good lesson for suppliers to learn, as well. When quoting a basket of similar parts, it’s wise to make sure that you understand your own pricing and reflect the underlying costs in a logical and linear way to your customer. This greatly reduces the risk of your customer casting doubts and driving your pricing down, perhaps unfairly.

Diagnostic vs. Leverage Tools and Absolute vs. Relative Should-Cost

The case study above is an example of the difference between using a Relative Should-Costing technique, versus an Absolute Dollar Should-Costing technique. If this sounds interesting to your company, you may want to read more in my previous article in Industryweek.com, Your Should-cost Number is Wrong, But It Doesn’t Matter. In this article, we talk further about using should-costing, not only as a diagnostic gage to tell you what the cost is, but as a tool for leverage to move the cost down.

Remember, no matter how badly you think you are pinned down in a pricing negotiation, there are always tools for leverage that can help you improve your position. Relative-Should costing is one of these powerful tools that should be in your tool box.

Comparing Quote Apples with Estimate Oranges

Product Cost in Industry, Purchasing / Sourcing 5 Responses »

Jul 122013

Today we are reposting the article we wrote this week for ENGINEERING.com. The original article is here and our announcement of our partnership with ENGINEERING.com is here. Enjoy!

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One of the most frustrating things for many engineers is understanding the quotes they receive from their suppliers. They want to know how these quotes compare to their own internal estimates. Unfortunately, most engineers are not skilled at getting the right answer.

Strangely, engineers are typically very good at this in their personal lives. Let’s say you’re going to buy a new stereo receiver. In a matter of minutes you have the following options laid out:

Option 1 – Amazon ($300) + Shipping ($0) + Squarespace extended Warranty ($50)
Option 2 – Amazon vendor ($270) + Shipping ($15) + Squarespace extended Warranty ($50)
Option 3 – Stereo Shop ($320) + No Shipping ($0) + Included Extended Warranty ($0)

In your personal life, you not only outline how much costs are, but where they are. That is, in which cost bucket does each dollar reside? So why is this so hard when dealing with a part quote at work? The answer is: it shouldn’t be!

Don’t ask what, ask where

The first step to unraveling quotes is to put the numbers aside – what matters first is to decide into which cost buckets each dollar should go. To illustrate this, let’s consider buying a lightly machined casting.

First ask, what resources go into delivering this casting to your shipping dock? Take a look at the figure below. On the top line in orange blocks, we show the various cost buckets for the casting. These include the raw material that is melted, the various processes that are applied, the machining, any painting, and then margin and logistics.

Hiller Associates Matching Estimates and Quotes

CLICK TO ENLARGE

Start with your estimate

We suggest that your starting point should be your own internal cost estimate from your cost expert, your spreadsheet, or from a third party Product Cost Management calculation tool.

It’s likely that the level of detail in your calculation method will be deeper than what you receive from suppliers. Even so, your tool or spreadsheet may not provide a number for each bucket of cost. In our casting example, our initial estimating method did not provide margin and logistics. Becaues these are real costs we will list them, noting that we don’t know what numbers to use for those costs at this point.

Lay out what you know from the Supplier Quotes

Now, it is time to match up your supplier quotes. We show three different quotes in the casting example. Your purchasing department may give you more quotes or less quotes. However, in our experience, three shall be the number of the quoting, and the number of the quoting shall be three. (If you don’t get that reference, please see the attached video).

The quotes you receive probably won’t line up exactly with your estimates. Suppliers, as in example Quote 3, rarely provide a detailed breakdown. Regardless, it’s important to know which costs are included in the $23.00. Are any costs included missing?

But what if I am missing a cost bucket?

It’s common to not have an estimate for every cost bucket from one single tool or spreadsheet. Thankfully, there are several methods to triangulate to a better estimate.

Look at past part quotes for similar parts.
Ask an expert. For example, your shipping department may know what it would cost to ship similar casting parts.
Use a different estimation tool that does include the missing cost bucket.
You can also surgically lift and triangulate cost buckets from the quotes themselves. For example, you could average the cost for logistics between Quote 1 and Quote 2, so your internal estimate of logistics cost becomes $1.50.

The benefits to you and your company

You may think that this exercise is just about whether you should be paying $23.00 for this casting or $20.00. That is an important question, but there are other big benefits to this method.

Missing Buckets – One of the biggest advantages to accounting for cost buckets is to identify any misunderstandings between your company and the supplier. It is better to find out now that the supplier has not included the shipping costs than to find out later.
Your time to shine in front of management – regardless of the final cost that you negotiate, if there is a question later from your management about why you paid what you paid for a part, you have a ready-made, easy-to-understand management slide prepared.
Negotiation power – deep understanding of costs is very useful when talking to the supplier with whom you decide to negotiate. Of course, you cannot show them the numbers from other suppliers’ quotes, but there is nothing wrong with showing your internal should-cost estimates.
Learning by doing – after you go through this exercise several times, you will start to develop an intuitive feel for what drives cost in a commodity class. In our example, you will start to understand the relative magnitude of machining vs. casting cost vs. raw material for lightly machined castings.

