The Concept of Open Book Costing - Case Study Example

 «The Concept of Open Book Costing» Introduction Supply and purchasing management use several approaches in dealing with suppliers for the supply of goods and services. One of these is the partnering system, also called collaboration, which uses the open book costing. There are several structures of partnering agreement that could work well in buyer-supplier relations. The concept of open book costing will be discussed in the study and its relevance to management will be evaluated. Question 1. Part 1 Definition and Description on the Concept of 'Open Book Costing' Open Book Costing is defined in a partnering arrangement done with selected suppliers, transactions are done with “openness, effective communication, close collaboration and cooperation, trust, honesty, transparency, sharing and mutual benefit”. (CIPS) CIPS thinks that the Open Book Costing is a useful tool to arrive at a greatest advantage from a partnering relationship of both buyer and seller. The purpose of this idea is to bring mutual benefit for both retailer and supplier. Open Book Concept has been derived from the Open Management practices spawned by Jack Springfield when he revolutionized management practices in 1986. (Inc. 2008) Strategic partnering framework have used in open management practices. Robert A. Rudzki -- Supply Chain Management Review, 3/1/2004, arrived at a framework of partnering arrangement which he had classified it as: 1. Transactional relationship: Noncritical; low value. Focuses on the efficiency of the transaction 2. Basic partnership: Noncritical but high value. Involves areas that are not a core capability. 3. Strategic partnership: Important; high value. Involves an exchange of technology or other core capability, for example. Valuable when acquisition is not possible or desirable — such as in cross-border situations or when there are financial limitations. 4. Acquisition/Equity stake: Critical; very high value. Source: Rudzki, R. A. (2004) In the traditional approach of transactional relations, negotiations revolve around price, terms, delivery and other issues related to the process of ordering. In strategic partnership, other terms are taken into consideration. Aside from the usual term, the will include such items as “levels of risk and reward sharing, managerial sharing, levels of contribution, balancing cultural differences, and methods of solving conflict resolution” (Rudkzi, 2004) In the traditional approach of purchasing, there are only two levels of personalities involved, that of the purchasing and the salesperson. On the strategic partnership, there are many more levels involved in all level, and at the highest level, such as big transactions, the chief executive are involved. Sometimes, the whole team of supplier’s management comes for interplay of transactions. On big transactions, the salesperson to purchasing alone does not work. Question 1, Part 2 The Recommendation and Description in which Relationship Type as a Buyer I would seek to apply Cost Transparency with Supplier In introducing the open book policy with supplier, there are certain limitations that must be observed. For example, supplier should not be obliged to reveal the entire business. Supplier should only reveal costs to the particular transaction, and CIPS suggests that a confidentiality of information be agreed upon. Contracts belonging to this arrangement may be short term or long term but should be done only if it has quantifiable benefit to the organization. Arrangements in the supply chain process and open cost management should be done by purchasing and management professionals of the company as this reflects policies of both organizations. Both buyer and supplier must be comfortable in the transaction and work together. This means both agrees on the information stated in the transaction. Buyer and supplier have to work on the costing, price of the commodity and details of the ordering process and any changes that would be needed. Supplier positioning. One of the duties of the Buyer in a company is to establish partner relations with suppliers. Buyer has to examine the suppliers products, evaluate their market share through their turnover, and investigate their organization. The data gathered through this investigation will help on the evaluation of the capability and reliability of the supplier to provide buyer a long term partner relationship in trade. Tactical Profit, strategic cost and transparency. Tactical profit and strategic costing could be arrived at with computations of fixed and variable cost to arrive at a break even point. Transparency of transaction could be achieved when both supplier and buyer sit down and discuss costs and expenses and both parties agree on the allowable margin of profit and come up with a strategic costing of the service or product. Question 2, Part 1 Three issues to make the organization attractive to suppliers Organizations ascribing to enter into partnering should provide incentives to attract suppliers. What are these incentives? This may include added value on the transactions that will be beneficial to supplier, such as long term contract, volume ordering, reduction in production costs and recognized margin of profit. Under the open book management, arrangements may vary and will depend on the length of the contract (short or long tem and the nature of the service.) Partnering gives advantages to buyer and seller It allows monitoring of