Product Cost Models — An Introduction

This weekend, I'd like to welcome Eric Hiller back to Spend Matters. Eric, who is founder and Chief Product Officer at aPriori, will be contributing a series of guest weekend posts on the subject of driving Spend Management upstream. And this is the third installment. Please join in welcoming Eric to Spend Matters!

Cost Models are the engine of Enterprise Cost Management and absolutely essential for its success. Where I work, Cost Models are what we live and breathe, and they are the subject of many passionate and heated discussions. Now, you might think I am getting awfully excited about something as seemingly dull as Cost Models, but let me see if I can convince you of the value of this topic over the next series of posts.

I realize that sometimes the very mention of the words "Cost Model" brings a rush of misconceptions to the mind of any manager or executive. "Cost Models? Isn't that something that those two specialist guys that sit in the corner do?" "Didn't we try to do that before and it didn't work ... took forever, wasn't maintainable ..., [insert your favorite 'we tried that before' assertion here]." These and many other questions may be in your mind, including the unspoken: "A post on Cost Models? ... sounds about as interesting as watching paint dry!"

Why should you care how cost models work? As someone who cares about how much your products cost, you need to have a working knowledge of the vocabulary and framework of Cost Models. More importantly, the type of cost model you use directly impacts your ability to hit your cost targets.

Last week, we introduced Enterprise Cost Management (ECM) at a strategic level with posts on The Language of Business (i.e. Cost) and The Fourth F (Finance). Now, over the next three weekends we will explore the tactical level of Enterprise Cost Management: Cost Models. As Sun Tzu said, "Strategy without tactics is the slowest route to victory. Tactics without strategy is the noise before defeat." ECM is the strategy; Cost Models are the tactics.

What are Product Cost Models? To start off, let's define the scope of what costs we are modeling. There are cost models for lots of things: from your next trip to Europe to estimating the cost of a new addition to your house. In our discussions, we are talking about Cost Models for Discrete Products, i.e. products made up of individual parts, assemblies, etc. -- what are traditionally referred to as "discrete manufacturing" products. (This is opposed to "process manufacturing," i.e. the making of detergent, food, chemicals, gasoline, et. al., products that are typically made via a continuous flow or homogenous batch manufacturing method.)

Cost Modeling is the discipline of predictively calculating what a product costs (read: time and money) to manufacture and deliver to the customer. Cost Models are the actual mathematical and logical methodologies that are created for this purpose.

Tomorrow, we will talk about what Cost Models are not and play Mythbusters for three common misconceptions about Cost Models. (Don't worry; it's safe. We won't be blowing anything up.)

Author: Eric Arno Hiller
Founder & Chief Product Officer of aPriori

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