understanding and using cost breakdowns
TRANSCRIPT
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Understanding and Using Cost
Breakdowns
Professional courses to optimize your buying team’s performance
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All
APD Personnel
Main Presenter – Jeoff Burris
Producer Jon Homrich
Introductions
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Executive Alignment
Purchasing strategies advance the CEO’s
vision for the company.
Collaboration
Purchasing works with other departments and
suppliers to achieve common benefits.
Influence
Purchasing is engaged on 100% of third party
spend across both COGS and SG&A.
Strategic Focus
Strategic resources focus on strategic activities
100% of the time.
People Management
Domain experts are provided the tools, training and
structures needed to be successful.
Access to Actionable Data
Spend decisions are made using real-time cost
and market intelligence.
Making Purchasing a Competitive Advantage
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We lever a network of >10,000
supply chain professionals, and
have both onshore and
offshore delivery capabilities
Our solutions are empowered
by a purpose built, proprietary
technology platform
We have a database of >1,000
cost elements based of >850
cost blueprints.
All of our solutions are provided on a modular, as-a-service, basis.
PeopleTools &
TechnologyIntelligence
Elevating the Role of Purchasing
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Companies can have as much as 70%
costs based upon supplier pricing.
So, your effectiveness in managing this
pricing is paramount to your
company’s financial success.
Importance
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Session 1 – July 11 - Raw Material and Labor
Increase understanding of the cost detail suppliers provide in their quotations. Review common ways suppliers inaccurately quote.
Session 2 – July 18
Burden and SG&A
Increase understanding of the cost detail suppliers provide in their quotations. Review common ways suppliers inaccurately quote.
Review top ways to: Improve analysis of the cost impacts of design changes. use the cost breakdown information to negotiate costs of design changes.
Objectives for this Training
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Poll Question
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Yearly Volume (11) Currency (12)Exchange
Rate per USD
USD 1.0000
EURO
TBD
Max. daily production (18)
Packag.responsib. (80)
750
Make part /
Drawing number
(20)
Make part
description
(21)
Quantity/Assy
(22)
Sub Supplier
(23)
Country of
Origin
(24)
UOM*
(25)
Unit price/UOM
(26)
Gross usage/part
(27)
Net
usage/part
(28)
Scrap Reclaim
Cost/Unit (30)
Total Raw Material
Cost (31)
Total Cost
(33)
56789123 Tie bar NA NA NA lb 0.4350 1.8375 0.9039 2.0% 0.0079 0.0542 0.7647 12.0% 0.0918 0.8565
56789123 Tie bar NA NA NA lb 0.4350 0.4500 0.2425 2.0% 0.0021 0.0542 0.1884 12.0% 0.0226 0.2110
56789123 Tie bar NA NA NA lb 0.4350 0.7600 0.4630 2.0% 0.0040 0.0542 0.3211 12.0% 0.0385 0.3596
56789123 Tie bar NA NA NA lb 0.4350 1.1200 0.4189 2.0% 0.0036 0.0542 0.4589 12.0% 0.0551 0.5140
56789123 Tie bar NA NA NA lb 0.4350 0.2400 0.1543 2.0% 0.0013 0.0542 0.1018 12.0% 0.0122 0.1141
56789123 Tie bar NA NA NA lb 0.4350 0.9800 0.3527 2.0% 0.0031 0.0542 0.4008 12.0% 0.0481 0.4489
0.0000 0.0000 0.0000 0.0000
0.0000 0.0000 0.0000 0.0000
0.0000 0.0000 0.0000 0.0000
0.0000 0.0000 0.0000 0.0000
0.0000 0.0000 0.0000 0.0000
* Unit of measure (kg, pound , etc) Total Raw Material: 2.2358 0.2683 2.5041
Program name (8) Part description (9)
2012 7/25/2011
Supplier (1) Drawing Number (2) Revision (3) Part Number (4) Price basis year (5)
OEM's Name (7) Life-time volume (10)
Offer date (6)
ABC Company 56789123 99999999
Payment Terms (13) Plant (14) Suppliers production site (15) Production batch size (16) Number/ shifts (17)
Safety Stock quantity (62) Delivery terms (65) Delivery frequency (78) Delivery lot (79)
NSDSM Adrian Mexico 10,500
Raw MaterialsItem description (19) Scrap Value/Part (29)
% $ / € /TBD
Raw Material SG&A and Profit Markup (32)
% $ / € / TBD
Delivery flexib. (81)
2,083 Weekly 10,500
Detail Stamping 25777427 - 1008 CRS in Coils
Detail Stamping 25777427 - 1008 CRS in Coils
Detail Stamping 25777425 - 1008 CRS in Coils
Detail Stamping 25777426 - 1008 CRS in Coils
Detail Stamping 25796964 - 1008 CRS in Coils
Detail Stamping 25777428 - 1008 CRS in Coils
Tie Bar Assembly 2,500,000
5000
500,000GM GMT 900
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What percent of the time are you asking suppliers to
complete the Inteva Detailed Cost Breakdown?
