Total Cost Management

A Contemporary issue on ‘Total Cost Management’- A new approach to control cost

Prepared by

:

Vishal Tilwani

Roll no.

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18 [sem-4]

Batch

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2010-12

Guided by

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Dr. Butalal Ajmera

Submitted to

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Department of Business Administration Faculty of management, Bhavnagar University, Bhavnagar.

INTRODUCTION

Total Cost Management is a company-wide systematic and structured approach, which provides a holistic framework to control, reduce and eliminate costs, throughout the value chain. This process of managing the financial outcome of activities encompasses all operations, internal and external. For these reasons, TCM is one of the most powerful tools that corporations can wield in their quest for competitive advantage. Total Cost Management is the effective application of professional and technical expertise to plan and control resources, costs, profitability and risk. Simply stated, TCM is a systematic approach to managing cost throughout the life cycle of any enterprise, program, facility, project, product or service. The TCM Framework is a representation of that ‘systematic approach”. The TCM Framework is a structured, annotated process map that for the first time explains each practice area of the cost engineering field in the context of its relationship to the other practice areas including allied professions. As the subtitle says, it is a process for applying the skills and knowledge of cost engineering. A key feature of the TCM Framework is that it highlights and differentiates the main cost management application areas: Project control and Strategic asset management.

DEFINITIONS

“Total cost management (TCM) is the name given by AACE International to a process for applying the skills and knowledge of cost engineering. It is also the first integrated process or methodology for portfolio, program and project management. AACE first introduced the concept in the 1990s and published the full presentation of the process in the "Total Cost Management Framework" in 2006.” “Total Cost Management is the effective application of professional and technical expertise to planned control resources, costs, profitability and risks. Simply stated, it is a systematic approach to managing cost throughout the life cycle of any enterprise, program, facility, project, product, or service. This is accomplished through the application of cost engineering and cost management principles, proven methodologies and the latest technology in support of the management process.” “Put another way, Total Cost Management (TCM) is the sum of the practices and processes that an enterprise uses to manage the total life cycle cost investment in its portfolio of strategic assets.” “Total Cost Management (TCM) is a systematic and structured approach to understand the costs of an organization, with the aim of providing a holistic framework to control, reduce and eliminate costs. Cost management is a philosophy, an attitude, and a set of techniques to create more value at lower cost. In this fast space competitive scenario, Cost Management information increases customer value.”

WHO IS AACE?

Since 1956, AACE International has been the leading-edge professional society for cost estimators, cost engineers; schedulers project managers, and project control specialists. With more than 5,500 members worldwide, AACE is the largest organization serving the entire spectrum of cost management professionals. AACE International is industry independent, and has members in 78 countries and 71 local sections.

PRINCIPLES OF TCM The eight principles of TCM are:

1. The quality must be managed 2. Everyone has a customer to delight 3. Processes are the problem and not the people 4. Every employee responsible for the quality 5. Problems must be prevented not just fixed 6. Quality must be measured so it can be controlled 7. Quality improvement must be continuous 8. Quality goals must be based on customer requirements

CONCEPTS INCLUDED IN TOTAL COST MANAGEMENT 1. Total Cost Management The sum of the practices and processes that an enterprise uses to manage the total life cycle cost investment in its portfolio of strategic assets. Describes the process employed in the profession of cost engineering. 2. Resource Management (1) The effective planning, scheduling, execution, and control of all organizational resources to produce a good or a service that provides customer satisfaction and supports the organization’s competitive edge and, ultimately, organizational goals. (2) An emerging field of study emphasizing the systems perspective, encompassing both the product and process lifecycles, and focusing on the integration of organizational resources toward the effective realization of organizational goals. Resources include materials; maintenance, repair, and operating supplies; production and supporting equipment; facilities; direct and indirect employees; and capital. 3. Project Management The methodical application of management knowledge, skills, and practices to project activities in order to meet project objectives… 4. Management Accounting The process of identification, measurement, accumulation, analysis, preparation, interpretation, and communication of financial information used by management to plan, evaluate, and control within an organization and to assure appropriate use of and accountability of its resources..

