The document presents cost reduction strategies and techniques focused on improving financial efficiency in procurement processes. It defines key terms like cost savings, cost avoidance, and value enhancement, and discusses methodologies including total cost of ownership, should cost analysis, and value analysis. Additionally, it emphasizes the importance of collaboration and innovative approaches in cost reduction efforts.

1. Cost Reduction Strategies:
Focus and Techniques
for
NAPM-Wichita
presented by
Thomas L. Tanel, C.P.M., CTL, CCA
President and CEO
CATTAN Services Group, Inc.
College Station, TX
© 2009 CATTAN Services Group, Inc.

2. Agenda Topics

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Cost Reduction Strategies and Ideas
Price and Cost Analysis--Applied
Total Cost of Ownership and Total System Cost
Use of “Should” Cost Models
Innovative Thought and Ideas Solicitation
Value Analysis and Engineering
Target Cost Analysis and Target Pricing
Low (Best) Cost Country Sourcing
Summary

3. Cost Reduction Strategies
 Cost Savings
 Cost Containment
 Cost Avoidance
 Value Enhancement

4. Cost Reduction Terminology
Product cost savings
 Defined as obtaining and realizing a lower unit
price on the same item than the unit price was in
the last contract period.
 A cost saving is valid for as long as the
comparative that generated the saving is; but
it is not to exceed the end of the contract period
in which the saving was produced. On the first
day of the next contract period the old price
becomes the baseline against which any future
cost savings are measured.

5. Cost Reduction Terminology
Revenue generation
 New financial sources that can be used to leverage or
increase monies/resources available to an activity.
 Revenue generation is a quantifiable monetary
benefit.
Non-monetary benefit
 A benefit that cannot be measured in terms of finances
or resources, such as better quality of services;
improved health, safety or quality of life; enhanced
security; enterprise-wide consistency; or contribution to
achieving supplier diversity goals.
Return on investment
 Monetary benefit from an investment as a ratio or
percentage of the amount invested.

6. Cost Savings
Cost Savings—definition
 A cost reduction that can be specifically identified
and will be made to a budget or program,
resulting from implementing a specific alternative
in lieu of continuing the present system.
 The result of a planned or deliberate action
taken by Purchasing
 Savings are a quantifiable monetary benefit
 There must be a direct activity reduction for a
savings to occur; thus, benefits are considered as
savings only if the estimate identifies benefits that
start accruing during the budget/activity’s fiscal
year.

7. Cost Avoidance
Cost avoidance—definition
 Financial or economic benefits that result from
an initiative but do not permit a monetary
reduction to a funded activity or budget.
 Is a quantifiable monetary benefit
 Usually addresses the reduction or elimination
of a future cost
 Does not lower the cost of materials purchased
when measured against historical results, but it
does minimize or avoid entirely the negative
impact on net income that a price increase
would have.

8. Cost Containment
Cost containment—definition
 The process of maintaining organizational
costs within a specified budget; restraining
expenditures to meet organizational or
project financial targets.
 Measures taken to reduce expenditure or
the rate of growth of expenditure, or the unit
cost of goods/materials/supplies/services.
 When an organization keeps costs low, or
within a limit that has been planned.

9. Value Enhancement
Value enhancement—definition
 Value which affects the whole-life costs or whole-life
income and its required functionality.
Value
 For any service or offering to have financial value, the
organization must have been willing to pay for it out of
pocket or must have already been paying for it in a way
that can be measured on the organization’s income
statement. This definition is a requirement for any
discussion of legitimate cost avoidances.
 For example, in practicing sustainable environmental
management, we may reduce the environmental impact;
while at the same time achieve cost reduction and create
environmental friendly conservation added value.

10. The Difference between
Price and Cost
 “Price” . . .
is a sales and purchasing concept.
 “Cost” . . .
is an accounting concept.

11. The Difference between
Price and Cost
Price =Cost of Material + Labor + Overhead
Price =Cost of Material + Labor + Overhead
+ General & Administrative Expenses
+ General & Administrative Expenses
+ Selling Expense + Profit
+ Selling Expense + Profit
Cost =Cost of Material + Labor + Overhead
Cost =Cost of Material + Labor + Overhead
+ General & Administrative Expenses
+ General & Administrative Expenses
+ Sales Expense
+ Sales Expense

12. Comparability Factors for Prices
Comparative price analysis involves the comparison of the current
proposed price with quotes or prices for the same or similar items.

