How does one determine whether a price quote is fair and reasonable?
Solution: This can be determined with AIMDRIVE-AI Cost Analysis. In this case a Should Cost analysis helps demonstrate whether the price proposal is within a reasonable range.
Example: Consider a new product purchase for which you have received a Price Quote of $100.00 per unit.
AIMDRIVE-AI Cost Analysis:
- Obtain the Industry Average Cost Profile of products sold by this industry to understand the proportion of the Products’ Sales Price that is attributable to each of the five cost elements
| Industry Average Cost Profile | % |
|---|---|
| Direct Materials | 60.0 |
| Direct Labor | 5.0 |
| Manufacturing Overhead | 15.0 |
| Cost of Goods Sold (COGS) | 80.0 |
| GSA & Other Expenses | 15.0 |
| Profit Before Tax (PBT) | 5.0 |
| TOTAL | 100.0 |
- Estimate what the Direct Material cost should amount to for the specific product you are buying. To do this you break down the Bill of Materials for the product and monetize each of those items based on the market price for the respective materials.
| Material | Quantity | Price($)/unit | Cost ($) |
|---|---|---|---|
| Direct Material #1 | 1 kilogram | $45.00/kilogram | $45.00 |
| Direct Material #2 | 500 grams | $10.00/kilogram | $5.00 |
| Total Direct Material Cost | $50.00 | ||
If required, based on an initial discussion with the supplier, a more detailed Should Cost Model can be developed that would include a deeper analysis of Labor and Machine Costs, Material Yields, Labor Efficiency and other factors.
By monetizing the first Cost Element, Direct Material, we have monetized 60% of the total product price. We can extrapolate the product price, i.e. the 100%, by dividing the Direct Material cost by the Direct Material percentage. This what we call a basic Should Cost Model.Example:
Direct Material ($50.00) is 60% of product price.
Product price = $50.00/0.60 = $83.33 (also known as “Should Cost”)
This can be compared to the existing quotation and the supplier can be challenged to explain the gap between the quotation of $100.00 and the Should Cost of $83.33
