The document discusses cost management strategies focused on identifying value and opportunities in the supply chain. It covers various cost classifications, management tools, negotiation tactics, and the importance of understanding supplier costs. Key concepts include total cost of ownership, target costing, and activity-based costing as techniques for achieving cost reductions and sustainable savings.

1. Cost Management
- Deepak Mathivathanan

2. Objectives
How can cost management help identify opportunities and assure value?
How can we determine:
• the supplier’s costs?
• delivery cost?
• our own use costs?
• disposal costs?

3. Strategic Cost Management
An externally focused process of analyzing costs in terms of the overall supply chain
• Measure and improve specific cost elements.
• Tools and techniques to sustain cost savings year over year.
• Cost culture vs price culture with internal stakeholders and suppliers.

4. Direct and Indirect Costs
Direct Costs: Costs that can be specifically and accurately assigned to a given
unit of production of a product or service
e.g., materials and labor
Indirect Costs: Costs incurred that normally cannot be related directly to any
given unit of production of a product or service
e.g., administrative expenses and plant overhead
When evaluating costs as either direct or indirect, the issue is the ability to trace
the costs directly to a unit of production

5. Variable and Fixed Costs
Variable costs
• Vary directly and proportionally with the units of products or services
produced
Fixed costs
• Generally, remain the same regardless of the number of units of products
or services produced
Semi-variable costs
• Vary with the number of units of products or services produced but are
partly variable and partly fixed

6. ABC or Pareto Analysis
Assign items to A (high-dollar), B (medium-dollar), or C (low-dollar)
spend categories
A items = greatest percent of annual spend
Cost management approach for A items:
• More time and managerial attention
• Understand supplier’s cost structure
• Identify opportunities for supplier or joint buyer-supplier initiative to
eliminate, reduce, or avoid costs in any cost elements (materials,
services, labor, and overhead)

7. Pareto Analysis and Supplier’s Strategic Positioning
A items: differentiated products or services (customized) or low cost
commodity-type items with high volumes:
Cost reduction opportunities:
• Custom: changing specification or design
• Commodity-type items: come from inside the supplier’s organization and
be from its supply chain, production process, service delivery system, or
distribution network

8. Portfolio
Analysis

9. Portfolio
Analysis &
Cost
Reduction
Opportunities

10. Cost
Management
Tools
1. Total Cost of Ownership
2. Target Pricing
3. Learning curve
4. Value Engineering
5. Activity based costing

11. 1. Total Cost of Ownership
The acquisition price plus all associated cost elements
Identify opportunities for each cost element
• cost reduction
• cost avoidance
Work with internal stakeholders and external suppliers to achieve cost
reductions/avoidance
Life-cycle costing (LCC) = TCO for capital acquisitions

12. Challenges in Using TCO
Difficult to:
– Identify and track cost elements
– Achieve changes internally to reduce/avoid costs
– Achieve changes externally with suppliers
– Use the information appropriately to compare suppliers

13. TCO Applications
• Highlight cost reduction and continuous improvement opportunities
• Aid supplier evaluation and selection
• Provide data for negotiations
• Focus suppliers on cost reduction opportunities
• Highlight advantage of expensive, high-quality items
• Clarify and define supplier performance expectations
• Create a long-term supply perspective
• Forecast future performance

14. Excuses for Not Using Cost Analysis
• Suppliers may not know their costs
• Interpretation of cost calls for an exercise of judgment
• Some suppliers are not willing to divulge cost information
• Some buyers have limited knowledge in cost estimating
• The seller’s costs do not determine the market prices
• The buyer is not interested in the supplier’s costs, the primary concern is
getting the best price
• If a supplier offers a price that does not cover its costs, the matter is the
supplier’s problem and not the buyer’s

15. Components of Total Cost of Ownership

16. 2. Target Costing Example

17. Goals of Target Costing
Organization-wide cost reductions in:
– Design to cost, on the part of design engineering
– Manufacture to cost, on the part of production
– Purchase to cost, on the part of supply

18. Target Costing Implications for Supply
Target costing provides supply with:
– a measurable target for supply performance
– a yardstick for measuring cost reductions
– a means of measuring the supplier’s efficiency

19. 3. Example of the 90 Percent Learning Curve

20. The 90 Percent Learning Curve – Logarithmic
Plot

21. 4. Value Engineering (VE) and Value Analysis
(VA)
Value methodology is
• a systematic approach to analyzing the functions of a product, part,
service, or process
• to satisfy all needed quality and user requirements
• at optimum total cost of ownership
Value engineering (VE): in product or service design
Value analysis (VA) : in product or service redesign

22. Value Expression
Value can be expressed as:
Cost
Function
VALUE 
Function = a noun-verb combination (e.g., holds liquid)

23. Goal of VE and VA
Perform a function at the same or an improved level while reducing costs
Eliminate or avoid unnecessary costs:
– do not provide quality
– do not extend product or service life
– do not provide features desired by customers

24. 5. Activity-Based Costing
Tries to turn indirect costs into direct costs by tracking the cost drivers behind
indirect costs
Overhead is divided into:
– costs that change in response to unit-level activities
– batch-level activities
– product-level activities
– the remainder are true fixed costs and are allocated according to traditional cost
accounting

25. Activity-Based Costing Implications for
Supply
Purchasers can use activity-based costing as a tool to reduce supplier costs
by:
• eliminating nonvalue-adding activities
• reducing activity occurrences
• reducing the cost driver rate

26. Supply Chain Financing
Emergence of financial technology, or “FinTech” companies
• Offer procure-to-pay technology solutions
• Early payments to suppliers include a small discount based on buyer’s
low credit risk
• FinTech firms collect account receivable from buyer based on normal
payment terms
• Allows suppliers access to accounts receivable promptly—providing
greater liquidity and cash flow certainty
• Can represent an important source of capital for small- and medium-
sized enterprises (S M Es)

27. Negotiation
The most sophisticated
and most expensive
means of price
determination
A difficult art requiring
judgment and tact
An attempt to find an
agreement that allows
both parties to realize
their objectives
Requires the buyer and
supplier, through
discussion, to arrive at a
common understanding
on the essentials of an
issue

28. Situations Where Negotiation May Provide Value
Any written contract
covering price,
specifications, terms of
delivery and quality
standards
The purchase of items
made to the buyer’s
standards
When changes are made
to drawings or
specifications
Following an
unsuccessful bidding
process
When problems of
tooling or packaging
occur
When changing economic
or market conditions
require changes in
quantities or prices
When problems of
termination of a contract
involve disposal of
equipment, materials or
tooling
When problems arise
under the various type of
contracts used in defense
and governmental
contracting

29. 11-31
© 2020 McGraw-Hill Education.
Model of the Negotiation Process

30. The Basic
Steps in
Developing a
Negotiation
Strategy
1. Develop the specific objectives (outcomes) desired from the
negotiation
2. Gather pertinent data
3. Determine the facts of the situation
4. Determine the issues
5. Analyze the positions of strength for both (or all) parties
6. Set the buyer’s position on each issue, and estimate the seller’s
position on each issue based on your research
7. Plan the negotiation strategy
8. Brief all persons on the negotiation team
9. Conduct a dress rehearsal
10. Conduct the actual negotiations with an impersonal calmness

31. 11-33
© 2020 McGraw-Hill Education.
The Zone of
Negotiation