The Total Cost Angle: Understanding Your True Energy Spend

Spend Matters would like to Welcome Herb Shields to Spend Matters. Herb is President of HCS Consulting. In full disclosure, Herb Shields and Lisa Reisman (my wife) are in the same Vistage executive group. Today, I've asked Herb if he could contribute a few thoughts on the total cost angle of energy spend, looking at a supplier's actual energy costs (versus what they might be telling you). Take it away, Herb!

Energy costs have reached record levels in 2008. Even though crude oil and gasoline prices have retreated somewhat from their peak, everyone's attention is now more focused on the potential impact of energy on their business for the future.

In talking to clients and colleagues, I am confident that most companies are recognizing and dealing with the impact of energy costs. Transportation cost increases are well documented either through increased direct fees or fuel surcharges. In a similar manner, companies that produce and sell oil based products can not generally afford to absorb the cost increases and pass them on quickly with appropriate communication to customers. And that's where it stops for most of us.

Having spent many years in corporate purchasing, I would like to make some suggestions to take your understanding of the total impact to a new level.

There is a very useful technique that the big guys have used for years -- cost breakdowns. Traditionally, the process looks at each of your purchased items and breaks the price the supplier is charging into raw material and/or components, labor, overhead, and profit. Let's use a plastic bottle as an example. The raw materials are typically resin (plastic) and colorant. Labor is the direct labor charge to mold each bottle. Overhead and profit is obvious, although in many cases the buyer does not know exactly what those are, but can make an educated guess.

Let's take a closer look while I suggest another term -- cost drivers. The cost driver for most plastic resins is OIL. Cost drivers of overhead include the ELECTRICITY and/or NATURAL GAS used to operate the suppliers' plant and equipment. You will have to measure or estimate the percentage impact the driver has on the item. You can do this yourself or ask your supplier to help.

So, to get the total impact of energy costs on your business you must do a similar analysis for all your purchased materials, or at least the major ones. Once you have done the math, you are now ready to check the logic behind the surcharges or price increases that are coming at your purchasing department every day.

Herb Shields is President of HCS Consulting.

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