cost optimization through simulation rev1

04/10/23 David A. Panek 1

David A. PanekProduct Cost Engineering

Cost optimization through simulation


BIO

Name: David A. Panek

Organization:CSS/MS/PCE

Education (Degree/College): Bachelor of Science Electrical Engineering and Bachelor of Science Computer Science

Area of Expertise:Tolerance analysis, Monte Carlo Techniques, Time to market improvement, Cost Estimation Techniques, Neural costing.

Years of Experience: 25 (costing)

Area of Focus: Improvements to cost control


Introduction

Other business you will be working might use the following:

Zero based pricing, Target costing, Strategic Cost Management, Total Cost Management, Should-Be Costing

Preparing for Negotiations

How do we prepare ourselves to negotiate from a position of knowledge?

What Knowledge do you need to generate a selling price


A brief review of Cost Elements

Elements of Cost

The major cost elements of UMC are:•Direct Material Cost (DMC) & Material Related Overheads•Direct Labor & Labor Related Overheads•G&A cost•Profit•Research and Development


Price vs Cost Analysis

• Price analysis evaluates and reviews only the total “bottom line” price.

• Cost analysis evaluates each cost element involved in the price, including profit.

Indicates areas of discussion/analysis which may result in price reduction

ProfitG&A Cost

Factory Overhead

Labor

Material & Packaging

SellingPrice


Finding elements of cost• Cost elements from financial statement.

• Definition of terms

• Element Details of production.

• Government data on elements in production and non production.

• Robert Morris Associates (RMA), Troy’s

• Edgarscan, Hoovers, Edgar database


Cost elements from financial statement.

Gross margin + Cost of Goods Sold = Selling price

(Gross Profit) (Cost of Sales) (Gross Revenue /Sales)

Net sales = Gross sales - returns - discounts

Gross Profit = Net sales - Cost of Sales

Operating expense = Sales, General & Admin. Expenses, Research and development, etc. Includes depreciation but not interest

Other expenses = Interest expense, misc. expenses and other non-operating expenses. Includes interest, dividends, and miscellaneous income

Profit = Gross profit- expenses


Definition of terms• Refer to Appendix A.

• Cost of Sales(cost of goods sold, COGS, direct cost) -- The cost of making or buying a product sold, or of providing a service rendered, consisting of direct personnel, direct materials (and other direct costs), and factory overhead.

• Gross profit (margin) -- Sales less cost of sales (direct costs).

• Sales (net sales, revenue, top line, total credit sales, etc.) --Income from the sale of a company’s product or service, less a deduction for returns and bad debt

• General and Administrative (G&A) expense -- An indirect cost associated with running a business, other than production or sales


Tradition analysis of selling price

M aterial D irect L abor

F actory O verh ead

C ost of G oods S old

O peratin g an d oth er expen ses Profi t

R esearch & D evelopment

G ross M argins(G ross Profi ts)

S el l in g Price


Gather information• Develop a road map

• Review surveys of industry.

• Review trade groups and supplier councils.

• Use internet search engines Google, Directhit, Northerlights, askjeeves, dogpile, mamma, vivisimo, etc

• Use the power of the normal distribution

• Work and rework ratio analysis.


Items than do not need optimization analysis

• Sheetmetal parts

• Shafts and other turnings

• Designed circuit boards

• Designed harnesses

• Plastic molded parts

• Powder metal parts

• Parts and assemblies that do not have R&D and other developmental work done. ( You still might have to pay NRE [non reoccurring engineering charges])


Looking at companies investing Intellectual Property in Assemblies• Information about the materials used

• Information about similar companies (Edgarscan, Hoovers, Troys as data source.

• Interview buyers or other people who bought similar items.

