Module III. Total Cost Analysis for TCO

Transcription

1 Module III Total Cost Analysis for TCO

2 Behavioral & Data Based Negotiation Techniques

3 Always Negotiate With Data Don t believe everything you read about negotiations Negotiations are no longer about psychological leverage, deceit, aggression, warfare, getting the upper hand, or getting an unfair advantage DATA is the foundation for all successful negotiations Psychological influence techniques help you find ways to motivate the other party and improve your results But they are not enough!

4 Rethinking TCO Pre 1980 s: Give me exactly what I asked for, fast 1980 s: Give me a lower price 1990 s: Give me a lower TCO 21 st Century: Give me an agile & cost effective Supply Chain

5 Purchase price Maintenance Change orders Consulting and training Storage & temperature control Quality/reliability Efficiency/output Safety & environmental Taxes, tariffs Shipping Exchange rates Depreciation Insurance Resale/Scrap value Acquisition Cost vs Total Cost

6 Cost Overruns They Happen! Think about a time where you misunderstood or miscalculated total cost what was the impact? How does it happen? Scope creep Imperfect forecasting Poor understanding of hidden costs Strategic misrepresentation of scope or cost Continued commitment to a project despite TCO problems

7 Various Types of Costs Financial Purchasing Fixed Variable Switching Direct Indirect/Soft Avoidance Sunk Opportunity Controllable Uncontrollable Administrative

8 Purchasing Costs Defined Direct cost savings: The quantified value of negotiated price related contract components (i.e. price reductions) Indirect/soft cost savings: The quantified value of negotiated non-price related contract components Cost Avoidance (100% cost savings!): Reduction in demand Elimination of components of what is being purchased All of the above should be based on what would have happened had purchasing not gotten involved

9 Calculating Indirect/Soft Cost Savings Ask the supplier what they would normally charge any other customer for the negotiated value add in question Increase in warranty Reduction in leadtime Dedicated customer support headcount Alternative is to do a cost model where savings are internal Ex s: Productivity savings, payment terms savings using WACC Source: Ghamami, Omid Capturing Soft-Cost Savings, ISM eside Supply Management, September/October 2010, Vol. 3, No. 5

10 Calculating Cost Savings Direct Cost savings should be calculated using Last Price Paid* or Supplier Opening Position and actual price obtained Cost savings % s are almost always calculated incorrectly! Ex below: Total Contract Value (TCV) is $.8M post negotiation Direct Cost Savings (DCS) are $.2M What is the direct cost savings %? Savings calculation should be Hint: TCV + DCS = Direct: DCS/(TCV +DCS) your old contract Indirect: ICS/(TCV +DCS) value Avoidance: ACS/(TCV +DCS) * Generally takes precedence if this data exists

11 Cost Models Used when custom product/service or sole sourced provider Should Cost Used when you KNOW that price exceeds budget under all scenarios Must Cost Benchmarking is best used for undifferentiated products/services Benchmarking Used when there is a material difference between acquisition cost and total cost Total Cost

12 Cost Benchmarking Sources Low Cost/Medium Applicability Industry publications Research studies Government/public agencies High Cost/ Med to High Applicability Third Party managed benchmarking Low Cost/High Applicability! RFP/RFQ/RFI 12

13 Must Cost Models Should be used when budget is less than benchmarks and cost models Cost models are target driven pricing models Requires customer/buyer flexibility and close partnership with supplier Works best with very low marginal cost products, such as software Can result in innovative cost, SOW, & spec solutions, but can also result in stalemates

14 The Must Cost Model is the ONLY time you break the cardinal rule of don t tell suppliers how much budget you have

15 Using Must Cost Models Know when to use must cost models Customer budget limits or finance target costs are key opportunities Look to harness supplier insight to meet targets without forcing a win/lose outcome

16 Should Cost Models Should be used for custom products/services Ideal is a collaborative process good supplier relationship is key! Review of associated supplier cost structure Set this expectation up front! Sign NDA if appropriate Review of fair industry profit margins for their NAICS code(s) Opportunity to take costs out of the equation! Key decision point: where to stop/start analysis

17 Should Cost Models Should cost models should only be used when comparative data doesn t exist Reason: they can be cumbersome and time consuming

18 Getting Industry Average Profitability Ask the supplier their NAICS code usually 6 digits Focus on their division for conglomerates Research industry average figures for that NAICS code Standard & Poor s Moody s Dunn & Bradstreet