They say that “It’s not about the destination; it’s about the journey.” The good news is that with part quote evaluation, both the journey has value (as shown by the four points above) and the so does the destination (e.g. paying $20, rather than $23 for a casting). Enjoy both!

A Product Cost Management Post to Upset Everyone!

Product Cost Culture, Product Cost in Industry, Product Cost Management 44 Responses »

May 062013

In last week’s post we talked about where Product Cost Management sits in the organization . We concluded that Product Cost Management lives in a weird no man’s land between purchasing, engineering, finance, and manufacturing. Because the area is a wilderness, we used the analogy the people seriously pursuing Product Cost Management in companies are similar JRR Tolkien’s legendary Rangers in the Lord of the Rings trilogy . The Rangers go about doing good and benefiting the general public, even when the public does not recognize the good they are doing. Sometimes, the general public even considers these solitary trackers and warriors as meddling, or even, sinister. We even compared the best product cost management folks to the most famous of all Rangers, Aragorn, son of Arathorn .

Several people wrote us about this article, very pleased with the analogy comparing product cost management people to Tolkien’s Rangers. They also validated our assertion that Product Cost Management in the organization, lives between other major functions. We must say that EVERYONE was on board with the post and feeling very good about it.

This week we’re going to burn through all that good will and make everybody angry!

We’ll do this by explaining why people from every one of the major functions in a manufacturing company are ill-equipped for Product Cost Management. Are we doing this for the schadenfreude* of internet lulz? No, we’re doing it because we believe these paradoxes are true. These are the unspoken but often thought, truths that need to come to the light of day.

*For a PG-13 musical definition of schadenfreude from Avenue Q, click here.

It’s unfortunate we have to say this, but we’re not embarrassed of it either. First, one disclaimer:

The statements below are obviously generalizations of the functions within the organization, as well as of the people of that make up those functions. Throughout our firm’s long experience in industry with Product Cost Management, we have met many individuals within each of these functions that do not fit the stereotypes below. However, the paradox below truths hold in general. Any resemblances to any person, living or dead, is purely coincidental.

Why each major function in a manufacturing company is so poor at Product Cost Management

Engineering

The short answer is, that engineering really doesn’t care about product cost that much. Product cost is a distant second or third , or maybe a fourth priority, compared to other product attributes such as time-to-market, quality , or performance. We say this despite the fact that we have data of our own, as well as data from other analyst firms, that show that when asked about product cost, product development executives will prioritize it near the top (usually 1st or 2nd). However, our experience in practice is that when the rubber meets the road, product cost is not the first or second priority. On a personal level, the paradoxical thing is that engineering is actually better equipped than almost any other function to do a good job at Product Cost Management.

Product Cost Abilities by Functional Group

CLICK TO ENLARGE

The reason for this is that a major challenge of Product Cost Management is linking the physical characteristics of a part (e.g geometry, features, mass , time to produce the part, etc.) to the financial (dollars and cents). Engineering lives and breathes the physical world. Engineers are trained to understand the physical world and to control it from the very first day they stepped foot into engineering school . They’re not afraid of the physical world . The problem is that product cost, despite the statements of most engineering executives, really is one of the last priorities to address when you’re in the middle of a product development program.

Finance

Finance relationship to PCM is the exact opposite of engineering . Finance DOES have the incentive to control product costs. In fact it, it’s their whole world. The problem is, most finance people are not from an engineering background, and are, quite frankly, terrified of the physical world of 3D CAD , features , and even if the manufacturing floor. To them, it is very uncomfortable to leave the safety of dollar numbers on an excel spreadsheet. They are also often hampered by the accounting classes they took in college. Specifically, Financial Accounting thinking has come to dominate the way they perceive Managerial Accounting in a way that is wholly inappropriate. Accounting , in reality, has a backwards looking allocation-of-cost viewpoint, rather than the forward looking predictive cost paradigm, which is needed for product cost management . The problems with the current accounting paradigm are certainly worth a future blog post, if not magazine articles or whole books !

Purchasing

Purchasing often suffers from the same malady as finance. They don’t understand the physical world very well. Many buyers also have a bit of a multiple-personality problem when dealing with product cost. On one hand, buyers are suspicious that the supplier is not telling them the truth and charging them too much. On the other hand, if a Product Cost Management person or another should-cost source provides the buyer with a product cost for a part that doesn’t match with the supplier gives them, the buyer often immediately concludes that the should-cost (not the quote) must necessarily be wrong . Riddle me that? They also have a a commodity worldview. It’s more beneficial for them to focus on large groups of parts within a commodity, as opposed to single parts within a product that is being developed. Finally, the incentive of RELATIVE cost reductions (i.e. “year over year” cost reductions) sets up a very bad dynamic with Product Cost Management. PCM is first focused on making sure the product comes to launch AT the right cost, rather than reducing cost year over year later. All these topics are worthy of extensive articles, in and of themselves, but that must wait.