• Data needed is cost of goods sold and gross margin

• Components of gross margins are covered in annual report if publicly traded company


Working with Product Cost Engineers and other business people you find the following information :

Profit -- equal probability -- 2-17% of DMC

SGA -- equal probability -- 3-10% of DMC

R&D -- equal probability -- 0-6% of DMC

DMC -- equal probability -- $4,920 - $5,432

Selling Price = DMC*(R&D + Profit + SGA) + DMC

Future color’s environmental unit


Results of simulation

Frequency Chart

$

Mean = 6,169.29.000

.007

.014

.020

.027

0

6.75

13.5

20.25

27

5,360.05 5,765.68 6,171.31 6,576.93 6,982.56

1,000 Trials 5 Outliers

Forecast: selling price


Calculated Gross Margin

Frequency Chart

Mean = 0.16.000

.006

.013

.019

.025

0

6.25

12.5

18.75

25

0.07 0.11 0.15 0.20 0.24


Forecast: Gross Margin


AssumptionA s s u m p t i o n : D M C C e l l : D 3

U n i f o r m d i s t r i b u t i o n w i t h p a r a m e t e r s :M i n i m u m $ 4 , 9 2 0 . 0 0M a x i m u m $ 5 , 4 3 2 . 0 0

A s s u m p t i o n : R & D C e l l : D 4

U n i f o r m d i s t r i b u t i o n w i t h p a r a m e t e r s :M i n i m u m 0 . 0 0M a x i m u m 0 . 0 6

A s s u m p t i o n : P r o fi t C e l l : D 5


A s s u m p t i o n : S G A C e l l : D 6


Mean = $5,176 .00

$4 ,920.00 $5 ,048.00 $5 ,176.00 $5 ,304.00 $5 ,432.00

DM C

Mean = 0 .03

0.00 0.02 0.03 0.05 0.06

R&D

Mean = 0 .10

0.02 0.06 0.10 0.13 0.17

Pr of i t

Mean = 0 .07

0.03 0.05 0.07 0.08 0.10

SG A


Gather information about industry averages

p value (approx): > 0.1000R: 0.9800W-test for Normality

N of data: 18Std Dev: 0.064374Average: 0.264389

0.40.30.2

.999

.99

.95

.80

.50

.20

.05

.01

.001

Pro

babi

lity

C1

Normal Probability Plot

PACIFIC SANDS INC 0.422DECTRON INTERNATIONALE INC 0.353LENNOX INTERNATIONAL INC 0.32SPECIALTY EQUIPMENT COMPANIES INC 0.315UNITED DOMINION INDUSTRIES LIMITED 0.308MESTEK INC 0.289POWERCOLD CORP 0.283AAF MCQUAY INC 0.266FEDDERS CORP /DE 0.256SCOTSMAN INDUSTRIES INC 0.25AMERICAN STANDARD COMPANIES INC 0.248NORTEK INC 0.235LANCER CORP /TX/ 0.228AAON INC 0.224HUSSMANN INTERNATIONAL INC 0.213YORK INTERNATIONAL CORP /DE/ 0.212ENGINEERED SUPPORT SYSTEMS INC 0.192TECUMSEH PRODUCTS CO 0.145


Compare results to industry average

Frequency Chart

Certainty is 33.00% from -Infinity to 0.23

Mean = 0.26.000

.007

.014

.020

.027

0

6.75

13.5

20.25

27

0.09 0.17 0.26 0.35 0.43


Forecast: Industry average


Compare results to industry average

Gross margin to industry average

.000

.007

.013

.020

.026

0.05 0.10 0.15 0.20 0.25

Normal DistributionMean = 0.26Std Dev = 0.06

Gross Margin

Overlay Chart


Analysis of results• Notice large difference in Mean of Gross Margin.

Check DMC and mark-up assumption

• Verify company you are working with is compared to right industry group

• Check annual report.