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Poll Results
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Buyer strives to control market forces that determine pricing.
Buyer strives to understand and help manage the cost drivers of the purchase.
Market Based Pricing Cost Based Pricing
Management of Pricing
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Profit
PriceProfit
Establishment of Pricing
Buyer Focus CostsPrice
Costs
Market Based Pricing Cost Based Pricing
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Management of Pricing
Positives
Straightforward Supplier
Participation
Swift Results
Simple Analysis
Usable for most commodities
Negatives
Limited understanding of cost
drivers
Struggle to understand pricing
validity
Inconsistent supplier pricing
Difficult to control price over
time
Market Based Pricing Cost Based Pricing
What are the Positives and
Negatives of getting detailed cost
breakdowns from suppliers?
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Let’s Use the Chat Feature to Share
What are the Positives
and Negatives of getting
detailed cost breakdowns
from suppliers?
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Management of Pricing
Positives
Straightforward Supplier
Participation
Swift Results
Simple Analysis
Usable for most commodities
Negatives
Limited understanding of cost
drivers
Struggle to understand pricing
validity
Inconsistent supplier pricing
Difficult to control price over
time
Positives
Detailed understanding of cost
drivers
Ability to validate quote
Establish methodology for
pricing adjustments
Standardize cost
Basis for collaborative
relationships and tools
Negatives
Involved Supplier Participation
Usable for select commodities
More time spent in preparing
and analysis
Market Based Pricing Cost Based Pricing
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Management of Pricing
What determines whether a buyer uses a Market or Cost Based approach?
Interest
Ability
Market Based Pricing Cost Based Pricing
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Buyer Interests
Supplier controls the design; buyer has no input.
Product has limited impact to buyer’s profit.
Manufacturing costs of the product are insignificant.
Buyer controls the design of the product and therefore can influence costs.
Product pricing has a significant impact to buyer’s profit.
Manufacturing costs of the product are significant.
Market Based Pricing Cost Based Pricing
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Buyer Ability
Suppliers hold the balance of power.
Few suppliers controlling the market.
Buyer has only market based tools, knowledge or resources.
New evolving product.
Buyer holds the balance of power.
Many suppliers.
Buyer has cost based tools, knowledge and resources.
Mature product.
Market Based Pricing Cost Based Pricing
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Global Sourcing - Market vs Cost Approach
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Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7 Year 8 Year 9
MarketInitial Sourcing with
competitive pressure
– no cost knowledge
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Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7 Year 8 Year 9
Market
Without cost knowledge,
price creep occurs
Global Sourcing - Market vs Cost Approach
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Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7 Year 8 Year 9
Market
Market testing/negotiations
used to reduce price
Global Sourcing - Market vs Cost Approach
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Global Sourcing - Market vs Cost Approach
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Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7 Year 8 Year 9
Market
Cycle repeats
Resourcing at the peaks captures market pricing
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Global Sourcing - Market vs Cost Approach
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Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7 Year 8 Year 9
Market
Cost
However, the market testing
fails to capture the true
cost.
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The Case for Cost
Breakdowns
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The Case for Cost Breakdowns
Effective use of cost breakdowns is the best cornerstone for effective cost management as it:
Provides buyers and managers with actionable data to improve purchased material cost.
Provides information required to understand global sourcing opportunities.
Improves negotiation results regardless of the negotiating model.
Can form the basis for more collaborative supplier relationships based upon cost models and tools to reduce waste and cost.
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Benefits to Buyers
Data driven approach, used consistently makes issue resolution easier.
