Types of Cost Models Used by Buyers of Manufactured Products
This blog is the second of a three-part blog series designed as follows:
- How cost models help companies succeed
- The types of cost models buyers of manufactured products use
- How buyers can use cost models effectively
We see four types of cost models being used by buyers today:
- Open book cost modeling
- Knowledge-based modeling
- Hyper-optimized cost modeling
- Attribute-based cost modeling
Open Book Cost Modeling
Open book cost modeling utilizes information provided by the supplier for material, labor, burden, SG&A and profit. Plant specific models are developed that are centered on a high degree of collaboration between customer and supplier to determine sale price.
Open book models are developed on a supplier-by-supplier basis using manufacturing cost studies done on a supplier’s shop floor. Every supplier, and every location attributable to that supplier, has a unique cost model. Open book models are highly credible and accurate, time-intensive to develop, and require detailed supplier participation. Open book models are the fastest path to the most savings while allowing suppliers to make a fair profit, and are designed to:
- Understand a supplier’s true cost structure to determine price
- Enhance transparency between customer and supplier
- Determine/form long-term relationships
- Become the baseline for data-driven price discussions
- Identify risks and opportunities
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Knowledge-based models are built using market data obtained from supplier quotes or third party data providers. Often they are built and apply to a specific geographic region, utilizing the material, labor, burden, SG&A and profit data from that region when calculating sales prices.
This method results in should-be pricing that is achievable within the region they are developed. Additionally, these models exhibit the following characteristics:
- Good level of credibility as they are using supplier data
- Less time intensive than open book cost models
- Less accurate than open book cost models
Hyper-optimized Cost Modeling
Hyper-optimized cost modeling is achieved by combining best-in-class global rates for material, labor, burden, SG&A and profit to determine a theoretical end item sale price. This method results in should-be pricing that is rarely achievable because all of the rates used are industry best.
The goal of utilizing a hyper-optimized cost model is to establish savings gaps between the global industry best-in-class cost data and the cost breakdown data reported by a supplier. Once these gaps have been identified, it becomes incumbent upon the supplier to start to close these gaps through cost reduction activities
Attribute Based Cost Models
When using attribute-based cost models, the buyer may not have access to cost information from the supplier or from third party sources. However, that does not mean that a cost model cannot be developed. Running a regression using the physical part characteristics and prices from a number of similar parts can yield very predictive pricing models. Some characteristics of these models are:
- Does not require supplier participation.
- Easy to develop.
- Less accurate – used mostly to identify “outliers” for investigation.
- Used for bearings, seals, motors…
Are there other types of cost models that you use?
In section 3 of the blog to be published next week, I will describe best practices in using cost models.