The Move to Open Book Costing

Recently, I was quoted in an Automotive News article on GM’s move to open book costing, which they call One Cost.

The article prompted a number of conversations with CEOs and sales executives not only about GM and their move to open book costing but also about the use of cost models and cost breakdowns by purchasing organizations.  Here is the essence of some of those conversations.

But first, let me give some background of how we got here.

The development of collaborative relationships and a thorough understanding of supplier cost structures was what brought me to purchasing. It was also the basis for forming APD 11 years ago.

After receiving an undergraduate degree in ’81, I spent time at Cummins Engine Company as a production supervisor. I got caught up in the Carter/Reagan recession (your choice on who to blame that on) and took the opportunity to get my MBA, thinking I would go back into operations when I finished.  Ford Motor Company recruited me and my freshly minted MBA into purchasing in 1984. At the time, they, and others in the industry, were trying to reduce the number of suppliers in their supply base and to move to a more cost-driven approach to purchasing.

30 years later, we’re back in the same place.

When I formed APD 11 years ago, I wanted to build a company around what drew me into the industry in the first place — the development of collaborative relationships and a thorough understanding of supplier cost structures.

Now back to some of the conversations we’ve been having as a result of the Automotive News article.

The two most frequent questions from suppliers regarding GM purchasing are these:

Q:  The process GM uses with us has not changed.  Why?

A:  This is not surprising. First, any new process has a roll-out period and it takes a company as large as GM time to disseminate it to the entire supply base.  Secondly, our belief is that open book costing is suitable for many but not all commodities. Cost and relationship management is not a “one-size-fits-all” proposition.  Cost and relationship tools will vary based upon the commodity dynamics. Therefore, some suppliers may never be involved in the process.

Q: We have been engaged in the One-Cost process but are concerned that the overall tenor of negotiations and the relationship has not changed.

A:  In all that I have read and heard, GM executives seem to understand that the relationship with the supply base needs to improve.  However, between the executives and the buyers are managers and directors who have been promoted and rewarded over time based upon the application of a certain set of tools and a certain set of behaviors.  Changing the tools and behaviors is difficult.  GM’s success in implementing change will be determined by its ability to visibly reward the early adopters within the organization and identify and train the laggards.

My suggestion is that suppliers help by learning the process that GM is trying to implement and understand the public statements being made regarding it.  These are quite positive.  When faced with behaviors or processes that are not in line, ask why.

Outside of GM’s use of open book costing, we are getting questions like this:

Q:  Our issue is that each of our customers has its own cost models or expectations and expects us to meet them. Customer A expects an overhead rate of $xxx while Customer B is OK with our overhead rate but expects SG&A to be below a threshold percentage.  Why can’t they just agree to one model?

A:  Our belief is that buyers should ask for accurate cost breakdowns and should expect that cost variances may and will occur among suppliers.  A low capital/high labor approach to manufacturing a commodity will have a different cost breakdown than a high capital/low labor method.  Each method might be low cost for a specific subset of the commodity.  The purchasing organization that tries to get every supplier to quote the same cost structures across the board will not build an understanding of true production costs.  Instead, they will get detailed cost breakdowns that meet the thresholds but hide costs in other areas.

Q:  In the end, it all comes down to price.  We submit a quote with a cost breakdown. The buyer comes back and says, I will source it to you if you lower the price.  In order to lower the price, we change the cost breakdown. In one case, we even changed the mark-up on material to be negative.  As long as the price matches, the buyer is OK, even with the negative mark-up.

A:  The first statement, “in the end, it all comes down to price” is actually accurate if the purchasing organization is behaving the way this CEO laid out.  If buyers are OK with negative mark-ups or don’t question how a supplier was able to lower the price, then the buyer is not actually interested in understanding the costing of a product.  The buyer who is trying to understand would not accept a revised quote without knowing what changed that allowed the supplier to provide a revised quotation.

At APD, we have a team committed to the belief that the relationships between buyers and sellers can be collaborative and built upon a shared understanding of costs.

How can you create a truly collaborative relationship throughout the entire manufacturing process? What does collaboration mean?

• It means transparency in the purchasing spend, plus knowing how “should-be” costs will be developed
• It means sharing scheduling of demand events and communicating strategic plans.
• It means leveraging automation and communication portals to understand procurement needs and processes.
• And finally, it means good relationships to foster problem solving and drive efficiencies.

The ultimate goal is getting the supplier and customer to communicate about cost, quality and delivery.

Do you have questions about how open book costing can work to benefit your organization?