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Cost Drivers and Open Book Costing

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  • Cost Drivers and Open Book Costing


    I am working for a company that manufactures cement sacks and printing. I have been taksed to develop the following:

    - A model that will track cost drivers and
    - Get information on suppliers cost structure

    I am not sure how to approuch this, especially getting updated information on material cost.

    Please , anyone who has done this or have an idea how to implement cost drivers model.



  • #2
    Re: Cost Drivers and Open Book Costing

    This is a very broad question.

    In order to do a cost driver analysis and model to manage/drive these cost you need to know what it actually means. Cost driver is exactly what it says: Everything that makes up the final cost of that product. Broad example:
    Widget - 25% Raw Material A, 5% Raw Material B, 13% Raw Material C, 15% Labor, 5% Warehouseing, 17% Transport, 5% Insurance, 15% Margin. Total delivered cost R100.00

    In order to obtain this information moves you from being a buyer to a specialist cos it is within this that true TCO is established. You get to know your commodity. Ask the supplier for the information, if they do not give it - ask again...and again. While asking do research - internet or by phone.

    ok, so lets take the example from above:

    R100 delivered cost for the widget with the cost driver breakdown as above.

    Now lets say Petrol price increase with 40%. Pertol is a cost driver of Transport, and lets say that it contibutes 70% to transport cost.

    Usualy what happens is you get a letter from the suplier of this product stating that petrol has gone up by 40% - but they will try and cover it themselves but they are asking a 7% increase - does this seem fair.

    Lets look:
    Transport = R17 thus petrol is R11.90.
    Petrol portion increaee 40% = R16.66
    Increase: R 4.76
    Transport new cost = R21.76

    Product "fair" increase and new price is R 104.76

    If the general 7% was accepted then the new price would have been R 107.00

    The above will work the same for decrease costs. The thing is you need to KNOW your commodity.

    Then again someone else might be able to give us more insight into this (or other ways of doing this)
    Jacques Fourie
    Director Operations
    Wanama Solutions


    • #3
      Re: Cost Drivers and Open Book Costing

      Hi Jacques

      Thanks for the reply; it really makes a lot of sense. I was actually thinking along those lines and I wasn’t sure how to approach it and if it is the correct way to do things.

      You are quit correct when saying one has move from being a buyer to a specialist, which what I actually need to do as a Purchasing Analyst

      Most suppliers take advantage of certain commodity increases and pass that as a general increase, which most buyers are not aware of that.

      The most powerful tool in negotiations is to have enough information about commodities you buy from your suppliers and the understanding of the market.

      Your example makes it easier for me to put the cost model together into practise.




      • #4
        Re: Cost Drivers and Open Book Costing

        Open Book Costing – What is Open Book Costing? with compliments from Commerce Edge's training programme on Supplier Management.

        Open Book Costing is where the Seller is prepared to reveal to the Buyer exactly what the cost make up of a product is and how he approaches cost allocation.
        In order for Open Book Costing to work effectively the Seller must be prepared to be completely open with the Buyer and be prepared to divulge information which under traditional circumstances would be unheard of due to the sensitivity of the data.

        What Information would be revealed by Open Book Costing?
        • In short everything! (in reality, as much as possible)
        • What overhead is recovered against the product
        • What the overhead is comprised of
        • How much profit is secured from the product
        • What are the materials cost, who does the Supplier buy from
        • What are the labour charges, how many man hours does it take to make a product
        • What is the Work in Progress at any one time, what materials stock do they carry, how much finished product is kept in stock and what is the cost of this;
        • What finance charges are being carried

        Open Book Costing – What is needed for Open Book Costing?
        Trust and security
        In order for Open Book Costing to be achieved there must exist a high degree of trust, and inter dependency between the Parties

        • Open Book Costing requires the Supplier to provide information which the Customer could use to exploit the Seller; therefore it is essential in moving to Open Book Costing that the Seller believes this will not happen
        • But if I can’t exploit it what’s its use?
        • The use of Open Book Costing is a demonstration to the Buyer that he is paying a fair price
        • Ensure that the Seller is operating efficiently
        • Identify inefficiency where costs can be eliminated and thus reduce the price without penalising the Seller
        • Identify opportunities where the Buyer could alter behaviour to take out cost from the Supply Chain

        Graphic Below indicates a suggested process to be followed for doing openbook costing with a supplier
        Attached Files
        Is profit made when you buy or when you sell?


        • #5
          Re: Cost Drivers and Open Book Costing

          Here is an article from CIPS, the Chartered Institute of Purchasing and Supply on Supplier Partnerships and the role of Cost Management.
          Is profit made when you buy or when you sell?