Approach 29 Apr. 2022

Deploying a Cost Structure Approach for Procurement

Controlling the cost structure is one of the pillars of Procurement, a function that faces double pressure: from the suppliers who are always inclined to increase prices, and their Management’s, asking for greater achievements.

We are noticing strong increases in commodity prices since the end of 2020.
These increases are due to a strong economic recovery, especially in China which alone absorbs nearly 50% of these raw materials in the world.

This situation generates not only longer delivery times and shortages, but also price increases.

In this context, the Procurement Departments are particularly called upon to avoid supply disruptions, but also manage the price increases of the products purchased.

A Negotiation Tool to Respond to a Crisis Context

In order to contain these increases demanded by suppliers, buyers can use an essential tool, which unfortunately is not always well controlled: the cost structure of the product purchased.

Indeed, understanding the structure of a supplier price makes it possible to isolate the material part of the total price. Therefore, to better negotiate this price increase by correlating supplier demand only to the material share in the product purchased while working to optimize the added value of the supplier.

The Cost Structure in Response to the Challenges of the Procurement Teams

The implementation of a cost structure approach allows to:

Identify new sources of gains
Be more efficient in negotiation
Have a costing posture & be able to anticipate changes in cost
Be more efficient in developing strategies by procurement families
Launch targeted progress plans with suppliers

The Ingredients for a Successful Deployment

To calculate a cost structure, all of the activities necessary to manufacture a product or service must be considered.

Conception: Time spent, R&D costs…
Raw materials and components: Quantities, costs, rejects…
MOD: Number of hours, hourly rates
Production methods: Initial cost and depreciation, lifetime, rate of use…
Quality: Cost of scrap, cost of quality control…
Logistics: Cost of warehouses, cost of inventories, insurance, transport…
General expenses: General expenses, taxes and duties
Margin: Industry average

Relevant Benchmarks, a way to Ensure Data Quality

Three main sources of information are available to the procurement teams:

1/ The Professional Environment

Indices and professional associations
Trade fairs
Manufacturers (costs + performance characteristics)
Second-hand market

2/ Internet

Studies, press review
Hourly cost (by country / region)
Taxes
Cost of Utilities (Electricity / Gas / Water…)

3/ The Suppliers

Call for tenders with a detailed cost structure
Visit / Suppliers audit
Supplier income statement

The cost structure approach requires obtaining information, particularly from the supplier, in a mutually beneficial framework.

In-Depth Knowledge of a Supplier’s Cost Structure is a Powerful Lever for Cost Reduction.

It allows to:

Set goal prices
Optimize by quantifying the cost reduction levers (volume effect, RTC *, BLC **, etc.)
Provide rational and structural data for decision support
Compare supplier offers and costs
Help suppliers to achieve target prices
Evaluate changes over time
Better negotiate with a good knowledge of the strengths and weaknesses of suppliers
Know precisely the costs of modifications during the development phase
Evaluate each technical solution during the redesign phase
Establish a cost reduction strategy

Illustration of the Subject

When negotiating with a supplier, the buyer will preferably use «comfortable» levers such as increasing volumes and competition.

But faced with these arguments, suppliers respond by increasing material prices, labor costs, transport, …

Very often in the absence of a cost structure, the buyer is faced with a wall. He who, it seems, was left with favorable elements, is now objected by the supplier that he «was lucky that prices were never revised upwards despites various increases in material prices”.

Beyond the simple issues related to negotiation, knowledge of the cost structure gives an overview of an organization maturity.

Three Prerequisites Identified for the Deployment of a Cost Structure Approach

Training in the cost structure with the widest possible panel of buyers (direct or indirect)
The definition and distribution to buyers of a cost structure template that will respect the «3U» rule (useful, usable and used)
A “favored” use of the cost structure approach during the tenders phase

The Approach Proposed by KEPLER

Defining & Sharing

Creating a working group with different types of buyers representative of the most important purchasing categories allowing to identify the cost structure models already used within the company so as to bring out a unique model that will take into account the rule of ‘3U’ or by adapting the grids proposed by KEPLER

Closing & Loading

Launching a Cost Structures training program with the widest possible range of buyers. Ideally, buyers should come out of the training with practical application cases to implement on their purchasing families
This training is also based on awareness of the latest digital costing tools based on AI / machine learning such as the easyKost software

Accompanying & Supporting

Promoting the use of the cost structure by supporting buyers with very operational coaching in the spirit of “learning by doing” during calls for tenders or when preparing for negotiations

Controlling the cost structure allows you to break away from the traditional balance of power with your suppliers to build an objective discussion allowing to find mutual avenues of cost reduction while guaranteeing a suitable margin for the supplier.

Associated Benefits

Internally

A more competitive company: by obtaining a better price from the start of a product’s life cycle and better performance (QCDI *)
A valued buyer: the perception of the buyer’s added value is better perceived by the other functions of the company because, by working on the cost structure, the buyer improves his knowledge of the products and suppliers while controlling a key data of the decision: the costs
A better understanding of the fair price: the buyer, through his detailed understanding, becomes a force for proposals by providing objective and quantified savings avenues and highlighting the cost of over-specifications
A maturity of the purchasing function which increases and results in a more efficient purchasing department

For suppliers

A lasting supplier-customer relationship: because we choose the supplier at the right price
A more factual and objective dialogue: we rely on shared data
Better collaboration: to set up an optimization plan over several years in order to reduce costs without penalizing the margin

For the customers

The contribution of the cost structure does not stop at the procurement doors: it allow justifying the price increase to the company’s customers
A shorter response time to the customer on new costings
More competitive prices simply

Deepen the discussion on the Cost Structure?

The KEPLER teams are at your disposal to discuss and support you in your transformation.

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Deploying a Cost Structure Approach for Procurement

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