Cost Analysis

Cost Analysis


Cost analysis should be employed when price analysis is impractical or does not allow a supply management professional to conclude that a price is fair and reasonable. Cost analysis is generally most useful when one is purchasing nonstandard items and services. This section focuses on the application of cost analysis to the acquisition cost of materials, products, and services.


Cost Analysis Defined


We have seen that price analysis is a process of comparisons. Cost analysis is a review and an evaluation of actual or anticipated costs. This analysis involves the application of experience, knowledge, and judgment to data in an attempt to project reasonable estimated contract costs. Estimated costs serve as the basis for buyer-seller negotiations to arrive at mutually agreeable contract prices.


The purpose of cost analysis is to arrive at a price that is fair and reasonable to both the buying firm and the selling firm. Estimates can be made with the help of one’s engineering department or b analyzing the estimates submitted by the seller. To analyze a supplier’s costs, a supply manager must understand the nature of each o the various costs a supplier incurs. The supply manger must compare the labor hours, material costs, and overhead costs of all competing suppliers as listed on their co-breakdown sheets. Most important, he or she must determine the reasons for any differences, focusing on three principal elements of cost: direct, indirect (overhead), and profit.


A supply manger always should be conscious of the fact that costs vary widely among manufacturing firms. Some firms are high-cost producers; others are low-cost producers. Manny factors affect the costs of specific firms as well as the cost of individual products within any particular firm. Some of the most important elements affecting costs are:

  • ·        Capabilities of management.
  • ·        Efficiency of labor.
  • ·        Amount and quality of subcontracting.
  • ·        Plant capacity and the continuity of output.


Each of these factors can change with respect to either product or time. For this reason, a specific firm can be a high-cost producer for one item and low-cost for another item. Similarly, the firm can be a low-cost producer one year and a high-cost producer another year. These circumstances make it extremely important for a supply manager to obtain competition among potential suppliers when appropriate. Competition can be a supply manager’s key to locating the desired low-cost producer.