Quoting has never been a seamless process. The idea is simple: The sales team provides the customer with a quote based on information produced by a neutral accountant’s analysis of costs and the markup necessary to achieve target profit margins. Manufacturing then executes on this information. However, the fishbone diagram of problems that can arise from this “simple” process would make a porcupine jealous. They may include sales people pursuing commissions and bonuses; accountants applying rigid standard costs and incomprehensible overhead; and manufacturing stuck with getting the job done and somehow taking the blame if it isn’t profitable.
There are many reasons why quoting may be complex, and some may defy universal resolution, such as the involvement of senior management or owners in customer relationships. One significant reason why quoting is often challenging, however, is because there is an absence of financial facts and data that have clear causal ties to the underlying economics of the transaction. Improving this element of information and making it consistently available and visible to everyone in the quoting process can eliminate a great deal of confusion and contentious discussion.
How can improvements be made?
First: Recognize that traditional product costing is a simplified financial model intended to create an inventory value for external financial statement, not a detailed causal depiction of resources and manufacturing processes. Traditional product cost only captures manufacturing costs, and these are normally distorted by labor-based costing, overhead allocations and many other issues. Broader organizational costs such as R&D, product engineering, selling and marketing, collection and finance, distribution, and so on are not even considered. Additionally, few companies have good customer costing to capture customer unique requirements, which can be a significant cost factor.
Second: Target improvements into manageable steps. It makes sense to start with manufacturing—which has the most direct and unambiguous costs—and perhaps with closely related activities like product design and engineering for highly customizable products. Generally, manufacturing has better operational data on its resources and processes than other parts of the organization.
The key to an effective quoting system is the same for any advanced managerial costing system. You must trace costs in a cause and effect manner from a resource to its output at an appropriately discrete level, and handle any non-causal costs without creating distortion. (Note: “Managerial costing” is costing done purely to support internal management decisions rather than for regulated financial reporting.) The only way to achieve this is to first build an operational model, and then design and collect cost information to match the flow of resources in the manufacturing processes.
This also enables feature-based quoting. Achieving this requires tracking fixed and proportional resource inputs to features both for direct resource inputs and for supporting resources. Overhead pools won’t work for costing as discrete as this. Support resources and processes must be causally modeled. The ability to rapidly and systematically apply incremental and marginal costs is critical and can only be achieved by understanding the fixed and proportional nature of resource inputs at a discrete level. This type of costing differentiates the cost of features, such as the number of holes or the number of support brackets requested. It significantly simplifies quoting, and reduces the back and forth between sales and manufacturing about what can and cannot be done. It further avoids unworkable “wish list” orders from sales reps unfamiliar with the intricacies of the manufacturing process.
Naturally not all features are manufacturing issues. Some relate to design, engineering, sales, marketing or delivery. Adopting an advanced managerial costing system can achieve these quoting objectives, and provide great insights into product, customer and channel profitability, which can be then used to develop new competitive strategies.
>>Larry White, CMA, CFM, CPA, CGFM, email@example.com, is executive director of the Resource Consumption Accounting Institute, which trains and advocates for improved cost information connecting operations to business performance.