How to Use Cost Modeling to Help Offset Inflation
by Edward Pretzel, President Collaborative Supply Chains Posted on 2022-07-29
Inflation is at high levels and is expected to be at high levels for the medium term. You can reduce the impact of inflation requests from your suppliers if you implement visibility into cost drivers.
Most parts and assemblies that are purchased by companies, are sourced and managed with a single price. Not having visibility into the cost drivers of components and assemblies makes it near impossible to identify waste and continuous improvement opportunities.
Even if you do have some cost breakdowns, most supply chain management organizations lack implementable cost standards that are recognized by suppliers. Credibility and leverage is key to success with implementation of cost models with suppliers.
Cost Modeling will accomplish 3 important strategic deliverables:
Cost modeling is a very effective way to bring visibility into cost drivers and waste reduction opportunities. These waste reduction opportunities can be used to offset inflation cost increases. Without cost modeling, you only have a price and are in the dark.
Only having a price hides the valuable cost driver data and prevents the customer’s ability to identify waste. Most suppliers want their customers to be ignorant with no cost data information. It is up to the customer to transition to cost modeling and cost data management and negotiations.
Common waste reduction opportunities that cost modeling will uncover includes the following.
Let’s look at a real world example.
The current price before inflation is $14.00
The price increase request is $15.03 or $1.03/part increase. The price increase request is due to 2 factors:
But after applying cost modeling and determining what the part should cost, there are 4 waste reduction opportunities that have become visible after a cost modeling analysis was completed.
The continuous improvement opportunities include the following:
The new target price after 100% of all improvement opportunities are recognized it $12.93/part.
This target price with all of the waste reduction would offset the entire inflation and provide for a price reduction if 100% of the offset was recognized.
But as with many negotiations, there is a compromise and both the customer and supplier will likely meet somewhere in the middle.
Savings money is a 2 step process. Step 1 is to find the savings. Step 2 is to implement the savings, many times through negotiations. In this example we have strong success in Step 1, identifying savings.