Total Cost of Ownership

and and
Price Analysis
1
Arshinder Kaur, Assistant Professor, DoMS,
IIT Madras
Total Cost of Ownership (TCO) Total Cost of Ownership (TCO)
Isit acorrect decisiontooveremphasizethe Is it a correct decision to overemphasize the
acquisition cost or purchase price?
Canit impact other ownershipandpost Can it impact other ownership and post
ownership costs?
TCO TCO
Acquisition cost
Ownership cost
Post ownership cost
2
Arshinder Kaur, Assistant Professor, DoMS,
IIT Madras
How TCO can be viewed in
S i ? Services?
Apart fromother capital intensivecosts, the Apart from other capital intensive costs, the
cost of maintaining the employee base is also
an important cost p
Wages as per experience?
Retail Retail
Can manage inventory related cost by J IT, quality,
cost, time
Equally important is the after sales adjustment,
warranty claims, maintaining customer satisfaction
f i d fi it i d for indefinite period
3
Arshinder Kaur, Assistant Professor, DoMS,
IIT Madras
Acquisition cost
Initial costs short term immediate cash outflow Initial costs, short term, immediate cash outflow
Price paid for material, freight delivery, capital purchases, installation,
testing
Purchase
price
Negotiations, discounts, standardizing specifications, substitute used
products
Developing requirements and specifications, price & cost analysis, supplier
Planning
costs
p g q p , p y , pp
selection, initial order processing
E-Procurement
Quality
costs
Prevention costs, Appraisal costs, Failure costs
Selection, certification and monitoring suppliers
Taxes
Customs duties and tariffs, Virtual warehouse, tolls, facility fees
Focus on compliance to avoid penalties, free trade zones
4
Arshinder Kaur, Assistant Professor, DoMS,
IIT Madras
Ownership costs
(Quantitative and Qualitative) (Quantitative and Qualitative)
Ongoing use of purchased product
Downtime costs
Troublesomeproduct Troublesome product
Reduced production volumes, idle resources, lost sales, late deliveries
Risk costs
Excess inventory Vs stock out, reduced cash flow, lost interest on cash flow,
obsolescence, theft, additional floor space
Cycle time cost
Strategic alliances with key suppliers,
Conversion costs Conversion costs
Wrong material (quality, form or design), material not optimized for production
process, machine time, labor requirements, scrap and rework
Production methods, employee training and working environment, methods of
accountingfor product costs(overheadcosts) accounting for product costs (overhead costs)
Non value added costs
Poor layout, poor scheduling, maintaining cumbersome operating procedures that
duplicate efoorts, routing taking more time
Others
Repair and maintenance, Warranty, Training, Contract administration
5
Arshinder Kaur, Assistant Professor, DoMS,
IIT Madras
Post ownership costs Post ownership costs
Disposal Disposal
Long term environmental impact
i i d d d li bili i Unanticipated warranty and product liabilities
Any other risks of customer dissatisfaction
6
Arshinder Kaur, Assistant Professor, DoMS,
IIT Madras
Price Analysis Price Analysis
7
Arshinder Kaur, Assistant Professor, DoMS,
IIT Madras
C t V l Customer Value
( ) Time Cycle Service Technology Quality
Value
+ + +
=
Price
Is price paid is fair and Is price paid is fair and
reasonable ?
8
Arshinder Kaur, Assistant Professor, DoMS,
IIT Madras
How to determine fair
or reasonable price?
Evaluation of suppliers actual cost Vs Evaluation of supplier s actual cost Vs
Actual purchase price paid
Control of costs associated with producing f p g
the product Vs Analyzing final price
9
Arshinder Kaur, Assistant Professor, DoMS,
IIT Madras
Pricing Pricing
IsCostAnalysisisasimportant asPrice Is Cost Analysis is as important as Price
Analysis?
