Deploying a Cost Structure Approach for Procurement
Approach 29 Apr. 2022

Deploying a Cost Structure Approach for Procurement

Controlling the cost structure is one of the pillars of Procurement, a function that faces double pressure: from the suppliers who are always inclined to increase prices, and their Management’s, asking for greater achievements.

We are noticing strong increases in commodity prices since the end of 2020.
These increases are due to a strong economic recovery, especially in China which alone absorbs nearly 50% of these raw materials in the world.

This situation generates not only longer delivery times and shortages, but also price increases.

In this context, the Procurement Departments are particularly called upon to avoid supply disruptions, but also manage the price increases of the products purchased.

A Negotiation Tool to Respond to a Crisis Context 

In order to contain these increases demanded by suppliers, buyers can use an essential tool, which unfortunately is not always well controlled: the cost structure of the product purchased. 

Indeed, understanding the structure of a supplier price makes it possible to isolate the material part of the total price. Therefore, to better negotiate this price increase by correlating supplier demand only to the material share in the product purchased while working to optimize the added value of the supplier.

The Cost Structure in Response to the Challenges of the Procurement Teams

The implementation of a cost structure approach allows to: 

  1. Identify new sources of gains

  2. Be more efficient in negotiation

  3. Have a costing posture & be able to anticipate changes in cost

  4. Be more efficient in developing strategies by procurement families

  5. Launch targeted progress plans with suppliers 

The Ingredients for a Successful Deployment

To calculate a cost structure, all of the activities necessary to manufacture a product or service must be considered.

  • Conception: Time spent, R&D costs…
  • Raw materials and components: Quantities, costs, rejects…
  • MOD: Number of hours, hourly rates
  • Production methods: Initial cost and depreciation, lifetime, rate of use…
  • Quality: Cost of scrap, cost of quality control…
  • Logistics: Cost of warehouses, cost of inventories, insurance, transport…
  • General expenses: General expenses, taxes and duties 
  • Margin: Industry average

In-Depth Knowledge of a Supplier’s Cost Structure is a Powerful Lever for Cost Reduction.

 It allows to:

  • Set goal prices

  • Optimize by quantifying the cost reduction levers (volume effect, RTC *, BLC **, etc.) 

  • Provide rational and structural data for decision support 

  • Compare supplier offers and costs 

  • Help suppliers to achieve target prices

  • Evaluate changes over time 

  • Better negotiate with a good knowledge of the strengths and weaknesses of suppliers

  • Know precisely the costs of modifications during the development phase

  • Evaluate each technical solution during the redesign phase

  • Establish a cost reduction strategy

Beyond the simple issues related to negotiation, knowledge of the cost structure gives an overview of an organization maturity.