5. Costs and Resources Any investment of time, money, human effort, or physical objects in the enterprise's products, services, and assets… 6. Strategic Asset Any unique physical or intellectual property of some scope that is of a long term or an ongoing value to the enterprise. 7. Enterprise Any endeavor, business, government entity, group, or individual that owns or controls strategic assets... 8. Process A flow of inputs and outputs with mechanisms that transform the inputs to outputs.. 9. Projects A temporary endeavor to conceive creates, modify, or terminate a strategic asset. 10. Operations Ongoing endeavors that use strategic assets... 11. Life Cycles It describes the stages or phases that occur during the lifetime of an object or endeavor. A life cycle presumes a beginning and an end. The asset life cycle describes the stages of an asset’s existence, and the project life cycle describes the phases of a project’s endeavors... 12. Life Cycles; Asset Describes the stages of asset existence from ideation through termination during the lifetime of an asset... 13. Life Cycles; Project Describes the stages of project progress from ideation through closure during the lifetime of the project

What are the important TCM tools / techniques?

Some of the important tools and techniques of Total Cost Management are as follows:•

Activity Based Costing

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Activity Based Management

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Target Costing

These tools are an organizational enabler for: •

Energy Cost Reduction

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Raw material optimization

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Production/Process Improvement

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Scrap/Waste Reduction

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Marketing/Distribution cost

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Inventory Management

TCM MATURITY MODEL

There are 5 levels of maturity in cost management practices which has been identified after considerable study and works with experts in domain field. The names of the levels are Minimal, Functional, Operational, TCM Enabled & Exemplary. The top layer should be the destination for all the corporate regardless of the sectors. It is expected that this Maturity Model assumes a very high level of importance in the evolving days of cost competitive pressures. CII also set in motion a roadmap of assessing the levels of the enterprises on a voluntary basis and several of them have already been rated. Several benefits are expected to accrue from the rating of the model beginning from strategic perspective of cost to benchmarking the best practice. The Credit Rating Agencies, Financial Institutions and Insurance companies can play a significant role in taking this model to the industry. Awareness of this model to the above sectors will enable a better perspective of their rating of the industry. A brief presentation to the prominent players in the Insurance, Credit Rating Agencies and Financial Institutions sector, will enable to bring in the right comment, visibility and efficacy of the model. The overview of the maturity model to the above sectors brings in; An organization's sojourn across the maturity levels of the model and its related advancement in cost perspective at unit level and corporate level • Facilitates better focus / understanding of systems / processes related to TCM •

Total cost management encompasses strategy as well as operations, covers all functions, spans different dimensions, and subsumes everything and everywhere. Total cost management seeks to: 1. Design a product that can be manufactured at a low cost 2. Eliminate wastes and delays in the manufacturing process 3. Direct resources at simplifying the customers offering to precisely what the customers want 4. Ensure that the right person is employed for the right job 5. Derive the greatest mileage from marketing and advertising expenditure. 6. Minimize organizational overhead expenses.

An organization committed to total cost management should pay heed to the following guidelines of total cost management. Understand Your Cost Drivers: Daniel Riley, cost management guru, divides cost drivers into two categories: structural and exceptional. Structural drivers emanate from strategic choices relating to the scale of operation (the volume the company produces and sells), the scope of operation that is the degree of vertical integration, the technologies employed by the firm, and the complexity by the firm, and the complexity of its offerings (the variety in products and services). The executioner drivers relate to how well a company does and what it does. The key factors here are workforce involvement, total quality management, capacity utilization, plant layout efficiency, product configuration and value chain linkages. Focus on the Entire Value Chain: A cost leadership strategy must focus on the entire value chain, not just the segments in which the firm is involved. In collaboration with its suppliers and customers, the firm should work toward cost savings in upstream as well as downstream activities. A firm’s competitive edge critically depends on its ability to manage its entire value chain relative to that of its rivals. Marry Total Cost Management to Business Process Reengineering (BPR): BPR is the fundamental rethinking and radical of business to achieve dramatic improvements in contemporary measures of performance such as cost, quality, service and speed. BPR is a logically of total cost management. The basic change demanded by the latter is provided by the former. Does it right the first Time and every time as Total Quality management demands. The very essence of Total Quality Management is the process of getting it right the first time and every time, be designing a quality chain that uses the customer€™s needs to produce exactly what he needs, at a price that he is willing to pay, and in a way that enables the company to do this without rejection, rework and redundancy. You do it right the first time, the cost of poor quality, reflected in the

cost of inspection, scrap, rework, and customer dissatisfaction will almost disappear.

