Materials Management BUS 3 – 141 Pricing and Make/Buy Decisions March 10, 2008.

Materials Management

BUS 3 – 141

Pricing and Make/Buy Decisions

March 10, 2008

2

Agenda

– Case 1 Review; Case 2 Assignment

– Term Project update

– Price

– Cost

– Value

– Make vs. Buy

Connecticut Circuit Manufacturers

4

Connecticut Circuit Manufacturers (CCM)

1. ABC Analysis for buying activity

2. Long Range Capacity Planning

3. Customer focus vs. Commodity focus

• Design Products looks like a different customer Segment It would be acceptable to focus some purchasing activity on

the unique components in the segment… But there is no reason to segregate ALL components by

Customer Mostly common resistors, etc… You can’t scale your purchasing department every time you

get a new customer!

5


ABC Analysis for buying activity – Dollars per Buyer

$390,000

$74,000

$15,680

$0

$50,000

$100,000

$150,000

$200,000

$250,000

$300,000

$350,000

$400,000

$450,000

Cooper Veber LeBlanc

Buyer Annual Usage Unit Cost Annual SpendIntegrated circuits Cooper 50,000 5.000 250,000Printed circuit boards Cooper 7,000 15.000 105,000Connectors Cooper 14,000 2.500 35,000

Cooper Total 390,000Resistors Veber 500,000 0.100 50,000Cables Veber 8,000 3.000 24,000

Veber Total 74,000Screws, nuts, washers LeBlanc 448,000 0.035 15,680

LeBlanc Total 15,680Grand Total 479,680

6


Possible scenario for Buyer reassignments

$250,000

$164,000

$65,680

$0

$50,000

$100,000

$150,000

$200,000

$250,000

$300,000

$350,000

$400,000

$450,000

Cooper Veber LeBlanc

Buyer Annual Usage Unit Cost Annual SpendIntegrated circuits Cooper 50,000 5.000 250,000

Cooper Total 250,000Cables Veber 8,000 3.000 24,000Connectors Veber 14,000 2.500 35,000Printed circuit boards Veber 7,000 15.000 105,000

Veber Total 164,000Screws, nuts, washers LeBlanc 448,000 0.035 15,680Resistors LeBlanc 500,000 0.100 50,000

LeBlanc Total 65,680Grand Total 479,680

Veber gives Resistors to LeBlancCooper gives Boards and Connectors to Veber

7


Long Range Capacity Planning

0

1,000

2,000

3,000

4,000

5,000

6,000

7,000

8,000

9,000

10,000

Yr1 High Yr1 Low Yr2 High Yr2 Low Yr3 High Yr3 Low Yr4 High Yr4 Low

Contract Design Capacity

Still not fully addressed

8


Customer focus vs. Commodity focus

Design Products looks like a different customer Segment

– It would be acceptable to focus some purchasing activity on the unique components in the segment……

– But there is no reason to segregate ALL components by Customer…. Mostly common resistors, etc…

– You can’t scale your purchasing department every time you get a new customer!

Next Case

10

Case 2: Deere Cost Management, p251, 9-1

1. FACTS OF THE CASE (Approx. 20% of Total Effort / Grade)

Quantitative data (Revenue, Inventory, Costs, Employees, Divisions, etc….)

2. BUSINESS ISSUES IDENTIFIED (Approx. 20% of Total Effort / Grade)

Customers, Suppliers, Internal Measurement Systems, Organization, Competitors, Supply Shortages, Price Increases, Cash Flow, etc…)

3. CONCLUSIONS (Approx. 25% of Total Effort / Grade)

What has been going well?

What needs improvement?

4. RECOMMENDATIONS (Approx. 35% of Total Effort / Grade)

What improvements should be made?

What (if any?) activities should be stopped?

How can the improvements be implemented?

Term Project

12

Term Project

Group Research Study Project:

Learning will be enhanced by observing or studying how actual organizations manage and leverage their Supply organizations.

