in t   f  Total Cost Structure                Sertus LLC. © 2011
Jay Peirce                           Understanding Total Cost: The Complete Cost Structure of Procurement(305) 215-3414   ...
Jay Peirce                              Understanding Total Cost: The Complete Cost Structure of Procurement(305) 215-3414...
Jay Peirce                           Understanding Total Cost: The Complete Cost Structure of Procurement(305) 215-3414   ...
Upcoming SlideShare
Loading in …5

Total Cost Structure


Published on

With Sertus' China Sourcing Experts as your partners, China is an ideal procurement center based on the entire cost structure and the factors that influence total cost. This report shares some insight into total cost structure.

Published in: Business, Health & Medicine
  • Be the first to comment

  • Be the first to like this

No Downloads
Total views
On SlideShare
From Embeds
Number of Embeds
Embeds 0
No embeds

No notes for slide

Total Cost Structure

  1. 1. in t f Total Cost Structure Sertus LLC. © 2011
  2. 2. Jay Peirce Understanding Total Cost: The Complete Cost Structure of Procurement(305) 215-3414 January 2006jay@sertusllc.comThe Paradox of ProcurementWhen an overheated economy begins to cool off, cost Typical Company USA thousands of USD tomost manufacturers begin to look for ways to remedy. The delay to market also pushed theirimprove efficiencies in production in order to help client’s to begin seeking alternative sources andreduce costs. For many companies, rationalization Typical Company USA lost several key customersof production processes can generate material as a result. What was expected to be thousands ofsavings, but they can involve lengthy labor USD in savings actually resulted in tens ofnegotiations, steep investments in new tools and/or thousands of USD in hidden costs and hundreds oftechnologies, and process reorganization that can thousands USD in foregone income.dramatically reduce the savings over the short runthat these same manufacturers are trying to In a recent report by Booze Allen Hamiltoncapture. Outsourcing is often considered a quicker (China’s Gold Rush: Should You Make the Journeyfix that can have a more immediate impact on East?, by Ronald Haddock, Peter Obdeijn,costs, especially when trying to reach short-term Mitchell Quint, Vikas Sehgal, Dermot Shorten, andstretch goals for a given year. However, it is Edward Tse, Booz Allen Hamilton, 2004,critical that companies understand the complete, the authors identify five keycost structure related to outsourcing or many of the dimensions that must be considered whensavings thought to have been realized will quickly purchasing from China, or run the risk of costdisappear as hidden costs find their way back into creep that can eat away pre-determined savings.the cost structure. These factors are: Manufacturing costs; Transportation efficiency;Uncovering Hidden Costs Lead time and scheduling;Typical Company USA Ltd., much like many of Product design;the companies that have gone before it, decides to Technical capabilities.begin a strategic sourcing initiative to help lowerits cost of goods. The company began to seek non-domestic sources to satisfy cost reduction demands Manufacturing Costsand locates several manufacturers in China that canprovide a competitively priced alternative to their Companies are easily lured by a competitive salescurrent supplier. It decides to abandon North price when seeking procurement alternatives. InAmerican and European procurement sources and China, where man hour costs are low by globalmakes a large-scale shift to China without fully standards, labor intensive goods are still veryunderstanding the underlying cost structure of this competitively priced. Within China, however,decision. Everything seemed to be pointing toward there are wage differences depending on thea significant reduction in cost of goods until location of production. In the interior, whereChinese manufacturers failed to meet important wages tend to be lower than in the large industrialdeadlines. Some product had to be air-freighted and highly populated cities, companies can findand even though they had spent a significant more competitively priced product. However, thisamount of time embedding into their purchase can add a number of unforeseen costs due toorder all of the critical spec, they ended up logistics challenges that not only impact deliveryreceiving product that was short of acceptable. On but can also influence the supply of raw materialstop of workmanship concerns, there were to the manufacturers in these locations. There arepackaging problems and some missing parts that large comparative advantages for factories that are
  3. 3. Jay Peirce Understanding Total Cost: The Complete Cost Structure of Procurement(305) 215-3414 January 2006jay@sertusllc.comlocated in the center of excellence for a particular necessitates larger order quantities and the dollarsproduct because most of the suppliers of raw tied up in inventory investments are oftenmaterials tend to concentrate around the large exaggerated due to rounding up practices to fillconsumers of these inputs. The risks involved with containers and minimize the unit freight factor fordisruptions to the inland logistics infrastructure can each piece shipped. Higher quantities also poseadd costs to factories that are located any higher risks – with manufactured defects having asignificant distance from their suppliers. These much greater impact than for small orderdisruptions can influence not only timely delivery quantities, where the damage is limited due to thebut also quality as factories attempt to claw back smaller order size. Getting a qualifiedunforeseen expenses by reducing cost elsewhere. intermediary to help control quality is crucial whenTherefore, when searching for a low cost provider, buying from China due to the increased risk posedit is critical that appropriate controls are in place to by a number of factors, not least of which isensure there are no quality concessions due to cost correlated to the large order quantities Chinapressure or delays due to logistics considerations. procurement necessitates.Consider hiring a good partner to help you monitoryour supplier relationships, whether it is through Product Designquality control or through production monitoring,because these hidden costs can destroy value very Engineering change orders present a whole new setquickly. of complexities when sourcing from China mostly because of the differences in local technicalTransportation Efficiencies capabilities and the risks posed by long lead times and large order quantities. The amount of obsoleteThere can be distinct pricing advantages that product that is received after changes areinfluence your selection process when dealing with implemented can be material in quantity andsuppliers in more remote areas. As we discussed, extend for some time due to the considerationsthe wage differential is often significant. Yet the mentioned. Therefore, it is imperative that buyersfreight considerations, to bring product from these either deploy their own engineering specialists toremote areas to port, should not be overlooked. oversee the entire process at origin or hireTransportation efficiency, which measures the ratio professional procurement specialists that can sendof the cost of transport to the total product cost, engineers and QC inspectors to oversee changefavors remote production for smaller, higher-value orders and ensure on-time deliveries of productadded items, which will have a lower freight factor that meets desired specifications.since the cost of transportation is generally fixedper unit volume. Technical CapabilitiesLead Time & Scheduling China is generally not recognized for its technical specialization in manufacturing. Although ChineseShipping out of China can add anywhere from four factories have made huge strides in the last fewto seven weeks on the water to Western years, the challenges posed by highly specializedHemisphere markets, depending on inland and application specific product are not easilytransportation distances and final destination. The handled by most Chinese suppliers. Factoryrisks associated with this longer lead time need to selection is even more important when dealingbe carefully contemplated and the potential impact with highly specialized manufacturing and findingon stock-outs and excess or obsolete inventory experts that can assist with this process is a criticalmust be incorporated into procurement costing success factor if considering China as aanalyses. Furthermore, the additional lead time procurement option.
  4. 4. Jay Peirce Understanding Total Cost: The Complete Cost Structure of Procurement(305) 215-3414 January 2006jay@sertusllc.comPutting it All TogetherFor Typical Company USA Ltd., and for manyothers considering China as a procurement center,an understanding of the entire cost structure andthe factors of influence that affect total cost areincredibly important in order to realize theanticipated savings that are motivating the decisionto shift procurement in the first place. Thisunderstanding involves going beyond typicalprocurement unit price analysis. It requires aholistic approach that brings in engineering andmanufacturing experience to define an optimalpurchasing strategy.For more information, please or visit