CIPS L4m6 Supplier Relationships · Free Practice Question Medium
Question 13
XYZ Ltd needs some costly and crucial high-pressure aluminum die castings for its operations. It has formed a cross-functional team to create cost models for this project. The cost models should be reliable so that the company can plan for different situations, such as how the price will change if they source from abroad, or whether they should make the design simpler.
The team has used accounting data to determine the cost elements such as materials, labour and overhead costs. They believe that this information on cost elements is sufficient for them to evaluate the pros and cons of each situation. Is this belief correct?
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A
Yes, because cost elements show the linkages between activities in each scenario
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B
Yes, because What-If analysis requires buyer to understand the reasons behind cost behaviours
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C
No, XYZ Ltd should capture cost drivers to highlight the trade-offs in each scenario
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D
No, because buyer will know the cost elements after identifying all cost drivers
Reveal correct answer
Correct answer: C
Explanation
Cost modelling is a vital skill for any buying organisation, as it enables them to understand the costs involved in procuring a product or service from a supplier. However, mastering this skill is not easy, as it requires a lot of data collection, analysis, and validation.
One of the key concepts in cost modelling is the distinction between cost elements and cost drivers. Cost elements are the basic components that make up the total cost of a product or service, such as direct materials, labour, overheads, profit margin, etc. Cost drivers, on the other hand, are the factors that influence the level or variation of the cost elements, such as volume, quality, complexity, location, technology, etc. For instance, if a buying organisation orders a larger quantity of a product from a supplier, they may benefit from a lower unit price, as the supplier can achieve economies of scale and reduce their fixed costs per unit. This is an example of a cost driver that affects the cost element of direct materials.
The purpose of cost modelling is to provide the buying organisation with reliable and relevant information on the supplier’s costs, so that they can make informed decisions on sourcing, negotiation, contract management, and performance evaluation. Therefore, a good cost model should be accurate and robust, meaning that it should reflect the actual costs incurred by the supplier, and that it should be able to handle different scenarios and assumptions. For example, a robust cost model should be able to show how the price would change if the volume, quality, or complexity of the product or service changes.
In the given scenario, the cross-functional team has only captured the cost elements of the supplier’s product, but not the cost drivers. This is insufficient to produce a robust cost model, as it does not account for the potential changes or variations in the costs. The team should also gather data on the cost drivers that affect the supplier’s costs, such as the production capacity, the level of automation, the degree of customization, the location of the supplier, etc. By doing so, the team can create a more comprehensive and flexible cost model that can support ‘what if’ analysis and scenario planning.
Reference:
- CIPS L4M6 study guide page 94-95 / The new syllabus 2024
- Cost modelling: A foundation purchasing skill, Julie A. Ask and Timothy M. Laseter
LO 2, AC 2.3
Discussion
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