Can change the tenor of negotiations from positional (win/lose) to less stressful, more collaborative, partnership based.
Increases buyers knowledge of operations as well as cost accounting thus providing more ability for lateral and promotional organization moves.
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Benefits to Suppliers
More objective and equitable quoting process.
Provide supplier feedback on cost competitiveness.
Ensures pricing is tied to cost.
Common understanding of cost structure provides supplier and customer with the basis for a collaborative relationship.
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Commodities that can use Breakdowns
Characteristics - - High manufacturing cost as a % of sales
Customers controls the design
Many suppliers
Examples –
Construction
Capital equipment
Plastic parts
Stampings
Assemblies
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Cost Breakdowns
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Approach
1. General accounting refresher to better understand what information is contained in a cost breakdown.
2. Analyze each of the 5 areas of cost in detail through discussions and workshop examples.
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5 Main Areas of Cost
Labor
Material
Burden
SG&AProfit
Selling, General, and Administrative
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Cost of Goods
Sold
Cost of Goods
SoldProfit Revenue
Material
Cost
Direct
Labor Cost
Burden/
Overhead
SG&A
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Material Cost
Labor
Material
Burden
SG&AProfit
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Material Cost Simplified
Material
Cost per
Unit of
Measure
Amount
of
Material
Used
Material Cost
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However, It’s not that Simple
Material specifications may be left to interpretation.
Manufacturing processes are not 100% efficient in using raw materials.
Suppliers mark up material cost to cover cost of procurement and storage.
Purchased materials are scrapped.
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Raw Materials - Purchased Parts
Raw Materials /
FabricationPurchased
Parts/Services
Transformed in Manufacturing Process
Assembled in Manufacturing Process
Services provided by an outside company
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Raw Material Cost Calculations
1 lb of Raw
Material Costing
$2/lb Goes Into
the Process
Raw Mat. Units * cost Per unit
1 lb * $2 per Lb = $2
1 Part is Produced
$2 / 1 Part = $2 per part
Raw Mat Cost/Part * (1+Scrap %) = Total Raw Mat Cost/Part
$2.00 per part * 1.01 = $2.02
1 Finished Part
Weighs
.9 lbs
1% of Finished Parts
are Scrapped in
Process
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Raw Material Cost Calculations
1 lb of Raw Material Costing $2/lb Goes Into
the Process
What about the scrap?
.1lb of engineered or fabrication scrap occurs in production
.009 lb of scrap occurs after production
1% * .9 lb = .009 lb
1 Finished Part Weighs
.9 lbs
1% of Finished Parts are Scrapped in Process
Total scrap produced .109 lb
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Raw Material Cost Calculations
1 lb of Raw Material Costing $2/lb Goes Into
the ProcessThe supplier sells the .109 lb of
engineered scrap for $.50 / lbs
$2.02 - $.0545 = $1.9655
1 Finished Part Weighs
.9 lbs
1% of Finished Parts are Scrapped in Process
This Scrap Resale reduces the material cost
.109 lb * $.50/lbs = $.0545
The process produces .1 lbs of engineered scrap and .09 lbs
of finished part scrap.
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Example - Raw Material Cost Calculations
1 lb of Raw Material Costing $3/lb Goes Into
the Process
1 Finished Part Weighs
.8 lbs
1% of Finished Parts are Scrapped in Process
What is the cost of raw material the supplier must purchase to produce
1 good part?
Raw Mat Cost/Part * (1+Scrap %) = Total Raw Mat Cost/Part
$_____ per part * (1 + ___) = _______3.00 .01 3.03
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ExampleRaw Material Cost Calculations
1 lb of Raw Material Costing $3/lb Goes Into
the Process
1 Finished Part Weighs
.8 lbs
1% of Finished Parts are Scrapped in Process
What about the scrap?
____lbs of Engineered or fabrication scrap occurs in production
_____lbs of Process scrap occurs after production
Total scrap produced _______ lbs
0.2
0.008
0.208
1% * .8 lb = .008 lbs
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Raw Material Cost Calculations
1 lb of Raw Material Costing $3/lb Goes Into
the Process
The supplier sells the ______lb of scrap for $.75 / lbs
1 Finished Part Weighs
.8 lbs
1% of Finished Parts are Scrapped in Process
____ lbs * $.75/lb = $_____
0.208
0.208 0.156
Total Raw Material Cost:
$______ - $______ = $____3.03 2.8740.156
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Material Breakdown – Best Practices
The breakdown has suppliers identify:
Material Type Material Purchase Cost Gross, Net Weights Process Scrap Benefits from Resale/Reuse of Scrap Country/Region of Origin
The Inteva breakdown has all of these!!!!