Total cost analysis
Applies the price/cost equation across multiple
processes that span two or more organizations
l h i across supply chain
10
Arshinder Kaur, Assistant Professor, DoMS,
IIT Madras
Cost Fundamentals
Essential to effective purchasing p g
Recognition of major cost components
Evaluatingtheprocessandproduct capability Evaluating the process and product capability
of suppliers
11
Arshinder Kaur, Assistant Professor, DoMS,
IIT Madras
Classification of costs
Fixed Costs (Property taxes, rent, depreciation)
Remains constant or stable and do not vary with volume Remains constant or stable and do not vary with volume
Change over time
Present even if there is no material output
Variable Costs
Change proportionally with output
Semi-variable
Have both fixed and variable cost component
What are the examples?
Total cost
S f ll h Sum of all three costs
12
Arshinder Kaur, Assistant Professor, DoMS,
IIT Madras
Classification of costs
(b d i i i h )
Direct costs(material andlabor)
(based on association with process)
Direct costs (material and labor)
Directly traced and allocated to an item
Direct outcomeof anoperationor process Direct outcome of an operation or process
Useful for determining item specific cost
Even can be used for make-or-buy analysis y y
Indirect Costs (burden costs)
Costs not assigned directly to a specific process or g y p p
production item
Energy required for machine, managerial and
administrative expenses
13
Arshinder Kaur, Assistant Professor, DoMS,
IIT Madras
Implications of cost from the
ti f l h i perspectives of supply chain
Cost reduction throughout the supply chain
Hurdles are price-based thinking p g
Choose different initiatives for different stage of
product lifecycle product life cycle
14
Arshinder Kaur, Assistant Professor, DoMS,
IIT Madras
Cost reduction Cost reduction
Teambasedvalueengineeringefforts Team based value engineering efforts
Supplier development
C i i Cross-enterprise cost improvement
J oint brainstorming efforts
Supplier suggestion programs
Supplychainredesign Supply chain redesign
15
Arshinder Kaur, Assistant Professor, DoMS,
IIT Madras
Pricing
Price/ Acquisition Cost- Largest component of
total cost total cost
Right price for one supplier is not necessary
th t th i ht i f th li t that the right price for another supplier at same
or at different points of time
There are no standard methods available for
determining right price
It is good to understand the constantly
changing variables, which influence pricing
16
Arshinder Kaur, Assistant Professor, DoMS,
IIT Madras
How to determine the right
i ? price?
Conditions of competition
V i bl i i i Variable margin pricing
Product differentiation
Regulation by competition
17
Arshinder Kaur, Assistant Professor, DoMS,
IIT Madras
How to determine the right
i ? price?
Conditions of competition
V i bl i i i Variable margin pricing
Product differentiation
Regulation by competition
18
Arshinder Kaur, Assistant Professor, DoMS,
IIT Madras
Conditions of competition Conditions of competition
Pure
Competition
Monopoly
Imperfect
Competition Competition Competition
Monopolistic Oligopoly
Imperfect>>>>>><<<<<<<<<<<<<Competition
19
Arshinder Kaur, Assistant Professor, DoMS,
IIT Madras
Pure Competition Pure Competition
Determinationof pricebasedonforcesof supply Determination of price based on forces of supply
and demand only
Producers are price takers p
No control over the price producers receive for
their products
Many buyers and sellers
Many products that are similar in nature hence
substitution can take place
Very few barriers to entry of new companies
20
Arshinder Kaur, Assistant Professor, DoMS,
IIT Madras
Imperfect Competition
Monopolistic
Many sellers produce many products
M b diff i d d f l May be differentiated products or not perfectly
substitutable products
Hospitality, Cereal, clothing
Oligopoly
only a few seller firms, relatively few different products
select group of firmshas control over the price
high barriers to entry
oligopolisticfirmsoften producenearlyidentical products oligopolistic firms often producenearly identical products
companies competing for market share, are interdependent
as a result of market forces
A bil d l Automobile and steel
21
Arshinder Kaur, Assistant Professor, DoMS,
IIT Madras
Monopoly p y
Only one producer/seller for a product
Entry into such a market is restricted due to high y g
costs or other impediments, which may be
economic, social or political
Prod cersarepricemakersandseller controlsthe Producers are price makers and seller controls the
entire supply of a particular commodity
Examples Examples
a government can create a monopoly over an industry
that it wants to control, such as electricity
i S di A bi th t h l t l in Saudi Arabia the government has sole control over
the oil industry
when a company has a copyright or patent that
h f i h k prevents others from entering the market
22
Arshinder Kaur, Assistant Professor, DoMS,
IIT Madras
How to determine the right
i ? price?
