This first part of the training will be dedicated to cost analysis. The focus will be put on «how to challenge the cost breakdown given by the suppliers» or if need be : «how to recreate the cost structure of the supplier». 1
As an introduction to the cost analysis part of this module, we are going to review together the various types of cost analysis that a buyer or any person involved on cost issues may be willing to perform according to the 3 phases of a project life cycle : design, development and serial production After this introduction our focus will be primarily on the development phase, as it is there that we need to challenge the cost breakdowns given to the suppliers. 2
First of all, we need to gather a global picture of the cost analysis issues by considering the 3 key phases in a project life cycle i.e. -The design phase where the functional specification and the first design options are being defined by the project team -The development phase starting right after the design freeze and where the company is developing the detailed solutions for the selected technical concept. At this point we get the tenders on components and material from the vendors. -The serial production or manufacturing phase where the company assembles the components on a daily basis. Depending on the phase we are in, the cost analysis issues are different : - At the design stage, the issue is to estimate the cost of a sub function or a single component for instance : a wire harness, a motor, a stamped cover, etc.. At this early stage, we do not have yet the full technical definition but only a vague definition of the specification. Therefore we cannot get real offers from vendors. However it is possible to make an analogical cost simulation based on key cost drivers in order to estimate the potential cost. An example of such an analogical cost analysis is shortly described in the next slide. -In the development phase, we should be able to get the cost breakdowns together with the tenders of the vendors. At this point the cost analysis issue will be to check the fairness of the price estimations and thus benchmark the supplier offers. We call this kind of approach an «analytical cost calculation» as it means to analyse every line of the cost breakdown given by the supplier i.e. material, machine, labour, overheads and so on. -Finally in the serial production phase, the issue is again different as we assume that we have chosen the right vendor with the right price. So the issue at this point is mainly to reduce the cost of a component or a function by playing with the technical cost drivers, this is why we perform a cost driver analysis. This last kind of analysis is what we need to do when we perform a productivity workshop with the supplier. 3
The first of the 3 approaches is done in the design pahse and is call the analogical approach. The basic principle is to calculate a cost based on -An extrapolation made from historical data available for similar components or parts purchased for previous projects -On a family of parts for which it is possible to identify key factors driving the cost. These cost factors (for axemple : power, volume, standard / non standard, ) are then processed with a linear regression analysis in order to find a coherence with the price paid. The table below shows an illustration for a wire harness connector family. As you can see several cost drivers have been identified such as : yearly volume, number of pins, amp level, water and dust tighness, security level, etc. It may appear that s several cost drivers initially selected have no influence on the price. In such a case, the system is requiring that you try other drivers in order to reach the required level of precision of the model. Once this model is built, it can be used for extrapolating the cost of a new project in the same family (as shown in the example) by indicating the values for each driver. 4
At this point it is important to comment upon the pros and the cons of such an analogical approach. On the Pro s, it is Well suitable for sub systems which complexity does not allow to make a full piece by piece analysis The other good point is that it can be updated on a regular base For the Con s there are 2 main limits to this kind of approach : -First its is only based on past information - Secondly it cannot be used to define a target but rather to give an idea of what the market currently offers in terms of price. 5
The second approach that a buyer may have to use is called the analytical approach It occurs during the development phase. In this phase of the life cycle, the goal is to challenge the offer of the vendors by analysing each cost item of the breakdown i.e. -The material, components and subcontracted operations which covers all material, components and other subcontracted operations the suppliers requires to manufacture the product -The direct labour cost which covers the cost of the direct people needed to run the machines -The machine cost which basically covers the cost of running equipments directly used during the production i.e.; the machines and their equipments (robots, conveyors,..) -The industrial overheads which covers the cost of the industrial support functions such as : engineering, process engineering, logistics, production planning,.. Etc -The SG&A which stands for sales, general and administration expenses that cover the cost of the company support functions such as sales, general administration, finance and accounting,.. etc -The operating profit which corresponds to the income generated by the vendor from his operational activities. -The packaging and the transport cost which includes the cost of the packaging elements (if any) as well as the transport to reach the customer. The sum of all these cost item gives the price we should pay for this piece or sub assembly. 6