performance; it gives due consideration to costing, provides discussions for developmental stages, and other considerations needed to carry on the project or services; and both parties are assured that cost and expenses for carrying on the project is agreed upon so that gains are measured suitably. (Williams, Ians) By maintaining transparency thru open book policy, buyer is confident that pricing is beneficial to both parties. Supplier will have greater advantages thru constant innovation when all parties look at ways to cut costs and share savings. Partnering allows suppliers to have focus on expenditures and forecasting, thus gaining improved budgetary control and reduction of administration cost. (Ian Williams) Question 2, Part 2 The three issues that can make our organization unattractive to suppliers are: Open Book approach is an innovation in the purchasing methods, and many suppliers are not willing to participate because of confidentiality of business. There are situations wherein suppliers are reluctant to develop partnering relation to a buyer company. First, when supplier perceived buyer to be an unimportant client in the marketplace as compared to those companies who do not care for partner relations. (CIPS) Second, when supplier does not feel comfortable with the arrangement, because some suppliers do not like their practice to be scrutinized. In this case, trust relationship has not been developed yet in buyer-supplier relation. Trust is one of the basic business ethics that has to be developed in the supplier-buyer relationship in partnering arrangement. Trust level of relationship takes time to develop and there are times suppliers shy away from this type of business transaction. Next thing is pricing. Suppliers feel that prices will be locked up and will drive prices up when expenditure is tightly controlled. In other way, suppliers cannot increase their prices when there is a need to because of the agreement. (Williams, I.) Third, the consideration of size and power of an organization.(CIPS) CIPs says that it is more easier to make partnering agreements when the balance of power in the transaction is more or less equal. Ways to reduce the impact they have upon the organization There are ways to reduce the negative impact of open book management upon the organization. First is to make the package attractive to suppliers, and then second, get the people in the organization understand the financials necessary in tracking business performance. To make partnering arrangement attractive to supplier, the organization should make the benefits of partnering more attractive than the traditional approach of purchasing. The arrangement should provide substantial benefits for both parties involved Dr. Carl Frahme, in his study on Open Book Management, said that “that it is a way of running a company that gets everyone to focus on helping the business make money.” Employees, Dr. Frahme said, would learn that it is part of their job to move financial numbers in the right direction and that they have something in stake to make the company succeed. Thus purchasing people should be trained to understand costs and expenses in order to be ready for negotiations. Question 3, Part 1 The concept of Break-Even Analysis i Break-even analysis is defined as “the study of the relationship between fixed costs, variable costs and revenue to determine the point at which total costs equal total revenue (that is, no profit, no loss), so that any further revenue will represent profit.” (Carew,Edna) Break-even analysis depends on the following variables Selling Price per Unit:The amount of money charged to the customer for each unit of a product or service. Total Fixed Costs: The sum of all costs required to produce the unit of a product. This amount does not vary as production increases or decreases, until new capital expenditures are needed. Variable Unit Cost: Costs that vary directly with the production of one additional unit. Total Variable Cost The product of expected unit sales and variable unit cost, i.e., expected unit sales times the variable unit cost. Forecasted Net Profit: Total revenue minus total cost. Enter Zero (0) if you wish to find out the number of units that must be sold in order to produce a profit of zero (but will recover all associated costs) Each of these variables is interdependent on the break-even point analysis. If any of the variables changes, the results may change. Total Cost: The sum of the fixed cost and total variable cost for any given level of production, i.e., fixed cost plus total variable cost. Total Revenue: The product of forecasted unit sales and unit price, i.e., forecasted unit sales times unit price. Source: Dr. Arsham Hossein. Break-even analysis helps managers to set price levels and adjust to its sensitivity; to target the best pricing based on the combinations of the variables and fixed cost and to determine different strategies that would provide financial advantages to the company (Dr. Arsham Hossein). The formula for arriving at the break-even point and graphic analysis are shown below: Q = FC / (UP - VC) where: Q = Break-even Point, i.e., Units of production (Q), FC = Fixed Costs, VC = Variable Costs per Unit UP = Unit Price Therefore, Break-Even Point Q = Fixed Cost / (Unit Price - Variable Unit Cost) Source: Dr. Hossein Arsham In relating this to actual operations, let us make the following assumptions Break-Even Analysis Selling price per unit: 1.5 Total fixed cost 600 Variable