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11.1 Deere Cost Management

SCM355: Choi F 9:00-11:45
by

Hudson Ramirez

on 19 October 2012

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Transcript of 11.1 Deere Cost Management

Cost Management Kyle Guthrie
Joey Ramirez Review the Case
Analysis of the Case
Key Issues
Discussion Questions
Solutions
Questions Overview Bryce Rood
John Taylor Better known as John Deere
Iconic Brand Recognition
Manufacturers and Distributes Agricultural Equipment
Also to lesser degree construction, forestry, commercial, and consumer equipment
Operates in 160 countries
Annual sales estimated to be $14 Billion About Deere & Co. Popular product sold by agricultural division
Conveyor System Component
Carries materials from point to point
Includes:
11.6 lbs of steel
46 pins (used to join links)
Estimated 20% scrap rate for steel The Gatherer Chain Standardized Product
Leverage/Commodity
Easy Replacement Parts
Sold Through Dealer Network
Component is purchased from Saunders Manufacturing
A long-term supplier The Gatherer Chain (con't) Saunders Manufacturing Located in Decatur, Illinois
3 hours from Moline, IL
John Deere's operation base
Steady Growth
Employs around 300 people
Family owned and operated
Owner Wayne Saunders
Tough, and Successful Business man
"Take it or Leave" approach Aftermarket Price:

Purchase Cost:

Cost-price ratio:

Unit Sales: Profitability Analysis Year 1 Year 2 Year 3 $40.00 $36.25 $30.00 $21.25 $22.61 $24.12 53% 62% 80% 475,000 410,000 350,000 Deere & Co. had been experiencing an increasingly negative inverse relationship regarding the purchase price of the gatherer chains, and the number of chains purchased. The Problem In a 3 year span:
The value of the final product has decreased by 25%
From $40 to $30 aftermarket price
Sales margins have decreased from 47% to 20%
Unit sales have gone from 475k to 350k
Yet, Saunders maintains the roughly the same amount of revenue Analysis $28 for 100 pounds of steel = $.28/pound
- 11.6 lbs. + 2.32 lbs. (20% scrap rate)=13.92

$.28x13.92 lbs.=$3.90
- $.035/ pin, requires 46 pins
- $.035x46 pins=$1.61

- $3.90+$1.61=$5.51 for materials/unit Saunders Estimated Cost -Annual Survey of Manufacturers:42% material
- $5.51x(1/.42)=$13.12 total cost/unit
- direct labor: $1.71
- indirect labor: $.79
- overhead: $2.62 Cost Con't A more accurate picture of Saunders cost of materials.
Does percentage breakdown Match industries?
Without knowing cost breakdown finding cost saving opportunities is difficult Incomplete Data Where can this crucial info be found? Saunders is most reliable place for accurate info
They have been unwilling to share any info
Other Sources:
Competitors in Industry
Saunders' Suppliers
Qualcomm Example - Estimated cost-price ratio:
- $13.12/$24.12= 54%
- Profit Margin of 46%
- Reasonable to negotiate the cost-price ratio to 67% ((54%+80%)/2)
- Price sold to Deere: .67x$30=$20.10
- Equaling a difference of $1,407,000 from the current budget. Saunders Profit Margin - If the scrap rate is reduced to 10% it would lead to $5.18 materials/unit and a savings of $.33/ unit.
- 11.6lbs+(11.6x.10)=12.76x$.28=$3.57
- $3.57+$1.61 (pins)=$5.18
- Lowers the total cost per unit for Saunders to $12.33 from $13.12.
- $5.18x(1/.42)=$12.33 Potential Cost Savings - If the same ratio from offered price to total cost is used for the lower cost, then the price for Deere would be lowered to $22.67.
- $24.12/$13.12=1.838
- 1.838x$12.33=$22.67
This would equal a savings of $507,500 under the current budget. Potential Cost Savings (con't) Saunders has been reliable.
Possible risks associated with developing a new supplier.
No other suppliers can beat the current price.
Harming Deere’s relationship with Saunders.
We are currently benchmarking – competitor’s prices have been lowering as well. Best Case Scenario: Keep Supplier Develop Specific Objectives
Return to a 50-50 cost-price ratio
Gain price information from Saunders
Gather Pertinent Data
Determine the Facts
Saunders cost structure, including percentage breakdown of costs.
Determining the Issues
Unbalanced cost-price ratio
Saunders hiding important cost information Negotiation Prep With Saunders There’s nothing to lose.
Helping Saunders to find new, cheaper suppliers.
Help to lower the scrap rate.
More Skilled Employees
Introduce general-purpose equipment for the manufacturing and assembly process.
Develop a written contract pertaining to these agreements.
Be Transparent. Look at each others cost-structures
Express the benefits of sharing information between the two companies Negotiation Considerations 1) What do you think is a fair price to pay Saunders for the gatherer chain?
2) Do you think Wayne Saunders would be prepared to negotiate pricing? What would you say to him?
3) Do we have enough information to estimate Saunders’ costs? What other data do you want and where would you get it?
4) What is an acceptable profit margin for Saunders for the gatherer chain?
5) Why not just develop a new supplier rather than negotiate with Saunders? Discussion Questions Questions 1: What do you think is a fair price to pay Saunders for the gatherer chain? The target price Deere would like to obtain is $15. That would result in a 50-50 cost/price ratio. A fair price would be $20.10. This would be sufficient for both parties. It allows for both parties to have an ample profit. Saunders does not want to lose Deere as a client. Answer: Question 2: Do you think Wayne Saunders would be prepared to negotiate pricing? What would you say to him? Wayne Saunders should be ready to negotiate with one of his biggest clients. There needs to be more transparency on both sides. They need to communicate their cost structures in order for both companies to succeed. Deere should help Saunders find cheaper suppliers of raw materials and increase productivity by reducing the scrap rate. Answer: Question 3: Do we have enough information to estimate Saunders’ costs? What other data do you want and where would you get it? While the sata will not be exact, we do have enough info to make sufficient estimates.


$5.51 of materials/unit
$13.12 total cost/unit

Find more exact costs of materials
Saunders is purchasing; their suppliers Answer: Question 4: What is an acceptable profit margin for Saunders for the gatherer chain? To meet them halfway between the two cost-price ratios, which would come to 67%, or a profit margin of 33% for Saunders. Answer: Why not just develop a new supplier rather than negotiate with Saunders? Question 5: Saunders has been a good supplier. Even though price has been an issue, we don't want to risk sacrificing quality or our relationship with Saunders. Additionally, the cost-price ratio and unit sales over the past two years suggests that the issue lies in the market's demand, not necessarily in the purchase cost. We also believe that we can introduce cost-cutting techniques to Saunders in order to ultimately lower Deere's costs. Answer: Questions?


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