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How Suppliers Incorrectly Quote
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Incorrect/Inaccurate Quoted Weights
Effective counter measures: Physically weigh parts yourself and compare
against quoted weight.
Compare quoted weight to CAD data weight.
________________________________
________________________________
________________________________
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Conflicting Material Types
US vs. Asia vs. Europe material standards
Effective countermeasures: Direct suppliers on which materials to use in
quote with detailed specifications.
Get engineering buy into equivalents prior to market test.
________________________________
________________________________
________________________________
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Material Type not Defined
Effective counter measures: On existing part quotes, use the current
supplier material.
Obtain engineering buy in into possible material options.
On a new part have engineering specify or have supply base make recommendations.
Conduct an RFI prior to the RFQ.
________________________________
________________________________
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Supplier Overstating Scrap Rates
Effective counter measures: Audit supplier operations data to support
quoted rates. – Quiet ops review audit.
Benchmark scrap % from other quotes and compare to see if supplier is inline with competition
Reviewing PPAP data
________________________________
________________________________
________________________________
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Inconsistent Supplier Scrap Rates
Effective counter measures: Compare supplier previously quoted rates
with current quoted rate.
Check other suppliers across the same parts.
Compare blank sizes.
________________________________
________________________________
________________________________
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Incorrect Scrap Resale Rates
Effective counter measures: Question supplier about their scrap? Do
they resell it? What is the value of their scrap. If there is value, supplier should quantify and credit customer.
Audit material scrap invoices for accurate scrap credit
Review against published indexes
ALWAYS review with economic adjustments
________________________________
________________________________
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Different Effective Dates
Effective counter measures: Question supplier about the dates especially
on new programs.
Specify effective dates in RFQ.
________________________________
________________________________
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Incorrect/Inaccurate Quoting
Including hidden rebates or productivity
Effective counter measures: Audit supplier component pricing through checking
paid invoices of parts. Audit of supplier payments. Compare across suppliers. Obtain quote from supplier directly. ________________________________ ________________________________ ________________________________
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Incorrect Part or # of Parts
Effective counter measure
Check components parts against drawings to ensure the components are of spec.
Suggest or direct specific second tier suppliers.
________________________________
________________________________
________________________________
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Uncompetitive Pricing
Effective counter measures:
Compare supplier component pricing to see where certain suppliers are uncompetitive.
Suggest or direct specific second tier suppliers.
Assist supplier with their purchasing practices.
Ask for tier 2 cost breakdowns.
________________________________
________________________________
________________________________
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Potential issue: ________________
Effective counter measures:
________________________________
________________________________
________________________________
Other Potential Issues
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Raw Materials Check List
Area Items Check
R
a
w
M
a
t
e
r
i
a
l
Type Material specifications are clear and consistent
Quoted Cost Consistent between suppliers
Quoted Cost Consistent with historical trends
Quoted Cost Consistent with published indices
Usage Gross part weights are consistent between suppliers
Usage Gross part weight has been verified by weighing
Usage Net part weights are consistent between suppliers
Usage Net part has been weighed
Usage Weights have been verified to CAD Calculations
Scrap Consistent scrap % between suppliers
Scrap Scrap % is consistent with historical quotes
ScrapScrap % has been validated with process and record audit
Scrap Supplier is providing "credit" for scrap resale
Scrap Consistent Scrap Resale rates between suppliers
Scrap Scrap Resale rates consistent with historical trends
Scrap Scrap resale rates consistent with published indices
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Purchased Part Checklist
Area Items Check
P
u
r
c
h
a
s
e
d
P
a
r
t
s
&
S
e
r
v
i
c
e
s
Parts Purchased parts and services are in line with design
Usage Number of purchased parts are consistent between suppliers
Sub-Suppliers Suppliers of purchased components are acceptable
Scrap Consistent scrap % between suppliers
Scrap Scrap % is consistent with historical quotes
Scrap Scrap % has been validated with process and record audit
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Labor
Labor
Material
Burden
SG&AProfit
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Labor & Burden Costs
Usually categorized together because their costs are generally based on a cost per hour.