19 Should Cost Models Help to break down supplier costs Enable better understanding of cost components, drivers, and opportunities Can identify inefficiencies, redundancies, overscoping, and other cost line item opportunities

20 Should Cost Models Require solid relationship with supplier, along with TRUST Cannot be done in first contract in most cases Unless you are doing analysis independently NDA may be required for data sharing Supplier will look for opportunistic behavior on purchasing s part

21 Should Cost Model ex. A consultant providing unique services wants $300/hour. There are no alternate suppliers, and therefore no benchmark data You know the following: If you were to hire this person as a permanent employee, you would pay her $120,000/year Your corporate burden rate is 30% The industry average profit margin for this supplier is 40% The average # of hours worked by permanent employees per year is 2,000 What should be your should cost proposal for an hourly fee?

22 Should Cost Model ex., cont. Category Amount Calculation Consultant Rate: $ Given Annual salary if hired: $ 120, Given Corporate burden rate at 30%: $ 36, = $120,000 * 30% Annual salary + burden rate: $ 156, = $120,000 + $36,000 Industry Average Profit Margin at 40% $ 104, = $156,000 / 60% - $156,000 Annual salary + burden rate + profit margin: $ 260, = $156,000 + $104,000 Annual salary + burden rate + profit margin per hour: $ = $260,000 / 2,000 hours

23 Not to scale, lines will vary by situation Generalized Supplier Cost Structure Don t Forget AFC! Supplier cost per unit = Average FC/Unit + Variable Cost/Unit Both cost factors decrease with production! $$ Cost Fixed Costs Variable Cost/Unit Fixed Costs/ Unit Production

24 Discussing AFC With Supplier First question to ask supplier: Will you be needing to increase any fixed cost infrastructure to support this proposed volume of business? If the answer is no, their AFC is decreasing and their contribution margin is increasing! Fixed costs are already spent Two approaches (can be step function): Variable Cost vs supplier price (since fixed costs are already paid) AFC + Variable Cost vs Supplier Price

25 Define All TCO Components for Total Cost Models Purchase Price Incurred Costs Policy Costs TCO Ownership Costs Use Costs Performance Costs 25

26 Performance Costs Cost of non/late delivery Cost of quality (too low AND too high) Transportation and packaging Inventory carrying costs Administration costs Supplier availability/flexibility Customer service Installation and modification costs Start up and switching costs Operator or TAC training Service & maintenance Supplies and spare parts Useful life Scrap or trade-in value 26

27 Ease of use Time factors involved Administration Oversight Training Etc. Use Costs Any supplier or product/service factors that change final output Ex s: Poorly performing suppliers are expensive to use because of monitoring Many software programs are expensive to use because of training 27

28 Incurred Costs Any additional charges from supplier outside of purchase price Expediting fee Consulting fee Training fees Any other adders (this is a supplier negotiation tactic!) 28

29 Policy Costs Costs associated with internal policy decisions, such as: Recycled material use Diverse supplier use Green supplier use Local supplier use Material use or avoidance requirement 29

30 Process Mapping for Total Cost Models Total cost analysis creates opportunity for process mapping Process mapping helps identify cost reduction/ elimination opportunities Also helps understand true total cost of acquisition Goal is to make best value decisions, not lowest price

31 Process Mapping Costs incurred at each step need to be understood! Which can be modified or eliminated?

32 Total Cost Models & TCO Reductions What does the supplier hear when you say I need a better price? Taking cost out of the Supply Chain is a true Win/Win The battle of supply chains the best supply chain wins!

33 Removing SC Costs vs Reducing Price Unnecessary Supply Chain Cost Supplier outgoing quality inspection, if your firm is also doing incoming quality inspections. Key Action to Remedy (includes renegotiation of price to reflect removed supply chain element) Eliminate either supplier outgoing inspection or customer incoming inspection which ever is less total cost effective 24 x 7 warranty support, when you only need 8 x 5 warranty service. Switch to 8 x 5 warranty service. 1 week leadtime on a product that you only need 3 weeks leadtime on. Switch to standard 3 week leadtime Expedited air shipping on all orders when standard ground shipping is acceptable. Supplier insurance of all deliveries when the customer s firm is also insuring the deliveries. Packaging that is either too large, too thick, or uses materials that are too expensive Having a five year warranty on a product, such as pc s, that only have a three year product shelf life. Supplier inventory levels excessive & high obsolescence due to poor customer forecasting Unnecessary product functionality features ordered by customer Switch to standard ground shipping. Eliminate either supplier insurance or customer insurance whichever is more expensive. Modify packaging to meet requirements while lowering TCO Change warranty to three year schedule. Implement forecasting communication process at supplier desired intervals Work with customer to negotiate removal of such features. 33