A Model for TCM A three T's-three C's-three M's model is proposed for the effective implementation of TCM. The philosophy behind TCM is to manage all company resources and activities that consume those resources. Therefore, the goal of a TCM program is to identify opportunities for, and monitor progress toward, continuous cost improvement. However, like TQM implementation, it is not enough for managers alone to be committed to TCM. All employees must adopt this philosophy. This modification of the underlying cost culture should be carried out in such a way that the individual goals of the employees merge with the goals of the organization. In other words, successful implementation of TCM depends on establishing and nurturing an appropriate organizational culture, wherein employees understand the impact their behavior has on costs, continuous improvement and the rewards (short-term and long-term) associated with continuous improvement. The nine components of this model are described below: Top management focus -- The first step to achieving TCM is to make a thorough assessment of the company's current environment, operations, philosophy and organization. The second step that top management should take is to delegate the task of implementation of TCM to a mid-level champion in the organization. This zealous and voluntary champion should have strong entrepreneurial skills, political savvy, and should be resourceful enough to generate whatever resources are needed for implementation of TCM. Finally, this TCM champion will need the support of top management to build his transition team. Mission/Goals -- A TCM philosophy should evolve around the mission/goals of the organization. In Figure 3, a loop is shown between mission/goals of the company and top management focus for the implementation of TCM. The commitment to continuous improvement and the steps needed to reinforce it should be aligned with the mission statement, core competencies and long-term goals of the organization. Chaparral Steel's mission as explained by CEO Gordon Forward, "One of our core competencies is the rapid realization of new technology into products. We are a learning organization." Keeping this in focus, the management style is wide open at Chaparral Steel. There is no assigned parking places, any different colored hard hats or uniforms reflecting title or position, and the company dining room is a local diner.

Technology -- Everything we do today in running a business involves technology of some sort, even though one or more technologies may be more important to the product or production process. Technology affects competitive advantage. Therefore, an effective implementation of TCM requires an understanding of the role of technology in determining relative cost or differentiation. The rise of continuous casting in steel-making is a good example of technology playing an important role in relative cost as continuous casters significantly reduce manufacturing cost. Timely rewards -- Once TCM is initiated by the champion, top management must not only commit itself, invest company resources and accept long-term results, but it must eventually establish a reward system to recognize those employees who make it happen. To reinforce the importance of innovation, creativity and its role in development of a healthy cost culture, it must be recognized and rewarded. Both financial as well as non-financial rewards should be used. Bonus schemes linked with company profits are generally a very effective way of providing financial rewards. The CEO of Chaparral steel observes, "We think janitors and secretaries are important in our success, too, and they should share in the rewards."

3M provides a good example of non-financial reward systems such as: * Honoring proven technical contributors with a membership in company's prestigious Carlton Society; and * A separate career path for those technical people who wish not to pursue a career in management.

Monitoring and control

-- Controls should be designed and implemented to

increase the rate of continuous improvement. Also, a systematic approach to monitor the progress of the organizational cost culture must be developed. Visual control by both supervisors and peers should be encouraged as compared to feedback information contained in control reports. The following phrases by Dorothy Leonard-Barton in her Sloan Management Review article, "The Factory as a Learning Laboratory," describes the monitoring and control process in the best possible way: "Most organizations are physically structured to emphasize vertical (hierarchical) and horizontal (functional) boundaries. In contrast, Chaparral management emphasizes homogenizing the level of knowledge throughout; few pockets of information are isolated by position, function, or working shift. Hierarchical boundaries are minimal. This is a do-it-yourself company with no acknowledged

staff positions and only a few positions that seem staff like, such as personnel. There are 50 graduate engineers and technicians, all with line duties. In fact, everyone has line responsibilities, most of them tied directly to steel production, and decision making is pushed down to the lowest possible supervisory level, 'where the knowledge is.'"

