10.7 Tool: Cost Modeling (AKA, Should Costing)
Better costing skills enable you to engage in new, more productive conversations with your suppliers. For example, you can ask and answer the question, "What should this product or service really cost?" Of course, to do this, you need to understand your suppliers' costs as well as they do. In fact, managers at great companies like Honda and Intel claim to know their suppliers costs better than the suppliers know their own costs!
How is this possible? At Honda, senior leaders decided advanced costing skills were critical to Honda's future. Honda set up a central Cost Research Department, which was tasked with becoming experts in manufacturing processes. As cost-modeling skills emerged, Honda began rotating managers from other functions into the costing group. The goal: Make cost modeling a corporate-wide capability.1 Let's take a brief look at cost modeling's four basic steps.
Step 1: Map the Process
To develop an accurate estimate of a component's cost, you need to know how it is made. The good news: As a purchasing professional, you visit a lot of suppliers' sites and tour their assembly lines. Simply put, you should know what best practice looks like. Your job is to combine your insight with the expertise of your operations and engineering specialists to map out the process and understand current costs.
Step 2: Identify Cost and Performance Drivers
With a process map hanging on the wall, you can begin to identify and evaluate key cost drivers (see Figure 10.8). Because a supplier's process design influences cost drivers, you need to incorporate Honda's 3A's "Go-to-the-Spot" philosophy:
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Go to the Actual place
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See the Actual part
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Learn the Actual situation.
Step 3: Evaluate Alternatives
Ask, "What if?" What would happen if...
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You changed the process configuration?
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You adopted a new technology?
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You provided some additional worker training?
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You changed materials?
Simply put, can you lower costs by improving the process?
Step 4: Evaluate Tradeoffs
Don't forget, every decision you make creates tradeoffs. Be sure your team takes the time to ask, "If we do this, then what happens?" What is the total impact on costs?
When you master cost modeling and know what a product should cost, you will earn credibility with suppliers. You can become a better partner—i.e., a customer of choice—as you use your insight to help your suppliers take costs out of their processes.
From the late 1990s onward, multinationals have scoured the globe for low-cost sources of supply. Which country do you think benefited most from this outsourcing craze? You know the answer: China. In fact, in the decade from 1998 to 2007, China attracted over $550 BILLION dollars of foreign direct investment (FDI). This surge in manufacturing investment led pundits to call China the "world's manufacturing shop." Because of its ability to suck up FDI, managers in rival countries like Mexico began calling China the "Black Hole." In 2003, Mexico lost over 200,000 manufacturing jobs—mostly to China! 2
However, by 2005, China had come under pressure to increase the value of its currency, the RMB, driving up the price of exports. More importantly, famously low manufacturing wages began to climb at about 18% per year. By 2015, wages had increased at least 5X. To make matters worse, in 2008, oil prices shot up to almost $150 per barrel. The result: The cost of shipping a standard 40-foot container from Shanghai to the U.S. East Coast skyrocketed to about $8,000. That's up from $3,000 at the turn of the millennium. 3 Although oil prices have dropped precipitously, the 2008 scare taught decision makers to ask, "What if?" Other costs including security (in the face of perennial terror threats) and environmental regulation are also on the rise.
The bottom line: The total cost of doing business in China has gone up dramatically. The Boston Consulting Group estimates that in 2014 total Chinese manufacturing costs were about the same as those in the U.S. 4 So, where is the right country to source from? Only a thorough—and current—cost analysis can answer this question!
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