Understanding and Using Cost Breakdowns. Professional courses to optimize your buying team s performance

Understanding and Using Cost Breakdowns Professional courses to optimize your buying team s performance 1

Introductions All APD Personnel Main Presenter Jeoff Burris Producer Jon Homrich 2

Making Purchasing a Competitive Advantage 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. People Management Domain experts are provided the tools, training and structures needed to be successful. Strategic Focus Strategic resources focus on strategic activities 100% of the time. Access to Actionable Data Spend decisions are made using real-time cost and market intelligence. 33

Elevating the Role of Purchasing People Intelligence Tools & Technology We lever a network of >10,000 supply chain professionals, and have both onshore and offshore delivery capabilities We have a database of >1,000 cost elements based of >850 cost blueprints. Our solutions are empowered by a purpose built, proprietary technology platform All of our solutions are provided on a modular, as-a-service, basis. 4

Importance 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. 5

Objectives for this Training 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. 6 Review top ways to: Improve analysis of the cost impacts of design changes. use the cost breakdown information to negotiate costs of design changes.

Poll Question

What percent of the time are you asking suppliers to complete the Inteva Detailed Cost Breakdown? Supplier (1) Drawing Number (2) Revision (3) Part Number (4) Price basis year (5) Offer date (6) ABC Company 56789123 99999999 2012 7/25/2011 OEM's Name (7) Program name (8) Part description (9) Life-time volume (10) GM GMT 900 Tie Bar Assembly 2,500,000 Yearly Volume (11) Currency (12) Exchange Rate per USD 500,000 USD 1.0000 EURO TBD Payment Terms (13) Plant (14) Suppliers production site (15) Production batch size (16) Number/ shifts (17) NSDSM Adrian Mexico 10,500 15 Max. daily production (18) 5000 Safety Stock quantity (62) Delivery terms (65) Delivery frequency (78) Delivery lot (79) 2,083 Weekly 10,500 Packag.responsib. (80) Delivery flexib. (81) 750 8 Raw Materials Item description (19) Make part / Make part Quantity/Assy Sub Supplier Country of UOM* Unit price/uom Gross usage/part Net Scrap Value/Part (29) Scrap Reclaim Total Raw Material Raw Material SG&A and Profit Markup (32) Total Cost Drawing number description Origin (26) (27) usage/part % $ / /TBD Cost/Unit (30) Cost (31) % $ / / TBD (20) (21) (22) (23) (24) (25) (28) (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 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 Detail Stamping 25777427-1008 CRS in Coils Detail Stamping 25777427-1008 CRS in Coils * Unit of measure (kg, pound, etc) Total Raw Material: 2.2358 0.2683 2.5041

9 Poll Results

Management of Pricing Market Based Pricing Cost Based Pricing Buyer strives to control market forces that determine pricing. Buyer strives to understand and help manage the cost drivers of the purchase. 10

Establishment of Pricing Market Based Pricing Cost Based Pricing Price Buyer Focus Costs Costs Profit Profit Price 11

Let s Use the Chat Feature to Share What are the Positives and Negatives of getting detailed cost breakdowns from suppliers? 13

Management of Pricing Market Based Pricing Cost Based 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 14

Management of Pricing Market Based Pricing Cost Based Pricing What determines whether a buyer uses a Market or Cost Based approach? Interest Ability 15

Buyer Interests Market Based Pricing Cost Based Pricing 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. 16

Buyer Ability Market Based Pricing Cost Based Pricing 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. 17

Global Sourcing - Market vs Cost Approach 120 115 110 105 100 95 Initial Sourcing with competitive pressure no cost knowledge Market 90 Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7 Year 8 Year 9 18

Global Sourcing - Market vs Cost Approach 106 105 104 103 102 101 100 99 98 97 Without cost knowledge, price creep occurs Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7 Year 8 Year 9 Market 19

Global Sourcing - Market vs Cost Approach 106 105 104 103 102 101 100 99 98 97 Market testing/negotiations used to reduce price Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7 Year 8 Year 9 Market 20

Global Sourcing - Market vs Cost Approach 107 106 105 104 103 102 101 100 99 98 97 Cycle repeats Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7 Year 8 Year 9 Market Resourcing at the peaks captures market pricing 21

Global Sourcing - Market vs Cost Approach 108 106 104 102 100 98 Market Cost 22 96 94 92 However, the market testing fails to capture the true cost. Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7 Year 8 Year 9