Labor Costs - costs associated with the amount of direct labor involved in the manufacturing a product.
Burden Costs - costs associated with the overhead and indirect labor costs involved in the manufacturing of a product.
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Labor Cost Simplified
Labor Cost
per Unit of
Time
Labor Time
Required for
Production
Labor Cost
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However, It’s not that Simple
Pure (Gross) vs. Actual (Net) Cycle time
Direct vs. Indirect Operators
Direct Labor Rate vs. Fully Fringed Rate
Process scrap needs to be accounted for in Labor cost
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Labor Cost Calculations
Process can
produce 60 gross parts in an hour
Gross Parts Per Hour * (Efficiency Rate) = Net Parts per Hour
60 * 0.80 = 48
Efficiency
Rate is 80%
Downtime occurs for machine breakdown, product changeovers, etc.
If downtime is planned at 20%, the 20% is referred to as the process inefficiency rate.
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Labor Cost Calculations
Operator
pay is $10
per hour
Direct Labor Rate + Fringe Rate = Fully Fringed Labor Rate
$10 + $5 = $15
Operator
benefits
cost the
company
$5 per hour
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Labor Cost
Calculations
48 net parts
per hour
# of operators * (FF-labor rate) / Net Parts per hour = labor cost
2 * $15/hr / 48 = $0.625/part
2 Operators
Fully Fringed
Labor Rate
is $15/hr
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Standard Hours
Process time in hours required to produce 1 part
1 hour divided by Net Parts Per Hour = Standard Hours
48 Net Parts per Hour would result in:
1 hour/48 net parts/hour = 1/48 = .020833
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Example - Labor Cost Calculations
Process has a Gross
Pieces per hour of 700 with 85% Efficiency
Rate
2 Operators
$14 per hour.
Operator
benefits cost
the company
$3 per hour
(# of Ops * Fully Fringe Rate) / (Net Pieces/Hr) = labor cost per part
( _____ * ______ ) / (______) = __________
*Gross pcs Hr * Efficiency Rate = Net Pieces Per Hour
________ * ____ = ______
$.05714
.85 595
2 $17.00 595
700
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Standard Hours for Our Example
1 hour divided by Net Parts Per Hours = Standard Hours
1 hour / 595 net parts/hour = 1/595 = .00168
Standard Hours * $34 = $.5712
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Direct vs. Indirect
Direct labor is applied to the actual production of the part. Examples:
Stamping press operator
Lead person – if tied to process
Carpenter
Indirect labor is not applied to the production of the part. Examples:
Machine repair
Janitor
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Labor Breakdown – Best Practices
Separates Direct Labor rates from fringe rates
Captures Indirect Labor separately from direct labor usually in Burden/Overhead
Captures gross and net production rates
Clearly captures process inefficiency
Utilizes rates in calculations that lead to final prices
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Overstatement of Inefficiencies
Effective counter measure:
Have supplier breakdown their inefficiencies. Look for items that stand out from array of quotations received.
Compare to other suppliers.
Compare to historical quotes.
________________________________
________________________________
________________________________
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Overstated # of Direct Employees
Effective countermeasures: Perform audit of supplier operations 6
months to a year after initial launch of product and compare to quote.
Compare previous quotes to current quote.
Compare to similar product quotes. Compare to PPAP/Control Plan/PFMEA. ________________________________ ________________________________ ________________________________
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Including Indirect in Direct
Effective counter measures:
Perform audit of supplier operations to determine which employees are direct and indirect.
Understand where indirect employee costs are allocated, typically accounted in overhead.
________________________________
________________________________
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Uncompetitive Wage Rates
Effective counter measures: Comparative data, other supplier data,
industry standard, online government data.
Audit supplier operations labor rate data to support quoted rates.
If applicable, audit supplier union contracts.