Conditions of competition
V i bl i i i Variable margin pricing
Product differentiation
Regulation by competition
23
Arshinder Kaur, Assistant Professor, DoMS,
IIT Madras
Variable-Margin Pricing
Firms mostly sell a line of product rather than just a y f p j
singleproduct
It is not about getting same profit margin oneach
product rather to generate satisfactory return on
whole line of products
Permitsmaximum competition on individual
products
Profitsfrom most efficiently produced successfully
priced items may offset the losses due to lower
marginsof inefficientlyproduceditems margins of inefficiently produced items
24
Arshinder Kaur, Assistant Professor, DoMS,
IIT Madras
How supply manager should
h dl V i bl i i i ? handle Variable margin situation?
Identify which products are high margin and
which are low margin
Producers sometimes follow average profit
margin over product line g p
Analyze full line products using pricing
methods methods
In depth analysis of entire product line
25
Arshinder Kaur, Assistant Professor, DoMS,
IIT Madras
How supply manager should handle
V i bl i i i ? Variable margin situation? (Contd..)
Pricingmethodsfor full lineproductsand Pricing methods for full line products and
specialty suppliers: should be same?
Shouldwefocusour priceanalysisbasedon Should we focus our price analysis based on
just one product at a time?
Inthelongrun: Priceisroughlyequal tothe In the long run: Price is roughly equal to the
cost of the least efficient producer who is able
to remain in business
In short run : by competition, supply and
demand
26
Arshinder Kaur, Assistant Professor, DoMS,
IIT Madras
Example: Variable margin pricing Example: Variable margin pricing
A printed circuit manufacturer incurs overhead for A printed circuit manufacturer incurs overhead for
1,88,000 boards consisting of about 4,000 designs.
The overhead generated by the production was
applied by the company to the boards on an equal
basis; however, about 20percent of theboardsdrove
80 percent of the overhead As expected the 20 80 percent of the overhead. As expected, the 20
percent were the low volume boards produced in
small lots. Sincethecompanybaseditspricesonthe p y p
cost estimates, thehigh volumeboards werehighly
overpriced.
27
Arshinder Kaur, Assistant Professor, DoMS,
IIT Madras
How to determine the right
i ? price?
Conditions of competition
V i bl i i i Variable margin pricing
Product differentiation
Regulation by competition
28
Arshinder Kaur, Assistant Professor, DoMS,
IIT Madras
Product Differentiation
Di i i hdiff i d d i h Distinguish differentiated products with
undifferentiated ones
Beware of trap- Some sellers successfully
make similar products APPEARS different
from those of competitors
It is about determining the quality of products g q y p
from the analysis of facts and NOT from
unsupported claims pp
29
Arshinder Kaur, Assistant Professor, DoMS,
IIT Madras
How to determine the right
i ? price?
Conditions of competition
V i bl i i i Variable margin pricing
Product differentiation
Regulation by competition
30
Arshinder Kaur, Assistant Professor, DoMS,
IIT Madras
Regulation by competition
Sellers quote different prices due to real costs
of production and or competitive position
We may think that it would be just the cost to
company and profit margin which sets the
price
Total cost = Cost of material + Cost of labor +
cost of overhead
Price = Total cost + Profit (12% of total cost)
But in reality it is the competition which drives
the price Need for business and price quoted
by competitors
31
Arshinder Kaur, Assistant Professor, DoMS,
IIT Madras
Regulation by competition Regulation by competition
Pricingisoneof themost important Pricing is one of the most important
management decisions a firm must make
Lowest Pricecanbe(Cost of material +Cost Lowest Price can be (Cost of material Cost
of labor)
Highest pricecanbe12%inexcess of total Highest price can be 12 % in excess of total
cost
Togainsatisfactoryvolumeof businessa To gain satisfactory volume of business a
seller may decide any price between lowest
and highest price g p
32
Arshinder Kaur, Assistant Professor, DoMS,
IIT Madras
Price analysis Price analysis
The examination of a sellers price The examination of a seller s price
proposal (bid)
by comparison with reasonable price
benchmarks,
without examination and evaluation
of the separate elements of the cost of the separate elements of the cost
and profit making up the price.
