Throughout my years of Cost Modeling, I’ve heard many terms around the types of models created. Theoretical Optimal, Ideal, Ruthless, Benchmark, Industry Standard, Supplier Specific among others and this is just by those who create them. I won’t make you laugh with the names people who dislike them apply to them. We’ve all heard them for ourselves.
To be a bit more concise, I’ll limit this discussion to three basic forms: Ideal, Benchmark and Supplier specific. Here are some definitions for this discussion:
Ideal The best of the best. The model should push the limits. It should represent the best design, the best material usage, the lowest cost region, the most economical manufacturing processes, no scrap and apply aggressive markups. It would be difficult for any supplier to ever reach this level.
Benchmark This is obtainable with effort. The model should represent the design as is, the location as specified (correctly verifiable rates including labor, floorspace, etc.), the CORRECT process for that region (examples: low or high labor content based on region, a vertical or horizontal mill, or the properly size press based on the product being produced). Low to no scrap. Industry best markups based on research. A supplier should be able to reach this with effort. It is a realistic goal
Supplier Specific These models are based on what the supplier is currently doing to produce your product or service. These models can be more difficult to produce if done correctly. To do these correctly, you need to get a complete understanding of not only how the product is produced (cycletimes, labor content, process flows, scrap rates etc.), but you will also need to get into their financials to develop the rates which they are applying.
As I stated above, each of these has their use: An Ideal could be used to set design targets, to let the organization now where their competition could be. Benchmarks are used to understand where you supply base is inefficient and is a great tool for negotiations. Supplier Specific’s are often used with process improvements. For example, if labor is reduced today, this is the impact you should see tomorrow. And they are also used to “tease” out profit levels when suppliers are not correctly communicating them.
If you have your goal in mind and you have the right support, any one of these could be used and provide benefits. There are some deep self-assessments that should help you pick the proper method as well.
Do you KNOW the level of the gap you have to a BENCHMARK? If your supply base is within a narrow gap to the BENCHMARK then you might consider Supplier Specific. Why MIGHT? First you have to be honest with yourself. Can you really help a supplier improve their processes? Do you really think you know their processes better than them and can they really benefit from your expertise? Afterall, you are trying to show them where they can reduce their product to you. If your gap is large, it makes mathematical since to get the price right first (through BENCHMARK SHOULD COST MODELS) before working on process improvements, but that will be another blog another day.
One of the issues with the IDEAL is that it gives the supplier an easy out. It will be easy for a supplier to push back as this is not realistic. They will never get there. It might not even be based on their location economics or the actual part they are producing. You will hear comments like; “If you let me change the design, I can help.” “I’ve offered my suggestions, but no one is willing to change.” “Show me your assumptions and I’ll show you where you’re wrong.” We will address this last reply in a future blog about how to utilize a cost model in negotiations.
I personally recommend starting with a benchmark to see where you are as a company. Do you really KNOW you are buying competitively? Not based on market, but based on science, a model. Get the price as close to the benchmark as possible through negotiations and understand why and where the gaps really are. Be honest with yourself, does your enterprise really have the expertise to improve the supplier or are they a supplier because they know more than you.
Wrapping this all up, there are various levels of Should Cost Models and all are fine if you know and agree to the end use of it and the enterprise’s expectations and skill level to implement.
Gerald (Jerry) Collins
Owner and Founder of Society of Cost Engineers