Materials Management BUS 3

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Materials ManagementBUS 3 141 Pricing and
Make/Buy Decisions March 10, 2008
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Agenda

• Case 1 Review Case 2 Assignment
• Term Project update
• Price
• Cost
• Value
• Make vs. Buy

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Connecticut Circuit Manufacturers
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Connecticut Circuit Manufacturers (CCM)

• ABC Analysis for buying activity
• Long Range Capacity Planning
• 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 cant scale your purchasing department every
  time you get a new customer!

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Connecticut Circuit Manufacturers (CCM)
ABC Analysis for buying activity Dollars per
Buyer
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Connecticut Circuit Manufacturers (CCM)
Veber gives Resistors to LeBlanc Cooper gives
Boards and Connectors to Veber
Possible scenario for Buyer reassignments
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Connecticut Circuit Manufacturers (CCM)
Long Range Capacity Planning
Still not fully addressed
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Connecticut Circuit Manufacturers (CCM)
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 cant scale your purchasing department every
  time you get a new customer!

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Next Case
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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?
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Term Project
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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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Price
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Definitions
Price
What the seller is paid for goods and services
provided
Cost
The expenses incurred in operating the
enterprise, making and buying materials, and
converting the materials to finished goods
Value
The difference between Price and Cost
Affordability
The ability to pay, without compromising cash
balances
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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
the MARKET than on Cost
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Cost
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Types of Costs
Direct Cost
Specifically assigned to a given unit of
production Examples are component materials,
assembly labor
Indirect Cost
Necessary to operate the enterprise, but not
specifically assigned to a given unit of
production (e.g. Rent, management salaries)
Fixed Cost
Does not change, regardless of the number of
units produced Examples are Rent and advertising
Variable Cost
Vary directly proportionately with the number
of units produced Examples are BOM x units
produced
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Relationship of Cost to Selling Price and Profit
1,000 Units
Average Cost 11.50 / unit
Selling Price 12.42 / unit
Profit percentage 8
Adapted from Leenders, Johnson, Flynn, and
Fearon, Purchasing and Supply Management,
Thirteenth Edition, McGraw Hill Irwin
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Impact of Volume on Cost (and Selling Price )
2,000 Units
Average Cost 9.50 / unit
Selling Price 12.42 / unit
Changes as Volume Changes
Profit percentage 31
Cost Behavior
Direct materials
11,000
Direct
Variable

Direct labor
4,000
Direct
Variable

Factory Overhead
2,500
Indirect
Fixed
No Change as Volume Changes

Manufacturing Cost
17,500
General, administrative,

1,500
Indirect
Fixed
and Selling cost

Total Cost
19,000

Profit
5,840

Selling Price
24,840
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Comparison of Fixed Variable Costs with Volume
Understanding Supplier Fixed and Variable costs
is CRITICAL to any Negotiation
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Value
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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
• Dont say, Its not my Job
• Think like the Boss
• Pick the BEST people and try to be like them
• Dont 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

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Factoring Supplier Price in Buying Decisions
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Pricing data varies for different Purchase Types
Raw Materials
Standard Production
Items of Small Value
Special Items
Services
Capital Goods
Resale
Raw Materials (Commodities)

• 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

Standard Production and Items of Small Value

• 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

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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 effort of negotiations. Major negotiations
should be outside routine production support.
Production support should focus on delivery 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
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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
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Make vs. Buy
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Definitions
Make
Producing the product or service with
resources from your own enterprise
Buy
Purchasing the product or service produced
by resources from an outside supplier
Insourcing
Sourcing the product or service back in after
the original Buy decision
Outsourcing
Sourcing the product or service outside after
the original Make decision
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Factors in deciding whether to Make or Buy
Reasons to Make (keep in-house)
Reasons to Buy (go outside)

• 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)

There is no single Right Answer that applies
to every business and every situation
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Insourcing and Outsourcing
A Make or Buy decision can be reversed, or
modified, if business conditions justify it
Insourcing would be recommended when

• 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

Outsourcing 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

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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