In a manufacturing company, the material cost can be as much as 50 – 70% of the company’s total variable costs. This means that the Purchasing department controls what is easily the single largest expense item on the Profit & Loss statement.
Ongoing management oversight, robust accounting systems and processes, and careful budgeting and monitoring of part changes are vital to controlling part costs.
As a part is developed and tracked throughout its lifecycle, effective communication between Product Development and Purchasing is key. Robust systems that capture design changes, part number changes and cost updates are essential in maintaining the integrity of the reporting process. An omission of cost related to a design change or negotiated supplier price change, or an error in recording the true cost of such changes on a high-volume part can have a significant impact on the bottom line. A mature cost tracking system is key to being able to control material cost.
A true partnership and collaboration between Product Development and Purchasing is necessary to lower material cost through ongoing Value Analysis/Value Engineering (VA/VE) efforts, competitive benchmarking and “make or buy” studies.
Do you have a cost tracking system?
The purchasing department needs to ensure that appropriate resources are deployed for tracking and monitoring parts and systems, including regular audits of the cost tracking processes. Prior to setting purchasing strategies and engaging the supply base in annual negotiations, buyers need to be made aware of the intricacies of the cost reduction and monitoring systems. The Do’s and Don’ts critical to maintaining compliance with Sarbanes-Oxley guidelines and principles also need to be understood by the purchasing department.
How robust is your system for cost tracking and forecasting?
- Does it accurately capture changes in part numbers and part cost?
- Does it segregate part number changes driven by causal factors (e.g., design, negotiations)?
- Does it ensure the flow-through of costs and prices when a part number changes as a result of a design change?
Do you know the details of your supplier contracts?
- Do they accurately reflect your procurement strategy?
- Do they contain any embedded derivatives (volume or price guarantees)?
- If so, does your financial system accurately reflect these guarantees when they are realized?
Your Purchasing department needs to have robust pricing practices in place that avoid costly financial penalties, such as:
- Parts that are mispriced or missing a price when generating a supplier claim.
- Generating a negotiated price reduction claim in the purchasing system against a supplier using selected parts only.
- Not including all parts and part levels in the claim.
Make sure that you have a robust audit system in place where all internal material cost control issues and processes are identified. Corrective action plans need to be clearly documented for resolution and expedient follow-up.
How well you manage material cost throughout product development and a product’s lifecycle has a significant impact on your company’s bottom line. Don’t underestimate the importance of sound accounting practices and robust cost tracking and reporting systems.