The Case for Cost Breakdowns

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. 24

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. 25

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. 26

Commodities that can use Breakdowns Characteristics - - High manufacturing cost as a % of sales Customers controls the design Many suppliers 27 Examples Construction Capital equipment Plastic parts Stampings Assemblies

Cost Breakdowns

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. 29

5 Main Areas of Cost Selling, General, and Administrative SG&A Profit Labor Burden Material 30

Cost of Goods Sold Cost of Goods Sold SG&A Profit Revenue Material Cost Direct Labor Cost Burden/ Overhead 31

Material Cost SG&A Profit Labor Burden Material 32

Material Cost Simplified Material Cost per Unit of Measure Material Cost Amount of Material Used 33

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. 34

Raw Materials - Purchased Parts Raw Materials / Fabrication Transformed in Manufacturing Process Purchased Parts/Services Assembled in Manufacturing Process Services provided by an outside company 35

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 Finished Part Weighs.9 lbs 1 Part is Produced $2 / 1 Part = $2 per part 1% of Finished Parts are Scrapped in Process Raw Mat Cost/Part * (1+Scrap %) = Total Raw Mat Cost/Part $2.00 per part * 1.01 = $2.02 36

Raw Material Cost Calculations 1 lb of Raw Material Costing $2/lb Goes Into the Process What about the scrap? 1 Finished Part Weighs.9 lbs 1% of Finished Parts are Scrapped in Process.1lb of engineered or fabrication scrap occurs in production.009 lb of scrap occurs after production 1% *.9 lb =.009 lb Total scrap produced.109 lb 37

Raw Material Cost Calculations 1 lb of Raw Material Costing $2/lb Goes Into the Process The process produces.1 lbs of engineered scrap and.09 lbs of finished part scrap. The supplier sells the.109 lb of engineered scrap for $.50 / lbs 1 Finished Part Weighs.9 lbs 1% of Finished Parts are Scrapped in Process.109 lb * $.50/lbs = $.0545 This Scrap Resale reduces the material cost $2.02 - $.0545 = $1.9655 38

Example - Raw Material Cost Calculations 1 lb of Raw Material Costing $3/lb Goes Into the Process What is the cost of raw material the supplier must purchase to produce 1 good part? 1 Finished Part Weighs.8 lbs Raw Mat Cost/Part * (1+Scrap %) = Total Raw Mat Cost/Part $ 3.00 per part * (1 + ).01 = 3.03 1% of Finished Parts are Scrapped in Process 39

ExampleRaw Material Cost Calculations What about the scrap? 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 lbs 0.2 of Engineered or fabrication scrap occurs in production 0.008 lbs of Process scrap occurs after production 1% *.8 lb =.008 lbs Total scrap produced 0.208 lbs 40

Raw Material Cost Calculations The supplier sells the lb 0.208 of scrap for $.75 / lbs 1 lb of Raw Material Costing $3/lb Goes Into the Process 0.208 lbs * $.75/lb = $ 0.156 1 Finished Part Weighs.8 lbs Total Raw Material Cost: $ 3.03 - $ 0.156 = $ 2.874 1% of Finished Parts are Scrapped in Process 41

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!!!! 42

How Suppliers Incorrectly Quote

Incorrect/Inaccurate Quoted Weights Effective counter measures: Physically weigh parts yourself and compare against quoted weight. Compare quoted weight to CAD data weight. 44

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. 45

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. 46

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 47

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. 48

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 49

Different Effective Dates Effective counter measures: Question supplier about the dates especially on new programs. Specify effective dates in RFQ. 50

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. 51

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. 52

Uncompetitive Pricing 53 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.

Other Potential Issues Potential issue: Effective counter measures: 54

Raw Materials Check List R a w M a t e r i a l Area Items Check Type Quoted Cost Quoted Cost Quoted Cost Usage Usage Usage Usage Usage Scrap Scrap Scrap Scrap Scrap Scrap Scrap Material specifications are clear and consistent Consistent between suppliers Consistent with historical trends Consistent with published indices Gross part weights are consistent between suppliers Gross part weight has been verified by weighing Net part weights are consistent between suppliers Net part has been weighed Weights have been verified to CAD Calculations Consistent scrap % between suppliers Scrap % is consistent with historical quotes Scrap % has been validated with process and record audit Supplier is providing "credit" for scrap resale Consistent Scrap Resale rates between suppliers Scrap Resale rates consistent with historical trends Scrap resale rates consistent with published indices 55

