Financial & Legal Aspects of Procurement
The marginal cost of a product is that incremental cost that arises when a firm produces one extra unit of a product (Drury, 37). The marginal cost of a product is arrived at when all the fixed cost associated with production of a product is absorbed by that product and only the variable costs remain. This means that the marginal cost is associated with the variable cost of product that are yet to be accounted for but have the capacity to be measured and accounted for.
The marginal cost of a product is usually made up of variable cost but sometimes a portion of the fixed cost is included in it. Expenses such as administration overheads and selling expenses can be apportioned and reflected in the marginal cost of a product. Therefore, the marginal cost of a product can be calculated by finding the change in cost of producing an additional unit divided by the change in quantity produced.
Marginal costing is a technique that can be used to help improve and sustain the economies of scale. Marginal costing will provide useful information regarding the production of an additional unit of a product. Instead of just growing a business blindly without the concerns of whether the growth is useful, marginal costing can be used to help aid the decision of growing a business. This type of assessment is in relation to the diminishing marginal utility. When the marginal cost of producing a product continues to increase as the business grows, the returns expected from such a growth will continue to decrease. This will result in diseconomies of scale, which could have been avoided if the marginal cost of the product was considered before growing the company.
Opportunities caused by marginal costing
Marginal costing is effective in controlling the cost incurred by the business when it needs to produce an additional unit of a product. The marginal cost can be compared with the marginal revenue and the management can decide on the best action to take based on the results. If a product marginal cost is less that the product marginal revenue then it will be unwise to develop that product because it will only increase the cost of the company. Therefore, marginal costing is useful in eliminating capricious allocation of overheads that will only increase the company’s total costs.
The simplistic nature of marginal cost will help a buyer make informed decision regarding the purchase of a category. The rationale behind this is that the buyer only needs to have the knowledge about marginal costing and then he can make a purchase that will be beneficial to his portfolio. With marginal costing, the buyer will be able to determine whether the category will result into a loss or a profit in the future. If the marginal cost of purchasing that category outweighs the marginal revenue of purchasing the same category, then the buyer will know it is not a sound business decision.
Every product or service has inputs that affect the cost of producing or providing that service. The inputs that affect the cost of any material or service are known as the cost drivers of that product or service. Therefore, any changes in the cost driver of a product will result in a change in the overall cost of any product. This is the reason why managers strive to determine the cost drivers of a product in order to be able to reduce the cost that the product incurs. The knowledge of cost drivers is insightful when an organization is looking to reduce its cost in order to gain a competitive advantage in the industry.
In order to establish the cost driver of a product properly, the management needs to develop a cost model. Below is an example of a cost model of producing cars and it illustrates how different cost models affect the total cost of producing a car.
The model above indicates that the cost of producing a car is affected by various elements. The elements in this case are the ones marked as cost drivers and any change in the cost drivers will affect the cost of producing a car. Below the effects of the major cost drivers will be analyzed.
Number of Setups
In order to produce a car, certain equipments and machines are needed in the production process. The machines needed need first to be set up and prepared in a way suitable for production. This process is a production process and it consumes time and resources. Therefore, the costs associated with setting up machines are included in the cost of producing the car. Therefore, to determine the machine set up rate, the organization can use the number of setups as the cost driver.
Number of Purchase Orders
This inputs required for producing a car need to be ordered from the suppliers. Therefore, the cost associated with ordering inputs can be apportioned based on the number of orders made. The number of purchase orders can therefore be used as a cost driver when an organization needs to apportion it overhead costs to different departments.
Number of Machine Hours
Production process requires the machine to be used in the process. This has the effect of depreciating the machines. Other costs that are associated with machine usage are the maintenance cost incurred and the repair costs. In order to determine the cost associated with machine usage the organization can use the number of machine hours in a production process as the cost driver. Therefore the cost of associated with using the machine can be calculated by multiplying the number of machine hours and the rate estimated per hour.
Number of parts
The cost associated with the assembling department can be calculated using the number of parts that have been assembled. In other instances, the weight of the parts assembled can be used to calculate the cost incurred in the assembling department. In the case of producing a car, various parts are produced then assembled together. The number of parts required to complete a whole car can be used as a cost driver to determine the cost incurred.
Number of Inspections
Organizations have the obligation to test and inspect their products if they are fit for final consumption. This is a safety measures and it is required by law in order to protect consumers from consuming harmful products. Furthermore, organizations need to ensure that their products are of the right quality in order to maintain their market share. Therefore, these cost associated with this department can be calculated using the number of inspections done on the products. The costs in this department include the salary of the experts inspecting the elements, electricity, and other forms of equipment need to test the products. Therefore, the cost driver that is appropriate for this department is the number of inspections done.
Number of Labor Hours
Supervision is required in order to ensure that the production process is transpiring as planned. Supervisors are paid salary, which will affect the cost of the car produced. Therefore, to determine the cost of such a department, the number of hours that the supervisors have worked can be used to determine the cost of the department. The number of hours worked by the supervisors can be multiplied by the rate that supervisors are paid in order to determine the cost of the department. The number of labor hour will also be used to apportion the overhead incurred in producing one car.
“Competition is just not about asking 4 or 5 suppliers to quote”. This statement is aimed at broadening the scope that most purchases have in terms of competition. The statement points out how many individuals think that by asking a number of competitors to bid for a product you are increasing competition between them. This however is not the case since competition between suppliers is affected by various factors. Such factors include the type of product being offered and availability of the product in the market. Considering various factors affecting competition, the four strategies below have been developed to ensure the right decision is made in relation to competition.