13. Total Cost of Ownership
(TCO)
TCO
=
Purchase
Cost
+
Logistics
•Inland Freight
•Ocean/Air Freight
•Transfer charges
+
Taxes
•VAT
•Incentives
+
Customs
Duties &
Fees
+
TCO – the sum of all costs
associated with any given
supply stream
Source: The Executive Guide to Supply Chain Management, David Riggs/Sharon Robbins
Other Costs
•Quality
•Safety Stock
•Supplier
Development
•Currency

14. Cost Reduction and Negotiation
ACQUISITION COST
Typical Negotiation Focus
TRAINING COSTS
MAINTENANCE
COSTS
WAREHOUSING
COSTS
ENVIRONMENTAL
COSTS
SALVAGE VALUE
Cost Reduction
Opportunities
Traditional Supplier Cost and Price Structure
Traditional Supplier Cost and Price Structure
OPERATING COSTS

15. Total System Cost (TSC)
Total System Cost (TSC) –
the sum of the buyer’s costs,
supplier’s costs and
interaction cost between the two

16. Total System Cost
Buyer
Costs
TSC Savings
Buyer
Costs
Interaction
Costs
Profit
Price
Savings
Interaction Costs
Profit
Supplier
Costs
Traditional
Focus
Supplier
Costs
Strategic

17. Elements of Cost
Selling
Price
and
Margin
Profit
General and
Administrative
Selling Expense
Overhead
Labor
Materials
Cost
of
Goods
Sold

18. Drive Out Costs Creatively
 Considering alternative products, designs, concepts,
and services, or looking at different or alternative
solutions to existing services, processes or applications,
requires a multi-disciplined approach, making use of
internal customers or subject matter experts as well as
first-tier suppliers or prime contractors.
 Remember to create an arena that is friendly and open
to suggestion, change, and innovation.
 When defining the elements of cost, focus on cost
reduction opportunities.

19. The Creativity Formula
Remember: Most of the opportunities to reduce costs occur during the
design, SOW, or conceptual stage for products and services—not after.

20. Should Cost Technique
 “Should Cost” as a price challenge
technique:
 Provides cost analysis to buyers to be used
for negotiations and determining price
reasonableness
 Provides cost analysis in responding to price
challenges and pricing issues from your
internal customers and management
 Should costs are independent analytical
estimates to determine the cost for
manufacturing an item.

21. Building a Total Cost Model
Total Price of Contract
Total Cost of Contract
Costs to Meet Contract Requirements
Product Costs
Direct
Costs
Indirect
Costs
Direct
Labor
Plus
Direct
Material
(Allocation
of
Overhead
to Labor
and
Material)
Other
Direct
Costs
(Other
Allocable
Costs Plus
Overhead)
G&A
Expenses
Profit
/Fee

22. Should Cost—Supplier Cost
Decomposition
 What is in a typical “Should Cost” report:





A detailed description of the item.
A list of references used in the analysis.
A break down of cost and labor burden rates.
Estimated unit prices for specified quantities.
A break down of the material and associated
cost and minimum economic buys.

23. Material—Terms & Definitions
Term
Definition
• Raw materials
Materials in a form or state requiring further processing
before they can be used
• Parts
Items that, when joined with other items, are not subject
to disassembly without destruction or impairment of
use
• Subassemblies
Self-contained units of an assembly that can be
removed, replaced, and repaired separately
• Components
Relatively simple hardware items which are listed in the
specifications for an assembly, subassembly, or end
item
• Manufacturing
Items that are required by or in support of the
manufacturing process
supplies
• Inbound
Freight, express, cartage, insurance, and postage for
goods purchased, in process, or delivered, which
transportation and
can be added to the cost of an item or as an Other
in-transit insurance
Direct Cost (ODC)

24. Direct Labor—Terms & Definitions
Term
Definition
•
Direct Labor
Work performed by individuals which is directly related to a specific
cost objective. This work is readily identifiable with a particular
product or service.
•
Indirect Labor
Work performed by individuals which is not identifiable with a single
final cost objective but is identified with two or more final cost
objectives or an intermediate cost objective. One example of
indirect labor is the work expended by the Controller of a
company. The Controller’s work is not directly identifiable in the
production of a specific product or service, since his or her work
includes several projects or tasks.
•
•
Labor Hour
The unit of time by which direct labor activity is measured.
Labor Rate
The dollar amount paid to an individual per a given amount of time
in consideration of work accomplished.
•
Labor Cost
The product (i.e., result) of multiplying labor hours by appropriate
labor rates.
•
Labor Category
A grouping of workers with similar skills or expertise or trade
classification.
•
Labor Mix
The combination of functional skills and levels of worker experience
required to accomplish a given task.
•
Basis of Estimate (BOE)
A statement of the rationale used by a supplier/contractor to
generate a cost estimate for a specific task or item to be
produced.