Culture -- Hayes and Wheelwright in their book "Restoring our Competitive Edge: Competing through Manufacturing," noted, "During the early 1980s, the concept of a 'corporate culture' gained widespread attention. Generally, culture has been used to describe the rules, norms, and expectations of an organization with regard to the behavior of its members. Such behavior, in turn, reflects the basic values, principles and philosophies shared by the organization." For implementing TCM, top management must also develop a cost-conscious corporate culture. The primary goal of a cost-conscious culture should be continuous improvement of quality, time and cost through innovation. Here we are talking about a culture in which workers are willing to be innovative enough to eliminate their own jobs because they believe they will then be assigned to more challenging and rewarding jobs. "No one is looked down upon," states a mill-wright at Chaparral Steel. "If I am supposed to know more than somebody else but that other person catches [an oversight], well that's fine -- he just bailed me out. I am more than likely going to help him out a different time." Continuous education -- The importance of commitment to an ongoing continuous education program is two-fold for the effective implementation of TCM. First, continuous education can facilitate the development of culture of managing by commitment to continuous improvement. Second, TCM requires employees to be innovative and creative, and continuous education can provide these skills to them. Chaparral Steel provides a good example of in-house training where selected foreman rotate from the factory floor to teach. The philosophy is explained by a instructor, "It creates a lot of credibility for the education program on the factory floor. What's more, I have to live with what I teach. So I'd better do a good job." Mechanism of change -- A capacity to deal with technological and organizational changes will be one of the most important factors in determining the success of TCM in an organization. TCM means changing and challenging everything we do -one thing that is sure to receive resistance. A successful change mechanism will need management with credibility, getting people to believe the message of the TQM philosophy. Commitment -- TCM requires that top management and every employee foster a philosophy of managing by commitment to continuous improvement. From the model, it is clear that commitment is by no means an end in itself. As a matter of

fact, there exists a feedback loop from commitment via continuous education to top management. Once top management receives the feedback, timely rewards and controls can be used again to develop a higher level of commitment to continuous improvement and a healthy cost-culture. TCM in JapanMuch has been written in the business press about how Japanese manufacturers outperformed their U.S. competitors in cost, quality and on-time delivery by using innovative practices like JIT production, total quality control, and the use of flexible manufacturing technologies. However, one area neglected so far in these discussions is how Japanese companies' cost management systems reinforce a top-to-bottom commitment to process and product innovation. Toshiro Hiromoto studied cost management systems at Japanese companies in several major industries including automobiles, computers, consumer electronics and semiconductors. He has published his experiences in a Harvard Business Review article, "Another Hidden Edge-Japanese Management Accounting," and noted that more than providing senior management with precise data on costs, variances and profits, cost systems employed by Japanese companies are used to mold the behavior of the employees in accordance with long-term manufacturing strategies. For example, high-level Japanese managers seem to worry less about whether an overhead allocation system reflects the precise demands each product makes on corporate resources than about how the system affects the costreduction priorities of middle managers and shop-floor workers. The Hitachi factory presents another good example of the philosophy of TCM. This factory employs an overhead allocation technique based on the number of parts in product models to influence its engineers' design decisions. Japanese companies have long known what more and more U.S. companies are now recognizing -- that the number of parts in a product, especially custom parts, directly relates to the amount of overhead. Manufacturing costs increase with the complexity of the production process as measured, for example, by the range of products built in a factory or the number of parts per product. In plants assembling diverse products, reducing the number of parts and promoting the use of standard parts across product lines can lower costs dramatically. Numerous other examples show how total cost management can play a significant role in integrating the innovative efforts of employees with the organization's long-term strategies and overall goals. Goals of Price/Cost Management

o Develop accurate price/cost information to enhance negotiating o o o

effectiveness Drive continuous price/cost improvement Effectively beat out the competition Determine type of supplier relationship

COST MANAGEMENT OBJECTIVES There are four objectives in cost management: 1. Spending timely-Ensure that money or resources are expended in accordance with the project or corporate capital expenditure plan;

2. Spending wisely—Ensure that monies are well-spent, i.e. that a planned unit of gain is achieved for each unit of expenditure; 3. Spending correctly—Ensure expenditures only for those things for which we are obligated; 4. Spending perceptively—Ensure that spending versus achievement variances are identified, analyzed, corrected or trended so that early warnings can enable timely actions.

EFFECTIVE COST MANAGEMENT Is A Process Rather Than a Discipline. The function of cost management is often regarded as a discipline or as a position within a project structure and assigned to individuals rather than to teams. Cost management requires processes and methodologies that can only function with information development and knowledge hand-off and enhancements. This is made possible through the deployment of assignment, collection, assessment, analysis, and strategic decision making processes. Cost management is a management function and responsibility and must be performed by teams using recordable and repeatable methodologies.