Students will research a local company and submit a written and classroom presentation. The scope of the presentation is to include:

How the Supply Management function is organized

How requirements are established*

How suppliers are selected and prices are negotiated*

Supply interaction with other functional groups in the organization

How the transportation and logistics process is organized and executed

Use of Technology

Other

* Included in the 9 Elements of the Supply Management Process

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Definitions

What the seller is paid for goods and services provided

Price

The expenses incurred in operating the enterprise, making andbuying materials, and converting the materials to finished goods

Cost

The ability to pay, without compromising cash balances

Affordability

The difference between Price and Cost

Value

15

Price

– Market Price

• Not necessarily based on supplier cost• Important for comparing alternative suppliers• Required when deciding whether to make in-house or buy• Good for discovering improvement opportunities for your business

– Suppliers have to make profits to stay in business

• It is important to know what is a “reasonable” price and profit are

The Selling Price is MUCH more dependent on theMARKET than on Cost

17

Types of Costs

Specifically assigned to a given unit of productionExamples are: component materials, assembly labor

Direct Cost

Necessary to operate the enterprise, but not specifically assignedto a given unit of production (e.g. Rent, management salaries)

Indirect Cost

Vary directly & proportionately with the number of units producedExamples are: BOM x units produced

Variable Cost

Does not change, regardless of the number of units producedExamples are: Rent and advertising

Fixed Cost

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Relationship of Cost to Selling Price and Profit

* Adapted from Leenders, Johnson, Flynn, and Fearon, Purchasing and Supply Management, Thirteenth Edition, McGraw Hill Irwin

Direct materials $5,500 Direct Variable

+ Direct labor 2,000 Direct Variable

+ Factory Overhead 2,500 Indirect Fixed*

= Manufacturing Cost $10,000

+General, administrative, and Selling cost

1,500 Indirect Fixed*

= Total Cost $11,500

+ Profit 920

= Selling Price $12,420

Cost Behavior

1,000 UnitsAverage Cost = $11.50 / unitSelling Price = $12.42 / unitProfit percentage = 8%

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Impact of Volume on Cost (and Selling Price )

2,000 UnitsAverage Cost = $9.50 / unitSelling Price = $12.42 / unitProfit percentage = 31%

Changes asVolume Changes

Direct materials $11,000 Direct Variable

+ Direct labor 4,000 Direct Variable

+ Factory Overhead 2,500 Indirect Fixed*

= Manufacturing Cost $17,500


1,500 Indirect Fixed*

= Total Cost $19,000

+ Profit 5,840

= Selling Price $24,840

Cost Behavior

No Change asVolume Changes

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Comparison of Fixed & Variable Costs with Volume

Unit Cost

1,000 2,000 5,000

Direct materials $5.50 Direct Variable 5,500.00 11,000.00 27,500.00

+ Direct labor $2.00 Direct Variable 2,000.00 4,000.00 10,000.00

+ Factory Overhead Indirect Fixed* 2,500.00 2,500.00 2,500.00

= Manufacturing Cost $7.50 $10,000.00 $17,500.00 $40,000.00

= Unit Mfg. Cost $10.00 $8.75 $8.00


Indirect Fixed* 1,500.00 1,500.00 1,500.00

= Total Cost $11,500.00 $19,000.00 $41,500.00

Average Unit Cost $11.50 $9.50 $8.30

Selling Price $12.42 $12.42 $12.42

Profit 920.00 5,840.00 20,600.00

Profit Percentage 8% 31% 50%

Cost Behavior

Units Sold

Understanding Supplier Fixed and Variable costs is CRITICAL to any Negotiation

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Applying Value Principles to your Career

– When you work, the company is BUYING what you are SELLING

• The work you do is WORTH something. Your company will continue to pay you when the work you do is worth more to them than what you cost

– Do more than your Job Description

• You really are not paid to do a specific job; you are paid to make money for your company

• The more valuable that you are, the more you will get paid – either by your company or the next company

– Don’t say, “It’s not my Job”

• Think like the Boss• Pick the BEST people and try to be like them• Don’t look at how little the poor performers are doing and complain

that you are doing more

– Think about how you can be worth MORE than what you are being paid

Factoring Supplier Price in Buying Decisions

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Pricing data varies for different Purchase Types

RawMaterials

StandardProduction

Items ofSmallValue

SpecialItems

ServicesCapitalGoods

Resale

– Published market prices; bought and sold in well-organized markets

– Monitor trends for opportunities to leverage unexpected dips in price

– Price indexes are available for escalator clauses

Raw Materials (Commodities)

