Thursday, August 13, 2009

CI - the pitfalls of reverse engineering products

When I first started doing CI, an early task was comparing product costs of ours to theirs. Seems sensible right? If they consistently make theirs for less and sell for same price, over time they "win". This is especially important in industry like FMCC where product cost as percent of selling price is substantial, but much less important in industries like pharmaceuticals where it often isn't.

Try these steps/answer these questions:

1) Do you have a current and representative sample of competitors product across regions, product dates, supply points, channels of distribution, etc. Especially important to track supply cycle and purchasing practices if product cost is tied to a highly variable commodity cost...why was Southwest Airlines profitable in 2008 and almost no one else was (they bought crude oil futures)

2) Don't let anyone (in our case it was the junior Financial Analysts) person who doesn't know how you actually make something calculate it. Should be someone who was/is in the business of making these kinds of products and had lots of experience modeling them or was close enough to the technical communities to be able to figure out ranges of accuracy. Form a team or network if you need to.

3) Calculate & analyze in the context of how competition makes it and the supply chain which supports- not how you do it. Often their products are made in a fundamentally different way than yours. This means you first need a deep understanding of their supply points/suppliers and the bio-chemical-mechanical-electrical-IT processes involved. Is their supply chain different...are they more vertically integrated? How important are they to any one supplier and what is condition of supplier? How do they purchase? How do they inventory? How efficient are they? How long/much do they use assets and in what condition are they? How much do they pay people and what is their organization structure? How do they allocate overheads among products? Do they have exclusive supply agreements on any precursor materials (probably cost them more?). Energy and utility costs vary from place to place. Tax structures and incentives vary.

4) Think about the product from a design and R&D perspective. Make sure you look at the inherent trade-offs that are made in the context of market demand and supply chain pricing of precursor materials. In some industries product spec is often tweaked to reflect pricing environment of materials, purchasers needs, competition, etc. Things are often dynamic vs. static. Some things depend on judgement vs. fact. While this has evolved in the past number of years, in my early days perfume costs in FMCC were estimated by the noses of experienced perfumers. Result turned out to be w/i only about 50% accuracy which led in a couple of instances to strategically flawed conclusions.

5) Often times people are assuming economic order quantities which ignore the fact(s) that an ingredient or part that goes into a specific competitor product is also purchased on a much larger scale across multiple businesses or products.

6) Try to break costs out by sku, variant, model to see where their leverage is.

7) Test the end result against market behavior over time.. Does their pricing behavior align with your conclusions? Is their marketing spend consistent with what your model says they can afford? How quickly do they retool or that consistent with the asset base/capability you have assumed?


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