HOW IS TCM DIFFERENT? Traditional purchasing techniques concentrate mainly on reducing the ‘price’ of the goods by attacking supplier margins. More sophisticated purchasing models extend this only as far as the whole life cost of the product. In TCM, all of the cost drivers throughout the whole supply chain are examined and opportunities for improvement are identified. Delivery is aided by taking a collaborative approach with suppliers to identify cost drivers and then act to reduce their effect. Acceptable supplier margins are maintained to encourage co-operation. Step change, sustainable cost reductions can be achieved which would never have been delivered through more traditional methods. TCM BENEFITS TCM delivers competitive advantages through lower costs and/or better products and services. This allows you to win market share and/or raise margins and to better manage and influence your market place.

Focus on cost, rather than price, allows us to identify the main cost drivers. Once identified opportunities such as outsourcing become more apparent, ultimately leading to an optimised supply chain. This benefits all the members throughout that chain. Suppliers are assets with expert knowledge second to none. Working with suppliers on product development and production to make smart choices and drive out costs delivers real sustainable value. Working closely with one or two key supplier partners per category gives insight into their processes and cost drivers which can then be applied across all suppliers in that category. Visibility across the entire supply network allows us to identify where processes are sub-optimal and where we can change and improve the process to drive out cost or add value. Stakeholder identification and management is critical to the success of TCM. These may be internal stakeholders across differing functions in the business or within different regions/business units or they can be external stakeholders such as suppliers and customers. Linking interested parties in an informed and engaged manner through transparency and collaboration delivers the right product/service to the right place at the right price and the right time. What gets measured gets done and so a set of Key Performance Indicators (KPI’s) are applied within TCM to measure benefits delivered such as cost savings, working capital reductions, supplier and customer perceptions and compliance.

TRAINING TCM utilizes standard templates and processes to build on existing skills and processes and align all procurement staff and other stakeholders in the common process. Prestige endorse and train our proprietary 7-step process (shown below) which is specifically designed to support a best-in-class approach to procurement activity.

RELATIONSHIP OF TCM WITH SUPPLY CHAIN MANAGEMENT In the era of control regime, the task of purchasing and selling was relatively easy - competition was less and the market was assured. But suddenly all that changed - the markets opened and competition increased; selling is now possible only if prices are reduced and quality improved in other words, the customer wants more and more per unit cost. To minimize the total production costs, it is recognized that one way is to tighten operations; another time tested method is to reduce cost of inputs. While it would be desirable that our suppliers reduce the cost of their supplies to us, the importance of building a relationship with the suppliers has been recognized. Establishing a long term relationship is possible only when the supplier and purchaser jointly decide to reduce the life cycle cost of an item by proper procurement, in such a way that it would lead to a win-win situation to both the parties - in other words, suppliers become “Partners in Progress”. Purchaser cannot squeeze the supplier endlessly; sourcing the right item from the right vendors, getting it to the purchaser’s premises in the right way at the right price and at the right time can alone optimize costs for the purchaser. This is possible only if there is mutual trust, which builds up in long term relationships.

Cost reduction can result in significant product cost saving, manufacturing cost saving, and life cycle cost saving when companies interested in cutting cost implement all 8 the elements of the following cost reduction strategy: 1. Cost Reduction by Design Cost Reduction Opportunities: •

•

Product development determines 80% of product cost. The concept/architecture phase alone determines 60% of cost! See how Design Determines Cost New article on Designing Low-Cost Products shows the top 5 design strategies to lower cost: breakthrough concepts, designing out quality costs, eliminating change orders, vendor-partnerships, and designing to minimize part cost and material overhead.

•

Article shows why cost is very hard to remove later after products are designed

The Results: •

Significant cost reductions by design for parts, labor, material overhead, quality, and product development; designing for lean production can maximize lean savings (See # 2 Lean Production Cost Reduction below).

How to Reduce Product Cost by Design: • • • •

Practice Concurrent Engineering with early and active participation of manufacturing, purchasing, vendors, etc. Implement Design for Manufacturability ( DFM ), Design for Lean, and Design for Quality For dramatic cost reduction - half cost to order-of-magnitude - optimize the concept/architecture phase To convert ideas, research, or prototypes into viable products, uses commercialization techniques to ensure success.

