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 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

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

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 Expensive  Yields Much More Information

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

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

Types of Discounts  Trade  Resale  End User  Volume  By Item or By Total  Prompt Payment  Seasonal  2%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 = Periods  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 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?

Payment Issues, Continued  How 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 Materials  Surcharges for Energy  Change Orders  Counting Indirect Labor as Direct  Allocation of Overhead

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

Sources of Information for Price Analysis  ISM Report on Business (  U.S. Government’s Bureau of Labor Statistics (  PPI of particular interest.  U.S. Department of Commerce (  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 Costs  Fixed 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 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

Motorola Example  145 Batteries  78 Displays  1447 Software Versions  2-4 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 Complexity  Motorola Example  Average Part Count  35% Reduction  Average Assembly Time  47% Improvement  Average Test Time  58% Improvement

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

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