The art of costing

Tiago Lopes, Industrial Engineer/Executive MBA, May 2014

A personal view into tools and methodologies

2

Warning! Cost ≠ Price ≠ Value

Price

Value

Cost

• Commercial arrangement• Premiums from

innovation, availability• Target RFQ• Strategy

• Form, Fit and Function• Quality, Delivery, Convenience,

Performance, etc.• Extrinsic and emergent

• Materials, Labor, Manufacturing, etc.

• Calculated reference for negotiations, continuous improvement

• Internal and actionable

The schematic of cost composition (and selling price)

Direct Labor

Direct Material

Investment Costs

Direct Cost

Production Costs

Processing Costs Operation

Costs

Organization costs

Total Cost

Profit

Selling Price

The compounding of costs should be enough to sell a product with a reasonable profit margin. By understanding and controlling these items, a business can be managed through a thought competitive environment to success.

Costing would be the action of identifying all the resources required to produce a product/service translated into an economic amount

Direct MaterialDirect materials cost is the cost of direct materials which can be easily identified with the unit of production - From Wikipedia, the free encyclopedia

To produce a certain product, materials are needed in a defined quantity and according to a specification.

This would also include the transportation of the materials to the production site and related packaging.

This quantification will be translated into the material costs.

Direct LaborDirect labor cost is a part of wage-bill or payroll that can be specifically and consistently assigned to or associated with the manufacture of a product, a particular work order, or provision of a service

My personal twist, is about the evolving world we live in. In a world were product can be as sophisticated as vaccines or software, PhD's are producing output. Other examples could be production made in robotized production lines…No worries, for every setting there is a model to apply!

- From Wikipedia, the free encyclopedia

Processing CostsProcessing costs are the costs incurred by the utilized technology found at each process or stage of manufacture, which will contribute to the overall cost of a product.

These would be the costs of the energy utilized, the maintenance required, waste management, specific spending in process enables such as oils, cooling liquids, etc.

I would also include costs as indirect labor (supervision), internal logistics and other overheads

Investment CostsInvestment costs will be the portion of the overall investment required translated into a cost that can be related to the product being manufactured.

To produce a certain good, machines, equipment, installations, patents, etc. are needed. How to make a wise repartition of that initial investment is what is all about…

There are rules according to tax laws but we have to understand the implications of the choices available to take the best decision.

Organization costsOrganization costs will be the costs from the organization not covered by a specific product/service.

It would be costs such as generic R&D, Sales, Marketing, Administration, etc. This type of cost is normally denominated as SG&A (Selling, General & Administrative Expense) but I would like to capture some other costs that are indirect to production and need to be covered.

It could also be the cost of the financing required, if a third entity is making the cash resources available against an expectation of scheduled repayments.

Profit

Profit is what a venture gains in its realization and it should be considered as an incentive to cover the risk cause by the application of the resources. Only by having some profit will stakeholders make the decision go ahead with a certain project.

There are also organizations that do not consider profit as their goal but profit should be gathered during the good years to cover for the bad ones – as such, its wise application is essential to grow or to survive

ConclusionsDear readers,For this first presentation I wanted to make a quick tour, not loosing myself in details…In the next presentations I shall go deeper on what I consider relevant to share, trying to avoid «clichés» and repetitions of self-proclaimed gurus.

I count on your feedback to help me achieve that!

Thanks in advance!

Who am I?• I’m an Industrial Engineer and exec. MBA• Experienced in– Management: Plant Management, Business management,

Project Management, VA/VE and other special projects– Operations: Supply chain, Industrial footpath & Green field

operations, Lean process installation & Ergonomics, Lean 6 Sigma continuous improvement

– Finance: P&L, Cost calculation, Price target strategies– International footpath, – Passionate for sci-fi and strategy