Manufacturing

In some ways, manufacturing is probably currently better equipped to deal with Product Cost Management than anyone else in the organization . Manufacturing people are usually comfortable with the physical attributes of the product, just as engineering people are (although they do not have the depth of knowledge in this respect that engineering typically does). Manufacturing does care about cost, just as finance does. They also have a practical nature like purchasing and are quite likely to be comfortable dealing with suppliers. However, there are PCM challenges and paradoxes for manufacturing, as well. First of all, due to rampant outsourcing in most organizations, the only manufacturing left in many companies is final assembly. Therefore, the manufacturing guys are often absent from the PCM ballgame. Their concern about how they’re going to assemble the parts together for the final product, not how to make the parts. Secondly, manufacturing is a very busy place, concerned with the here and now and fighting fires, rather than more strategic pursuits such as Product Cost Management.

What to do?

So, we’re all in a bit of a pickle functionally with Product Cost Management. The table to the right gives a summary of the paradoxes we face functionally. It also adds one global problem that we talked about last week, which is that PCM doesn’t really fit nicely within any of these functions.

Given these structural problems in the organization’s functional cultures, is it any surprise that most companies struggle with Product Cost Management?

What’s the solution? It’s probably too complex of a problem for one Silver bullet. However, hopefully in the next post we can propose at least one possible way to move beyond the organizational problems and paradoxes discussed today.

The Rangers of the Wilds – Where does product cost management live in the organization?

Project Cost Management 5 Responses »

Apr 292013

If you are a Product Cost Management person with an inner nerd like us, then you probably love and the Lord of the Rings trilogy by JRR Tolkien. One of the iconic characters in the book is the king in exile, wondering the wilds as a Robin Hoodesque type of character, a man named Aragorn. One of the things that makes this character so compelling is the fact that he, and his brothers-in-arms, the Dunedain Rangers, secretly wander the wilds protecting those who are blissfully unaware of the evil all around them.

Why do we love Aragorn, who goes by the nom de guerre “Strider” so much? It’s because Aragorn is unpretentious, self-sufficient, self-sacrificing, and yet dangerous and mysterious at the same time. Aragorn gets things done, even when those around him don’t realize it. And when those around him do get to know him, they are astounded at just how powerful, efficient, and clever he is.

Yes, Strider is a misunderstood man, as Mr. Butterbur, the bartender at the Prancing Pony, the inn at Bree says,

He’s one of them rangers. Dangerous folk they are — wandering the wilds. What his right name is I’ve never heard, but around here, he’s known as Strider.

Strider and the rest of the Rangers don’t really have a home, and so it is also with Product Cost Management in most organizations. It’s very rare to find Product Cost Management a department that is not a part of a larger organization. And, it is always seems to be the red-headed stepchild of that organization. No one really knows exactly who these guys are or what they do, except that “I think they know a lot about cost and manufacturing stuff.” Product Cost Management never seems to fit in with the organization in which it has been placed, and everyone is always wondering if it really belongs in another organization.

So where does product cost management belong in the organization? That’s a difficult question because Product Cost Management relies so heavily on information from four different organizations. In order to do their work of profit maximization, expert in PCM deep domain knowledge of the following:

What is the geometry a part, a subsystem, a product, and how does the geometric features, tolerance, and materials of these physical items relate to their costs?
What is the costing structure of the organization, what are its overhead rates, what are its labor rates?
What suppliers does the organization have and what are the cost structures of these organizations? What are their manufacturing capabilities?
What is the organization’s internal manufacturing capabilities?

These are very broad pieces of information that are flung across the organization. If we look at the figure above, we see that these pieces of information are hidden in the four main functions of a manufacturing company: engineering, finance, purchasing, and manufacturing. Product cost management, like the Rangers in JRR Tolkien’s trilogy, seems to live in the no man’s land or wilderness between these organizations, where few people from any of the four organizations are comfortable operating.

Why are most people so uncomfortable operating in this nexus? Well, that’s a subject for our next post.

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

PCM Technique / Cost Models, Product Cost Culture, Purchasing / Sourcing 12 Responses »

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

The Voice of Should-Cost (Voices Series, Part 3)

PCM Technique / Cost Models, Product Cost Culture, Purchasing / Sourcing, Uncategorized 4 Responses »

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.

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

The Voices of Discord in Product Cost Management (Voices Series, Part 2)

Product Cost Culture, Product Cost in Industry, Product Cost Management 1 Response »

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:

Cost was never targeted properly in the first place (a.k.a. the Voice of Hope was listened to over the Voice of Reason)
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)
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.

Do you hear the voices? (Voices Series, Part 1)

Product Cost Culture, Product Cost in Industry, Product Cost Management 4 Responses »

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:

Click to Enlarge! Voices in Product Cost Management

What are the ‘Voices’ in the discussion of product cost and profit
What are the target costs or cost statuses that the voices dictate or influence
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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