Materials Management

BUS 3 – 141

Pricing and Make/Buy Decisions

October 15, 2007

Page 2 2

Agenda

– Exam Review

– Case 2

– Price

– Cost

– Value

– Make vs. Buy

Exam Review

Page 4 4

Grade Distribution – Exam 1

1617

11

7

0

4

8

12

16

20

A B C D/F

`

Count % of Total Cum %A+ 2 3.9% 3.9%A 10 19.6% 23.5%A- 4 7.8% 31.4%B+ 6 11.8% 43.1%B 5 9.8% 52.9%B- 6 11.8% 64.7%C+ 4 7.8% 72.5%C 5 9.8% 82.4%C- 2 3.9% 86.3%D+ 2 3.9% 90.2%D 2 3.9% 94.1%D- 3 5.9% 100.0%

Grade

Page 5 5

Item & Description

Where Used

Qty Per Assy

Qty On Hand

Lead Time

Past Due 1 2 3 4 5

MV2008 MB1234 1 5,000 1 Gross Requirement 0 7,000 5,000 4,000 14,000 2,000

Coffee Table On Order 0 4,000 3,500 0 0 0

Projected Available 5,000 2,000 500 -3,500 -17,500 -19,500

Planned Order Complete 0 0 0 3,500 14,000 2,000

Question # 29 --> Planned Order Starts 0 0 0 14,000 2,000 0

Cum Planned Order 0 0 0 3,500 17,500 19,500

K2002 SJSU141 1 11,000 2 Gross Requirement 0 0 0 14,000 2,000 0

Wood Top On Order 0 0 0 0 0 0

Projected Available 11,000 11,000 11,000 -3,000 -5,000 -5,000

Question # 30 --> Planned Order Complete 0 0 0 3,000 2,000 0

Planned Order Starts 0 3,000 2,000 0 0 0

Cum Planned Order 0 3,000 5,000 5,000 5,000 5,000

K2004 SJSU141 4 40,000 3 Gross Requirement 0 0 0 56,000 8,000 0

Leg On Order 0 0 0 17,000 0 0

Question # 31 --> (see Period 4) Projected Available 40,000 40,000 40,000 1,000 -7,000 -7,000

Planned Order Complete 0 0 0 0 7,000 0

Questions # 32 and 33 --> Planned Order Starts 0 7,000 0 0

Cum Planned Order 0 7,000 7,000 7,000 7,000 7,000

MRP Questions

Next Case

Page 7 7

Case 2: Sedgman Steel (p. 176) Due Oct 29, 2007Please include the following:

1. FACTS OF THE CASE Quantitative data (Revenue, Inventory, Costs, Employees, Divisions, etc….)

2. BUSINESS ISSUES IDENTIFIED Customers, Suppliers, Internal Measurement Systems, Organization, Competitors, Supply Shortages, Price Increases, Cash Flow, etc…)

3. CONCLUSIONS What has been going well? What needs improvement?

4. RECOMMENDATIONS What improvements should be made? What (if any?) activities should be stopped? How can the improvements be implemented?

Be concise. Use a format equivalent to what you would use in writing a persuasive email to your boss. Try to limit your report to no more than one page, single-spaced. Longer will be accepted, but is not required.

Approx. 20% of Total Effort / Grade

Approx. 20% of Total Effort / Grade

Approx. 25% of Total Effort / Grade

Approx. 35% of Total Effort / Grade

Price

Page 9 9

Definitions

What the seller is paid for goods and services provided

Price

The expenses incurred in operating the enterprise, making andbuying materials, and converting the materials to finished goods

Cost

The ability to pay, without compromising cash balances

Affordability

The difference between Price and Cost

Value

Page 10 10

Price

– Market Price

• Not necessarily based on supplier cost• Important for comparing alternative suppliers• Required when deciding whether to make in-house or buy• Good for discovering improvement opportunities for your business

– Suppliers have to make profits to stay in business

• It is important to know what is a “reasonable” price and profit are

The Selling Price is MUCH more dependent on theMARKET than on Cost

Cost

Page 12 12

Types of Costs

Specifically assigned to a given unit of productionExamples are: component materials, assembly labor