________________________________ ________________________________ ________________________________
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Labor Checklist
L
a
b
o
r
Operator Wage Rates Consistent with previous quotes
Operator Wage Rates Consistent with industry norms
Operator Wage Rates Consistent with regional norms
Operator Wage RatesFringe rates are in the normal range of 25-35% of labor rate
Production Rates Consistent with previous quotes
Production Rates Consistent with competitors
Production Rates Consistent with PPAP
Production Rates Verified by Audit
Inefficiency Rates Consistent with previous quotes
Inefficiency Rates Consistent with competitors
Inefficiency Rates Consistent with PPAP
Inefficiency Rates Verified by Audit
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Session 2
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Session 1 – July 11 - Raw Material and Labor
Increase understanding of the cost detail suppliers provide in their quotations. Review common ways suppliers inaccurately quote.
Session 2 – July 18
Burden and SG&A
Increase understanding of the cost detail suppliers provide in their quotations. Review common ways suppliers inaccurately quote.
Review top ways to: Improve analysis of the cost impacts of design changes. use the cost breakdown information to negotiate costs of design changes.
Objectives for this Training
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5 Main Areas of Cost
Labor
Material
Burden
SG&AProfit
Selling, General, and Administrative
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Example - Raw Material Cost Calculations
2 lbs of Raw Material Costing $2/lb Goes Into
the Process
1 Finished Part Weighs
.8 lbs
2% of Finished Parts are Scrapped in Process
How many parts must the supplier plan to produce if the supplier needs 100 good finished parts?
Raw Mat Cost/Part * (1+Scrap %) = Total Raw Mat Cost/Part
$_____ per part * (1 + ___) = _______2.00 .02 2.04
# of finished parts required * 1 + Scrap %
100 * (1 + .02) = 102
What is the cost of the raw materials required to produce 100 good parts?
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ExampleRaw Material Cost Calculations
2 lb of Raw Material Costing $2/lb Goes Into
the Process
1 Finished Part Weighs
.8 lbs
2% of Finished Parts are Scrapped in Process
What about the scrap?
____lbs of Engineered or fabrication scrap occurs in production
_____lbs of Process scrap occurs after production
Total scrap produced _______ lbs
1.2
.016
1.216
2% * .8 lb = .016 lbs
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Raw Material Cost Calculations
2 lb of Raw Material Costing $2/lb Goes Into
the Process
The supplier sells the ______lb of scrap for $.75 / lbs
1 Finished Part Weighs
.8 lbs
2% of Finished Parts are Scrapped in Process
____ lbs * $.75/lb = $_____
1.216
1.216 0.912
Total Raw Material Cost:
$______ - $______ = $____2.04 1.1280.912
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Example - Labor Cost Calculations
Process has a Gross
Pieces per hour of 600 with 80% Efficiency
Rate
2 Operators
$15 per hour.
Operator
benefits cost
the company
$4 per hour
(# of Ops * Fully Fringe Rate) / (Net Pieces/Hr) = labor cost per part
( _____ * ______ ) / (______) = __________
*Gross pcs Hr * Efficiency Rate = Net Pieces Per Hour
________ * ____ = ______
$.07917
.80 480
2 $19.00 480
600
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Burden / Overheads
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So far,we have talked about Labor and Material Costs.
Labor
Material
Burden
SG&AProfit
Selling, General, and Administrative
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Burden / overheads Vs SG&A
Burden or Overhead:
Manufacturing costs associated with the
production of a part.
SG&A
Front office, corporate costs.
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Does anyone have some examples of burden
and SG&A?
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What’s Included in Burden
Indirect Labor Material
handlers Team
Leaders Training Maintenance
Fringe Benefits Vacation Pay Workers
Comp Pension
Services & Supplies
Operation Supplies
Tools Utilities
Gas Electricity Water
Salaried Labor Operation
Supervisors Engineering Materials
Management Fringe Benefits
Health Care Insurance
Services and Supplies Rent/Mortgage Building/Capital
Insurance Depreciation
Salaried Labor Supervisors
Fringe Benefits Workers Comp Health Care Insurance Pension
Services and Supplies Telephone &
Communications
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Allocating Burden
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Allocating Burden to Part Cost Simplified
Net Pieces
2,000,000
Burden Cost
$8,900,000
Burden Cost
Per Part
$4.45
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However
Different part designs
Different mfg processes
Multiple plants
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Cost Allocation – Spreading the costs around.
