ISQA 439/539

Price and Cost Analysis

Five Requirements of Competitive Bidding

Five Requirements of Competitive Bidding Enough Dollars Enough Suppliers Enough Time Suppliers WANT Business Clear and Complete Specifications

When Not to Use Competitive Bidding

Difficult or Impossible to Estimate CostWhere Other Non-Price Issues are

ImportantSpecifications Likely to ChangeLarge/Special Tooling or Set-Up CostsWhen Supply Industry Has Big Backlog

Two Step Bidding

Price and Cost Analysis Objectives

Buyer’s Biggest Fear?

Determine a Fair PriceRemove Excess or Unrelated Costs Ensure Supplier Earns a Fair ProfitFind Ways to Reduce Overall Cost of

Ownership

Price and Cost Analysis

Price Analysis: Comparison of prices without regard to cost elements Quick, Easy Inexpensive Doesn’t yield much information

Suitable for industry standard products

Price and Cost Analysis

Cost Analysis: An examination of the elements of cost Direct Materials Direct Labor Overhead Profit

Takes Time, More Complex, More ExpensiveYields Much More Information

Price AnalysisFour Tools

Competitive Price Proposals Compare Catalog or Market Prices Historical Price Comparison Independent Estimate

Most Suitable for Industry Standard Items

Often Used With Competitive Bidding

Contract PricingFixed PriceFixed Price + IncentiveCost PlusCost Plus Fixed FeeCost Plus, Not to ExceedTime and Materials Indexed Price

Types of Discounts

Trade Resale End User

Volume By Item or By Total

Prompt PaymentSeasonal2%10 ARI vs 2%10 EOM

Prompt Payment Discounts

2% 10, Net 30 Give up use of money for 20 days in

exchange for 2% discount 365 / 20 = 18.25 Periods 18.25 X 2% = 36.5 % Annually

Even if We Only Pay Monthly, Not ARI 12 Periods, 2% Each = 24% Annually

What If We Negotiate 3% 7 Days?

Value of Negotiating Extended Terms

From Net 30 to Net 60Additional 30 Days (1/12 Year) Use of

MoneyAssume Alternate Use of Money Earns

6% Per Year6% / 12 = .50%/moWhich is Better – Extended Terms or

Prompt Payment Discount?

Payment Issues, ContinuedHow to Get A Discount Without Getting

a Discount

Productivity Improvement Curves (Learning Curves)

Graphic Illustration of Productivity Improvement from Repetition

Constant Rate at Each Doubling of Repetitions

Cost for One X Quantity Ordered

Learning Curves, Illustrated

Learning Curves and Volume Discounts

Ways to Hide Profits

Surcharges for MaterialsSurcharges for EnergyChange OrdersCounting Indirect Labor as DirectAllocation of Overhead

Additional Thoughts on Pricing

Minimum Order QuantitiesPrepaid FreightOvercoming Price Increases

Smile and Say ‘No’ Require Justification

Incentives for Suppliers to Reduce Their Costs Helping With Their Purchasing

Robinson-Patman Act

Sources of Information for Price Analysis

ISM Report on Business (www.ism.ws). U.S. Government’s Bureau of Labor Statistics (

www.bls.gov). PPI of particular interest.

U.S. Department of Commerce (www.commerce.gov).

Commercial commodity indexes (e.g., those offered by Dow Jones).

Cost Analysis Custom Products High Volume Requirements Cost Elements

Design Quality/Tolerances Processes Productivity Economies of Scale Sourcing Volume/Learning Curve

Types of Costs ALL Costs are Variable With Enough Time Variable, Within Time Limits

Vary With Decision Variable (Usually Volume) Direct Materials Direct Labor Machine Operating Costs Depreciation – Based on Usage Set-up Costs? Profits

Types of CostsFixed Costs

Building Light, Heat Set-up Costs? Depreciation – Based on Time Administrative / Overhead Costs

Types of Overhead

Manufacturing Overhead Engineering / R&D Overhead Sales and Marketing Overhead General and Administrative Overhead

Application of Overhead

Overheads Pooled Applied as a Percentage of Direct Labor

Applied to a Mature or Industry Standard Product?

Applied to Products Under Long Term Contract?

On the Value of SimplicityComplexity Often Originates With

Creative (Engineering Driven) Cultures Too Many Products Too Much Product Complexity Too Many Low Volume Products Little Component Reuse Too Many Parts Many Non-Standard Parts

Motorola Example145 Batteries78 Displays1447 Software Versions2-4 Times More Complex Than

Competitors

Lean and Complexity Complexity Complicates Supply

Systems Requires More Suppliers Larger Inventories Slower Require More People Harder to Manage Dramatically Increases Costs

Lean and ComplexityMotorola Example

Average Part Count 35% Reduction

Average Assembly Time 47% Improvement

Average Test Time 58% Improvement

Warranty ManagementFour Warranties of UCCNegotiating Extended and Expanded

WarrantiesLabor Costs of ReplacementLonger DurationBegins at Date of Installation

Warranty Tracking System

Concluding Thoughts

Price Analysis Takes Time Cost Analysis Takes More Time Negotiating With a Supplier Without One or

the Other is Going into Battle Unarmed Good Data is the Foundation Planning is Essential Never Talk to a Supplier Without a Plan Negotiate to Achieve Your Plan Quantify Results