In this third and last phase of the project life cycle i.e. the production phase, the cost driver analysis seeks to identify the generating factors of the cost in order to seek cheaper alternatives (during a workshop for instance). There are 2 categories of cost drivers : -The functional drivers which are related to the customer specification (i.e. functionality and performance). For example on a fog lamp for a car : to be able to work under ambient conditions : from -40 C up to + 80 C -The technical drivers which are related to the technical solution (i.e. COMPANY design and/or the supplier organization). For example on the fog lamp : an aluminium casting reflector or manual deburring of the seal aftar demoulding. These 2 solutions are the result of a choice either made by THE COMPANY (for aluminium casted part) or by the supplier (for the manual deburring). They both drive the cost because of their complexity in terms of operational implementation ti i.e. expensive material (aluminium), expensive process (casting or deburring). 7
Before we enter into the details of the cost calculation rules, we shall first give a global view of the cost analysis process. 8
This cost analysis process is composed of 5 steps. The very first step of the cost analysis process will be to ask the supplier to give us a detailed quotation based on the standard COMPANY format. Please click on the icon on the top right part to access this template on line. This standard and generic template may be completed by some additional breakdown formats, specific to a family of parts. Please click on icon 2 and 3 to access the 2 examples for injection moulding parts and metal stamping. The second step of the cost analysis process will be to challenge the figures with the rules of calculation as well as with benchmark information in order to point out inconsistent figures or mistakes, This comparison will enable us to detect discrepancies between our calculation and that of the supplier. The 3rd step of the process will be to collect more information on the supplier s GENBA. In fact several discrepancies may be related to some specific organizational reasons that we need to understand by going deeper in the analysis. This GENBA information can be obtained using different ways : 1 - Use SQA visits 2 - organize some cooperative productivity workshops 3 - Update the PPAP. This deeper understanding of supplier s GENBA, will help us to sort out the various justifications of the discrepancies : Either : Critical operation requiring more time or resources than initially planned Or : Pure commercial reason indicating some hidden margin. The 4th step will be the recreate the should cost taking into account the criticalities of the GENBA. Finally the fifth step will be to start again to negotiate with the supplier using the simulated should cost. Please click on the icon on the top right part to access this template on line. This standard and generic template may be completed by some additional breakdown formats, specific to a family of parts. Please click on icon 2 and 3 to access the 2 examples for injection moulding parts and metal stamping. 9
In order to challenge the cost information given by the supplier or maybe recreate the cost structure, we need to explain now how to perform the calculation of each cost item i.e. the material cost, the direct labour, the machine cost,, the industrial overheads, the SG&A expenses and the profit. 10
Let s start first with material cost 11
Calculating the cost of the material and the components is the result of the multiplication of 3 factors : the gross weight or the quantity consumed, the cost per Kg or per unit and the percentage of handling cost which covers the cost of buying the material (cash cost), and the inventory carrying cost (insurance, space, depreciation, etc..). For this cost item we must take care of the usual pitfalls : - Always check the gross weight. The initial estimation may come from a theroretical calculation done at an eraly stage of the project. The reality may turn out to be different, and since material may be a significant share of the cost, it is important to check it. It strongly advised to check these weights before performing the cost analysis and without the presence of the supplier. - The cost per kg or per unit may be quite dependant on the ordering quantity. The supplier may have a bad price because is order too little quantities. - The handling cost should stay in the range of 4 to 5%. It may in some specific case exceed 5% but it should then be justified by a low unit value, and or a space constraint. - The recycling of the material must be clearly shown in material cost calculation either it is reprocessed (for example in plactic injection moulding) or sold (aluminium, steel, plastics,.) 12
Here is an illustration of the calculation of the cost of material for a plastic injected cover. The key input data for this example are the following : -The type of material is PBT -The material cost / kg is 2.65 /Kg -The handling cost is 4% - The gross weight is 150 g - The net weight is 140 g - The scrap rate is 2% - The maximum authorized share of regrained material is 5 % of piece weight hti.e. 7 g (i.e. 5% of 140g) - The non regrained material is sold at a value of 0.8 / kg The calculation of the material cost is the following : Material loss = the difference between the gross weight and the net weight (10 g) + the scrap (150 g x 2% = 3g) the regrained material (7g) which equals 6 g Thus the material cost is : 0,144 Kg x 2.65 x 1.04 = 0,3969 / piece In this case, the cost of the loss is (2.65-0.8)x 0.006 = 0.0111. Please note that on purpose, the material loss is not included in the calculation of the material cost. This loss will be added at the very end of the full calculation, after profit and Sg&A in order to avoid considering this loss as an element of the cost breakdown subject to profit margin. 13
The second cost item we need to calculate is the labour cost 14
Calculating the direct labour cost is obtained by dividing the hourly labour rate by the speed per hour. It is important to have a clear definition of what the hourly rate includes. The hourly labour rate includes wages and salaries social security private pensions so s casualty insurance welfare services (canteens, cultural and recreational activities, ) taxes on labour. It doesn t include any share of indirect labour. For 2006 the benchmarks for hourly labour rates (in / hour) are the following : -France : 22-23, 23 germany : 17-25, Spain : 17-1818, Japan : 22; Mexico : 2-3, China:1, Korea : 12-13, Portugal : 8-10. It is also important to note that the speed / hour should be an average production speed for 1 hour and thus should be instant speed multiplied by the OEE. (for instance for an instant speed of 100 parts/ hour with an OEE of 85% the real speed is 85 parts / hour). 15
