Practice 15 Supplier assessment cost approaches and techniques

Practice 15. Supplier assessment: cost approaches and techniques © Cengage Learning – Purchasing & Supply Chain Management 4 ed (1 -84480 -024 -5)

Program • • How is the purchase price determined? Pricing methods The learning curve Supplier assessment © Cengage Learning – Purchasing & Supply Chain Management 4 ed (1 -84480 -024 -5)

How is the purchase price determined? The price ultimately paid for materials and services is result of environmental factors (internal and external): n Internal factors: can bring about a change in the materials’ costs before the finished product is placed on the market. (logistical, technical or organizational factors) n External factors: those factors that change the availability of a product in a given market. (economic, socio political or technological factors) © Cengage Learning – Purchasing & Supply Chain Management 4 ed (1 -84480 -024 -5)

Environmental factors Internal factors Logistics factors External factors Technical factors Economi c factors Organizational factors Supplier Trying to raise the price Sociopolitical factors Technological factors Black box Influences on the price © Cengage Learning – Purchasing & Supply Chain Management 4 ed (1 -84480 -024 -5) buyer Trying to reduce the price

How is the purchase price determined? Corey (1978) considers prices to be based on three models: 1. 2. 3. Cost-based pricing. The supplier’s offering price is directly derived from his cost price. Market-based pricing. The price of the product is determined on the market and is generated by market circumstances (demand, supply, stock positions, economic factors etc. ) Competitive bidding. The price is influenced by market factors as well as cost factors. This situation is most common. © Cengage Learning – Purchasing & Supply Chain Management 4 ed (1 -84480 -024 -5)

Method of price setting purchase product group based on cost factors based both on market and cost factors emphasi 50/5 emphasi s on cost 0 s on factors market factors x Raw materials Semi-manufactured goods Components Standard x x x Non-standard x x x Finished products x x x x x MRO Services x © Cengage Learning – Purchasing & Supply Chain Management 4 ed (1 -84480 -024 -5) based on market factors x x

Pricing Methods Factors suppliers have to take into account to set the selling price: ¨ ¨ ¨ Expected demand Number of competitors Expected development of the cost price per product unit Customer’s order volume Importance of the customer to the supplier Value of the product to the customer © Cengage Learning – Purchasing & Supply Chain Management 4 ed (1 -84480 -024 -5)

Pricing Methods The following pricing methods can be distinguished: ¨ ¨ ¨ Cost-plus pricing. Adding a fixed percentage mark-up to the cost price. Target-profit pricing. The price is determined based on profits that should be made. Pricing based on the buyer perceived value. A rule in marketing: do not base your price on the cost price but on what the market can bear. Pricing based on the competitors prices. Tender-based pricing. Based on a request from the principal, contractors are invited to submit bids for a specific job. The job is awarded to the contractor with the lowest bid. © Cengage Learning – Purchasing & Supply Chain Management 4 ed (1 -84480 -024 -5)

Pricing Methods A special characteristic of pricing policies for industrial products is the discount policy which is applied: • Cash discount: e. g. 2% discount for payments within 10 days • Quantity discounts: to stimulate larger quantity orders. • Bonus agreement: linked to the amounts purchased from a specific supplier for a specific period. • Geographical discount: given to customers located near the supplier. • Seasonal discount: applied to improve capacity utilization in periods when sales decline. • Promotional discount: provided to temporarily stimulate the sale of a product. © Cengage Learning – Purchasing & Supply Chain Management 4 ed (1 -84480 -024 -5)

Pricing Methods The following list can help the buyer to gain insight into the supplier’s cost structure: • Materials cost: to be itemized according to the major components • Direct labor cost: information can be obtained by consulting the collective labor agreements for each particular industry • Transportation cost • Indirect cost: divided into general management costs and sales costs © Cengage Learning – Purchasing & Supply Chain Management 4 ed (1 -84480 -024 -5)

The learning curve n n It was discovered (in American Airline Industry) that the cost price per unit decreased at a fixed percentage as experience (the cumulative production volume of a type of aircraft) increased. . The learning effects result from: § § § § Reduced supervision as experience with production grows Increased profits, from improved efficiency through streamlining the process Reduced defects and line reject rates during production Increased batch sizes (less time spent on resetting machines) Improved production equipment (after a while) Improved process control Reduced engineering changes © Cengage Learning – Purchasing & Supply Chain Management 4 ed (1 -84480 -024 -5)

