Cost Analysis

To get the best possible value for each purchase, supply chain professionals need to ensure that the price they are paying is fair and reasonable. Such an assurance cannot be made without knowing the exact costs of products or services to be sourced outside. Therefore, cost analysis is one of the most important tools for sourcing. In a nutshell, cost analysis is an attempt to obtain the “lowest fair and reasonable” price of outsourced products or services. That attempt includes the breakdown and examination of current and anticipated costs associated with the purchase of those products or services. Cost analysis is particularly useful for answering the following questions related to sourcing

• Are we paying more than what the product or the service is really worth?
• Are we being charged the same as another buyer would be charged?
• How does the current price compare to a price paid in the past for the same or similar goods or services?
• Is the quoted price a discounted price or a list price? Is there room for price haggling?

The ultimate purposes of cost analysis are to identify and eliminate unnecessary costs; to ascertain that the price being quoted is equitable for both the buyer and the supplier; and to provide the supply chain professional with an objective negotiation tool. Because cost often reflects managerial efficiency, its specific measures may vary from one company to another or one period to another. Also, depending on the method of cost analysis, its estimates may differ from one analysis to another. Considering this complexity and volatility, one should keep in mind the four key principles of cost analysis

Capture cost drivers, not cost elements. Answer “what incurs costs,” not just “what comprises cost.”

• Build commodity-specific cost drivers. Inherent differences in products will cause different cost drivers.
• Consider the total cost of ownership. Few sourcing decisions should be based solely on the product or service’s purchase price.
• Start simply and then add complexity to the cost analysis only as needed. Focus on the most important cost drivers

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