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Manufacturing Cost Tug-of-War – Part 2
By Mark L. Casey | April 3, 2008
In our previous article we explored the factors that go into the cost expectations of OEMs. Those factors involve most of the functional departments within a company. When the design phase reaches a certain point, the procurement group will send out Request for Quote (RFQ) packages to potential suppliers. There are various methods used to determine which potential suppliers will receive the RFQ. We will not detail them here, but usually a minimum of three suppliers will get the RFQ. Sometimes the RFQ may go to over ten suppliers. Suppliers sometimes derisively refer to this approach as a “cattle call.”
Depending on the complexity of the product and the completeness and accuracy of the data package, the supplier quotes could be returned in a few days, a few weeks, or even a month or more. Since I have always represented suppliers that are hoping to win the business, I have never been on the purchasing side of things. I would imagine, however, that there is a certain excitement the procurement person feels as he or she begins to open up the quotes.
In this article we will explore the nature of the quotes that come back from CMs and the first step in the process that often occurs at this stage as OEMs try to make their final supplier selection.
Normalization – Comparing Apples to Apples
Normalization is the process of making sure that you are fairly evaluating competing quotations or proposals.
Going back to the car dealership example we used in the first part of this series, have you ever noticed that it is sometimes difficult to fairly compare the prices being offered by competing dealerships? The reason for this is that the cars themselves can have a dazzling array of features and packages. Jim Bob’s New Cars is willing to sell the 2008 Ford Mustang to you for $29,999 while Leroy’s Righteous Rides will sell it for $29,399. Why the $600 difference? It could just be that Jim Bob wants to make a higher margin. It’s not your job to provide his higher margin. However, it could be that Jim Bob’s Mustang has a rear spoiler while Leroy’s does not. Or, it could be the multiple CD changer in Jim Bob’s Mustang. To really get down to who has the better deal, you have to “normalize” their two prices.
Let’s return to the sourcing world and provide an example. Let’s say you are in the procurement role, and it is your job to evaluate the two quotes you have from contract manufacturers to manufacture the company’s solar powered toothbrushes.
Supplier # 1 has presented a quote of $1.08 per toothbrush at a quantity of 500,000 Estimated Annual Usage (EAU). There is a tooling charge of $75,000. In the notes section of the quote is the following:
(1) FOB Hong Kong.
(2) Part # 4493992AO-2 is an obsolete part according to the manufacturer so we quoted Part # 4493992AO-W which the manufacturer says replaces the obsolete part.
(3) This quote does not include functional test.
Supplier # 2 has presented a quote of $1.26 per toothbrush at a quantity of 500,000 EAU. There is a tooling charge of $90,000. In the notes section of the quote is the following:
(1) FOB Reynosa, MEX.
(2) This quote includes a functional test of 30 seconds per unit with test fixtures to be provided by customer.
(3) Packaging included in price assuming individual plastic case for each item and packaged 144 per box.
In order to normalize the quotes you have to pay careful attention to the differences in them and then adjust to a norm. The first quote is FOB Hong Kong. This means that freight forwarding, customs, etc. is not included in the quote. There is a cost to “land” the product at your factory or distribution facility that is not accounted for in the quote. By the way, there is nothing sneaky or unethical about a quote like this. The manufacturer is not a freight forwarder, so the standard way products are quoted is FOB some logical point like their factory or a nearby port (like Hong Kong). The second supplier is FOB Reynosa, MEX. We need to adjust for the lower cost of shipping from Mexico to our US address as opposed to from Hong Kong. Additionally, this means we will need to understand any advantage me might get by trading with a country that is part of the North American Free Trade Agreement. There will most likely be import cost savings.
In addition, the first supplier mentions an obsolete part and quoted a substitute. The second supplier did not mention it. Does this mean that the second supplier quoted an obsolete part? Did they do a shoddy job of evaluating the bill of materials (BOM) and didn’t catch it? Does this reflect an overall shoddy approach to their work? Is Supplier #1 even right about that part? What is the cost difference between the obsolete part and the new replacement? Presumably Supplier #2 will get a similar price on the new part. We may need to normalize Supplier #2′s quote by plugging in the cost of the replacement part. If we have time we may want to alert Supplier #2 to this situation and allow them to refresh their quote.
Tooling is another difference between the two. Tooling is a one-time fixed cost, not an ongoing variable expense, but we still need to note that one is higher than the other and try to normalize the two. Finally, Supplier #2 included both functional test and packaging. It will be important to get back with Supplier #1 to be sure that they did not include packaging in their quote. You know that they did not include functional test because the note says so. Normalization will involve adding some cost to Supplier #1′s quote for both functional test and packaging. The other option is to remove the cost for functional test and packaging from Supplier#2′s quote.
Once all of these factors are addressed and normalized, you then can really compare apples-to-apples. Of course, in most cases much more work is left to be done before selecting a supplier and negotiating a supplier agreement.
Conclusion
In part three we will examine additional factors that play in the decision about how much to pay and how to make your final supplier selection.
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