25. Indirect Costs—Terms & Definitions
Term
Definition
• Indirect Costs
Any cost that cannot be directly identified with a single final cost objective
but can be identified with two or more final cost objectives or an
intermediate cost objective
• Overhead
Indirect costs related to specific operations, such as general product
lines, organizational groups, and groups of contracts. Overhead is a
type of indirect cost pool that is related to the specific operations of
the firm. The three major types of overhead are material, labor, and
fringe benefit (if not included in labor overhead). The three
overheads differ in regard to which costs they include and how they
are allocated.
• General &
Administrative
Any management, financial, and/or other expense incurred by or
allocated to a business unit for the general management and
administration of the business unit as a whole
• Business Unit
Any segment of an organization, or an entire business not further divided
into segments
• Home Office Expense
The expenses of an office responsible for directing or managing two or
more, but not necessarily all, segments of an organization
• Indirect Cost Pool
A logical grouping of incurred costs identified with two or more objectives
but not specifically with any final cost objective
• Cost Objective
A function, organizational subdivision, contract, or other work unit for
which cost data are desired and for which provision is made to
accumulate and measure the cost of processes, products, jobs,
capitalized projects, etc.

26. Profit—Terms & Definitions
Term
Definition
• Profit
Represents the
performance
contracts
• Fee
Represents a flat charge paid as compensation for services or
supplies provided and is associated with cost
reimbursement contracts
• Risk
The level of uncertainty associated with specific factors
regarding contract performance
excess of revenue over applicable costs of
and is associated with fixed-price type

27. SUPPLIER PART COST BREAKDOWN WORKSHEET—Part A
SUPPLIER NAME:
CONTACT:
E-MAIL:
PART NUMBER:
VOLUME QUOTED:
QUOTE NO:
DESCRIPTION:
EST. TOOL LIFE:
DATE:
DRAWING ISSUE:
TOOLING CAPACITY
@ Hrs/day:
@ Days/Week:
EXCHANGE RATE:
RAW MATERIALS & PURCHASED COMPONENTS
#
Item Descriptions (1)
Item ID (2)
CURRENCY:
Unit of Measure (3)
Unit Cost (4)
1
2
3
4
5
6
7
Total Material Cost
Total Cost (5)

28. SUPPLIER PART COST BREAKDOWN WORKSHEET—Part B
LABOR AND OVERHEAD
Labor Details
#
Operations Process Descriptions (6)
Labor
Rate
(7)
Std
Hrs
(8)
Labor
Cost (9)
Machine Data
Op.
(10)
Mach.
Size (11)
Mach. Type
(12)
Overhead Detail
Var. Cost
(13)
Fixed Cost
(14)
1
2
3
4
Total Labor
Cost
Total Overhead Cost
Total Manufacturing Cost (material + labor + burden) (16)
Selling, General and Administration Expenses (17)
Selling Price
FROM TOOLING COST BREAKDOWN—TOTAL TOOLING COST QUOTED
Total Cost (15)

29. Meeting the Competitive Demands of
Supply Management through
Supplier Ideas Solicitation

30. Meeting the Cost Reduction Mandate
through Innovative Thought and
Supplier Ideas Solicitation
 EPI and Concurrent




 Change procurement
engineering
method/instrument
 Volume and forecasts
VMI/SMI/SOMI/ISM
 Inbound freight and
Cycle or lead time
reduction
packaging
Addition or elimination  Relaxed specification,
of value-added
material substitution,
services
or service level
improvements
Standardization

31. Competitive Bidding—
Use Ceteris Paribus
 Buyers normally look at the price (total cost) as stated
on each bid to determine which supplier should be
awarded the PO or contract.
 If there are any differences, for a fair evaluation, then
allowances must be made for the differences in
performance and pricing.
 When comparing performance
or prices the buyer should use
Ceteris Paribus assumptions
(everything else held constant)
so you compare “an apple to an
apple, not an apple to an orange.”