cost per unit 0.5 Forecasted net profit 0 Managerial information at break even point Units sold 600 Revenue $900 Fixed cost $600 Variable cost $300 Total Costs $900 Profit/loss 0 Source: Dr. Hossein Arshran To find the break even point Interest rate or taxes 0.1 Total fixed cost $600 Variable cost per unit $0.5 Selling price per unit $1.5 Break even point 916.75 Source: Dr. Hossein Arsham Question 3, Part 2 The Information to be used within a negotiation if we assume that we had calculated a Supplier's Break-Even point prior to a negotiation Assuming that the supplier has arrived at a break even point prior to negotiation with the buyer, following information that would be relevant in the negotiations, among others is competitors’ pricing and positioning in the market. It would be important to discuss in the negotiating table the comparative prices of the competitors to determine if both parties will derive an advantage in the transaction. Knowing the supplier’s break even point will allow negotiations on the elasticity of demand and supply and various points of pricing that could work competitively and acceptable to both parties. Partnering arrangement will be attractive only if it adds value to the contracting parties. Advantages are important issues that have to be spelled out, so that no one would be charged to taking advantage of one’s position. This is where the concept of size and power takes place wherein no party should be disadvantaged in the transactions. Question 3. Conclusions and recommendations Partner arrangement may not be suitable for all conditions particularly in highly competitive market, for example commodity supplies, where prices fluctuate with supply and demand. In this case, both parties will be at disadvantaged points and would rather not enter into an agreement. Partner arrangement work best under the instances cited by CIS Examples include supply of hotel services, services and works contracts, supply of critical items for manufacturing and various construction projects which require long term services and contracts. Partnering in this aspect is shown as critical in supporting the buyer’s business. Use of analysis to support discussion / conclusions / recommendation. Recognition of applicability of ideas to employer or context set. Partnering and adopting open book policy has been found to be acceptable to 184 executives surveyed coming from Europe, North America and the Asia-Pacific region. James A. Cookie (01 April 2005) reports the result of study done by Accenture, a consulting company, on companies reining in supply chain costs which showed that there has been an increase of overall product availability from 87 percent to 90 percent between 2001 and 2003. This report also said that the assurance of a potent supply of materials when they are needed has direct influence on the cost and revenue of firms. This report also showed that during the same period that the “average supply chain cost has decreased slightly from 102. percent of sales to 9.8 percent. Executives viewed that collaboration showed significant levels of saving opportunity and cuts down expenses. Other significant findings of this study showed that organizational barriers were some of the key implementing barriers in collaborative practices. With regards to inventories, executives found it as among the best alternative to improve availability of supply without undermining turns or inflating inventories, says the report. “Utilizing collaborative practices can drive down costs across the supply chain. Companies that master this capability have an opportunity to create competitive advantage.” Presentation of a balanced viewpoint. What works well and what doesn’t? Not all partnering are successful. This has been pointed out by Robert Rudzki. in his report that in mid-1990, that The Conference Board said that as many as 40 percent of partnerships have failed. The failures were attributed to power, difference in company culture, mistrust and fear of over dependence to supplier which are all human factors. These failures also account to factors related to “partner selection” and “partnership implementation”. (Rudzki) Customers also cited lack of trust to supplier, such that there will be more risks than benefits, and fears that a relationship will mean relinquishing control.On the part of the supplier there is fear that scrutiny of their costs and expenses is open to manipulation by buyer. Their bargaining position on pricing will be lessened as there is transparency on working on costs. Here, it seems the burden of information lies on the supplier. Both buyer and seller are locked up in price positioning after agreement has been settled, and should there be changes due to fluctuations, another negotiation has to be done. There are also internal and external factors to reckon with as these affects partner relations. Poor leadership and changing climates have been cited for failure of partner selection It will take a lot of effort and hard work of trust building for employee participation and particularly to the supplier relation. On the part of the employees, knowing the financials is part of educating employees so they understand their contribution to the bottom line, involving them in decisions, and making them responsible to the areas of their operation. Julian Hunt of Grocer, in his article on Sept. 2002, explained that the theory behind the concept of strategic partnership seems reasonable as suppliers work with buyer in