Chaos Theory And Cost Breakdown Analysis In Sourcing

Umesh Verma

Download the guide on manufacturing supply chainsCan a butterfly flapping its wings in Timbuktu disrupt your supply chain in the Mall of America, Minnesota? Chaos theory aficionados will answer with a resounding yes, as the butterfly effect, applied here, would dictate that the small wind from the butterflies can yield a snowstorm over time due to magnification.

Strategic sourcing professionals have numerous capabilities to leverage the butterfly effect: develop small changes that result in a dramatic positive impact on the business.

Let’s study one: cost breakdown analysis.

Cost breakdown analysis

A cost breakdown analysis (CBA) can help you understand the different components that make up the cost of a product. Its usual constituents are factors such as material, labor, overhead, etc.

You can get this information from multiple sources such as professional service providers, expert consultation, internal benchmarks, and so on. A key source of information can be your own suppliers. An in-depth understanding of what cost drivers influence your product thus helps to establish the cause-and-effect flow of various events on the product’s supply chain.

Getting cost data from suppliers

The days when suppliers were reluctant to share their cost information with the buying customer are over. The concern that the buyer would use strong-arm tactics for pricing negotiations is very much going the way of the dinosaurs.

Progressive, forward-looking enterprises are moving towards effective supplier collaboration in a multi-enterprise network environment. Your suppliers can be the best source of information to provide strategic insights for not just new product launches, but for high-volume, mature products as well.

Cost breakdown insights as part of sourcing

At the time you raise an RFQ (request for quotation), getting cost information pertaining to various cost drivers in different cost groups from suppliers can provide valuable insights. This can definitely alert you to take proactive steps in commodities markets to protect yourself from future disruptions.

Significantly more important is that it can highlight the differences in patterns from the average norm across different suppliers and can thereby provide untapped opportunities for cost savings and other KPIs (key performance indicator) improvements. The ability to cross-pollinate best practices and ideas across the supplier ecosystem results in a win-win situation for all stakeholders. Long-term, the relationships with stakeholders can evolve into different business models such as buy-sell, cost-plus, and other multi-tier cost/risk management strategies.

Cost traceability across the product lifecycle

As the product progresses throughout its lifecycle (in some cases, a multi-year lifecycle, or in the case of an Apple iPhone, as short as one year), detailed cost-breakdown analysis for all components is necessary to facilitate better margin understanding. Many organizations experience a “cost-gap” – missing information about product cost.

Developing a cost framework across this product lifecycle (from prototype to launch to high volume to retirement or next-generation) will eliminate cost gaps. This approach enables professionals to make the best decisions as the product traverses through various product milestones and decision gates while translating into improved product and supply chain sustainability.

In summary, cost breakdown analysis leads to a stronger, nimbler organization better equipped to handle the challenges brought by the flapping of the wings of a butterfly in Timbuktu!

For more insight, download the IDC whitepaper Achieving Competitive Advantage with Trading Partner Collaboration in a Global, Dynamic Supply Chain.

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Umesh Verma

About Umesh Verma

Umesh Verma is director for Sourcing Solutions for Direct Spend at SAP Ariba. As part of the Product Management organization, he works closely with customers in diverse industries – such as discrete manufacturing, retail, and high tech – to address their sourcing technology needs. Prior to SAP Ariba, Umesh worked in various roles in procurement and supply chain in Fortune 500 companies such as Intel aand Amgen, and as a management consultant with PwC. Umesh has a Master’s in Business from University of Iowa and a Bachelor’s degree in Chemical Engineering from the Indian Institute of Technology, Kanpur.