Summer, February 2012

"Why Cost Analysis Matters" by Jimmy Anklesaria

President & CEO, Anklesaria Group, Inc. 

For over twenty five years, I have had the privilege of working with some of the best companies in the world. It never ceases to amaze me as to the similarities between companies in different industries or diverse countries. When I poll an audience of supply chain professionals with the question, "how many of you are under pressure to reduce cost?" about 90% of the audience normally raise their hand.

Next, if I ask the same group, "how many of you can honestly say that you understand the cost structure of the product, service or capital equipment that you are buying?" hardly 10% raise their hand. Somehow, there seems to be a disconnect here. How do you manage something (cost) that is so important to over 90% of the people, when hardly 10% say they understand the very thing that they are supposed to manage?

The first step in the journey of managing cost is to understand various elements of cost that make up the price. Later one can expand this understanding to the other cost elements beyond price that constitute the Total Cost of Ownership. Many professionals shy away from this first step in the mistaken belief that cost modelling is a complicated process and that they just don’t have the time or capability to do it. That is far from the truth. With the amount of information available from public sources today, there is no reason why one cannot make a reasonable estimate of the cost of a product or service. It’s called industry cost profiling. Using financial and manufacturing data from government statistics, company annual reports and other sources, one can create a profile of a given industry. Next, with the help of a subject matter expert or on-line data sources, one could estimate the material/labour cost and using the ratios from the industry cost profile, project the sale price of that product or service.

Here is a very basic example: An Engineering Service company quoted a client a sum of £395,000 for the design of a tool. The project called for one Engineering Manager, four Mechanical Engineers and two technicians for a period of 40 days. Using publically available data, the client built a profile that indicated a typical Engineering Services Company spent 29.2% of its revenue on Direct Labour. Using the information the client calculated the total labour to be £72,477. So, if £72,477 represented 29.2% of a typical contract, then the contract price would have to be around £248,209. It was hard for the supplier to argue with the logic since this was a standard request that did not demand unusually high overhead or excessive risk. Regardless of the final price negotiated, the supplier is put on notice that they are dealing with a well informed buyer who is not willing to take a quote and knock a few percentage points off a wrong number.

I’m sure everyone with negotiation experience believes in the adage, "knowledge is power". The use of cost models and good cost analysis builds credibility for a buyer, gives him/her the power to negotiate tough but fair contracts and earn the respect of one’s stakeholders as well as the supplier. And, believe it or not, it actually is FUN.

In conjunction with The Faculty, Jimmy will be delivering The Faculty’s Strategic Cost Management Workshop in Melbourne on 26-27 March, Sydney on 29-30 March and Brisbane on 14-15 May 2012. For more information, contact Georgette Chadraoui at The Faculty on (03)9654 4900 or via email.

Here are what some CPOs had to say about the Strategic Cost Management Workshop:

“My whole team at my last job went through the course and it left them totally empowered to have intelligent conversations with their suppliers. It has instant ROI, my team saved $15 million after participating in SCM."
- Cindy Dunham, General Manager - Operations West Procurement, Rio Tinto

“SCM is a mandatory requirement for members of my team. It takes out the price discussion from supplier negotiations and allows you to focus on the real components of value.”
- Ron Brown, Head of Supply & Logistics, Newcrest Mining

“The Strategic Cost Management course is a core component of the capability development plans for my team. We have gained considerable value from improving our skills in utilising price rise and fall mechanisms, “should cost” modelling and negotiation techniques. Members of our finance and legal teams have also attended the program.”
- Sharyn Scriven, Group Manager Procurement & Supply, Energex Limited