Cost management can be an intimidating competency to procurement professionals who strongly associate cost with accounting – the measurement of financial information for external or internal reporting.
However, it is a process procurement professional are strongly involved with and so they should also be at the centre of the cost management process. It is simply another extension of the procurement discipline.
By mastering Cost Management tools and techniques procurement professionals can help their organization achieve global competitiveness, not only in cost but also in preparing them to anticipate and proactively serve the needs of the customer through increased innovation.
During a supplier selection process, buyers need to check if the agreed price is a fair price. They must calculate the cost to find out what the right price is and where to focus to reduce extra cost.
Since most companies have increased outsourcing, they depend much more on the performance and cost of their suppliers. Buyers will contribute to the profit of their companies by effectively managing the costs.
The Cost Management Process
The cost management process is executed in 3 steps:
- Search cost information
- Calculate cost
- Reduce cost
During the first step, search cost information, the buyer determines the cost of components like raw materials, machines and labour that are used to manufacture the purchased item. Throughout the second step, calculate cost, the direct cost is calculated by adding material and labour costs. The direct cost is the cost that will disappear if the manufacturing of the item is cancelled at a certain point. The indirect cost, also called overhead, is the cost that is NOT directly related to the manufacturing process. It includes administration, resources such as procurement staff, sales resources, management resources, office space, taxes etc…
During the third step of the cost management process, reduce cost, comparisons are realized between the calculated cost and the agreed price.
Total Cost of Ownership (TCO)
Not all purchases are subjected to a TCO analysis, only those that bring significant maintenance or operating costs across a long usable life. TCO is intensively used to support the purchase of computing systems, software, vehicles, buildings, equipment and machines. TCO analysis serves different purposes and each calls for its own TCO figure. When actually using TCO figures, judgment plays an important role in identifying which cost components are included in the analysis.
TCO analysis is based on a team approach, workshop, and it is performed in 5 steps:
- Define the lifetime costs, the cost components that are part of the analysis, by organizing a workshop which should be attended by the stakeholders, the internal customers who requested the purchase and a financial controller;
- Create the possible scenarios. Each scenario will have its own TCO number;
- Compare the developed scenarios using financial ratios (return on investment or ROI, payback period, internal rate of return or IRR, CAPEX etc.);
- Select the best fitting scenario;
- Implement the chosen scenario.
Read more about the Competences:
|Strategy Development||Category Management||Finance Management|
|Cost Management||Sourcing Process||Negotiation|
|Legal||Performance & Contract Management||Operational Procurement|