1. Chapter 11 Cost Management ©McGraw-Hill Education. All rights reserved.

2. Key Questions Addressed in Chapter 11 How can cost management and negotiation tools help identify opportunities and assure value? How can we determine – the supplier’s costs? – deliverer’s cost? – our own use costs? – disposal costs?

3. Strategic Cost Management An externally focused process of analyzing costs in terms of the overall value chain – A continuous improvement process – Measure and improve specific cost elements – Tools and techniques to sustain cost savings year over year – Strategic partnering to achieve competitive advantage – An opportunity for strong supply leadership to develop a cost culture rather than a price culture with multiple internal stakeholders and suppliers

4. ABC or Pareto Analysis and Cost Management Assign items to A (high-dollar), B (medium- dollar), or C (low-dollar) category A items = greatest percent of annual spend Cost management approach for A items: – More time and managerial attention – Understand supplier’s cost structure – Identify opportunities for supplier or joint buyer- supplier initiative to eliminate, reduce, or avoid costs in any cost elements (materials, services, labor, and overhead)

5. Portfolio Analysis ©McGraw-Hill Education. All rights reserved. 5 non-critical items bottleneck items strategic items leverage items Value Risk Low High Low

6. Major Categories for the Components of Total Cost of Ownership ©McGraw-Hill Education. All rights reserved. 6 Pretransaction Components Identifying need Investigating sources Qualifying sources Adding supplier to internal systems Educating: – Supplier ins firm’s operations – Firm in supplier’s operations Transaction Components ●Price ●Order placement/preparation ●Delivery/transportation ●Tariffs/duties ●Billing/payment ●Inspection ●Return of parts ●Follow-up and correction Posttransaction Components ●Line fallout ●Defective finished goods rejected before sale ●Field failures ●Repair/replacement in field ●Customer goodwill/reputation of firm ●Cost of repair parts ●Cost of maintenance and repairs Total Cost of Ownership Source: Lisa Ellram, “Total Cost of Ownership: Elements and Implementation,” International Journal of Purchasing and Materials Management, Winter 1993.

7. Target Costing Example ©McGraw-Hill Education. All rights reserved. 7 Future Market Price – Desired Profit = Target Cost Current Price Part/System Price Verified By Cost Standards Target Cost Desired Profit Current Cost Component Target Costs A B C Purchased Component Part Level Costs Internal Costs > Current Profit Model- to- Model Change Adjust for Spec. Differences

8. Value Expression Value can be expressed as: VALUE = Function Cost – Function = a noun-verb combination (e.g., holds liquid)

9. Activity Based Costing Tries to turn indirect costs into direct costs by tracking the cost drivers behind indirect costs Manufacturing overhead is divided into: – costs that change in response to unit-level activities – batch-level activities – product-level activities – the remainder are true fixed costs and are allocated according to traditional cost accounting

10. Negotiation The most sophisticated and most expensive means of price determination A difficult art requiring judgment and tact An attempt to find an agreement that allows both parties to realize their objectives Requires the buyer and supplier, through discussion, to arrive at a common understanding on the essentials of an issue