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Burden/Overhead Cost by
Department Total Cost
Inj. Molding $4,500,000
Welding $2,000,000
Assembly $2,400,000
1. Costs are assigned to departments or individual machine types.
2. The total machine hours are calculated for each group.
Allocating Cost of Goods Sold
Total Machine
Hours Available
45,000
30,000
100,000
Cost per Hour
$100.00
$66.67
$24.00
CostsMachine
HoursBurden Cost
Per Hour
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Burden/Overhead Cost by
Department Total Cost
Inj. Molding $4,500,000
Welding $2,000,000
Assembly $2,400,000
1. Costs are assigned to departments or individual machine
types.
2. The total machine hours are calculated for each group.
Allocating Cost of Goods Sold
Total Machine
Hours Available
45,000
30,000
100,000
Cost per Hour
$100.00
$66.67
$24.00
CostsMachine
HoursBurden Cost
Per Hour
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Burden/Overhead Cost by
Department Total Cost
Inj. Molding 50 ton $500,000
Inj. Molding 100 ton $1,500,000
Inj. Molding 200 ton $2,500,000
Welding $2,000,000
Assembly $2,400,000
Burden costs will vary by machine size.
Allocating Cost of Goods Sold
Total Machine
Hours Available
10,000
15,000
20,000
30,000
100,000
Cost per Hour
$50
$100
$125
$66.67
$24.00
Suppliers who do not recognize this will:
▪ Be uncompetitive on small machines
▪ Lose money on large machines
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How wrong is a supplier’s quote if they used an overstated cost of $100 per
hour when the cost should have been $50 per hour and the part takes .5
machine hours to make?
Allocating Cost of Goods Sold
Burden cost per hour / number of parts produced per hour = burden cost/part
They quoted: $100 / 2 = $50
They should have quoted: $50 / 2 = $25
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Burden Costs
Labor
Material
Burden
SG&AProfit
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Fixed and Variable
Fixed CostVariable Cost
As volume increases or decreases generally these costs increase or decrease by proportional amounts.
Examples: Material Cost Direct Labor Cost Consumable tools & MRO
Stay the same regardless of the part volume.
Examples: Building rent Interest payments Software costs
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What’s Included in Burden
Variable Burden Indirect Labor
Material handlers
Team Leaders
Training Maintenance
Fringe Benefits Vacation Pay Workers
Comp Pension
Services & Supplies Operation
Supplies Tools
Utilities Gas Electricity Water
Fixed Burden Salaried Labor
Operation Supervisors
Engineering Materials
Management Fringe Benefits
Health Care Insurance
Services and Supplies Rent/Mortgage Building/Capital
Insurance Depreciation
Variable & Fixed Burden Salaried Labor
Supervisors Fringe Benefits
Workers Comp Health Care Insurance Pension
Services and Supplies Telephone &
Communications
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Burden Cost Simplified
Net Pieces
Per hour
Burden Cost
Per Hour
Burden Cost
Per Part
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Burden Cost Calculations
48 Net Parts
out per Hour
(Fixed Burden Rate/Hr + Variable Burden Rate/Hr) / # of Net parts out per Hr = Total Burden Cost
( $75 + $25 ) / 48 = $2.08 per part
Process requires a
Fixed Burden rate of $75/hr
and a Variable
Burden rate of $25/hr
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Burden Cost Calculations
40 Net Parts
out per Hour
(Fixed Burden Rate/Hr + Variable Burden Rate/Hr) / # of Net parts out per Hr = Total Burden Cost
( $175 + $25 ) / 40 = $5.00 per part
Process requires a
Fixed Burden rate of
$175/hr and a Variable
Burden rate of $25/hr
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Burden Cost Calculations - Alternative
Part requires a Net Std Hrof 0.02083
(Fixed Burden Rate/Hr + Variable Burden Rate/Hr) * Net Standard Hour = Total Burden Cost
( $75 + $25 ) * 0.02083 = $2.08 per part
Process requires a
Fixed Burden rate of $75/hr and a Variable Burden rate of
$25/hr
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Variable and Fixed Cost
Cost of
Goods SoldProfit Revenue
Material
Cost
Direct
Labor
Cost
Burden/
Overhead
SG&A
Variable CostFixed
Cost
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Contribution Margin
RevenueContribution
Margin
A company sells one product, price: $2.00
Variable cost to produce: $1.25
Contribution Margin: $.75
Variable
Cost
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Contribution
# of Units
Sold
Contribution
Margin Contribution
$.75 10,000,000 $7,500,000
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Profit
ContributionFixed
CostProfit
$6,000,000$7,500,000 $1,500,000
However if volume falls by 33%
$6,000,000$5,000,000 $(1,000,000)
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Profit
ContributionFixed
CostProfit
$4,000,000$5,000,000 $1,000,000
The good news…..