Critical commodity
Critical commodities are products that are critical to the ongoing operations of the business. Such purchases have the tendency to be available through a few suppliers and they tend to be quite expensive. They involve large expenditures that might cripple the business in case of a wrong decision. The purchases also have the characteristic of being complex in nature and their quality is critical to the livelihood of the business. When dealing with such a commodity it is not advisable to invite suppliers to quote and compete for the purchase order. This situation is usually delicate and the best solution will be to find a supplier and form a partnership with them. It will be beneficial if the organization increases the role of such a supplier so that they can handle the purchase order as diligently as possible.
This strategy involves heavy negotiations with the supplier and an inherent understanding of the supplier process management. Due to the nature and importance of such a purchase order, he firm need to have a contingency plan in case the supplier is not able to deliver that order.
Routine Commodity
Many alternative products that the firm can choose from characterize routine commodities (Moore, Robert &Clifford 37). Furthermore, numerous suppliers in the market supply these products and therefore they are perfect match for a competitive strategy. These products are used in every day transaction and they rarely have a huge impact on the operations of the organization in the event that they are not supplied. The qualities of this product also rarely affect the quality and the operation of the firm.
The best strategy for such products will be to simplify the acquisition process because of their level of significance. The firm can also automate the purchase of such orders since there are no heavy negotiations needed. A firm can create a system that scrutinizes tenders and offer the order to the lowest bidder. This is beneficial to the firm since it will cut cost and reduce the labor required in procuring such commodities.
Leverage Commodities
Leverage commodities are commodities that usually involve high expenditure on the part of the purchaser. Even though these commodities involve high expenditures, they are usually ample in the market place. This means that they are easily acquired and have various alternatives. The characteristic of these products are also perfect for a competitive strategy between the purchaser and supplier. The best character of the product that facilitates a competitive strategy is the fact that the products are price sensitive therefore; a change in price will have a effect on the quantity of product demanded and supplied.
A firm therefore needs to maximize on the commercial advantage presented by these products. The firms need to ensure that the suppliers constantly compete for the purchase order for these products. Since the products involve huge investments the firms stands to save on costs if the suppliers continue to engage in price wars in order to be competitive. This is aided by the firm’s effort to promote competitive bidding.
Bottleneck Commodities
Bottleneck commodities have complex specifications that require intricate manufacturing process (Moore, Robert &Clifford 37). The availability of these products is scarce and only a few parties in the market can supply these products. Bottleneck commodities also have huge impact on the operations of the organization and can affect the future operations of the organization. These products are characterized by advancement in technology and innovations.
The best strategy for dealing with these products is to ensure that their supply is continuous by managing suppliers. The firm can undertake to help develop new supplier of the product in order to ensure their operations are not threatened by a shortage in supply. It can do these by introducing new supplier in the market so that the uniqueness of the existing suppliers can be diluted. The technological aspect of such a product needs to be considered before making any contracts. Since technology is dynamic, the firms should engage in short-term contacts so that they can always have a competitive advantage once the technology of the supplier is outdated.
Techniques Used in Competition
Different techniques are used to help a firm carry out a competitive or collaborative strategy. These techniques are the ones that differentiate between the two strategies. In competitive strategy, the following techniques are applied to ensure a successful strategy:
- Promote competitive bidding
- Exploit market trends
- Little negotiations
In a collaborative strategy, the following techniques are used:
- Heavy negotiations
- Manage supply
- Increase role of supply
The main difference between the two strategies is that the techniques used in a collaborative strategy are aimed at showing the supplier that firm depends on them, while in a competitive strategy it is the vice versa. A competitive strategy clearly states that with or without your supply, the operations of the business will continue. The firm therefore does not intend to be friend the supplier unlike in a collaborative strategy where the firm intention is to make the supplier feel as part of the firm.
A tender bond is issued to act as a surety in the case that the tenderer fail to deliver on the requirements of the contract (Luk 238). Therefore, it will act to cushion the organization if an individual who tendered his bid is unable to perform his duties. The tender bond will be damages that the organization incurs after its process slowed down because of the inability of the wining tender to perform his duties.
A tender bond is also used to differentiate between serious suppliers and jokers in the industry. Therefore, any supplier who is sure he can meet the requirements of the tender will not have a problem in providing a tender bond. This is because he is assured that his bond will not be forfeited by his lack of performance. The organizations intention when it issued the tender bond was to invite tenders from serious suppliers. The tender bond persuades suppliers who are not sure of their ability to supply not to bid for the contract. By issuing a tender bond, the organization ensured that it saved its time and resources by only going through tenders from reliable suppliers who have the capacity to deliver on the contract.
Disadvantages of a Tender Bond
Since a tender bond requires that the supplier provide the amount of the tender bond upfront, then it will reduce a supplier’s cash flow. In case where the tender price is huge, then the tender bond will be a huge amount. This will affect the working capital of the supplier and might affect its operations. However there are cases where you bank might not want the whole amount, this will be helpful to the supplier and will not affect his capital flow.
The supplier also face the risk of the tender being called by the beneficiary without any specific reason. This mostly happens when the tender was unconditional (Luk 238). This will damage the finances of the supplier since he will lose money for no good reason.
Tender bonds also increase the cost of the supplier. This is because suppliers take insurance bonds in order to protect themselves for huge losses in case the beneficiary calls for the tender bond. This reduces the net profit that a firm would have received in case they did not apply for a tender bond.
Works Cited
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Drury, Colin. Management and Cost Accounting. London: Thomson Learning, 2007. Print.
Luk, Kwai-wing. International Trade Finance: A Practical Guide. Kowloon, Hong Kong: City University of Hong Kong Press, 2011. Print.
Moore, Nancy Y, Robert W. Bickel, and Clifford A. Grammich. Developing Tailored Supply Strategies. Santa Monica, Calif. [u.a.: Rand, 2007. Print.Bottom of Form