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Cost models can foster new levels of supplier collaboration and transparency

Cost models: Important tools

Procurement teams increasingly are being asked to support ever more differentiated products, meaning more stock keeping unit (SKU) complexity and more specifications to manage. As a result, cost models have become an increasingly important tool in procurement’s arsenal.

Cost models can be especially valuable for products with which prices are influenced by volatile but measurable input costs, including commodities like resins or paper, as well as labor costs.

In cases like these, should-cost models can provide buyers and suppliers a platform for building better relationships. The purpose of a cost model is to:

  • Provide price and margin protection for both customer and supplier for commodities with volatile feedstocks or variable demand or order patterns.

  • Serve as an efficient tool for new product pricing, particularly for commodities with large SKU count or high product churn.

  • Deliver insights needed to execute continuous improvement projects; for example, by helping predict how changes in ordering process, specifications or replenishment policies will impact production, service and delivery cost.

  • Identify cost components where the customer may be able to generate better cost levels than the supplier (i.e., Tier II sourcing).

  • Provide planning capabilities for raw material cost impact planning and risk hedging strategies.

Cost model types

Depending on the product category, depth of supplier relationships and product complexity, cost models can take different forms and reach various levels of granularity.

Broadly speaking, we can break these into two types:

  • Pricing models: These typically do not expose underlying cost drivers; instead the output of the model is a finished goods price based on a “matrix” of input factors, often referred to as “menu-based pricing.”

  • “Clean Sheet” cost models: These provide more granularity into the various inputs, but require deeper knowledge of production process efficiencies, manufacturing waste, factory overhead and other manufacturing processes.

Where cost models offer the biggest benefits


What categories or spend areas are the best fit for the use of cost models? Based on our experience working with clients to develop or make better use of cost models, organizations are likely to find the most value in categories where one or several of these factors are present:

  • Feedstocks are commoditized;

  • Conversion of raw materials into final product is a substantial cost driver;

  • There is a relatively standard manufacturing process for finished products;

  • The amount of spending is large enough to justify the time and effort required to build, manage and maintain the model.


The majority of the categories within the packaging area share these characteristics, and are therefore attractive areas for evaluating and developing a cost and price modelling approach.

In future articles, we will dig further into the key elements required for robust cost models, and discuss how cost models can be used effectively in supplier discussions and negotiations to drive value and increase collaboration between suppliers and customers.


Authors
Barbara Moser

Barbara Moser


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Vladimir Ryabovol

Vladimir Ryabovol


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