33
Arshinder Kaur, Assistant Professor, DoMS,
IIT Madras
Tools to conduct price analysis Tools to conduct price analysis
Analysisof competitive priceproposals Analysis of competitive price proposals
Comparison with regulated, catalog, or market
prices prices
Use of web based e-procurement
Comparison with historical prices
Use of independent cost estimates p
34
Arshinder Kaur, Assistant Professor, DoMS,
IIT Madras
Analysis of competitive price
l proposals
Therupeevalueshouldbelargeenoughtojustify The rupee value should be large enough to justify
expense
Clear specifications of item or service p
Adequate number of suppliers must be there in
market
Technically qualified suppliers
Seller actively want contract
Sufficient time must be given to prepare for
pricing
35
Arshinder Kaur, Assistant Professor, DoMS,
IIT Madras
Analysis of competitive price
l proposals
At least two sources have responded
Proposal are responsive to the buyers p p y
requirements
Supplierscompetingindependentlyfor the Suppliers competing independently for the
award
36
Arshinder Kaur, Assistant Professor, DoMS,
IIT Madras
Regulated, Catalog and Market
prices prices
Prices set by Law or Regulation
Catalogprice Catalog price
A price that is included in a catalog, a price list or some
other form that is regularly maintained by supplier
Inspections can be done by customers
Request for recent sales summary
Market price Market price
Result from interaction of many buyers and sellers
Willing to trade at a given market price g g p
Generic product and not unique to the seller
Eggs, vegetables, fruits
D il k t i i bli h di th Daily market price is published in the newspaper,
independent of the supplier
37
Arshinder Kaur, Assistant Professor, DoMS,
IIT Madras
Internet/ E-Commerce
Price, catalogs through internet
Buying exchanges
i f d ll ff i id i l List of pre-approved sellers offering identical or
similar products
Prices, discounts from list prices are provided , p p
Reverse auctions
Potential suppliers are able to see prices submitted by
their competitorsandrevisetheir bidsuntil thepre their competitors and revise their bids until the pre-
established closing time for the auction
Tailored global searches g
Expanded internet search capabilities
Scanning all relevant public and private websites
worldwide worldwide
Procurement-specific portals
38
Arshinder Kaur, Assistant Professor, DoMS,
IIT Madras
Historical prices Historical prices
Comparingproposedbidwithhistorical quotes Comparing proposed bid with historical quotes
or prices for the same or similar item
Changedconditions Changed conditions
Is it one-time charges?
Effect of inflationor deflationontheprice Effect of inflation or deflation on the price
39
Arshinder Kaur, Assistant Professor, DoMS,
IIT Madras
Independent cost estimates Independent cost estimates
Whenother techniquesof priceanalysiscannot When other techniques of price analysis cannot
be utilized
Cost analysiscanbedonetoget thefair and Cost analysis can be done to get the fair and
reasonable estimate
40
Arshinder Kaur, Assistant Professor, DoMS,
IIT Madras
Purchasing of Special Design Purchasing of Special Design
Whoownsthedesign? Who owns the design?
Who has the right to apply for patent?
h h i l li h li Who owns the special tooling the supplier
must obtain to produce item?