Activities Supportive to Low Cost Product Development: • • • • • •

Co-locating Engineering with Manufacturing ensures the best teamwork; avoid distant off shoring If outsourcing, choose local vendors which ensures early and active vendor participation in product development teams Pre-select Vendor/Partners who will help develop products; avoid lowbidding So that vendors will help with design Implement standardization and good product portfolio planning for the best focus Total cost measurements (#8) to quantify all costs affected by design Correcting Counterproductive Policies. New ventures and startups will be able to implement these principles right away. Established companies may have to first correct counterproductive policies, by prioritizing portfolio planning, scrutinizing high-overhead sales, emphasizing thorough up-front work, quantifying all costs, and avoiding time-draining attempts to reduce cost after design, going for the low-bidder, or moving production offshore. See full article on counterproductive policies.

2. Lean Production Cost Reduction

Cost Reduction Opportunities: •

Lean production benefits include doubling labor productivity, cutting production throughput times by 90 percent, reducing inventories by 90 percent, cutting errors and scrap in half errors

The Results:

• •

Significant cost reduction possible by raising labor productivity and eliminating waste Even greater returns when lean is extended to a Build-to-Order business model (See # 3 Overhead Cost Reduction below)

How to Reduce Manufacturing Cost: •

Implement Lean Production

Activities Supportive to Lean Production: • • • • • •

Design product families for lean production Concurrently Engineer flexible processes Implement standardization to enable dock-to-line distribution Rationalize products to eliminate the most unusual products with the most unusual parts and processes Total cost measurements to quantify all costs related to manufacturing Keep control of manufacturing in-house or with vendor/partners; avoid off shoring, avoid long and distant supply chains

3. Overhead Cost Reduction See article on how to implement Mass Customization in the April 2011 issue of Mechanical Engineering, published by ASME Cost Reduction Opportunities: •

Standard products can be build to-order without forecasts or inventory and specials can be mass-customized on-demand; see articles on Build-toOrder and Mass Customization

The Results: • • •

Inventory carrying costs can be eliminated Procurement costs can be reduced with automatic, on-demand resupply Better responsiveness leads to more sales

How to Reduce Overhead Cost: •

Implement Build-to-Order and Mass Customization to build products ondemand without forecasts or inventory

Activities Supportive to Build-to-Order & Mass Customization: •

Implement lean production

• • •

Rationalize products Total cost measurements to quantify overhead costs Keep control of manufacturing in-house or with vendor/partners; avoid long and distant supply chains; avoid off shore manufacturing

4. Standardization Cost Reduction Cost Reduction Opportunities: • •

Standard part lists can be 50 times less than proliferated lists; see Standardization Results Standard parts are easier to get and fewer types need to be purchased; see Standardization Benefits

The Results: • •

Economies of scale result from larger purchases Material overhead of the standard parts can be one-tenth that of proliferated lists

How to Reduce Cost with Standardization: •

Implement Standardization with a practical procedure has been developed to standardize part and materials for new designs

Activities Supportive to Standardization: • • •

Rationalize products to eliminate or outsource the most unusual products that have the most unusual parts and materials Total cost measurements to justify standardization efforts and encourage picking standard parts Don’t merge acquired products into the same plant or build others’ products; see article on Negative Effects of Mergers and Acquisitions

5. Product Line Rationalization Cost Reduction Cost Reduction Opportunities: •

Implement Product Line Rationalization and focus on the most profitable products as discussed in the section: How Rationalization can Triple Profits!

The Results: • • •

Eliminate the "loser tax" on cash-cows to subsidize low-margin products Identify and remove products that are losing money on a total cost basis Reduce overhead demands and costs for hard-to-build "loser" products

•

Free up valuable resources to work on cost saving efforts in engineering , operations and, and supply chain management

How to Reduce Cost with Product Line Rationalization: •

Implement Product Line Rationalization to eliminate or outsource low-profit products that have high overhead demands and are not compatible with cost reduction strategies

Activities Supportive to Product Line Rationalization: • •

Product Portfolio Planning focuses new product development Total cost measurements to identify opportunities and supports rationalization decisions

6. Supply Chain Management Cost Reduction Cost Reduction Opportunities: • •

Supply Chain Simplification can greatly simplify Supply Chain Management Spontaneous supply chains can pull parts into production on-demand without forecasts or inventory

The Results: • • •

Material overhead can be reduced by a factor of 10 for standard parts and materials Purchasing leverage results from high quantities of standard parts Automatic resupply eliminates forecasts, purchase orders, inventory, and expediting costs

