Three Requirements of an Effective Cost Management System – Part 1


In this three part blog, we’ll discuss the three requirements of building and implementing an effective cost management system for complex manufacturers.  First up is the need for complex and process manufacturers to have a complete view of costs.

Complete view of costs
When you think of manufacturing costs on a high level, the basic cost categories come to mind: raw materials and direct labor.  But in process manufacturing, these basic categories are flooded with complexities like processing yields, machine variances or supplier costs.  To get a true picture of manufacturing costs, consider three components – Product Costs, Logistics and Distribution Costs, and the Cost to Serve.

Product Costs
Product costs include the materials and labor required to convert raw materials into finished goods.  Calculating product costs is a significant challenge for process manufacturers who have multiple production lines or locations.  Why?  Because it is virtually impossible to manufacture the exact same product for the exact same cost in two different places.  In a typical ERP environment, cost managers are forced to pick one cost for a particular product, but in reality there are multiple unique costs – one for each location the product is manufactured.  Without this level of detail, manufacturers loose the true cost picture and can inadvertently make poor operating decisions that could potentially hurt the company’s profits.

Additional factors like yield and scrap can play a significant role in understanding overall costs.  Scrap that is reintroduced into the production process must be credited properly.  Yields can vary due to changes like substituting raw materials or using a different manufacturing route to produce the finished good.  Beyond these factors, each manufacturing process will have its own unique issues like tool and die costs or set-up and clean-up costs that also affect the overall product cost.

Logistics and Distribution Costs
Overhead costs like logistics and distribution are often arbitrarily distributed to products or SKUs based on formulas that have little to do with the actual customer order.  These costs can make up a significant portion of the overall cost of deliver to the end customer, so developing a method to more accurately assign transportation costs is critical.  To develop an accurate depiction of profitability, cost managers must appropriately allocate these overhead costs by product, customer or job.

Cost to Serve
Knowing how much it costs to service your customers is a vital component to overall manufacturing costs.  Sales and marketing, accounting, and other business activities incurred can become a significant overhead category and appropriately allocations are needed to ensure you have an accurate view of the costs to serve a particular customer.

Stay tuned for part two where we’ll discuss the importance of maintaining multiple cost sets to improve your operating decisions.  Get instant updates on new blog posts by subscribing to our RSS feed.