32. Value

33. What Is Value?—Four Distinct Kinds
 Exchange Value
 Cost Value
 Esteem Value
 Use Value

34. Value Analysis and
Engineering (VA/VE)
1. An organized creative
approach to cost reduction
2. Emphasis on function or use
3. Identifies areas of excessive
or unnecessary costs
4. Eliminates non-value added
activities

35. VA/VE Job Plan—Philips Example

36. Value Equation
Quality/Worth
Value
=
Cost

37. How To Get Started in VA/VE
 Identify what is it and what




does it do?
Obtain and review all available
cost information
Try to anticipate roadblocks
Promote cooperation with
VA/VE effort
Seek guidance from those in
management that assigned
study

38. VA Is the Way—Ten Ways to
Reduce Co$t
1. Use it to reduce cost in
design, concept, or SOW
2. Use cross-functional teams to
approve product or service
offering changes
3. Consolidate supplier base
using full service partners
4. Reduce paperwork with
supply base by using more
EDI/E-Com
5. Bundle any engineering
changes or project scope
changes quarterly
6. Move towards common, simple
methods and standard items or
services used at multiple sites
or facilities
7. Use returnable dunnage or
containers instead of nonreturnable
8. Identify and eliminate
unnecessary testing, measuring
and diagnostics
9. Reduce the number of
prototypes or models
10.Consolidate “A” type purchases
with suppliers’ if possible

39. Process of Determining
Target Costs
Cost
Costs not
subject to
subject to
Target =
+
cost
cost
Costs
reduction
reduction
activities
activities

40. Target Costing Process

41. Target Cost Breakdown
and Impact

42. Target Cost Breakdown
and Impact

43. Target Pricing
A reduction in the direct
costs of a supplier’s cost
profile has more impact on
your bottom line than a
major percentage discount
in the supplier’s price.
Negotiation based on cost
allows you to challenge the
logic of each element of the
price.

44. Vendor
Preferred Supplier
Marketing, Purchase Orders,
Proposals, Variations in Quality
Partner/Alliance
Redundant Capabilities in Systems,
Activities that Add No Value,
Approval Processes, Contracts,
Excessive Communications and
Controls, etc.
Cost to Serve
Cost to Serve
Cost to Serve
Profit
Profit
Profit
Competitive Bidding
Based upon Variable Profit
Redefined (Streamlined) Process
Reduces Cost and Yields
Acceptable Profit
Reengineered Process through
Close Relationship; Maintains
Profit and Greater Cost
Reduction

45. Target Pricing Perspective—
An Example
For a service contract, the
total
quoted
price
was
$260,565.
A 1% reduction on the price is
one thing, but reducing each
of the cost elements by 1%
yields
an
actual
price
reduction of more than 2.5%.
Individual cost elements are more vulnerable to argument than the price as a whole

46. Elements of Cost-Services
Profit and Margin
COSP
Other Services/Overhead
Service Labor
Materials and Supplies
Occupancy
Equipment and Technology

47. Opportunity Knocks
The ultimate objective is to maximize
the value of each purchase spend
dollar.
Sometimes the buyer has a chance to gain the upper hand.
This occurs when the supplying industry’s margins are healthy
because selling prices rose faster than their costs escalated.

48. Low (Best) Cost Country Sourcing
(LCCS)
Near Sourcing
Domestically
Outsourcing
Overseas
Indigenous
Localization
Transfer business
to provide materials
or services by
swapping out
overseas suppliers
for closer proximity
to home country
Transfer internal
dept,activity or
process to more
capable suppliers or
contractors to lower
cost of ownership
Find and develop
local indigenous
sources to support
country markets for
low cost country
plants and
distribution facilities
Adapted in part from Ariba’s Executive Overview on this subject

49. LCCS and Supply Chain Risk
Although significant cost savings
opportunities exist , the risk may
be greater when dealing with unfamiliar
suppliers, different business protocols,
language barriers and new cultures.

50. Landed Cost
LC = TSC ÷ SU
Note: Total Selling Cost (TSC)
and Selling Unit (SU)

52. SUMMARY and THANKS
© 2009 CATTAN Services Group, Inc.