N287E - Advanced Financial Management Cost Management Strategies

Cost Management Public vs. Private Sector

Public Sector
Custodians of Public Funds Must Provide Open Access to Business Opportunities Must Establish Cost Reasonableness for each Decision Value Propositions can only be evaluated using Cost Per Quality Point Analysis

Private Sector
Primary Fiduciary Responsibility is to Shareholders Cost Management is Focused on Bottom Line Strategic Alliances and Supply Chain Management Value Propositions evaluated using Best Value Analysis

Cost Consequence Accountability

Public Sector
Delegations of Authority Discretion Limited by Policy Balancing Mandates Against Available Funding Deficit Spending

Private Sector
Corporate Business Plan Risk and Incentives often Drive Policy Performance is Driven by the Bottom Line Risk and Profitability Drive Spending

Cost Containment Strategies

Limit Access to Sources Pre-Authorization vs. Post-Audit Ensure Accurate Contract Administration Process Re-Engineering Mutual Gains Incentives (Partnerships) Risk Mgmt vs. Risk Defense/Aversion

Leveraged Purchasing
Commit Total Spend in Exchange for Deep Long-Term Discounts (Commitments Contract) Seek Standardization Adjust Requirements to Create a Market Integrate Order-Delivery-Payment Systems Jointly Attack Other Cost Drivers

Impacts of Integrated Financial Systems

Upside Minimize Multiple Databases Apples to Apples Eliminate the Back Room Downside Pushes Central Functions to Frontline Need to Re-engineer Processes If you cant ask for it right, you cant get it.

E-Commerce Issues
Cost Back-Filling the Requisition Function Matching Rules, Tolerances, & Returns The Need for EDI Content Management Keeping Up with Innovation

Return on Capital Employed

Return on Capital Employed

=
Net Income Capital Employed

=
Revenue

=
Total Expenses Working Capital

=
Cost of Goods Sold

Fixed Assets

Other Expenses

=
Accounts Receivable

=
Overhead

Inventory

Accounts Payable

Materials

Return on Capital Employed

Return on Capital Employed 10%

=
Net Income To Increase By $1M Capital Employed $10M

=
Revenue $15M Either Increase By $1M Cost of Goods Sold $9M

=
Total Expenses $14M Or Decrease By $1M Working Capital $1M

= +
Other Expenses $5M

Fixed Assets $9M

=
Accounts Receivable $3M

=
Overhead $2M

Inventory $2M

Materials $7M

Accounts Payable $4M

Return on Capital Employed

Return on Capital Employed 10%

=
Net Income To Increase By $1M Capital Employed $10M

=
Revenue $15M Either Increase By $1M Cost of Goods Sold $9M

=
Total Expenses $14M Or Decrease By $1M Working Capital $1M

= +
Other Expenses $5M

Fixed Assets $9M

=
Accounts Receivable $3M

=
Overhead $2M

Inventory $2M

Materials $7M

Accounts Payable $4M

Return on Capital Employed

Return on Capital Employed 10%

=
Net Income To Increase By $1M Capital Employed $10M

=
Revenue $15M Either Increase By $1M Cost of Goods Sold $9M

=
Total Expenses $14M Or Decrease By $1M Working Capital $1M

= +
Other Expenses $5M

Fixed Assets $9M

= +
Inventory $2M

=
Overhead $2M

Materials $7M

Accounts Receivable $3M

Accounts Payable $4M

ROCE Example
Labor $700,000
Operating Cost Elements

Sales $5,000,000
Minus

Materials $2,300,000

Cost of Goods Sold $3,800,000

Plus

Net Income $400,000

Divided By

Profit Margin

8%

Overhead $800,000

Other Costs $800,000

Sales $5,000,000

Multiply

Return On Investment 10%

Inventories

$500,000
Accounts Receivable $300,000 Cash $300,000 Current Assets $1,100,000
Plus

Sales $5,000,000
Divided By

Assets

Total Assets $4,000,000

Asset Turnover Rate 1.25

Fixed Assets $2,900,000

Impact from 5% Price Reduction

Labor $700,000
Operating Cost Elements

Sales $5,000,000
Minus

Net Income

Materials

-5% $2,185,000
Overhead $800,000

Cost of Goods Sold

$515,000
Divided By

$3,685,000
Plus

Profit Margin

10.3%

Other Costs $800,000

Sales $5,000,000

Multiply

Return On Investment

Inventories 5%

13%
Sales $5,000,000 Current Assets

$475,000
Accounts Receivable $300,000 Cash $300,000

$1,075,000
Plus

Divided By

Assets

Total Assets

Asset Turnover Rate

$3,975,000
Fixed Assets $2,900,000

1.26

What is strategic sourcing?