– Can be found in catalogues from manufacturers, distributors, and retailers

– Published “list price”, with opportunities for better prices based on volume

– Good candidates for online buying, using searches and/or auctions

– Frequently a broad category is covered by a single Sales Representative who pools buys for volume discounts

Standard Production and Items of Small Value

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Quotations and Bidding

– Qualify your bidders

• Ability to execute the technical requirements• Potential to be a Partner

– Include a reasonable number of bidders (not too many and not too few)

– There must be NO appearance of favoritism

– Specifications need to be VERY CLEAR and not open to interpretation

– Price is not the only thing that matters

– Firm bid: first bid is the last bid too

– BAFO Bid: Best And Final Offer – The potential supplier is given additional information after the initial bid and is given the opportunity to prove a second bid

Time and budget must be planned to account for the effortof negotiations. Major negotiations should be outside routine

production support. Production support should focus ondelivery and quality, with pricing previously negotiated

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Alternatives when Bids are virtually Identical

– Choose a supplier already doing business with you

– Negotiate non-price concessions

• Freight• Warranty• Consigned inventory

– Choose a supplier with social benefits

• Largest domestic content• Women and minority owned• Closest in proximity

– Select based on recommendations by customers

Beware of Collusion

27

Key Elements of Negotiated Contracts

– Price, Volume, Quality, Service

– Price protection

– Escalator clauses

– Cancellation clauses

– Liability

– Ethical practices

Will be covered in a subsequent chapter

Make vs. Buy

29

Definitions

Producing the product or service with resourcesfrom your own enterprise

Make

Purchasing the product or service produced byresources from an outside supplier

Buy

Sourcing the product or service “back in”after the original Buy decision

Insourcing

Sourcing the product or service “outside”after the original Make decision

Outsourcing

30

Factors in deciding whether to Make or Buy

– Quantities too small for outside tooling and economies of scale

– Quality requirements are too tight for outsider to produce

– Manufacturing is a core competency

– Greater assurance of supply with dedicated production capacity

– Lower cost

– Protect Intellectual Property

– Avoid sole-source dependency

– Distance to supplier too great

– Significant customer requires it

– Backup capacity

– Manufacturing is not a core competency

– Supplier has expertise in a technology or product

– Greater capacity

– More flexible capacity

– Buying Modules or subassemblies, rather than many component parts, simplifies operations

– Lower risk with multiple sources of Supply

– Lower cost

– Negotiated unit cost removes temptation to overbuild to absorb fixed cost

– Good supplier in close proximity

– Significant customer requires it

– Open up new markets (e.g. NAFTA)

Reasons to Make (keep in-house) Reasons to Buy (go outside)

There is no single “Right Answer” that applies toevery business and every situation

31

Insourcing and Outsourcing

A Make or Buy decision can be reversed, or modified,if business conditions justify it

– Supplier no longer produces the product or goes out of business

– Volumes become too low

– Major price increases

– Reinforce the linkage between Design and Production

– Projected savings of “Buy” decision were not realized

Insourcing would be recommended when:

– Capable suppliers have entered the market

– Volumes increased dramatically

– Major internal cost increases

– Core competencies re-evaluated

– IT systems enable effective communication and control

– Government incentives

Outsourcing would be recommended when:

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Risks of Outsourcing

– Supplier priorities can be re-directed (often to competitors)

– Limited control during times of scarcity

– Original savings projections not realized

– Additional fees and charges introduced after original agreement

– Pricing and terms from the original agreement significantly changed in subsequent negotiations

– Supply, Legal, Technical, and other resources are frequently re-directed to ensure benefits are achieved and relationships maintained

– Customer, employee, market, or political criticism

• Domestic vs. offshore• Union vs. non-union• Increased turnover of key individuals

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The Role of Purchasing in Outsourcing

– Ensure that an objective, fact-based decision process is in place

– Provide several sources

– Provide expertise in Requests for Proposals

– Take the lead in developing and negotiating Contracts (with Legal)

– Monitor and manage the ongoing relationship

– Take the lead in negotiating subsequent contracts and identifying back-up suppliers over time

Materials Management BUS 3 – 141 Pricing and Make/Buy Decisions March 10, 2008.

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