$6,000,000$5,000,000 $(1,000,000)
Fixed costs are not Fixed!!
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Burden Breakdown – Best Practices
Capture Burden by process type (not as overall plant wide rate)
Separate labor fringes from burden rate (if possible)
Asks suppliers to differentiate between fixed and variable burden (if possible)
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Burden Issues
Overstatement
Inconsistent Quote to Quote
Double counted in SG&A and Burden
Effective countermeasures: Perform audit of supplier overhead costs
Have suppliers fill out detailed information on burden costs accounts
Compare to other suppliers
Compare to historical
________________________________
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Burden Checklist
B
U
R
D
E
N
Rates
Consistent with previous
quotes
Rates Consistent with competitors
Rates Vary with machine size
Rates
Do not include employee
fringe
Rates Do not include items in SG&A
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SG&A and Profit
▪ SG&A Selling, General, and Administrative
▪ Profit
Typically accounted for as a % markup of total manufacturing costs or as a % of sales.
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SG&A and Profit
11
SG&A Markup (Gross) Profit Markup
SalesAdvertisingCommissionsSales SalariesTravel and Marketing
General and AdministrationAdministration SalariesTrainingTravelMoving expensesOffice Supplies
The positive gain from an
investment or business
operation after subtracting for
cost of goods sold, or total
manufacturing cost
Typically it is the amount of
money a company designates
as required to re-invest in
desired business growth
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SG&A and Profit
In order to understand supplier true SG&A and Profit cost it is important that:
All SG&A accounts are correctly captured in SG&A
SG&A and Profit percentages are clearly stated
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SG&A and Profit Cost Simplified
Cost of
Goods Sold
(COGS)
SG&A and
Profit
Markup %
SG&A and Profit
Cost
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SG&A and Profit Issues
Overstated
Double counted with Burden
% not going down as business grows
Effective counter measures:
Compare percentages with previous quotes
Compare percentages with competitor quotes
Compare against public record is available (if supplier is publicly traded)
Audit
Negotiate – many times sales has a range to work to
________________________________
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SG&A and Profit Checklist
Area Items Check
S
G
&
A
P
R
O
F
I
T
Rates Consistent with previous quotes
Rates Consistent with competitors
Rates Consistent with financial statements
Rates Do not include items in Burden
Case 1 – Capstone Case
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Using Cost Breakdown info
to Control Costs
Professional courses to optimize your buying team’s performance
11
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1. Create a cost driver table
Part # Quote Date Supplier Raw Material
Cost UOM Gross Wt
Net Wt
12348900 1/1/2017 Smith EN 1043 .5400 lb 1.2 1
0909808 3/1/2017 Jones EN 1043 .5200 lb 1.4 .9
Include most important drivers
Add data from each quote
Add key calculations (e.g., Net wt / Gross Wt.)
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#2 Create an Excel Workbook for Each
Part/Supplier
Add a new tab for each RFQ
Send this workbook to supplier w/ each Design Change
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3. Add the Cost Driver Summary to
Part/Supplier Workbook
Should mirror your Cost Driver Summary
for easy cut and paste.
Part # Quote Date Supplier Raw Material
Cost UOM Gross Wt
Net Wt
12348900 1/1/2017 Smith EN 1043 .5400 lb 1.2 1
0909808 3/1/2017 Smith EN 1043 .5200 lb 1.4 .9
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4. Review quote with the supplier
Are the explanations clear? (will you understand them in 6 months?)
Are the cost changes consistent with:
Suppliers historical quotes
Other suppliers quotes
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5. Update your Master Cost Driver Summary
Should be a quick Copy and Paste
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6. Analyze your Cost Driver Data
Identify inconsistencies
Build cost models
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Wrap - up
Questions:
Next Steps:
Training evaluation
On line problems – Thursday
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Understanding and Using Cost
Breakdowns
Professional courses to optimize your buying team’s performance
12