Horror Stories of Costing

December 06, 2012

How "Costing" Costs Gear Manufacturing Companies Money.


My pet peeve is seeing companies lose money needlessly in the process of costing and pricing. This happens for four reasons:

1) They don’t have a good handle on material, parts, and job costs.
2) They don’t keep up with the changes to those costs over time.
3) They don’t stick to their guns when it comes time to quote a job to a potential customer.
4) They don’t document business operating practices and agreements with customers.

These situations are mainly a result of tradespeople not putting on their “business hats” when running their company. There are some easy solutions to these problems (with an important exception to the rule).

The Top Four Mistakes (Horror Stories!)
Horror Story #1- “Toss it up in the air”
Costing is a science; quoting is an art. Do you know anyone who quotes parts by throwing them up in the air and “guessing”? I do.

I was meeting with an engineer, talking about a new product his company was bringing out. We had made some prototypes, and he was under pressure to give his sales and purchasing guys a cost estimate for a group of parts. He literally picked up the parts, threw them up in the air and, by the time they hit his palm, divined their cost. He even managed to break down the costs for different quantities. For obvious reasons, I was both impressed and amused. Certainly, if you've been at the costing game a while, your guesses can be quite accurate. Without concrete numbers, however, the math quickly becomes hazy and estimates become worthless.

In addition, customers are notorious for challenging prices, saying, “That part shouldn’t cost that much!”  I’m betting some purchasing agents are “closet estimators” who got stuck buying parts!

So why do companies have a hard time costing jobs, materials, and parts?  It’s a difficult question, to be sure. Here’s what I’ve found out after working in the industry for years and talking to dozens of outfits: Yes, most are under the gun to produce quotes and have limited time to gather the necessary information to price jobs. By guessing, however, profits will be small, if there are any at all. Others have not put into place the systems to gather accurate costs for input into their current systems in order to determine profitability. Regardless, a company has to be sure of its costs so that it can quote a firm price and let the quotation process work its way out. Manufacturing owners must think like business people first.

Horror Story #2- “But I Only Want to Buy One!”
I had a customer who, when my company first started doing processing for him, was sending in lots ranging from 50 to 100 pieces. Our pricing to him was simple: a unit price plus a setup. Cost-per-piece was simple math. Let’s say the cost was $10 per piece, plus a $50 setup. The price for 100 was $10.50 and the price for 50 was $11.00 - not much of a price change. But the circumstances did change. In order to “keep it moving” on their end, somebody at the customer’s plant got the bright idea to make only enough pieces to fill an order or to split a lot. The lot sizes dropped below 50. Then things got interesting. At 40 pieces, the price would be $12.95. At 25 pieces, it goes up to $16.00 each. At 10 pieces it bills out at $25.00 each. Why does it go up so much? Everybody knows that as the quantity goes down, the price-per-piece must go up because some of the costs are fixed (setups, inspection, and overhead). These costs get spread out over fewer pieces. Also, as the quantity goes down, the overall efficiency of a job declines, because the operator is unable to reach a “steady state” of flow for that operation.

So what’s the problem? All they have to do is adjust their price to their customer to account for the change in price due to the reduction in quantity, right? No problem, except that many standard-cost systems only take a single cost or time for the standard. Uh-oh. Your standard cost has the 50-piece price in it and you are paying the 10-piece price out to vendors. This is bad. Very bad.

Horror Story #3- “We’ll lose money on every job, but make up for it in volume”
I had a competitor who was going after a big customer with a high number of parts that would fit perfectly into their shop. They worked up the price on the parts and sent their salesman out to close the deal. He was instructed to use the quotes as guidance, but was not bound by the prices they had worked out. Unbelievably, he literally asked the customer how much them wanted to pay, and then told them, “No problem. Just send the work in at that price.” Everyone at the plant was thrilled that he had gotten the work, but soon his boss was asking some tough questions, such as, “Are we making any money on these jobs?” Seems logical that someone would ask this, right? Well, according to the salesman, they were “losing money on every job and trying to make it up in volume.” The boss was furious and promptly fired the salesman, who I’m sure to this day thinks he did right by the company.   

By now, you’re probably saying, “We’d never do anything that stupid. Nobody does that . . . do they?”

Yes. Unfortunately, many companies cost and sell their parts for inadequate prices, regardless of whether these prices exceed their own costs. On top of that, it is doubtful that the costs gathered to quote the job are accurate in any event and therefore do not reflect the true cost of the part. Simply stated, any cost that materially affects the total cost should be calculated.

Horror Story #4- Failure to Keep Good Paper Records of Agreements and Meetings, or, "If we can't prove it, we're going to eat it!”
We had a customer who was supplying us gages for use on their parts. The gages would travel back and forth between the two companies requiring some coordination, especially when gages were out for calibration and unavailable.

One day, we got a call from the purchasing agent requesting a meeting to discuss the gages. At their plant, they suddenly said that they wanted us to take over control of the gages, as they felt it was too expensive for them to keep up anymore (in excess of $100k). This cost consisted of not only the labor to operate the gage-control system but also the cost to calibrate and replace the gages as required.

