How Purchasing Cost Models Help Companies Succeed

This blog is the first of a three-part blog series which will discuss:

• How cost models help companies succeed
• What types of cost models do buyers of manufactured products use
• How buyers can use cost models effectively

Cost models provide buyers with valuable benchmarks to validate supplier pricing. Used effectively, they help drive optimal design, reduce the time required to bring products to market and help companies succeed.

When it comes to understanding supplier cost structures, I admit that I am biased. After all, understanding supplier cost structures was what started my career in procurement. Ford Motor Company sold me on the idea.

In 1984, the country was emerging from a recession after a long period of economic growth in the 70s. During the prosperity of the 70s, Ford used frequent market testing to establish supplier prices. However, in order to be effective, the market testing required many suppliers. Once the economy took a downward turn, many suppliers created havoc with bankruptcies and supply issues.

Emerging from the recession, Ford wanted fewer suppliers and wanted them to be financially healthy. Additionally, Ford wanted a better understanding of supplier manufacturing costs so that designs could be optimized for efficient manufacturing.

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I was finishing college for the second time with a newly minted MBA to accompany my bachelors in operations and my experience as a production supervisor. Ford approached me and convinced me that I wanted to be in purchasing for the following reasons:

• The goal of having fewer suppliers would conflict with their practice of using frequent market tests to control pricing. Therefore, they needed to move to a more cost-based approach.
• Competition in the automotive market was intense, requiring Ford to design products faster and more cost efficiently. Faster design cycle times meant that buyers could not wait on finalized designs to source components. They would have to be sourced before design finalization to meet the compressed timing. Sourcing before design finalization would also provide the supplier value analysis/value engineering input on the design to lower its cost.
• My manufacturing and finance experience meant that I could meet the objective of understanding the suppliers’ cost structures and establish pricing without ongoing use of market tests.
• Finally, Ford believed that the understanding of cost would lead to greater collaboration with the suppliers, not only on the design but on ongoing cost reduction and product improvement.

So, Ford convinced me and I joined the team and started my journey in collaborative, knowledge-based sourcing through understanding manufacturing costs. I established Advanced Purchasing Dynamics in 2004 to continue this journey by developing and implementing a variety of cost models to help clients move to collaborative, knowledge-based processes.

What are the benefits we have seen from this approach?

• Collaborative cost modeling enables purchasing, engineering and operations to work with fewer suppliers.
• Suppliers can be sourced prior to design, brought into the design process and can help optimize it; this results in shorter design time/lower cost.
• Suppliers, removed from the constant threat of market testing, are more open with intellectual property on process, design and costs.
• Customer and supplier teams can use the models to drive cost and design improvements.
• Customers who are faced with make/buy decisions can make them with full knowledge of the suppliers’ and their own manufacturing costs.
• They keep a supplier from “buying the business” by pricing at a loss.