Direct Cost

Necessary to operate the enterprise, but not specifically assignedto a given unit of production (e.g. Rent, management salaries)

Indirect Cost

Vary directly & proportionately with the number of units producedExamples are: BOM x units produced

Variable Cost

Does not change, regardless of the number of units producedExamples are: Rent and advertising

Fixed Cost

Page 13 13

Relationship of Cost to Selling Price and Profit

* Adapted from Leenders, Johnson, Flynn, and Fearon, Purchasing and Supply Management, Thirteenth Edition, McGraw Hill Irwin

Direct materials $5,500 Direct Variable

+ Direct labor 2,000 Direct Variable

+ Factory Overhead 2,500 Indirect Fixed*

= Manufacturing Cost $10,000

+General, administrative, and Selling cost

1,500 Indirect Fixed*

= Total Cost $11,500

+ Profit 920

= Selling Price $12,420

Cost Behavior

1,000 UnitsAverage Cost = $11.50 / unitSelling Price = $12.42 / unitProfit percentage = 8%

Page 14 14

Impact of Volume on Cost (and Selling Price )

2,000 UnitsAverage Cost = $9.50 / unitSelling Price = $12.42 / unitProfit percentage = 31%

Changes asVolume Changes

Direct materials $11,000 Direct Variable

+ Direct labor 4,000 Direct Variable

+ Factory Overhead 2,500 Indirect Fixed*

= Manufacturing Cost $17,500

+General, administrative, and Selling cost

1,500 Indirect Fixed*

= Total Cost $19,000

+ Profit 5,840

= Selling Price $24,840

Cost Behavior

No Change asVolume Changes

Page 15 15

Comparison of Fixed & Variable Costs with Volume

Unit Cost

1,000 2,000 5,000

Direct materials $5.50 Direct Variable 5,500.00 11,000.00 27,500.00

+ Direct labor $2.00 Direct Variable 2,000.00 4,000.00 10,000.00

+ Factory Overhead Indirect Fixed* 2,500.00 2,500.00 2,500.00

= Manufacturing Cost $7.50 $10,000.00 $17,500.00 $40,000.00

= Unit Mfg. Cost $10.00 $8.75 $8.00

+General, administrative, and Selling cost

Indirect Fixed* 1,500.00 1,500.00 1,500.00

= Total Cost $11,500.00 $19,000.00 $41,500.00

Average Unit Cost $11.50 $9.50 $8.30

Selling Price $12.42 $12.42 $12.42

Profit 920.00 5,840.00 20,600.00

Profit Percentage 8% 31% 50%

Cost Behavior

Units Sold

Understanding Supplier Fixed and Variable costs is CRITICAL to any Negotiation

Value

Page 17 17

Applying Value Principles to your Career

– When you work, the company is BUYING what you are SELLING

• The work you do is WORTH something. Your company will continue to pay you when the work you do is worth more to them than what you cost

– Do more than your Job Description

• You really are not paid to do a specific job; you are paid to make money for your company

• The more valuable that you are, the more you will get paid – either by your company or the next company

– Don’t say, “It’s not my Job”

• Think like the Boss• Pick the BEST people and try to be like them• Don’t look at how little the poor performers are doing and complain

that you are doing more

– Think about how you can be worth MORE than what you are being paid

Factoring Supplier Price in Buying Decisions

Page 19 19

Pricing data varies for different Purchase Types

RawMaterials

StandardProduction

Items ofSmallValue

SpecialItems

ServicesCapitalGoods

Resale

– Published market prices; bought and sold in well-organized markets

– Monitor trends for opportunities to leverage unexpected dips in price

– Price indexes are available for escalator clauses

Raw Materials (Commodities)

– Can be found in catalogues from manufacturers, distributors, and retailers

– Published “list price”, with opportunities for better prices based on volume

– Good candidates for online buying, using searches and/or auctions

– Frequently a broad category is covered by a single Sales Representative who pools buys for volume discounts