Purchased Part Checklist Area Items Check Parts Purchased parts and services are in line with design P u r c h a s e d P a r t s & S e r v i c e s Usage Sub-Suppliers Scrap Scrap Number of purchased parts are consistent between suppliers Suppliers of purchased components are acceptable Consistent scrap % between suppliers Scrap % is consistent with historical quotes Scrap Scrap % has been validated with process and record audit 56

Labor SG&A Profit Labor Burden Material 57

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. 58

Labor Cost Simplified Labor Time Required for Production Labor Cost Labor Cost per Unit of Time 59

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 60

Labor Cost Calculations Process can produce 60 gross parts in an hour 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. Gross Parts Per Hour * (Efficiency Rate) = Net Parts per Hour 60 * 0.80 = 48 61

Labor Cost Calculations Operator pay is $10 per hour Operator benefits cost the company $5 per hour Direct Labor Rate + Fringe Rate = Fully Fringed Labor Rate $10 + $5 = $15 62

Labor Cost Calculations 2 Operators Fully Fringed Labor Rate is $15/hr 48 net parts per hour # of operators * (FF-labor rate) / Net Parts per hour = labor cost 2 * $15/hr / 48 = $0.625/part 63

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 64

Example - Labor Cost Calculations 2 Operators $14 per hour. Operator benefits cost the company $3 per hour Process has a Gross Pieces per hour of 700 with 85% Efficiency Rate *Gross pcs Hr * Efficiency Rate = Net Pieces Per Hour 700.85 595 * = (# of Ops * Fully Fringe Rate) / (Net Pieces/Hr) = labor cost per part ( 2 * $17.00 ) / ( ) 595 = $.05714 65

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 66

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 67

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 68

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. 69

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. 70

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. 71

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. 72

Labor Checklist L a b o r Operator Wage Rates Operator Wage Rates Operator Wage Rates Operator Wage Rates Production Rates Production Rates Production Rates Production Rates Inefficiency Rates Inefficiency Rates Inefficiency Rates Inefficiency Rates Consistent with previous quotes Consistent with industry norms Consistent with regional norms Fringe rates are in the normal range of 25-35% of labor rate Consistent with previous quotes Consistent with competitors Consistent with PPAP Verified by Audit Consistent with previous quotes Consistent with competitors Consistent with PPAP Verified by Audit 73

Session 2

Objectives for this Training 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. 75 Review top ways to: Improve analysis of the cost impacts of design changes. use the cost breakdown information to negotiate costs of design changes.

5 Main Areas of Cost Selling, General, and Administrative SG&A Profit Labor Burden Material 76

Example - Raw Material Cost Calculations 2 lbs of Raw Material Costing $2/lb Goes Into the Process How many parts must the supplier plan to produce if the supplier needs 100 good finished parts? # of finished parts required * 1 + Scrap % 100 * (1 +.02) = 102 1 Finished Part Weighs.8 lbs What is the cost of the raw materials required to produce 100 good parts? 2% of Finished Parts are Scrapped in Process Raw Mat Cost/Part * (1+Scrap %) = Total Raw Mat Cost/Part $ 2.00 per part * (1 + ).02 = 2.04 77

ExampleRaw Material Cost Calculations What about the scrap? 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 lbs 1.2 of Engineered or fabrication scrap occurs in production.016 lbs of Process scrap occurs after production 2% *.8 lb =.016 lbs Total scrap produced 1.216 lbs 78

Raw Material Cost Calculations The supplier sells the lb 1.216 of scrap for $.75 / lbs 2 lb of Raw Material Costing $2/lb Goes Into the Process 1.216 lbs * $.75/lb = $ 0.912 1 Finished Part Weighs.8 lbs Total Raw Material Cost: $ 2.04 - $ 0.912 = $ 1.128 2% of Finished Parts are Scrapped in Process 79

Example - Labor Cost Calculations 2 Operators $15 per hour. Operator benefits cost the company $4 per hour Process has a Gross Pieces per hour of 600 with 80% Efficiency Rate *Gross pcs Hr * Efficiency Rate = Net Pieces Per Hour 600.80 480 * = (# of Ops * Fully Fringe Rate) / (Net Pieces/Hr) = labor cost per part ( 2 * $19.00 ) / ( ) 480 = $.07917 80

Burden / Overheads

So far, we have talked about Labor and Material Costs. Selling, General, and Administrative SG&A Profit Labor Burden 82 Material

Burden / overheads Vs SG&A Burden or Overhead: Manufacturing costs associated with the production of a part. SG&A Front office, corporate costs. 83