Strategic Sourcing

A systematic process to reduce the total cost of purchased products and services by fully leveraging the Universitys combined purchasing power, without compromising quality or service. Up to 41 Business Units 10 Campuses 5 Medical Centers 3 National Laboratories 23 California State Universities

Total Cost Approach Achieve Best Value

Tip of the Iceberg
Purchase Price

Total Cost
Transaction / Admin Cost
Delivery, Freight, Handling, Set-Up Implementation Cost Communication/Marketing Training Cost of Non-Conformance (Quality) Maintenance, Warranty, Parts

Yield, Useful Life, Consumables

Inventory, Shelf-life, Waste Disposal, Scrap Risk, Liability

Strategic Sourcing Process

Traditional Purchasing
Focus on tasks Function isolated Reactive Insular, static Unit price based Adversarial supplier relationship Win/lose Corrective Measures Undefined standards Lowest price - price driven

Strategic Sourcing
Focus on process performance
Alignment with stakeholders Proactive Total cost framework

Diverse sourcing strategies

Create collaboration, trust Suppliers as a key resource Preventive measures

Fit for purpose

Value driven (e.g. lowest cost per quality point)

Strategic Sourcing is a process rather than a series of activities

Strategic Sourcing Methodology

This must be a joint effort between purchasing departments across the UC system and our internal stakeholders
Project Plan and Scope determined Resource Commitment Obtained (people, dollars, etc..) Kick-Off Meeting Conducted Team members identified Stakeholder Requirement sessions conducted Existing contracts summary produced Requirements weighting sessions conducted UC requirements published Sourcing strategy developed and communicated User adoption strategy and implementation plan developed Initial cost/benefit analysis developed Negotiation strategy document developed Meetings/Negotiations with finalists Agreements signed

Launch Sourcing Team

Develop Spend Analysis

Determine UC Requirements

Conduct Market Analysis

Develop Category Strategy

Evaluate & Select Suppliers

Negotiate Agreements

Implement Solution and begin SRM

Analyze total spend by Category and Location and determine percent that is sourceable Document historical purchases Develop current TCO for each Location Quick Hits identified

Complete pre-bid industry analysis RFI developed / distributed (if needed) Supplier responses to RFI evaluated Final market analysis published

RFP developed / distributed RFP responses evaluated and scored Short list of finalists selected

Implementation team assigned Implementation plan finalized Implementation completed Ongoing SRM plan created and implemented

Strategic Sourcing Opportunity

University of California
$7.0 Billion paid invoices $2.5 Billion construction $4.5 Billion of opportunities

$100 Million Commodities

Office Equipment and Supplies Laboratory Supplies IT Hardware / Software

Strategic Sourcing Goals

Maintain or increase product and service quality Leverage UC buying power through strategic alliances Create more efficient procurement processes Educate the UC community Determine the appropriate product distribution system Demonstrate significant on-going cost savings Meet our service and community standards
(Sustainability, Small/Disadvantaged businesses, etc.)

Channeling
VWR Implementation YTD January to July 2005
Campus Berkeley Los Angeles San Diego YTD 2005 $ 581,295 $1,628,382 $ 993,908 YTD 2004 $ 418,962 $1,088,067 $ 723,884 % 38.7% 49.7% 37.3%

Average Growth: 41.9%

San Francisco $ 891,566 $ 783,345 13.8%

Automate Payment
UCSF processes ~ million vouchers
Federal Express: 27,815 Arrowhead: 6,256 Verizon: 8,983

ROCE Example
Labor $700,000
Operating Cost Elements

Sales $5,000,000
Minus

Materials $2,300,000

Cost of Goods Sold $3,800,000

Plus

Net Income $400,000

Divided By

Profit Margin

8%

Overhead $800,000

Other Costs $800,000

Sales $5,000,000

Multiply

Return On Investment 10%

Inventories

$500,000
Accounts Receivable $300,000 Cash $300,000 Current Assets $1,100,000
Plus

Sales $5,000,000
Divided By

Assets

Total Assets $4,000,000

Asset Turnover Rate 1.25

Fixed Assets $2,900,000