How to Reduce Cost in Supply Chain Management: • • • •

Design products around standard parts to simplify Supply Chain Management Standardize parts to focus Supply Chain Management on high-volume, easy to get parts Rationalize away the most unusual products which have the most usual, hardest-to-get parts Establish Vendor/Partnerships, which saves more money than low-bidding

Activities Supportive to Supply Chain Cost Reduction: • •

Total cost measurements to encourage and justify standardization and rationalization Don’t merge acquired products into the same plant or build others’ products; see article on Negative Effects of Mergers and Acquisitions

7. Quality Cost Reduction Cost Reduction Opportunities: •

The Cost of Quality can be 15% to 40% of revenue;

The Results: •

Quality costs can be greatly reduced; in some cases reducing quality costs can double profits

How to Reduce the Cost of Quality: • • •

Eliminating quality costs starts with designing in quality Quality costs in manufacturing can be eliminated with Six-Sigma programs Rationalizing away unusual products raises net factory quality and avoids wasting quality resources on inherently lower quality products

Activities Supportive to Quality Cost Reduction: •

Total cost measurements to quantify the Cost of Quality

8. Total Cost Measurement to Support All Cost Reduction Activities Cost Reduction Opportunities: •

Total cost measurements are imperative to encourage and support the above activities to reduce all cost categories

The Results: •

All the above cost reduction activities are encouraged and supported; the results are quantified, thus encouraging more total cost reductions.

How to Reduce Cost with Total Cost Measurements: •

Implement total cost measurement with the easy-to-implement cost driver approach

Activities Supportive to Total Cost Measurements: • •

Until total cost can be quantified, everyone must make decisions based on total cost thinking Senior management understands the importance of quantifying total cost, implements total cost measurements, and encourages all cost decisions to be made on basis of total cost

How Not to Lower Cost; Short-sighted attempts prevent real cost reduction:

Don't try to remove cost after the product is designed because cost is designed into the product and hard to remove later; see article on How Not to Lower Cost Don't use low-bidding, which only appears to save one category of cost, but can substantially raise many less-obvious costs and compromise other important goals like quality, delivery, and missing out on the major contributions that vendor/partners can make when they help product development teams design products; see article on Low-Bidding. Don't offshore manufacturing for cost, which will not result in a net cost savings because of hidden overhead costs and because it inhibits, compromises, or thwarts 6 out of the 8 cost reduction strategies (presented on the home page) due to the following reasons: Off shoring manufacturing separates manufacturing from engineering and thus thwarts Concurrent Engineering and compromises the 80% of the cost determined by the design. Further, transferring, supporting, and dealing with quality and delivery problems of remote manufacturing absorbs many resources in engineering (in one case, 75%), manufacturing, and purchasing whose time would be better spent developing low-cost products. See Cost Reduction by Design summary and the article Design for Manufacturability Off shoring manufacturing to distant contract manufacturers increases the delivery time, which makes it hard to pull parts just-in-time and makes build-toorder impossible. Further, parts may be batched for shipping, which is opposed to the one piece flow aspects of Lean Production. Finally, off shoring manufacturing removes production from the control of the OEM manufacturer. All of these effects conspire to: • •

•

• •

Compromise Lean Production; see Lean Production Cost Reduction summary and the article on Lean Manufacturing Make it impossible to implement Build-to-Order and Mass Customization; see Overhead Cost Reduction summary and the Build-to-Order article and Mass Customization article. Make it hard to implement standardization because contract manufacturers' preferred parts probably won't correspond to your standard parts, so, in order to realize the production benefits of standardization, part numbers may have to be changed, which may increase a company's part proliferation. Make it hard to optimize supply chains; see Supply Chain Management Cost Reduction summary and details in the article on off shoring. Make it hard to maximize quality and implement Six Sigma without data and control over manufacturing; see Quality Cost Reduction summary and the article designing in Quality.

If all 8 cost reduction strategies are implemented, the cost savings will be much greater than appeared possible through off shoring. For more, see read the article on offshore manufacture. Don't take prototypes into production without commercialization; Also see article on "How not to commercialize products"

Correcting counterproductive policies may be a prerequisite to designing HalfCost Products. Don't try to save cost with unethical business practices. See the article: Good Ethics is Good Business.

REFERENCES • • • • • • • •

www.cimaglobal. http://www.prestige-purchasing.com/total-costmanagement-study.html www.microbuspub.com/ en.wikipedia.org/wiki/ www.qsrequin.com www.aacei.org/ http://www.icoste.org www.amazon.com