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For many managers, it is difficult to implement
cost-saving plans because of the requirement to invest in new
capital equipment, be it a copier or a car. Especially during
these recession-weary times, most management teams are looking
at sales, not support. It is incumbent upon you to make your
case on the basis of benefits, not features, for the firm. The
best way to accomplish this benefit proposal is to determine
alternate equipment expenses and to explicitly state the
economic results gained by implementing the alternative. Be
certain that your replacement technology has a productivity
and cost advantage, and compare the current environment to
your proposed one, using the lifetime cost of both
environments. Clearly spell out hard dollar results.
I had an event where I compared the cost of maintaining a
five year-old, IBM copier to the replacement and maintenance
cost of an equally featured replacement. On first blush, one
would think it better to stay with what you've got. Wrong! It
cost far less to pay for a new machine, supplies and
maintenance than to put the owned unit into service. When
you have those numbers, compare the savings to the bottom
line. A worksheet I find helpful is shown below. Included are
several possible costs you may face, when buying capital
equipment, that may not be apparent during your cost-gathering
efforts. You should use a similar worksheet when pricing the
TOTAL COST (also known as LIFE COST) of a product, and be sure
to get a written affirmation from the vendor that ALL costs
are included. In this worksheet, I consider the cost of funds,
known as the Present Value of Funds (PVF). (This PVF was based
upon the 10 year U.S. Treasury Bond rate - April 1991) Be
certain to subtract your warranty from the first year's
maintenance cost. In this example, a ninety-day warranty was
included in the purchase price. I multiplied a one-year
maintenance cost by .75 to get my first year's cost.
I added installation, training and labor descriptions in
this worksheet, as vendors have a habit of leaving some costs
out of a cost analysis until after you have made the purchase
commitment. Salespersons know that it is highly unlikely that
you will reverse a decision to purchase, in spite the cropping
up of forgotten and/or hidden costs, as the purchase reversal
competes with either ego or unwanted attention from
supervisors.
LIFE CYCLE COST ANALYSIS - ELECTRONIC-THING-YOU-PLUG-IN
Unit Cost: $14,500 7 year life
Year Year
Year Year
Year Year
Year Year
0
1
2
3
4
5
6
7
Maintenance
$1,088 $1,450 $1,450
$1,450 $1,450 $1,450
$1,450 $1,450
INSTALLATION
wiring
software
custom software
electrical
DEINSTALLATION
ENVIRONMENTAL OR
OTHER DISPOSAL COSTS
TRAINING
users X turnover
LABOR
specialists
DELIVERY
Total Cost
$15,938 $1,450
$1,450 $1,450
$1,450 $1,450
$1,450 $1,450
at 8% PVF
1
0.9259 0.8573
0.7938 0.7350
0.6806 0.6302 0.5835
$15,938 $1,343
$1,243 $1,151
$1,066 $ 987
$ 914 $ 846
Total Present Value Cost: $23,488 minus any salvage value,
plus any costs that are added in the areas labeled above, such
as installation, labor, etc.
Be certain to get, in writing, a statement from a prospective
vendor that all known costs have been included AND that the
vendor will not charge you for the difference. Of course, you
will have to allow for unforeseen events, acts of God & so
forth.
Savings in Relation to Profits
There are two ways to increase a firm's profit. You can either
increase prices or reduce costs. Needless to say, there is a
great deal of competition in almost every business segment,
and both price and sales increases are out of the question,
because fierce competition has kept prices down and the
recession will keep sales growth near zero.
The solution is
simple: A percentage increase of cost savings, through a
strategic purchase, offers a percentage increase in profit, in
inverse proportion of the multiple factor that the cost of
sales bears to profit. If the cost of sales is ten times
profit, and cost is reduced 1%, an increase in profit of ten
percent is realized.
Original Changed
Environment Environment
SALES = $11 SALES = $11
C.O.S. = $10 C.O.S. = $ 9.90 (1% cost reduction)
Profit = $ 1 Profit = $ 1.10
$1/$10 = 10% $1.10/$1.00 = 10% RISK FREE increase in profit
In your cost justification, you must relate the departmental
savings of your plan to that of an increase in sales. For
example, upon examination of your firm's annual report, you
will find SALES, COST OF SALES, and PROFIT. Assuming that your
capital equipment purchase will save $20,000 of annual
departmental expenses, use the following format:
Sales................$1,000,000.00
Cost of Sales......$900,000.00
Profit...................$100,000.00 or 10%
Your solution would be the equivalent of a $200,000 sales
increase with much less risk than the selling effort.
Profit...............$120,000.00 or 10% ($100,000 + your
$20,000)
Sales............$1,200,000.00 (Sales = 10 X Profits)
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