We told them that we would give it some thought and get back to them. During one of several internal meetings, someone at our plant remembered a meeting we had a number of years ago about gages. After we pulled out a letter that contained some notes and conclusions about the “gage problem”, we knew we were now on solid ground to reply.

The notes from the earlier meeting showed that previous managers from the customer (no longer with the company) had expressed exactly the same concerns about the costs and logistics; they concluded that they should retain control and “eat” the cost to pay for the gages.

We dodged a bullet, but it shows that a seemingly reasonable request can turn into a monster if you don’t have your wits about you and your paperwork in order.

Four Great Solutions To End The Horror!
So how can tradespeople, machinists, and engineers who run a shop get better at putting their “business hats” on when it comes to costing?  Here are four easy steps:

Step 1: Write down the numbers... somewhere. Getting all of the costs together for a particular job is essential for quoting and determining profits. These costs include (but are not limited to) labor, material, overhead, tooling, and outside processing as a start. They can be collected by paper, electronically, or by a combination of both. Before my manufacturing company had a computer system to handle the accounting, all of these records were accumulated on paper.

On one side of a costing card was the quoting area, where the price was made from calculated internal cost and quotes from vendors for outside operations. After totaling these costs, a markup was applied to get the quoted price. Obviously, this was not an exact science, but the markup took care of the overhead, tooling, and commission costs in addition to the profit we expected to make. Once the job was entered, employees would turn in daily work records that were (in the case of “made complete” jobs, as opposed to single-operational jobs) transferred to routing cards at the end of that job. Outside costs were also accumulated on these cards as they were incurred.

Only at the end of the job were total costs tabulated and examined for profitability. The calculated costs were compared to the actual cost incurred to see the results. Most of the time, we did fine. Other times we were a bit off, so we adjusted the costs for next time and watched things a little closer. The lesson here is this: Without gathering the costs, there is no way you can get a handle on your profits.

Step 2: Computerize your data. As we evolved, we purchased a computer system from one of our customers and started to develop a cost-estimate system. Over time, all of the paper records were eliminated and the costs/labor records were held in the computer. Not only were they now able to be backed up to prevent loss, we now had real-time access to the costs being turned in, instead of walking around and having to find several documents before getting a look at the raw numbers. Now all costs that were incurred could be compared to estimates as they occurred in addition to a full review at the end of a job. The two most attractive features were: (1) Repeat runs of the same part number could be reviewed side-by-side and compared for costs, and (2) all job types, whether single-operational or make-complete jobs, were now recorded in one system.

Computerization simplifies recordkeeping so that all costs can be entered, reviewed, and acted upon in real time or in accordance with a quoting system.

Step 3:  A “quotation system” can be fun! Once we had accurate records for labor hours, purchased materials, and outside process costs, along with a firm handle on tooling and overhead costs, we developed a quoting system that used the accumulated costs to further streamline the process.

Now, this became the fun part of the entire process. It forced us to examine the cost of machine time by machine type, rather than by a flat rate across a department. In other words, it now mattered whether or not a part was run on a newer CNC gear-cutting machine or an older, mechanical one. Different rates were set and then incorporated into quotes. In addition, full lists of outside operational quotes were now entered into the system and recorded for possible use during the actual job. Overhead, tool, and shipping costs could now be entered directly into the quote process rather than boiling them into some nebulous markup factor.

Having a quotation system, you can now use the power of a computer to automate many tedious, time-consuming actions, some as simple as adding up the costs. Obviously, someone must still sign off on quoted price, but you now can depend on accuracy as well as expediency when using quoting software that takes real costs into account to build more profitable jobs.

If the process pretty much goes to plan, all of these can go a long way toward making sure that your quotes are correct and that your jobs will make money. However, if your system does not mimic the way you are processing, or you are using obsolete or inaccurate information, well, all bets are off. Bad decisions and no profits will be the results.

Step 4: Document, document, document! It is vital that you document your contact with your customers to build a history over time. In this fashion, you develop a memory with the customer that can be referred to months and years after the fact. This is especially important when dealing with your customers who have high turnover in management positions. That way, when a situation rears its head (again!) you can pull out some meeting minutes or a letter that was sent and show how the situation was resolved in the past.
While this kind of library doesn’t guarantee a cost-friendly result, it can certainly end some ugly discussions outright or at least minimize the cost impact to you.

The One Big Exception To The Rule
Now and then, every company takes a job that makes little or no money. That’s just the cost of doing business. However, you must know exactly what your costs are to determine what your rock-bottom price is, limiting (or hopefully eliminating) the number of bad jobs. Loss leaders are OK if you have your costs controlled and accounted for. Just make sure you’re getting additional work to compensate for the consideration you are giving up to get it. 

About The Author

David Senkfor

is the president of TopGun Consulting, a manufacturing consultancy with a focus on helping companies improve their practices and processes to increase the profitability and satisfaction of the owners of those companies. David has over 30 years of experience in manufacturing, more specifically in the gear industry. Using his experience, David is able to quickly assess difficulties  and recommend simple, yet effective, solutions to those issues. For more information, contact David Senkfor at david@topgunconsulting.net or (602) 510-5998, or visit Top Gun’s website at www.topgunconsulting.com.