Specify the answers to above questions in p y q
purchase contracts unequivocally to avoid any
future uncertainties
41
Arshinder Kaur, Assistant Professor, DoMS,
IIT Madras
Pricing method for design work
Purchasers standpoint- Separate the suppliers
chargesintothreecategories charges into three categories
Price for design and development work
Price for special tooling and equipment
Price for manufacturing
Other desirable or possible contract can be
Purchasedesignworkandtoolingcompletelyapart Purchase design work and tooling completely apart
from the manufactured components
There can be a situation when supplier prefer to
develop a proprietary product and enjoy
monopoly
42
Arshinder Kaur, Assistant Professor, DoMS,
IIT Madras
Documenting Price Analysis Documenting Price Analysis
PriceAnalysisReport- WrittenSummaryof Price Analysis Report Written Summary of
the analysis for a given procurement
Basisfor thesupplymanagersconclusionthat Basis for the supply manager s conclusion that
a price is fair and reasonable
What tobeincludedinreport What to be included in report
Abstract of bids received
Price negotiation memorandum in the findings of ce ego o e o du e d gso
price analysis
Restate key issues and decisions
43
Arshinder Kaur, Assistant Professor, DoMS,
IIT Madras
Discounts Discounts
For perceptivesupplyprofessional For perceptive supply professional
Technique for reducing prices after all other
techniquesarefailed techniques are failed
Trade discounts
Q i di Quantity discounts
Seasonal discounts
Cash discounts
44
Arshinder Kaur, Assistant Professor, DoMS,
IIT Madras
Trade discounts
Reduction from list price given to various classes
of buyers and distributors to compensate them for
performingcertainmarketingfunctionsfor the performing certain marketing functions for the
original seller of the product
Sequence of individual discounts (25%, 10% and q (
5%): Series discounts
For example The retails price is Rs. 100
F ll di d i 25% f R 100 R 75 Full discounted price 25% of Rs. 100= Rs. 75
10% of (Rs. 100- 25) = Rs. 7.50
5%of (Rs 100 25 10) Rs 338 5% of (Rs. 100-25-10) = Rs. 3.38
The manufacturers selling price is = 100-25-7.5-
3.38=Rs. 64.12 3.38 Rs. 64.12
45
Arshinder Kaur, Assistant Professor, DoMS,
IIT Madras
Cash discounts Cash discounts
Pricereductionsfor theprompt payment of Price reductions for the prompt payment of
bills
Offeringdiscountsasapercentageof thenet Offering discounts as a percentage of the net
invoice price
46
Arshinder Kaur, Assistant Professor, DoMS,
IIT Madras
Why seller offers cash discounts Why seller offers cash discounts
Attendant costs Attendant costs
Cost of tied-up capital
Cost of operatingacredit department Cost of operating a credit department
Cost of some bad-dept losses
S i hi db i b t d t Savings achieved by overcoming above costs due to
short term payment may be passed on to the buyer
47
Arshinder Kaur, Assistant Professor, DoMS,
IIT Madras
Why buyer prefers cash discounts Why buyer prefers cash discounts
Negotiatehighest possiblecashdiscounts Negotiate highest possible cash discounts
For example most commonly used cash
discount is discount is
A discount of 2% can be taken
if the invoice is paid within 10
days
2% 10 days
net 30 days
y
Th f ll h ld b
net 30 days
The full amount should be
remitted if payment is made
between 10 and 30 days after
receipt of the invoice p
48
Arshinder Kaur, Assistant Professor, DoMS,
IIT Madras
Cash discounts
Is 2% a good amount of saving?
Lets see it annually
f i
y
A bill payment can be done in 30 days
but discount (of 2%) can be taken up
to tenth day
If the buyer is
not interested
to take the
discount
to tenth day
The buyer is paying 2%
of the total amount of
invoice to use the cash
i l d f 20 d
How many 20 day
periods in a year
(365 days) =
365/20 18 25
What is the 2%
times 18.25
twenty day
periods?
involved for 20 days
365/20 =18.25
periods?
A 2/10 discount translates into an annual discount rate of 36.5 %
(2% times 18.25) ( % )
Getting 36.5 % of annual discount is a good business, Capability
to understand the time value of money 49
Arshinder Kaur, Assistant Professor, DoMS,
IIT Madras