Chapter 2 Flashcards
During negotiation a buyer will negotiation on price and non price variables. i.e. cost of unit vs warranties, contractual terms etc.
Its important to note that non price variables do have a cost. i.e is an extended warranty of 5 years free? no it is costed into the unit price as added value. Buyer could analyse this and find that units commonly break after 5 year period so the warranty actually has no value in the negotiation. The buyer can put a cost on the non price variable and calculate the ‘Total Cost of Supply’
How would you describe the Profit Leverage affect?
This model shows that it is possible for a focus on cost savings to generate a bigger impact to profitability than increased sales or just charging more for the product. It can difficult to increase costs and increase sales on products.
It suggests that if you keep the selling price the same e.g. 100p, 5% margin to start, ‘other costs’ remain the same at 45p, focused costs reduced by 5% from 50 - 47.5, means that margin has now increased to 7.5% which is a 50% increase in margin!
Can you name examples of direct and indirect costs?
Direct costs are those directly involved in production of product. Examples include, raw materials, parts, externally provided services, transport, labour, expenses i.e. software specific to that production.
Indirect costs are those indirectly involved in production of product. examples include, advertising, finance, consumable not accounted individually such as stationery, cleaning, production machinery spare parts and servicing, indirect labour such as marketing , sales, R&D, expenses such as rent, rates, allowance for bad debts. These as overheads.
According to CIPS Cost breakdown pie chart, what are the element of vendor cost analysis?
Materials - 40%
Profit - 20%
Labour - 25%
Overheads - 15%
Remember, it’s critical for buyer to understand how supplier costs make up price so that buyer can challenge bundled cost that the buyer is not benefitting from. For example, with software license if their is a fixed cost for software, why would the buyer want to pay a fixed cost when they are only going to use half of the package. If they pay, this means the buyer is subsidizing the cost of the package for other customer of the supplier which would use all element of the package. The supplier cost incorporate a cost for servicing their ongoing debts which could be unethical and so on.
How would you describe fixed, variable and semi variable costs?
Fixed costs - costs that do not vary with levels of output
Variable costs - costs which vary with levels of production
Semi- variable - a mix of both. e.g. gas utilities
What is the definition of addressability spend?
This follows examining the costs which make up the supplier price. Fixed, variable etc. From this the buyer should aim to understand which costs are unlikely to be negotiated on such as minimum wages, commodity costs, regulation fees etc. This then leaves the elements of cost for buyer to target for negotiation such as margin, employee benefits, bundle cost, transport and son on.
Remember, suppliers with high FC to VC ratio, need high volumes to break even, but once achieve may be able to offer discount for bulk orders
Supplier with high VC to FC will not bale to able to offer discount for bulk order as most of their costs are variable
How is Value Engineering and Value Analysis linked? What’s the difference?
The aim of both activities is to understand cost components of a product/ service to identify element which add cost but no added value. this way you are targeting supplier cost, not their profit. Thus, they should be malleable to support it.
Value analysis is usually first, which involve breaking down costs to see where waste exists i.e. unnecessary charges which are bundled into cost which doesn’t benefit you i.e. delivery cost for collections.
Value Engineering usually follows by deconstructing something to remove items/ waste and reduce costs. i.e. remove a component
Ray Carter suggests using the following mnemonic for STOP WASTE in support of these actions:
Standardisation Transportation Over-engineering Packaging Substitutes Weight Any unnecessary processing Suppliers input To make Eliminate
What does the Supplier Cost Curve shows us?
The model shows us the fluctuation is price vs output stating that supplier costs will be highest at highest and lowest output levels. When a factory first opens, it has significant overhead/ fixed costs to recoup so price is passed onto buyer. As output increase, those overhead/ fixed costs can be spread amongst ore units and reduce the price per unit. The lowest price point on the curve is know as the ‘Sweet Spot’ where ‘Long Range Average Cost is at its lowest. This point is the buyer strongest position to negotiate.
What is the formula for break even?
Price - variable cost = contribution
Fixed cost/ contribution = breakeven (in volume/ units)
Example:
Fixed cost £500
Variable cost £5
Price per unit £10
Contribution = £10-£5 = £5
BE= £500/£5= 100 units
Remember, the power of knowing the suppliers BE is that you can start from a position of any extra units are pure margin and those before it have now covered their costs. those additional unit in theory don’t need to cover the fixed costs anymore thus that embedded cost could be negotiated out.
Remember, margin of safety of BE graph is the difference between BE point and the total revenue.
What is the definition of Absorption Costing?
Absorption costing is the act of incorporating indirect cost into the direct costs of producing a unit using an estimated basis of allocation. Remember, indirect into direct costs.
What is the definition of marginal or variable costing?
Imagine a supplier produces 100 units for £1000 and the cost of making the 101st is £1005. The average cost per unit was £10, but the 101st marginal cost is £5. In short, a buyer should negotiate with the supplier to only charge the marginal/ variable cost for the product for increased orders.
The supplier can accomplished increased sales from this action, however, if it gives it to a few buyers, their other customers will become unhappy for not getting it either. This then threatens the supplier price integrity.
This is linked to Dynamic pricing which is where a supplier changing the price depending on live market market conditions, fluctuating demand, already hitting sales target so offer discounts their after to squeeze more sales etc. Think of Ryanair flights, changing every few minutes.
What is Activity Based Costing?
Imagine you have product A & B, both have 1 hours labour, the same material costs but A requires 60 mins of machine processing and B needed 6 minutes. a standard method of costing would be a % of X and labour hours, the costs of each product would be the same. however, this ignores the cost of A need 54 min extra machine processing. This means product B will be subsidizing cost of A. Activity based costing look at the specific process of each products production to capture all costs, not just a standard % absorption.
What is mark up?
The amount added to the cost of an item to get its selling price. The difference between cost and selling price i..e mark up is then gross profit. Gross profit is followed by various deductions which soon become net profit. E.g. £50 cost, £50 mark up, £100 selling price, £50 gross profit
Mark up is shown as a %
Mark up = Price - cost/ cost *100