34 Cost Modeling Best Practices Have team in place that has visibility to various cost components Start basic, and add complexity later Start with variable cost components exclusively attributable to your demand Cost models developed in cooperation with suppliers are most effective Do what if cost model analysis instead of just what is Do Pareto analysis on data findings Separate controllable from uncontrollable

35 Rules for Cost Models Revision # s and dates, every time! ONE owner for the cost model ONE place where it resides All data variables categorized and documented Fact Estimate Assumption Documentation of where/when/from-whom each data point came from. Perform sensitivity analysis with estimates and assumptions

36 Company X Food Service Cost Model Scenario: Company X wants to bring in a full service catering company to make lunch at their facility and serve it in Company X's new café area, which has no cooking equipment. Because this area is also used for meetings outside of lunch hours, there is a setup fee and breakdown fee that Company X must pay every day before and after the lunch period. Company X employees will only pay $5 for luncheon meals and Company X will subsidize the difference, including associated taxes. Three vendors have been qualified to serve these meals and their proposals are as shown below for comparable meals. Part of the purpose of this effort is to keep employees from losing time by going offsite to eat, where time is lost and company confidential information may also be overheard by third parties during employee conversations. Cost per Meal* Min req. Comments Vendor A $ 8.50 $ 850 Vendor B $ 9.50 N/A They expect a gratuity as well Vendor C $ 7.00 $ 500 They offer two meal options - $7 and $8 price points * does not include taxes Cost Model Information Category Figure Comments Assumption/Fact/Estimate # of Employees in work site 500 Fact Average hourly pay $50 Does not include burden. Assumes $100K/year and 2,000 paid hours worked. Data obtained from Jane Doe in HR. Estimate Average # of hours lost when employees eat out 0.5 Conservative figure for driving offsite, ordering, eating, paying, and driving back, with 1/2 hour subtracted for how much time they would spend if they ate in Estimate Average productivity cost of employee eating out once $25 Assumes employee will not work the extra hours lost due to eating out Assumption Employee Café Utilization 28% Best estimate by Steve Johnson in Corporate Services is 28% - reflects 30% from M - Th, and 20% on Fridays. Based on café utilization at other Company X sites. Estimate Cost of breakdown and set up of café area on daily basis $50 Daily charge by facilities maintenance vendor to set up and break down café area before and after lunch on daily basis Fact

37 Net Savings/day to Company X with Productivity Savings and set up & break down fee Accounted for % Employee Utilization** Vendor A Vendor B Vendor $7/meal Vendor $8/meal 15% $ 1, $ 1, $ 1, $ 1, % $ 2, $ 1, $ 2, $ 2, % $ 2, $ 2, $ 2, $ 2, % $ 2, $ 2, $ 3, $ 2, % $ 2, $ 2, $ 3, $ 3, % $ 3, $ 3, $ 3, $ 3, % $ 3, $ 3, $ 4, $ 4, Sensitivity Analysis Company X Food Service Cost Model Sensitivity Analysis Gross Cost/day of Meal Program (independent of payee) % Employee Utilization** Vendor A Vendor B Vendor $7/meal Vendor $8/meal 15% $ $ $ $ % $ $ 1, $ $ % $ 1, $ 1, $ $ 1, % $ 1, $ 1, $ 1, $ 1, % $ 1, $ 1, $ 1, $ 1, % $ 1, $ 1, $ 1, $ 1, % $ 1, $ 2, $ 1, $ 1, Cost/day to Company X After $5 Employee Price Point AND $50/day facilities setup & break down fee for the Café area % Employee Utilization Vendor A Vendor B Vendor $7/meal Vendor $8/meal 15% $ $ $ $ % $ $ $ $ % $ $ $ $ % $ $ $ $ % $ $ $ $ % $ 1, $ $ $ % $ 1, $ 1, $ $

38 Module III Summary ALWAYS negotiate with data, and know which cost model type is best for your situation Calculate cost savings correctly and comprehensively Develop the mindset of taking costs OUT of the Supply Chain when assessing TCO Follow the cost modeling practices & rules in this module for best results Use what you have learned to build a ROCK-SOLID CASE in supplier negotiations