looking at the cost of production and identifying ways in which it can be lessened to work for their own benefit. However, Hunt says there are suppliers who are not at all comfortable in this set up, such as in a situation wherein your biggest customer asks you to open up your books for scrutiny of cost structure. He said that this is the predicament of suppliers of Salisbury, one of the largest food retailers who are implementing this strategy. Relative to this, Grocer reported result of their poll survey wherein senior executives in grocery manufacturing industry expressed concerns in the moves of multiple companies to implement open book strategies. (Sept. 7, 2002) This survey said that only half of the panel surveyed approved of this strategy. Hunt says suppliers are not at all comfortable in this set up, such as in a situation wherein your biggest customer asks you to open up your books for scrutiny of cost structure. He said that this is the predicament of suppliers of Salisbury, one of the largest food retailers who are implementing this strategy. Relative to this, Hunt reported result of their poll survey wherein senior executives in grocery manufacturing industry expressed concerns in the moves of multiple companies to implement open book strategies. (Sept. 7, 2002) This survey said that only half of the panel surveyed approved of this strategy, and would cooperate only to a certain point of exposure. (Hunt) Question 4, Part 1 To Evaluate and Assess the Statement 'Purchasing people are the last people that sales professionals approach when they are looking for business from a company' I will disagree with the statement, as in large companies, requirements for materials and services are directed to the Supply and Purchasing people. This is discussed with suppliers who want to supply or bid on the project. Suppliers expressed their intention through formalized process of bidding or arrangement. Generally, purchasing people are given the authority by management to assess the capability of suppliers, both technically and financially to supply the organizations’ requirement. This is done by accreditation of suppliers wherein careful investigation is done by purchasing management. In the traditional selection of suppliers and transactions only the sales and purchasing persons are involved and only recently that other levels of people in the business have been involved. The Impact on our Organization In a company set using open book policy, it is the duty of supply and purchasing professionals to determine the services and works suitable for a partnering arrangement. CIS says that it is also the function of this department “to work cross-functionally with colleagues in identifying suitable suppliers to become the company’s partner.” This means as professionals in the field, they have an access to information on reliable suppliers that would suit their purpose. Failure in the future of partner relations would be blamed on the purchasing professionals who did the selection. Impact of an open book policy An open book management is intended to attain efficiency in the operation and to maximize benefits for the organization. This policy hopes to provide the confidence in each other’s commitment to share general business information, including cost information. Question 4, Part 3 My Recommendations in which I make as a Purchasing director concerning this issues are: Partnering arrangements has been successfully done in many approaches in business, both long term and short duration. In studies reviewed, this type of approach cuts down administrative costs, reduce anxiety on inventory and availability of materials when they are needed by manufacturer. Purchasing management has a long list of accredited suppliers, and it entail a lot of effort, time, and administrative cost to do transactional purchasing, much more if it is a big company who has varied activities. An established procedure and structured agreement with a well selected supplier could benefit the company under this set up. As Purchasing Director of the company, I would base my recommendation on a partnering arrangement with suppliers who could give additional advantages such as services, over and above the usual supply and delivery of goods. As such, partnering arrangements are most likely solutions when there are value added strategies in the transaction that would benefit both parties. List of references Arsham, Hossein, Dr. Break-even analysis. Weatherhead School of Management. [on line] Available from http://home.ubalt.edu/ntsbarsh/Business-stat/otherapplets/BreakEven.html. Retrieved 13 Jan. 2009. Carew, Edna. Break-Even Analysis. The Language of Money. Financial Dictionary [on line] Available from Retrieved 13 Jan. 2009. CIPS. Partnering. ]on line] Available from Retrieved 13 Jan. 2009 Cooke, James A. 01 April 2005. Study finds companies reining in supply chain costs, Logistics Management Publication [on line] Available from < http://www.allbusiness.com/company-activities-management/operations-supply> Retrieved 14 Jan. 2009. Frahme, Carl E, Ph.d. Open Book Management, Our Perspective. [on line] Available from Retrieved 13 Jan. 2009. Hunt, Julian 1 Sept. 2002. Pandora’s book open.High Beam Researh.Grocer [on line] Available from Retrieved 13 Jan. 2009 INC. Open Book Management [on line] Available from Retrieved 13 Jan. 2008 Rudzki, Robert A. 01 March 2004. The advantages of partnering well. Supply Chain Managemen Review [ on line] Available from Read More