Does anyone have some examples of burden and SG&A? 84

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 85

86 Allocating Burden

Allocating Burden to Part Cost Simplified Burden Cost $8,900,000 Burden Cost Per Part $4.45 Net Pieces 2,000,000 87

However Different part designs Different mfg processes Multiple plants 88

89 Cost Allocation Spreading the costs around.

Allocating Cost of Goods Sold Burden/Overhead Cost by Department Total Cost Total Machine Hours Available Cost per Hour Inj. Molding $4,500,000 Welding $2,000,000 Assembly $2,400,000 45,000 30,000 100,000 $100.00 $66.67 $24.00 1. Costs are assigned to departments or individual machine types. 2. The total machine hours are calculated for each group. Costs Machine Hours Burden Cost Per Hour 90

Allocating Cost of Goods Sold Burden/Overhead Cost by Department Total Cost Total Machine Hours Available Cost per Hour 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 10,000 15,000 20,000 30,000 100,000 $50 $100 $125 $66.67 $24.00 Burden costs will vary by machine size. Suppliers who do not recognize this will: Be uncompetitive on small machines Lose money on large machines 92

Allocating Cost of Goods Sold 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? 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 93

Burden Costs SG&A Profit Labor Burden Material 94

Fixed and Variable Variable Cost Fixed 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 95

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 96

Burden Cost Simplified Burden Cost Per Hour Burden Cost Per Part Net Pieces Per hour 97

Burden Cost Calculations Process requires a Fixed Burden rate of $75/hr and a Variable Burden rate of $25/hr 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 98

Burden Cost Calculations Process requires a Fixed Burden rate of $175/hr and a Variable Burden rate of $25/hr 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 99

Burden Cost Calculations - Alternative Process requires a Fixed Burden rate of $75/hr and a Variable Burden rate of $25/hr Part requires a Net Std Hr of 0.02083 (Fixed Burden Rate/Hr + Variable Burden Rate/Hr) * Net Standard Hour = Total Burden Cost ( $75 + $25 ) * 0.02083 = $2.08 per part 100

Variable and Fixed Cost Cost of Goods Sold SG&A Profit Revenue Material Cost Direct Labor Cost Burden/ Overhead Variable Cost Fixed Cost 101

Contribution Margin Revenue Variable Cost Contribution Margin A company sells one product, price: $2.00 Variable cost to produce: $1.25 Contribution Margin: $.75 102

Contribution Contribution Margin # of Units Sold Contribution $.75 10,000,000 $7,500,000 103

Profit Contribution Fixed Cost Profit $7,500,000 $6,000,000 $1,500,000 However if volume falls by 33% $5,000,000 $6,000,000 $(1,000,000) 104

Profit Contribution Fixed Cost Profit $5,000,000 $6,000,000 $(1,000,000) The good news.. Fixed costs are not Fixed!! $5,000,000 $4,000,000 $1,000,000 105

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) 106

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 107

Burden Checklist B U R D E N Rates Rates Rates Rates Rates Consistent with previous quotes Consistent with competitors Vary with machine size Do not include employee fringe Do not include items in SG&A 108

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. 109

SG&A and Profit SG&A Markup Sales Advertising Commissions Sales Salaries Travel and Marketing General and Administration Administration Salaries Training Travel Moving expenses Office Supplies (Gross) Profit Markup 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 1 110

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 111

SG&A and Profit Cost Simplified Cost of Goods Sold (COGS) SG&A and Profit Cost SG&A and Profit Markup % 112

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 113

SG&A and Profit Checklist Area Items Check S G & A P R O F I T Rates Rates Rates Rates Consistent with previous quotes Consistent with competitors Consistent with financial statements Do not include items in Burden Case 1 Capstone Case 114

Using Cost Breakdown info to Control Costs Professional courses to optimize your buying team s performance 1

1. Create a cost driver table Part # Quote Date Supplier Raw Material Cost UOM Gross 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 Net Wt Include most important drivers Add data from each quote Add key calculations (e.g., Net wt / Gross Wt.) 116

#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 117

3. Add the Cost Driver Summary to Part/Supplier Workbook Part # Quote Date Supplier Raw Material Cost UOM Gross 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 Net Wt Should mirror your Cost Driver Summary for easy cut and paste. 118

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 119

5. Update your Master Cost Driver Summary Should be a quick Copy and Paste 120

6. Analyze your Cost Driver Data Identify inconsistencies Build cost models 121

Wrap - up Questions: Next Steps: Training evaluation On line problems Thursday 122

Understanding and Using Cost Breakdowns Professional courses to optimize your buying team s performance 1