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

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.