The learning curve Basic principle Each time the cumulative production volume of a particular item doubles, the average time required to produce that item is approximately x % less of the previously required number of hours Cumulative amount produced 1000 Required time in hours per unit 20 2000 16 4000 12. 8 8000 10. 24 16000 8. 2 © Cengage Learning – Purchasing & Supply Chain Management 4 ed (1 -84480 -024 -5)

The learning curve is preferably used: n n When it concerns customized components, manufactured by a supplier at the customer’s specifications When large amounts of money are involved When the buyer cannot request competitive quotations because, e. g. , a considerable investment has to be made in moulds and specific production tooling which lead the buyer to single sourcing. When direct labor costs make up an important part of the cost price. © Cengage Learning – Purchasing & Supply Chain Management 4 ed (1 -84480 -024 -5)

Supplier assessment The need for objective assessment of suppliers increases as the role of the supplier in the business chain grows. Supplier assessment may take place at four different levels: 1. Product level. Focuses on establishing and improving the supplier’s product quality 2. Process level. Not the product, but the supplier’s production 3. Quality assurance system level. The entire supplier quality 4. process is closely investigated. organization is subject of investigation by the customer. Company level. Besides quality aspects also financial aspects are taken into consideration. Also auditors want to get an idea of the quality of management (how competitive is the supplier in the future? ) © Cengage Learning – Purchasing & Supply Chain Management 4 ed (1 -84480 -024 -5)

Supplier assessment Two types of assessment may be differentiated: § Subjective methods are used when companies evaluate suppliers § through personal judgments. Objective methods attempt to quantify the supplier’s performance. The following techniques and tools can be used (1) § Spreadsheets; used to systematically compare and asses § quotations obtained from suppliers. Important criteria are listed on one axis and the supplier quotations on the other. Personal assessment; used for suppliers with whom exist close business relationships. Specialists who have experience with the suppliers rate them according to a agreed checklist © Cengage Learning – Purchasing & Supply Chain Management 4 ed (1 -84480 -024 -5)

Supplier assessment Techniques and tools (2): § Vendor rating: Limited to quantitative data only. Entails measuring § Supplier audit: Entails that the supplier is periodically visited by § Cost modeling: Specialist from the buying company estimate, the aspects of price, quality and delivery reliability per supplier. specialist(s) from the customer. They investigate the production process and quality organization. based on the production technology, the cost of the product. This may lead to ‘should cost’ discussions with the supplier. © Cengage Learning – Purchasing & Supply Chain Management 4 ed (1 -84480 -024 -5)

Supplier assessment Framework for identifying the most important cost drivers: Category Description examples Design Costs attributable to product design trade-offs n Facility n Materials Product line complexity Costs related to the size of n Facility scale the facility, equipment and n Degree of vertical process technology employed integration n Use of automation Geograph Cost associated with the location of the facility relative y to the customer Operation Cost that differentiate a well run facility from a poorly run s © Cengage Learning – Purchasing & Supply Chain Management 4 ed (1 -84480 -024 -5) Location related wage rate difference n Transportation costs to customer n n n Labor productivity Facility utilization

Supplier assessment Difference between supplier auditing and vendor rating: Aspect Supplier auditing Vendor rating Orientation Focus on future Based on historical data Application New and current suppliers Current suppliers Nature Mainly qualitative Mainly quantitative Scope Broad, many aspects Limited, few aspects Work Time consuming Standard data Data processing Subjective, manually Factual, computerized Relation with suppliers Co-operation Based on internal administrative data © Cengage Learning – Purchasing & Supply Chain Management 4 ed (1 -84480 -024 -5)

Conclusions n Pricing and cost structures of suppliers are always interrelated, but the effect they have on one another is not always clear. n It is crucial to buyers to be able to lift the veil that covers the supplier’s pricing policy n Some methods to do so: Closely monitoring the supply market ¨ Monitoring individual supplier financial performance ¨ Make analysis of supplier’s cost price ¨ Monitor developments in the supplier’s performance on price, quality, delivery, etc. ¨ © Cengage Learning – Purchasing & Supply Chain Management 4 ed (1 -84480 -024 -5)