Supply chain cost analysis

1
Cost Driver Analysis
 Cost driver analysis identifies processes,
activities, and decisions that actually create
cost for the supply chain.
 Cost drivers vary over time and among
different products and services.

2
 Generic Cost Drivers
 Level of outsourcing within a company. Companies that
outsource may experience higher costs for additional services
than if it had internal operations. Overall costs may be lower
when demand is erratic.
 Use of nonstandard materials, components and parts. Custom
items are more costly because of low economies of scale. Custom
parts may have better performance or lower operating costs.
 Scale of operations. Very large manufacturing operations must
have high stable volume. Small manufacturing operations may be
unprofitable at high-volumes due to overtime costs, inefficiency
in operations, machine breakdowns and maintenance issues.
 High level of finished goods product mix. The more options the
organization offers its customers, the more inventory it may have
to carry, and the more flexible it production operations must be.

3
Cost Driver Analysis
 Cost drivers are not inherently good or bad.
 Cost reduction strategies must analyze cost
drivers in relation to their impact on the value
proposition.

4
 Cost-Reduction Considerations
 For each product or service, how do you become aware of the
value proposition in your organization at any point in time?
 What is the value proposition for your organization, product,
service?
 Does the value proposition vary among business units and
products or services?
 If so, are you certain you have identified the right value
proposition?
 Does the value proposition vary over time?
 If so, are you certain you have identified the current or future value proposition?
 Will current/proposed activities be transparent to the customer?
 If not, what in what way will they be visible?
 Are these areas that the customer values?
 Will the impact be positive, negative or neutral?

5
Responsibility for Strategic Cost Management
 Historically accounting and finance had
responsibility for reporting and managing costs.
 SCM requires a broader cost perspective.
 Corporate Response:
 Intel - accounting and finance develop tools, supply
managers are responsible for delivering cost savings
 SBC - internal consulting groups attack complex
problems

6
Strategic Cost Management Tools
 Cost analysis: including “should-cost” analysis or
zero-based pricing, as well as analysis of service
provider cost elements.
 Price analysis: understanding the prices available in
the competitive marketplace.
 Total cost of ownership: analyzing the true cost of
acquisition, use, maintenance and disposal of a good,
service, capital equipment, or process.
 Target costing: determining what the market will
bear and working backwards to see how much you
can afford to produce the product or service for, and
still make a profit.

7
Decision Classification
 Once the process has been mapped and a good
understanding of the system has been
achieved, a decision matrix can be used to
determine the appropriate cost management
tool.
 The decision matrix classifies decisions
according to:
 Nature of the Buy
 Relationship with Supplier

8
Classifying Suppliers/Purchases

9
Classifications of Decisions
 Low Impact – low-cost commodity items;
focus is on price analysis/comparison
 Leverage – large purchases of items in
competitive markets; focus is on cost analysis
 Strategic Item – large purchases from
important suppliers; focus is on continuous
improvement
 Critical Projects – large dollar volume
infrequent purchase; focus is on life cycle cost

10
Tool Selection

11
Activity-Based Cost Management
 Traditional cost accounting systems are used
for internal reporting costs.
 Ideally, cost accounting would like to use
direct costing which determines cost based on
actual expenditures.
 Overhead, a pool of indirect costs,
complicates direct costing.

12
Traditional Cost Accounting
 Traditional cost accounting aggregates all
indirect expenses into a classification called
“overhead”.
 Overhead is then allocated to production
based on some benchmark activity.
 Changes to the benchmark activity may
distort true cost performance.

13
Traditional Cost Allocation System

14
Activity-Based Cost Management
 Activity-based accounting provides a more
accurate alternative to traditional cost
accounting.
 Activity-based accounting attempts to match
indirect costs with the products or services
that generate them.
 Activity-based accounting allocates indirect
costs based on the cost drivers that actually
create them.
15
ABC Allocation

16
Activity-Based Cost Management
Implementation of an ABC accounting system is
a non-trivial event. Organizations may have to
rethink:
 Pricing strategy
 Marketing strategy
 Manufacturing strategy

17
Total Cost of Ownership (TCO)
Total cost of ownership is defined as a
philosophy for understanding all relevant supply
chain related costs of doing business with a
particular supplier for a particular good/service,
or the cost of the process, were particular supply
chain design.
 Attempts to look at the big picture, considering
cost beyond that of the purchase price.

18
Total Cost of Ownership Analysis

19
Step 1: Identification of Benefits Sought
The first step in TCO analysis is to determine the benefits sought
from the analysis. Reasons to conduct TCO analysis include:
 Performance measurement
 Framework for cost analysis
 Benchmarking performance
 More informed decision making
 Communication of cost issues internally and with suppliers
 Encourages cross-functional interaction
 Support an outsourcing analysis
 Support continuous improvement
 Helps identify cost savings opportunities

20
Step 2: Form a TCO Team
Once a project has been identified, a TCO team should be formed. Members should include
purchasing, users, and any functional/technical experts.

21
Step 3: Identify Cost Drivers
 Begin the analysis by expressly identifying
potential costs by mapping the process flow
for all aspects of the project.
 From the flowcharts, brainstorm key cost
drivers.
 Gather cost data for all identified cost driver
for each alternative.

22
Step 4: Fine Tune
 Step 4 allows for fine tuning of the TCO
analysis including the use of sensitivity
analysis.
 Sensitivity analysis allows for testing of “what-if”
scenarios.
 Decisions that do not change based on changes to
assumptions of data are said to be robust.
 Managers can have more confidence in robust
decisions.

