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You know the cost, but what about the “should cost”?

By toby nichols, PA financial services expert

Managing the cost of manufacture is of vital importance across sectors, from automotive and industrials to consumer products and healthcare. Yet, many companies find it hard to effectively manage the cost of materials and manufacturing processes. This presents an opportunity for Private Equity to release significant cost savings from their portfolio companies, even those with mature operations.

While they often understand the cost of the effective components in their products – for that’s where they make their money – other parts can be a mystery, or ignored entirely.

This presents tremendous opportunity for those willing to consider the cost of casings, standard electronic components and sub-assemblies, right down to the raw materials in their products, devices and manufacturing processes.

So what does it entail?

Disassembling products – the “tear-down” – means that you can analyse each component, assembly and sub-assembly and compare the actual bill of materials against a “should-cost” view of the product.

Armed with this information businesses can renegotiate procurement contracts in full view of the deal they’re getting from suppliers. No longer will suppliers have control over price setting! We’ve seen that this typically allows businesses to achieve a 10-15% cost reduction.

But this can go further than being simply a procurement exercise. By reviewing product needs against the materials used businesses can identify areas of over-design and unnecessary spend. Creating even more opportunity to reduce costs – potentially up to 20-35%.

We recently worked with a leading manufacturer of pump-based medical devices and were able to identify where their assembly was 34% over-priced and help them re-negotiate back to the "should cost" price to release $2m p.a. cost savings. 

For Private Equity this kind of review is particularly important as the savings can be achieved without disruption to the business or wider operations, and are directly cash generating. There’s also greater investment value once an exit multiple is applied. And who would argue with that?

 

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