The third item of the cost calculation is the machine cost 16
The hourly cost of machines includes only the 5 items of the direct costs of running the equipment i.e. - The depreciation of the investment - The financial interest - The maintenance - The energy cost related to the use of the machine - The cost of the space used by the machine This cost does not include the cost of the support functions such as tool shop or adjusters which are addressed within the cost category called «industrial overheads». Therefore it explains why when we compare the results of our calculation with the supplier s rates (which usually takes the «full machine cost» including overheads) we may find significant differences. 17
To perform the calculation of a machine cost, we need 3 different input information : The cost information which includes -The machine cost with its various equipments -The cost of the energy used by the machine ((electricity, gas, etc..) in the country of location - The cost of financing the machine (Interest rate) The technical information which include: - Space occupied by the machine. Usually we consider 4 to 10 times the surface occupied by the machine to account for runways and storage areas. The operational information which includes : - the number of shift the company operates - The number of working days / year. This time can vary a lot according to the industry and the country - the life time of the equipment. The life time can be short for fast moving technologies (3 to 4 years) but rather long (8 to 10 years or more) for stable technologies (stamping, injection moulding). The calculation will consist in calculating the cost of each item over a period of time such as 1hour, 1 year or the whole life time and then divide by the corresponding number of hours. 18
A this point it is important to clarify the impact of the efficiency or OEE (overall equipment efficiency) rate in the calculation. The concept of efficiency will be detailed further down in this training module but we can already explain its global purpose. The efficiency indicate the remaining percentage of the time when we exclude all times lost with non efficient work such as : bad quality, failures and breakdowns, reduced speed, set up times and all other down times. In our calculation of the machine hourly cost we do not include the OEE impact. So we assume that the efficient is 100%. The reason is that the efficiency impact will be addressed at the cycle time level when we shall multiply the hourly cost of the machine by the cycle time of the Job done by the supplier. To illustrate this point let us show an example of a stamping machine : -Let s consider an hourly cost of 25 with a speed of 120 shots per minute. This speed was measured during the visit at the supplier. If we assume that the supplier operate with an OEE of 85% then the cost per piece (or shot) can calculated as follow : 25 / 120 x 60 x 85% = 0,00408 / piece (or shot). The efficiency should be related to a specific machine or even sometimes to as specific job and thus it is logical to apply the OEE rate on the cycle time and not on 19
The principle is to calculated an hourly cost for each of the 5 cost items i.e : -Depreciation cost -Financial cost -Maintenance cost -Energy cost -And space cost Once all data s have been gathered, we can then sum up these costs in order to get the global hourly cost of the machine. The calculation can be either done with the exact information given by the supplier or based on assumptions of what the normal conditions should be for this kind of activity (stamping, casting,.). 20
For depreciation the calculation will be based on set of input data. To illustrate how to proceed we will take the example of 125 tons injection moulding press. In this case the input are the following : - The investment cost including the other equipments (robots, conveyors,..), in this case 120 000 - the daily working time, usually 3 shifts of 8 hours - the yearly working time : usually 220 to 250 days / year, 220 days in the present illustration - the life time of the machine which depends on the speed of obsolescence of the technology. For many industries it is between 7 and 10 years. In the present example we have taken 7 years. Then the calculation of the hourly depreciation cost for the machine is the following : - Number of hours for the whole period : 24 hours / day x 220 days / year x 7 years = 36960 hours. - The hourly depreciation cost is : 120 000 / 36960 = 3,25 21
Interest rates are based on the WACC «weighed average cost of capital» which indicates how the company structures the its financial resources. Usually a good assumption is to consider 50% financing by bank loan and 50% by own financial resources. the bank loan interest rates varies from one country to the other but in western Europe a 5% would be a good guess for 2006 the expected return on capital is 15% for own financial resources. For a WACC with 50% bank loans and 50% own financial resources, the interested used for the calculation would be : (50%x 15%) + (50% x 5%) = 10% 22
Now that we have the interest rate we can calculate the hourly cost for financial interest The calculation for financial interests is based on 3 input data : -The cost of the machine -The interest rate (resulting from the WACC calculation) -The Number of years of the financial plan. The amount of interest paid during the period is calculated thanks to the formula given here in where : - n is the number of years - K is the amount of the investment - «i» is the financial rate The financial cost / hour is the amount of interest over the period divided by the number of hours of the same period. For the example of the injection press the calculation is the following : Financial interest for 7 years : - 7 x 120 000 x 10% - 120 000 = 52555 1- ( 1.1) -7 The cost per hour is then : 52555 / 36960 hours = 1.422 / hour. 23
