Developing and Using Open Book Cost Models for Metallic Commodities. Robert Maks, Vice President, Cost Engineering

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1 Developing and Using Open Book Cost Models for Metallic Commodities

2 Developing and Using Open Book Cost Models for Metallic Commodities Background The financial crisis of 2008 lent credence to the adage that only the strong survive. The balance of power between customer and supplier shifted to become more equal. The notion of annual price reductions baked into contracts was challenged. The concepts of early upfront business awards and increased collaboration between supplier and customer started to become a reality. Today, purchasing organizations at the OEMs are led largely by individuals with engineering/manufacturing backgrounds. OEMs expect their Tier I suppliers to have cost standards/cost models to guide their business relationship and accelerate focus on continuous improvement. page 1

3 What is Open Book Cost Modeling? Simply put, Open Book Cost Modeling is a collaborative effort between a customer and a supplier to do the following: Understand a supplier s true cost structure to determine price Enhance transparency between customer and supplier Determine/form long-term relationships Identify risks and opportunities Open Book Costing s main goal is to facilitate cost-related discussions between customers and suppliers around material, labor, burden, SG&A and profit that are data/fact driven. Open Book Models become the baseline for current and future pricing-related discussions. Additionally, Open Book Modeling serves as a valuable tool to help identify and eliminate waste. things most of which will eventually become bad (for example, you will experience unexpected price increases or even have your supplier go out of business). So how does this relate to Open Book Costing? Let s look at the simple example below, assuming that price is represented by the height of bars A & B: Assuming quality, delivery, and payment terms are equal, traditionally Supplier A would be selected. Using a traditional approach to sourcing, the business in question would be awarded to Supplier A. However, Open Book Modeling would provide cost transparency into Supplier B that would lead to a different decision. Why Use Open Book Cost Modeling? To a supplier, inaccurate costing is the equivalent of death by a thousand cuts. If you are going to market with products that are not properly costed, you will tend to win business that you have under-costed, and lose out on business that you have over-costed. Over time this will drive down profitability. To a customer, the impact of dealing with a supplier that has inappropriately priced the goods you buy can mean a great number of thinner margins The message here is that better visibility leads to better cost management and better decision-making. Open Book Modeling is the fastest path to the most savings while maintaining, or even increasing, profitability. page 2

4 Is Open Book Cost Modeling for Everyone? Open Book Cost Modeling is not for everyone. To understand why Open Book is not for everyone let s look at the bubble chart below that has been populated with some sample data: Looking at the chart, the horizontal axis represents the number of suppliers that exist in the market (many suppliers to the left and few suppliers to the right). The vertical axis represents the impact on a buyer s business (low impact toward the bottom and high impact toward the top). The commodities listed in the upper left quadrant (many suppliers exist with high impact on the buyer s business) would be considered the sweet spot for Open Book. The buyer has many suppliers from which to purchase, while having high impact on the business. Stated differently, the buyer has the ability to change suppliers fairly easily when the appropriate business rationale exists (i.e., savings, improved quality, etc.). This doesn t mean that you can t engage in Open Book Modeling for the commodities that fall into the other three quadrants - just be sure to choose your opportunities carefully. The best analogy that comes to mind is to use the right tool for the job; don t use a hammer to install a screw. Getting Started with Open Book Cost Modeling? As just discussed, choosing the right commodity for Open Book Cost Modeling is critical. Strong spend and the ability to realign the supply base are paramount in attracting suppliers to engage. Buyers need to engage suppliers who have the right capabilities and who meet the proper quality, delivery and financial criteria. Tying in strategic/preferred supplier status and offering the opportunity to be involved in early sourcing activity are excellent enticements to grab the attention of suppliers. Some additional elements that are key to consider as you get started with Open Book: This is a cooperative process both sides need to have input to the process Models cannot go below the supplier s costs Supplier must have final approval of the cost model The model must be based on actual costs Summary Open Book Cost Modeling is the fastest path to the greatest sustainable savings. Both buyer and seller will benefit if done in a collaborative manner. Choosing the right commodities, identifying the proper partner(s) and focusing on correct long-term business rewards will ensure success. page 3

5 About APD, the Purchasing Authority Advanced Purchasing Dynamics (APD), the Purchasing Authority, provides manufacturers with market-leading solutions to streamline all facets of procurement and purchasing operations. Companies partnering with APD benefit from six service components: ProcureForce purchasing software, cost engineering, training, placement/recruitment, consulting and Service Delivery & Optimization of purchasing processes. APD s ProcureForce cloud software solution and precision cost engineering services deliver a real-time assessment of supply chain operations and identify ways to streamline processes and lower costs. Manufacturers gain value through APD by should be cost modeling, and automated purchasing analytics and reporting, resulting in improved decision-making. With the Purchasing Authority, enterprises decrease costs and improve bottom lines. Visit apurchasingd.com for more information. About the Author Bob leads the Purchasing Authority s cost engineering group with an extensive background in purchasing in the manufacturing sector. For more than 18 years, he has developed, led and implemented procurement/sourcing strategies across direct and indirect commodity segments including: polymers and resins, stampings, seating components, capital and tooling, MRO, purchased services and travel. Bob lends his expertise to implementing the major cost models used by the Purchasing Authority: true cost modeling, knowledge-based market testing, benchmark and teardown analysis and attribute modeling. Using true cost modeling, APD s cost engineers walk the plant floor to map labor, overhead, and material costs. Buyers can then use ProcureForce software to easily compare supplier quotes to should-be cost models. Working with the cost engineers, Bob uses knowledge-based market testing to develop quotation frameworks to obtain critical information about manufacturing processes and costs. ProcureForce completes the analysis and optimizes the quotations to develop knowledge-based cost models. Copyright 2015 Advanced Purchasing Dynamics and/or its affiliates or licensors. All rights reserved page 4