ISQA 439/539

1. ISQA 439/539 Price and Cost Analysis

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

3. When Not to Use Competitive Bidding • Difficult or Impossible to Estimate Cost • Where Other Non-Price Issues are Important • Specifications Likely to Change • Large/Special Tooling or Set-Up Costs • When Supply Industry Has Big Backlog • Two Step Bidding

4. Price and Cost Analysis Objectives • Buyer’s Biggest Fear? • Determine a Fair Price • Remove Excess or Unrelated Costs • Ensure Supplier Earns a Fair Profit • Find Ways to Reduce Overall Cost of Ownership

5. 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

6. Price and Cost Analysis • Cost Analysis: An examination of the elements of cost • Direct Materials • Direct Labor • Overhead • Profit • Takes Time, More Complex, • More Expensive • Yields Much More Information

7. Price Analysis • Four 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

8. Contract Pricing • Fixed Price • Fixed Price + Incentive • Cost Plus • Cost Plus Fixed Fee • Cost Plus, Not to Exceed • Time and Materials • Indexed Price

9. Types of Discounts • Trade • Resale • End User • Volume • By Item or By Total • Prompt Payment • Seasonal • 2%10 ARI vs 2%10 EOM

10. 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?

11. Value of Negotiating Extended Terms • From Net 30 to Net 60 • Additional 30 Days (1/12 Year) Use of Money • Assume Alternate Use of Money Earns 6% Per Year • 6% / 12 = .50%/mo • Which is Better – Extended Terms or Prompt Payment Discount?

12. Payment Issues, Continued • How to Get A Discount Without Getting a Discount

13. 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

14. Learning Curves, Illustrated

15. Learning Curves and Volume Discounts

16. Ways to Hide Profits • Surcharges for Materials • Surcharges for Energy • Change Orders • Counting Indirect Labor as Direct • Allocation of Overhead

17. Additional Thoughts on Pricing • Minimum Order Quantities • Prepaid Freight • Overcoming Price Increases • Smile and Say ‘No’ • Require Justification • Incentives for Suppliers to Reduce Their Costs • Helping With Their Purchasing • Robinson-Patman Act

18. 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).

19. Cost Analysis • Custom Products • High Volume Requirements • Cost Elements • Design • Quality/Tolerances • Processes • Productivity • Economies of Scale • Sourcing • Volume/Learning Curve

20. 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

21. Types of Costs • Fixed Costs • Building • Light, Heat • Set-up Costs? • Depreciation – Based on Time • Administrative / Overhead Costs

22. Types of Overhead • Manufacturing Overhead • Engineering / R&D Overhead • Sales and Marketing Overhead • General and Administrative Overhead

23. 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?

24. On the Value of Simplicity • Complexity 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

25. Motorola Example • 145 Batteries • 78 Displays • 1447 Software Versions • 2-4 Times More Complex Than Competitors

26. Lean and Complexity • Complexity Complicates Supply Systems • Requires More Suppliers • Larger Inventories • Slower • Require More People • Harder to Manage • Dramatically Increases Costs

27. Lean and Complexity • Motorola Example • Average Part Count • 35% Reduction • Average Assembly Time • 47% Improvement • Average Test Time • 58% Improvement

28. Warranty Management • Four Warranties of UCC • Negotiating Extended and Expanded Warranties • Labor Costs of Replacement • Longer Duration • Begins at Date of Installation • Warranty Tracking System

29. 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