The yearly cost of maintenance is calculated as a % of the investment cost (1): usually between 2 and 5%. This percentage varies according to the type of technology but also according to the age of the equipment. Please note that for machines such as drilling, grinding, polishing etc... We should consider also a specific additional cost for consumables such as lubricants, small tools, etc This cost can represent up to 5 or 6 / hour in some case and it is not included in the percentage mentioned herein. The input data for the calculation are the following: Value of the equipment or machine when new: 120 000 Number of hours / year: 5280 % of maintenance cost: 3% Then the hourly cost of maintenance is: 3% x 120 000 / 5280 hours = 0.682 / hour 24
The calculation of energy cost is based on: -The energy consumption The energy consumption depends on the nominal power and the % of utilization. This % of utilization depends on how the machine operates. For instance a plastic injection press only uses 50% of the nominal power due the specific cycle : injection, cooling, opening of the mould, etc Finally in the calculation we must multiply the nominal power with the % of utilization to get the consumption and then we can multiply this result by the cost of the Kw/h. In the present case, the cost of energy per hour is 35 Kw/h X 50% X 0.06 = 1.05 Please note that the cost of the Kw/h depends on the negotiation capacity of the supplier. 25
The cost of space is based on -the space need for running the activity of the machine -The yearly cost of space And The number of working hours / year The total space needed must account for runways and other storage areas: It is usually around 4 to 10 times the space of the machine itself according to the type of parts produced (bulky or not). The yearly cost of the m² depends on the location. It is currently in between 50 to 70 / m² in western countries. In the example taken the input data are the following : - Surface of the machine : 6 m² - Yearly cost of the m² : 50 : - Number of hours per year : 5280 The illustration gives the following calculation : Space allowance : 6 times the surface of the machine or 6 x 8 m² = 48 m² => Hourly cost of space : 48 x 50 / 5280 = 0.454 / hour 26
The principle is to calculated an hourly cost for each of the 5 cost items i.e : -Depreciation cost -Financial cost -Maintenance cost -Energy cost -And space cost To get the global hourly cost of the machine you will have to sum up all the costs that we have gone through on this slide. The calculation can be either done with the exact information given by the supplier or based on assumptions of what the normal conditions should be for this kind of activity (stamping, casting,.). As a results of all the previous calculation, the hourly cost of the machine is the sum of all 5 cost items. In the present case the hourly rate is 6.6. Again it is important to note that this hourly cost does not include any overhead cost nor efficiency impact. 27
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Item n 4 of the cost calculation is the industrial overheads 30
The scope of the industrial overheads usually covers all the cost generated by the functions supporting the operational activities i.e. R &D Information technology Production engineering Purchasing Logistics and warehousing Planning, scheduling of production, etc t They do not include sales, general and administration expenses which are a separate cost item. As a general calculation rule we shall consider that OI equals between 25 and 35% of the industrial added value (i.e. machine and labour cost). A regular production plant without high technology nor real R&D should be on the low side of the ratio (25%), whereas other companies providing a high level of engineering skills would on the high side (35%). OI are the first part of the overhead cost of the company, the second part being SG&A. Altogether OI + SG&A are generally equals around 15% to 17% of sales according to the company profile. However comparing these expenses with the sales, may not be very relevant as the ratio might be strongly affected by the value of the material. 31
The fifth element that we need to calculate is the Sales general and administration expenses (also called SG&A) 32
The scope for sales, general and administration expenses usually covers all the all the cost generated by the business support activity such as : general management sales and marketing finance and accounting Human resources Travel expenses,.. The Calculation rule is quite simple : SG and A usually represent around 5 to 7 % of the piece price. 33
Finally we need to calculate the operating profit 34
Regarding operating profit, it is important to remember that the operating profit mentioned in the cost breakdown is before income tax. In terms of calculation rule, the profit level depends on the supplier market segment and supplier position. For the «tier 2 suppliers» level of the automotive industry this profit is usually in the area of 4 to 7 % of the piece price. 35
Finally we need to account for packaging and transport cost. 36
As a general remark : : Packaging cost covers the cost of the lost items needed for the protection of the parts during transport. Very frequently returnable containers are used and do not require any additional protection. If such a protection is needed it should be checked carefully as the minor cost is very often over estimated by suppliers Regarding transport cost, selling conditions are quite often ex work with a milk run system which means that the optimization of transport needs to be addressed at customer level. 37
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At this point we would like to thank you for having spent some time learning this module. We hope you enjoyed it and we would like to remind you to make a hard copy of all the slides so that you can keep track of all the calculation rules and concepts we have been reviewing. We wish you a very good success for the implementation with your suppliers 40