Cost Modeling - Cost Factors, Should Cost and TCO PDF

MGMT46501 STRATEGIC SOURCING AND PROCUREMENT COST MODELING Cost management as a strategic supply function Learning objectives After completing this lecture, you should be able to  Understand the key principles for strategic cost management  Understand the should-cost model and total cost of ow...

MGMT46501 STRATEGIC SOURCING AND PROCUREMENT COST MODELING Cost management as a strategic supply function Learning objectives After completing this lecture, you should be able to  Understand the key principles for strategic cost management  Understand the should-cost model and total cost of ownership (TCO)  Understand the principles to identify the cost drivers  Understand the common cost modeling approaches Strategic cost management From internal cost management to supply chain cost management Strategic cost management Supply chain focus Strategic cost management Managing life cycle cost Total acquisition cost Should cost - “What the product or service should cost?” price= cost + margin Should-cost model Mapping cost drivers in extended value chains A cost driver is a specific dimension of cost that is attributable for a significant portion of the overall pattern of cost increases or decreases. Examples of cost drivers:  Materials: Commodity fluctuations, handling difficulties, tolerances, lead times, design limitations, managed flow, cost of poor quality  Labor: Production method: complexity, awkward, safety concern, scrap, efficiencies, turnover, correction, cost of poor quality  Overheads: Machines / tools: complexity, uniqueness, indirect labor, maintenance, transactional costs, governmental constraints. Total cost of ownership (TCO) TCO is the present value of all costs associated with a product, service, or capital equipment that are incurred over its expected life. TOC helps identify and measure cost elements beyond standard unit price, transport, and tooling and analyze cost drivers when evaluating purchase proposals or supplier performance. There are four common cost categories:  Purchase price – Invoice amount paid to the supplier.  Acquisition costs – Costs of bringing product to buyer. – Examples: administration, transportation, and taxes.  Usage costs – Product: Costs of converting purchased product into finished product and supporting its usable life. – Service: Costs associated with the service performance that are not included in the purchase price. – Capital equipment: Costs of operating the equipment through its life. – Examples: inventory, conversion, scrap, warranty, installation, training, downtime, and opportunity costs  End-of-life costs – Net of amounts spent/received at salvage. – Examples: Obsolescence, disposal, clean-up, and project termination costs.  Total cost of ownership (TCO) Consider the purchase of 1,000 desktop PCs of a three-year life cycle for a company. The company’s cost of capital was 12 percentage. TCO calculation for one purchase option TCO calculation 3,090,480 3,090,480 3,064,480 T𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜 𝑁𝑁𝑁𝑁𝑁𝑁 = 9,909,837 = = = 1.12 1.122 1.123