Blog

Learn How Modern Manufacturers are Leveraging PCM to Improve Profitability

Abe Chaves

How to Get a Fair Price on NPI Parts

FavoriteLoadingAdd to favorites

When you’re sourcing NPI parts, you could have two different types. One is brand new parts – parts you have never purchased before that are not similar to any other parts. The other is modified parts – parts you have never purchased before, but are simply a modification of an existing part. It might be a little bigger, or a little smaller, or it has an extra bend here, or a few extra holes, but essentially it is very similar to an existing part. Let’s take each one of these cases separately.

Sourcing Brand New Parts

When you’re looking at a completely new part, many companies, depending on the complexity and criticality of the part, will work with a strategic supplier. In some cases, if the new part, is simple enough, and considered low risk, you might even just send it out for bid like any other part.

Regardless of which of these two strategies you follow, I recommend you start by estimating the cost of the part with your product cost management (PCM) tool. Then confirm your estimate has the right volume, the right batch size, the right material, any necessary secondary processes are included, etc.

For NPI parts, keep in mind that you may want to account for risk. Many suppliers will add a little extra cost, beyond the estimates for the part, because they’ve never made the part before and nobody else has made, so they add a small cost to account for risk, and that is warranted. It is a risk that the supplier is taking, and you should compensate them for that.

There are “learning curves” available that show the cost of a never-made-before part relative to a steady-production cost. These curves are by industry and you could use this % cost differences to estimate what is fair compensation for this risk.

I recommend that you then send the part out for bid, either to your strategic supplier, or out for an open bid to multiple suppliers, without a target price. Ask for a price breakdown from the outset so you can understand the capabilities each supplier has to make the part, and which capabilities are required to make the part.

Compare Key Elements of Your Estimate to Quotes

Once you get the quotes back, you should compare the key elements to the estimate generated by your product cost management tool and make adjustments if necessary. Key elements include the cost of material, main manufacturing process, each of the secondary processes, and other factors such as packing and shipping.

For example, compare the material cost across estimates and adjust your cost estimating tool cost down if the average quote comes back with a lower material cost.

This is because, for example, if it’s a sheet metal part, it may be a part that is very good to dynamically nest with other parts, and so the utilization that you are calculating may be lower than the suppliers are calculating, because in fact they can fit parts that are being made for other clients, or the material prices may have dropped in the last 3 months.

That’s just one example, but the point is, you should adjust the price in your cost estimating tool accordingly. Similarly, if you find a process included in the quotes that you didn’t expect, but is required, you need to add that to your product costing tool as well.

Once you have completed your comparisons, you will have an adjusted cost estimate and a set of quotes, assuming the part was sent out for an open bid.

Determine Your Target Price

If you have one quote that is lower than your cost estimate, even after making the appropriate adjustments, you should use that lowest quote as your target price. That’s assuming the supplier is viable, qualified to make the part, understands what goes into making the part, etc. Then the lowest quote, plus or minus a small percentage, becomes your target price.

If not, then the estimate generated by your cost estimating tool becomes your target price and you will send the package out as best and final to perhaps two or three suppliers. I recommend sending it to your top two suppliers with a target price.

One of two things will happen next.

Either the supplier(s) will bid at or close to your target price, in which case it’s a success. Or the supplier(s) may give you a reduction in price, but not come anywhere near the target price that you had hoped for.

Begin Negotiations or Open Book Discussions

In the latter case, you go back to the supplier and begin Fact-Based Negotiations.  Since you have the price breakdown from the suppliers, because you asked for it up front, you can compare it to that of your cost estimating tool, and you follow the process as described in that previous post.

If you’re working with a strategic supplier, you use the estimates from your product cost estimating tool to establish the basis for your open book discussions. When you send the request for quote to your supplier, you request a breakdown of the costs, and then you just go through each line item, and note where the discrepancies are, and use that information to further the conversation on how you can collaborate to lower costs.

You may want to give your strategic supplier credit for a learning curve. When a supplier has never made a part before, and especially if it’s a risky part to make, they will want some extra money to cover the cost in case something goes wrong.

Typically with strategic suppliers, you give them some extra cost the first year, and then you give them a little less extra cost the second year, and hopefully, by the third year they will have worked out the kinks to making the part, and should be able to give you a more steady cost.

In some cases it’s done by volume; the first hundred parts at this price; the next hundred parts at that price, etc. This is a common practice which your product cost estimating tool will not have included in the cost model unless you created a specific NPI model, and included these costs.

Again, your goal is to understand what is driving the cost, and then explore ways to reduce that cost. In some cases suppliers will provide good ideas on how to re-engineer the cost out of the part, that’s why I recommend having engineering present when you go through this process of exploring what’s driving the cost for a part.

Sourcing Modified Parts

What happens if the part is not a completely clean sheet, brand new part, but is a modification of an existing part? In that case, things become simpler.

The process I suggest is to start by estimating the cost of the existing part with your product cost estimating tool. Then estimate the cost of the modified part. Next, calculate the difference between the estimate for the existing part, and the estimate for the modified part. Finally, apply that percent difference to the price that you pay the supplier for the existing part and that becomes your target price.

For example, you have a new part that is a modification, maybe slightly bigger than an existing part, which your cost estimating tool indicates should cost $10.00. When you estimate the cost of the new part, you get $12.00. The difference between the two is 20%.

Then, you look up what you’re paying the supplier for the existing part; let’s say it’s $10.50. Don’t worry about the small difference between your estimated cost and what you’re actually paying.

Next, multiply the $10.50 by 1.2 and you get $12.60, which is what you should be willing to pay that supplier for the new part.

In most cases that should be a very firm target price. In the cases in which it’s not, then again you use Fact-Based Negotiations to figure out why there is a difference, and what can be done about it.

Case Study: Exploring Should-Cost vs. Actual Cost Leads to Huge Savings

As an example, a client was buying a shaft for a fly wheel. They had an old design, and let’s say the old shaft cost $50.00. The new shaft, which was slightly bigger, actually cost nearly $100.00, but their cost estimating tool indicated it should cost $60.

The large discrepancy between the estimated cost and what the customer was actually paying resulted in discussions with the supplier to understand why the part was twice the cost when it was very similar to the old part, only slightly bigger.

It turns out the diameter specified for the old part was very close to a standard size forging the supplier could buy. It required very little machining to get it to the specified size, and very little material was wasted.

The diameter of the new part was such that they needed a much larger standard size forging. As a result, they were paying for more material than they needed and more machining time on that shaft.

After discovering this, the client went back and reduced the diameter of the shaft by 18mm to get it close to a standard size forging, and brought the cost down much closer to what the cost estimating tool had calculated. They did need to add the weight to another component on the fly wheel, but it was a lot cheaper to add the weight to another component.

This was a case where the client used the generated cost estimate to start a conversation with their supplier and arrive at a much lower cost in the end.

Tell Us About Your Experience

Are you using a product cost estimating tool to analyze your NPI parts and identify savings opportunities?  What kind of results have you had? Tell us about it in the comments.

Want to Learn More?

Download our whitepaper, Are You Overpaying for Your Outsourced Parts?, for best practices on identifying components with the greatest potential for cost savings.

Leave a comment

Note: Fields marked with (*) are required

Time limit is exhausted. Please reload CAPTCHA.

Top

Get articles about product cost management best practices delivered to your email inbox.