Materials Management BUS 3 – 141 Pricing and Make/Buy Decisions October 15, 2007

Page 2 2 Agenda –Exam Review –Case 2 –Price –Cost –Value –Make vs. Buy

Exam Review

Page 4 4 Grade Distribution – Exam 1

Page 5 5 MRP Questions

Next Case

Page 7 7 Case 2: Sedgman Steel (p. 176) Due Oct 29, 2007 Approx. 20% of Total Effort / Grade Approx. 25% of Total Effort / Grade Approx. 35% of Total Effort / Grade

Price

Page 9 9 Definitions What the seller is paid for goods and services provided Price The expenses incurred in operating the enterprise, making and buying materials, and converting the materials to finished goods Cost The ability to pay, without compromising cash balances Affordability The difference between Price and Cost Value

Page Price –Market Price Not necessarily based on supplier cost Important for comparing alternative suppliers Required when deciding whether to make in-house or buy Good for discovering improvement opportunities for your business –Suppliers have to make profits to stay in business It is important to know what is a “reasonable” price and profit are The Selling Price is MUCH more dependent on the MARKET than on Cost

Cost

Page Types of Costs Specifically assigned to a given unit of production Examples are: component materials, assembly labor Direct Cost Necessary to operate the enterprise, but not specifically assigned to a given unit of production (e.g. Rent, management salaries) Indirect Cost Vary directly & proportionately with the number of units produced Examples are: BOM x units produced Variable Cost Does not change, regardless of the number of units produced Examples are: Rent and advertising Fixed Cost

Page Relationship of Cost to Selling Price and Profit * Adapted from Leenders, Johnson, Flynn, and Fearon, Purchasing and Supply Management, Thirteenth Edition, McGraw Hill Irwin 1,000 Units Average Cost = $11.50 / unit Selling Price = $12.42 / unit Profit percentage = 8%

Page Impact of Volume on Cost (and Selling Price ) 2,000 Units Average Cost = $9.50 / unit Selling Price = $12.42 / unit Profit percentage = 31% Changes as Volume Changes Direct materials$11,000DirectVariable +Direct labor4,000DirectVariable +Factory Overhead2,500IndirectFixed* =Manufacturing Cost$17,500 + General, administrative, and Selling cost 1,500IndirectFixed* =Total Cost$19,000 +Profit5,840 =Selling Price$24,840 Cost Behavior No Change as Volume Changes

Page Comparison of Fixed & Variable Costs with Volume Understanding Supplier Fixed and Variable costs is CRITICAL to any Negotiation

Value

Page Applying Value Principles to your Career –When you work, the company is BUYING what you are SELLING The work you do is WORTH something. Your company will continue to pay you when the work you do is worth more to them than what you cost –Do more than your Job Description You really are not paid to do a specific job; you are paid to make money for your company The more valuable that you are, the more you will get paid – either by your company or the next company –Don’t say, “It’s not my Job” Think like the Boss Pick the BEST people and try to be like them Don’t look at how little the poor performers are doing and complain that you are doing more –Think about how you can be worth MORE than what you are being paid

Factoring Supplier Price in Buying Decisions

Page Pricing data varies for different Purchase Types Raw Materials Standard Production Items of Small Value Special Items Services Capital Goods Resale –Published market prices; bought and sold in well-organized markets –Monitor trends for opportunities to leverage unexpected dips in price –Price indexes are available for escalator clauses Raw Materials (Commodities) –Can be found in catalogues from manufacturers, distributors, and retailers –Published “list price”, with opportunities for better prices based on volume –Good candidates for online buying, using searches and/or auctions –Frequently a broad category is covered by a single Sales Representative who pools buys for volume discounts Standard Production and Items of Small Value

Page Quotations and Bidding –Qualify your bidders Ability to execute the technical requirements Potential to be a Partner –Include a reasonable number of bidders (not too many and not too few) –There must be NO appearance of favoritism –Specifications need to be VERY CLEAR and not open to interpretation –Price is not the only thing that matters –Firm bid: first bid is the last bid too –BAFO Bid: Best And Final Offer – The potential supplier is given additional information after the initial bid and is given the opportunity to prove a second bid Time and budget must be planned to account for the effort of negotiations. Major negotiations should be outside routine production support. Production support should focus on delivery and quality, with pricing previously negotiated

Page Alternatives when Bids are virtually Identical –Choose a supplier already doing business with you –Negotiate non-price concessions Freight Warranty Consigned inventory –Choose a supplier with social benefits Largest domestic content Women and minority owned Closest in proximity –Select based on recommendations by customers Beware of Collusion

Page Key Elements of Negotiated Contracts –Price, Volume, Quality, Service –Price protection –Escalator clauses –Cancellation clauses –Liability –Ethical practices Will be covered in a subsequent chapter

Make vs. Buy

Page Definitions Producing the product or service with resources from your own enterprise Make Purchasing the product or service produced by resources from an outside supplier Buy Sourcing the product or service “back in” after the original Buy decision Insourcing Sourcing the product or service “outside” after the original Make decision Outsourcing

Page Factors in deciding whether to Make or Buy –Quantities too small for outside tooling and economies of scale –Quality requirements are too tight for outsider to produce –Manufacturing is a core competency –Greater assurance of supply with dedicated production capacity –Lower cost –Protect Intellectual Property –Avoid sole-source dependency –Distance to supplier too great –Significant customer requires it –Backup capacity –Manufacturing is not a core competency –Supplier has expertise in a technology or product –Greater capacity –More flexible capacity –Buying Modules or subassemblies, rather than many component parts, simplifies operations –Lower risk with multiple sources of Supply –Lower cost –Negotiated unit cost removes temptation to overbuild to absorb fixed cost –Good supplier in close proximity –Significant customer requires it –Open up new markets (e.g. NAFTA) Reasons to Make (keep in-house) Reasons to Buy (go outside) There is no single “Right Answer” that applies to every business and every situation

Page Insourcing and Outsourcing A Make or Buy decision can be reversed, or modified, if business conditions justify it –Supplier no longer produces the product or goes out of business –Volumes become too low –Major price increases –Reinforce the linkage between Design and Production –Projected savings of “Buy” decision were not realized Insourcing would be recommended when: –Capable suppliers have entered the market –Volumes increased dramatically –Major internal cost increases –Core competencies re-evaluated –IT systems enable effective communication and control –Government incentives Outsourcing would be recommended when:

Page Risks of Outsourcing –Supplier priorities can be re-directed (often to competitors) –Limited control during times of scarcity –Original savings projections not realized –Additional fees and charges introduced after original agreement –Pricing and terms from the original agreement significantly changed in subsequent negotiations –Supply, Legal, Technical, and other resources are frequently re-directed to ensure benefits are achieved and relationships maintained –Customer, employee, market, or political criticism Domestic vs. offshore Union vs. non-union Increased turnover of key individuals

Page The Role of Purchasing in Outsourcing –Ensure that an objective, fact-based decision process is in place –Provide several sources –Provide expertise in Requests for Proposals –Take the lead in developing and negotiating Contracts (with Legal) –Monitor and manage the ongoing relationship –Take the lead in negotiating subsequent contracts and identifying back- up suppliers over time