Standard Production and Items of Small Value

Page 20 20

Quotations and Bidding

– Qualify your bidders

• Ability to execute the technical requirements• Potential to be a Partner

– Include a reasonable number of bidders (not too many and not too few)

– There must be NO appearance of favoritism

– Specifications need to be VERY CLEAR and not open to interpretation

– Price is not the only thing that matters

– Firm bid: first bid is the last bid too

– BAFO Bid: Best And Final Offer – The potential supplier is given additional information after the initial bid and is given the opportunity to prove a second bid

Time and budget must be planned to account for the effortof negotiations. Major negotiations should be outside routine

production support. Production support should focus ondelivery and quality, with pricing previously negotiated

Page 21 21

Alternatives when Bids are virtually Identical

– Choose a supplier already doing business with you

– Negotiate non-price concessions

• Freight• Warranty• Consigned inventory

– Choose a supplier with social benefits

• Largest domestic content• Women and minority owned• Closest in proximity

– Select based on recommendations by customers

Beware of Collusion

Page 22 22

Key Elements of Negotiated Contracts

– Price, Volume, Quality, Service

– Price protection

– Escalator clauses

– Cancellation clauses

– Liability

– Ethical practices

Will be covered in a subsequent chapter

Make vs. Buy

Page 24 24

Definitions

Producing the product or service with resourcesfrom your own enterprise

Make

Purchasing the product or service produced byresources from an outside supplier

Buy

Sourcing the product or service “back in”after the original Buy decision

Insourcing

Sourcing the product or service “outside”after the original Make decision

Outsourcing

Page 25 25

Factors in deciding whether to Make or Buy

– Quantities too small for outside tooling and economies of scale

– Quality requirements are too tight for outsider to produce

– Manufacturing is a core competency

– Greater assurance of supply with dedicated production capacity

– Lower cost

– Protect Intellectual Property

– Avoid sole-source dependency

– Distance to supplier too great

– Significant customer requires it

– Backup capacity

– Manufacturing is not a core competency

– Supplier has expertise in a technology or product

– Greater capacity

– More flexible capacity

– Buying Modules or subassemblies, rather than many component parts, simplifies operations

– Lower risk with multiple sources of Supply

– Lower cost

– Negotiated unit cost removes temptation to overbuild to absorb fixed cost

– Good supplier in close proximity

– Significant customer requires it

– Open up new markets (e.g. NAFTA)

Reasons to Make (keep in-house) Reasons to Buy (go outside)

There is no single “Right Answer” that applies toevery business and every situation

Page 26 26

Insourcing and Outsourcing

A Make or Buy decision can be reversed, or modified,if business conditions justify it

– Supplier no longer produces the product or goes out of business

– Volumes become too low

– Major price increases

– Reinforce the linkage between Design and Production

– Projected savings of “Buy” decision were not realized

Insourcing would be recommended when:

– Capable suppliers have entered the market

– Volumes increased dramatically

– Major internal cost increases

– Core competencies re-evaluated

– IT systems enable effective communication and control

– Government incentives

Outsourcing would be recommended when:

Page 27 27

Risks of Outsourcing

– Supplier priorities can be re-directed (often to competitors)

– Limited control during times of scarcity

– Original savings projections not realized

– Additional fees and charges introduced after original agreement

– Pricing and terms from the original agreement significantly changed in subsequent negotiations

– Supply, Legal, Technical, and other resources are frequently re-directed to ensure benefits are achieved and relationships maintained

– Customer, employee, market, or political criticism

• Domestic vs. offshore• Union vs. non-union• Increased turnover of key individuals

Page 28 28

The Role of Purchasing in Outsourcing

– Ensure that an objective, fact-based decision process is in place

– Provide several sources

– Provide expertise in Requests for Proposals

– Take the lead in developing and negotiating Contracts (with Legal)

– Monitor and manage the ongoing relationship

– Take the lead in negotiating subsequent contracts and identifying back-up suppliers over time