23
Step 5: Present
 Step 5 requires that the TCO analysis findings
be presented to the appropriate management
level.
 Format for presentation should include:
 Summary of TCO analysis results
 Sensitivities
 Non-Cost Issues
 Recommendation
 Presentation should also include “soft” costs

24
A Return to the Opening Story
Based on what you have now read and discussed:
1. Why the companies engage in across-the-
board demands for cost-cutting rather than
using a strategic cost management approach?
2. What is a good way to identify promising
initial project for strategic cost management?
3. How do problems with current management
accounting systems complicate the strategic
cost management process?

25
A Return to the Opening Story
4. How can a company reduce costs without
compromising quality or service?
5. Who needs to participate in strategic cost
management?
6. What tools can help the firm understand the
broad cost implications of its decisions?

26
Why SC performance measurement?
Measurement creates understanding:
“If you cannot measure it, you cannot understand
it”
Measurement drives behaviour:
“What gets measured gets attention.”
Measurement help communicate strategy
Measurement is a prerequisite for high level
execution and attainment of world-class results.
Measurement leads to results:
“What you measure is what you get”
SC Performance measurement

Defining SC
Performance
Measures

Implementing/
Monitoring of
Measures

Strategic Use
of
Measurement
Systems
Traditional performance measurement
Areas that are essential to measure in order to
accomplish customer service and profitability goals:

Asset
Managemen
t

Cost Customer
Service
Traditional
Measurement

Productivity Quality
Traditional measurement – main issues
Traditional measurement systems are not holistic, they
are designed to capture and communicate primarily
functional information (silo approach).

Traditional measures are primarily oriented to short-

term financial results and cost-cutting.

Traditional customer service measurements often do

not provide a clear understanding of customer
expectation or satisfaction levels.
What must be emphasized in SC measures
Alignment:
With SC strategy
Intra-organizational alignment
Inter-organizational alignment

Customer satisfaction:
For whole chain
Contribution of each process

Systemic/holistic view:
Moving beyond simple functional excelle nce
 Examples of SC performance measures
Total Supply Chain The sum of all the costs incurred in planning, designing, sourcing, making, and
Cost delivering a product broken down for each member of the supply chain
Source/Make Cycle The cumulative time to build a shippable product from scratch —if you start with no
inventory on hand or on order. Consists of total sourcing lead time, release-to-start
Time
build, total build cycle time, and complete build-to-shiptime
Supply Chain The theoretical number of days required to recognize a major shift in market
Response Time demand and increase production by 20 percent
Total number of days of inventory required to support the supply chain—fromraw
SC Inventory Days
materials to the final customer acquisition. Expressed as calendar days ofsupply
of Supply
based on recent actual daily cost of sales
A perfect order is an order that is delivered complete, on time, in perfect condition,
Perfect Order
and with accurate and complete documentation. Fulfillment is the percent of orders
Fulfilment
that are perfect (Perfect orders/Totalorders).
 Recommendations in designing
performance measures
Performance measures should be derived from strategy
Performance measures should be simple to understand
Performance measures should provide timely and accurate
feedback
Performance measures should be based on quantities that can
be influenced, or controlled, by the user alone or in co- operation
with others
Performance measures should focus on improvement
Performance measures should be objective – not based on
opinion
Performance measures should be based on trends rather than
snapshots
Performance measures should employ ratios rather than
absolute numbers
Performance measurement “system”

Defining SC
Performance
Measures Performance
measurement
Implementing/ system
Monitoring of
Measures

Strategic Use of
Measurement
Systems
SC Measurement implementation -
Scorecards
Scorecard gives a graphical summary of performance over
a specific period of time.
It also provides a mechanism for evaluation and
communication of performance along critical dimensions.
It also gives insight into the importance of each
performance dimension
In supply chain domain, especially the supplier scorecards
are very common

Weighted
Metric Weight Score Score
On time delivery 50% 84% 42
Invoice accuracy 10% 95% 9.5
Quality 30% 90% 27

Environmental impact 10% 100% 10

Total Score = 88.5
Different types of performance systems
Strategic use of measurement systems
Beside monitoring performance of the processes and whole chain, a supply chain
performance measurement system can be used for:
Benchmarking the processes
Decision on the performance improvement areas
Justifying different improvement projects
 Different types of Benchmarking
processes
Competitive Benchmarking – evaluating best practices of
leading competitors within industry.
Noncompetitive Benchmarking – evaluating best practices
regardless of industry.
Internal Benchmarking - large global firms may find
opportunities to disseminate best practices within the
organization (e.g., different branches of one retail chain)

For benchmarking we need:

A reference model

A set of metrics
Supply Chain Operations Reference
Model (SCOR)
The best available tool for SC benchmarking is SCOR model.
It provides both “a reference model” (so, two units in the
benchmarking process become comparable) and the reference
“set of metrics”.
It is developed by Supply Chain Council to present a standard
supply-chain process reference model enabling effective
communication among the SC partners
Three elements of SCOR model:
Standard processes: Plan, Source, Make, Deliver, Return,
Enable
Standard metrics: Perfect Order Fulfillment, Cash-to-Cash
Cycle Time, Cost of Goods Sold, etc.
Standard practices: EDI, CPFR, Cross-Training, Sales &
Operations Planning, etc.
 Five principles of Supply chain
Management
Principle 1: a clear supply chain strategy is the foundation to align the
decisions of different actors and business units and avoid ad-hoc firefighting
or sub-optimal decisions.
Principle 2: defining supply chain strategy calls for understanding the
customers’ needs and formulating a clear customer value proposition.
Principle 3: in order to communicate supply chain
strategy, drive actors to align with that strategy and
monitor the success of processes to deliver value, a
well-defined supply chain performance measurement
system is a must.
Principle 4: supply chain management aims at developing capabilities
that help achieving the supply chain strategy.
Principle 5: the pillars for manging every supply chain are integration
and collaboration.
Thank u