• Try percent of sales approach to verify numbers.Use SIC 3585 or NAICS 333415


Element Details of production.Percentage of Sales Approach

1. Identify SIC (NAICS)code for supplier’s product

2. Define all cost elements as a percentage of sales

3. Calculate Cost of Goods Sold as percentage of total sales. Use Edgar, Edgarscan, or RMA.

4. Calculate material as percentage of sales (column G divided by column H ASM)

5. Calculate direct labor as percentage of sales (column E divided by column H ASM)

6. Calculate factory overhead as a percentage of sales. [Results of step 3 - (step 4 + step 5)]

7. Complete analysis


Example of Percentage of sales Approach -- production

• NAICS Code (333415 - Air Conditioning & warm air heating & commercial/industrial refrig. equip mfg.)

• Supplier publicly traded company. Use Edgarscan

• Information from Edgarscan

– Sales 100%, Gross Profit 26%

• COGS = Net sales - Gross Profit

– [100 - 26] = 74

• Materials = ASM (1998) column G/ column H

– ASM column G = 13,693 million

– ASM column H = 24,938 million

– G / H = 54.9%


Example of Percentage of sales Approach -- Production

• Labor = ASM column E/ column H

– ASM column E = 2,480 million

– ASM column H = 24,938 million

– E / H = 9.9%

• Factory Overhead = Step 4 - (Step 5 + Step 6)

– 74 - (54.9 + 9.9) = 9.2%

• Converting percentages into dollars:

– Materials 3157

– Direct Labor 569

– Factor Overhead 529

– Cost of Goods sold 4255


Example of Percentage of sales Approach -- production

• Converting percentages into dollars:

– Materials 3157

– Direct Labor 569

– Factor Overhead 529

– Cost of Goods sold 4255

– Operating & other expenses 1153

– Profit 345

– Sale price (for example) 5750

• Available is a possible distribution of similar companies to compare Gross margins against. If the distribution is normal you can find the lower 30% where best in class would like to do business.


Government data on elements in production and non production.

• Title 13 of the United States Code direct the Census Bureau to take the economic census every 5 years, covering years ending in 2 and 7

• Individual businesses use the data to locate potential markets and to analyze their own production and sales performance relative to industry or area averages

• Labor codes are determine using Occupational Employment Statistics Occupational Structure 1997-1998


Comparison with Percent of Selling Price

• Found some of the items in Direct material cost was based on using machine hour rates which included profit and G&A in the results thus making higher.

• Discussions have shown the percentages give was based on companies using both machine hour rates and standard percent of sales. This would raise the mark up rate so it would approach the Industry average gross margin.

• Company agreed to slightly lower price based on cost analysis. Savings of between $550 to $650 per unit.


The Power of Knowledge

• Improved understanding of goals

• Ability to solve problems

• Better negotiating position

• Builds respect and cooperation

•Data for making decisions•Definition of terms•Gather information•Fact based conclusions

Results obtained


Reference information (web)• http://stats.bls.gov/blshome.htm (Bureu of Labor

statistics home page)

• http://www.census.gov/prod/2000pubs/m98-as1.pdf (Annual survey of Manufactures )

• http://www.rmahq.org/Ann_Studies/asstudies.html (RMA annual study page to order)

• http://www.sec.gov/edgarhp.htm (Edgar database SEC)

• http://www.hoovers.com/ (Hoover’s financial information)

• http://edgarscan.pwcglobal.com/servlets/edgarscan (Financial statements online) [Not available]


Reference information• Zero Base Pricing - David K. Burt, Warren E. Norquist,

Jimmy Anklesaria - 1990 - ISBN 1557381321

• Vest-Pocket Guide to Business Ratios - Michael R. Tyran - 1992 - ISBN 0139519483

• Cost Estimator’s Reference Manuals - Rodney D. Stewart, Richard M. Wyskida, James D. Johannes - 1995 - ISBN 0471305103

• Handbook of Product Cost Estimating & Pricing - Thomas S. Dudick - 1991 - ISBN 0133727807

• Certification Study Guide AACE International - 1996 - ISBN 188551705X

• Cost Estimating - Rodney D. Stewart - 1991- ISBN - 0471857076


Questions and comments

• Thank you

[email protected]

585-494-1526

cost optimization through simulation rev1

Economy & Finance