Manufacturing cost analysis is more than a financial assessment—it’s the key to unlocking potential savings, refining negotiations and optimizing procurement decisions. Understanding the intricacies of this analysis for sourcing and procurement teams can lead to more informed strategic product sourcing decisions.
Pinpointing cost drivers is especially important as procurement teams work to reset operations amid the transition between price strains caused by the pandemic and today’s inflationary environment. Manufacturers use cost analysis to validate price increases independently or use their insights to negotiate price changes with suppliers in new market conditions.
“We now have an opportunity to go back into the supply base and claw back some of the lost productivity suppliers had because of social distancing,” said Rob Lidster, former Chief Procurement Officer for GE Appliances and current Advisor at Arcline Investment Management. “We can say to our suppliers, ‘Look, you’re no longer social distancing. Are you getting 30 pieces per hour? Are you back up to what you originally quoted at 45 or 50 pieces per hour?’”
A Closer Look: How Procurement Can Apply Manufacturing Cost Analysis
At its core, manufacturing cost analysis is the projection of the total cost for a finished product. It is a tool that allows procurement teams to negotiate more effectively, spotlighting areas for potential cost reductions. This isn’t just about raw material costs. It encompasses labor, facility expenses, machinery depreciation and much more.
Modern procurement teams are replacing their manual Excel spreadsheets with automation-driven manufacturing cost estimation software to increase the accuracy and speed of their projections.
With greater insight and real-time visibility into their product’s total manufacturing costs, organizations are successfully identifying:
- Cost drivers in the early design stage (and can then make design improvements)
- Components or parts that are cost outliers (and can then provide an opportunity to renegotiate with suppliers)
- The most efficient manufacturing processes and routings
A Three-Step Guide to Master Cost Analysis
Manufacturing companies that follow a disciplined process can uncover savings and make procurement decisions quickly and confidently. Here’s a synopsis of each step.
1. Identify Product Cost Outliers
To make the most significant impact, procurement teams should first zero in on parts that offer substantial cost-saving potential. First, identify the scope of the components to analyze. One approach is to segment parts into manufacturing process groups, such as sheet metal or casting components. Then, you can further refine your focus by selecting components by material type.
Then, use your enterprise resource planning (ERP) or other sourcing data systems to get the pricing information for the parts you are analyzing—including the expected annual purchase volumes. Multiply the two figures to yield the total spend per part. The intent is to bring into scope the components with the largest spend by segment.
Now that you’ve defined the scope, gather all critical data associated with each specified part. To improve the accuracy of their projections, internal cost engineering teams must incorporate the following into their calculations:
- Component material types
- Each part’s estimated batch size
- Actual or estimated annual production volumes
- Secondary processes required by the design (e.g., heat treatment, anodizing, etc.)
- Current quoted costs and supplier location details
- Production processes used to manufacture the part(s)
Product cost engineering teams can begin their component spend analysis with this information. You can conduct this review using spreadsheets or accelerate that process with manufacturing cost modeling software from providers, such as aPriori.
Once generated, use the estimates for should cost analysis. This exercise allows teams to compare their projections with supplier prices and identify the parts where significant savings opportunities lie.
2. Investigate Cost Anomalies
This phase involves scrutinizing the outliers identified in step one, and includes the following steps:
I. Double-check initial outliers. Re-review your estimates to ensure that product forecasts are accurate and that no contractual or relationship impediments exist.
II. Evaluate potential savings. Measure potential savings (your current spend—the potential spend if you purchased materials or components based on the estimated price). Calculate the net percentage difference between the estimate and your current price to account for the erosion of savings during the negotiation. Ensure that there are enough potential savings and enough of a percentage difference to make it worth your time to pursue each part.
III. Create an action plan. Confirm the routing/manufacturing process with the supplier and get a basic cost breakdown of relevant quotes to plan for a successful discussion with suppliers. This will include the cost of:
- raw materials
- primary manufacturing
- secondary production processes
- assembly cost if applicable
- non-recurring engineering (NRE) costs
Then compare these details with their estimates to identify gaps and formulate a discussion plan to determine the root cause of the gap and determine how to close it collaboratively.
IV. Identify product redesign opportunities to save costs. These can be identified by plotting your cost estimate—using a uniform batch size for all parts—against the finished weight of the component. A best-fit line should then be drawn. Examine parts with more than one standard deviation above the best-fit line for design inefficiencies or other factors causing higher costs.
3. Implement Cost-Saving Measures
Here’s where you translate insights into action (or it’s where the rubber meets the road if you prefer). Manufacturers execute their cost-reduction plans and act on their product redesign or renegotiation goals.
Regarding the redesign approach, cost specialists and design engineers collaborate to make successful, cost-effective product iterations. Alternatively, manufacturers can ask their suppliers whether a part can be redesigned to fit a manufacturing process more efficiently. It is often fruitful to ask the supplier, “What would you change to reduce the cost of this part?” Suppliers tend to be very collaborative if you ask this question about a couple of parts but will likely give you generic answers if you ask for ideas on all the parts they make for you.
To capitalize on renegotiation opportunities, sourcing professionals can approach suppliers with their fact-based should cost estimates, and review this with suppliers one step at a time to discover where and why the differences exist. These findings can help sourcing teams negotiate with suppliers and identify the underlying cause of the difference between an estimate and a quote. Procurement teams will achieve savings by resolving the root-cause issue.
Cost Analysis is a Wise Investment
Manufacturers continue to deal with lingering supply chain issues and inflationary pressures that increase component costs. However, by following the three steps outlined above, you will be well positioned to better identify, assess and capitalize on valuable cost-saving opportunities.
