How to negotiate nine(9) cost elements in contracts

Preamble

Every successful contract begins with a solid foundation of cost estimation and negotiation.

Whether you're negotiating for manufacturing, construction, or service delivery, understanding the financial nuances can mean the difference between profit and loss.

Overlooking even a single cost element can lead to unexpected overruns, strained relationships, or project delays.

This blog dives deep into the nine essential cost elements that must be accounted for, helping you gain clarity, minimize risks, and negotiate better terms for long-term success.

From raw materials to marketing expenses and contracts for supply, installation, testing, and commissioning, let's explore what it takes to ensure your contracts are both comprehensive and cost-efficient.

In this blog, the following two questions are answered for each of the nine(9) cost elements

·????? 1 What are the key components in each cost element ?

·????? 2 How to estimate Costs for each cost element ?

This ?Blog also includes ?illustration reference of each cost element included in my course in Udemy as per the link below

https://www.udemy.com/course/contract-negotiation-i/learn/practice/1624053#content

Cost estimation for five (5) below cost elements has been included in cost estimations and negotiation opportunities.

1 Grey Iron casting (Bought out contract named? as Type 1)

2 Hot Forgings ( Bought out contract named? as Type 1)

3 Machined components?? ( Bought out contract named? as Type 1)

4 Jacuzzi system involving supply installation, testing and commissioning (low-value contract named? as Type 2)

5. Lift system for high-rise building involving supply installation, testing and commissioning (High-value contract needing integration with other site contracts and named? as Type 3)

1. Material Costs

Materials often represent a significant portion of project costs. These include raw materials, semi-finished products, consumables, and spare parts. Estimating material costs requires:

• Key Components:: Raw materials like steel, wood, or chemicals; traded items, semi-finished goods; and any consumables used during production or delivery.
• Material Cost Estimation involves identifying the raw materials used in the item, their quantities, and unit prices based on market rates or supplier quotes)
• Illustration: My Udemy lecture includes Illustrations for material costs of ?GI Castings depicting costs towards : Material? cost key components include Pig Iron, Or & steel scrap, Or & GI Casting Scrap, Ferroalloys, Coke, Limestone, Sand, Binder & so on
• Template: A resource template named S3RT6 is included in my course at Udemy for estimating material costs in case of a variety of materials are included in the contract.

?2. Labor Costs

Labor costs encompass costs to the company, including wages, salaries, benefits, welfare costs, etc. These can vary greatly based on geography, skill requirements, and project duration.

• Key Components: Salaries of skilled and unskilled workers, overtime pay, and training costs.
• Labour Cost Estimation: Involve identifying direct manpower and indirect manpower (skilled and unskilled) engaged for bought-out operations or for supply, installation, testing and commissioning
• Illustration: My Udemy lecture includes such Illustrations for? hot forgings depicting costs towards: Payroll/welfare costs for Die Makers, Punch Makers, Metallurgists, Quality Control Inspectors, Maintenance Technicians, and so on
• Template: A resource template named S3RT7 is included in my course at Udemy for estimating manpower costs, including skilled and unskilled manpower.??????????????????????????????????????????????????

3. Equipment Costs

Equipment costs can be substantial, especially in industries like construction and manufacturing. This includes the purchase, lease, or maintenance of machinery.

• Key Components: Acquisition or leasing of machinery, maintenance costs, and operational expenses.
• Plant & Machinery costs estimation: Includes? Determining Depreciation, AMC, and allocating these to? Items/materials based on throughput time and annual production
• Illustration: My Udemy lecture includes such Illustrations for? equipment for GI foundry? depicting costs toward: Cupola Furnace, Electric Arc Furnace, Ladle Furnace, Moulding Machines, Core Machines, Shakeout Machines, Tumbling Machines, Sand Handling Equipment, and so on

4. Manufacturing variable? Costs

These costs cover the transformation of raw materials into finished products. They include energy consumption, process time, and waste management.

• Key Components: Utility bills, machinery wear and tear, and process optimization costs.
• Manufacturing Variables costs: Estimate costs based on direct power, fuel/ consumables, inward Freight, marine premium, rejection rate at the receipts stage, and WIP rejection at the client end. This may also include QC costs and any other costs related to manufacturing.

Illustration: My Udemy lecture includes Illustrations for? Manufacturing variable costs ??for GI foundry? depicting costs towards : Power, Furnace Oil, Natural Gas, Water, Compressed Air, Labor wages (Mold Makers, Core Makers, Pattern Makers, Machinists etc), QC gauges,% rejection of casting, and so on??

5 . Tools Costs

Tools include hand tools, power tools, and machining equipment necessary for production or service delivery.

• Key Components: Purchase or rental of tools, wear and tear, and replacements.
• Tools cost estimation ?Tools/Jigs - cost, tool resharpening costs & wear rate/consumption
• Illustration: My Udemy lecture includes Illustrations for cutting tool costs for machined parts depicting costs towards: Tool costs?for machines like Lathes, Boring machines, and Grinding machines based on process sequence and throughput time

6? Jigs and Fixtures Costs

Jigs and fixtures are specialized tools used in manufacturing to hold or guide parts during production. These are essential for precision and efficiency.

• Key Components: Design, fabrication, and maintenance of jigs and fixtures.
• Jigs and Fixtures Costs estimation: Based on annual consumption, usage frequency, and material durability. And replacement of wear and tear parts
• Illustration: My Udemy lecture includes such Illustrations for? Jigs/ fixture costs for GI Castings depicting costs towards?Pattern Equipment, Core Boxes,? Gating & Risering Systems, Moulding Boxes, Pouring Ladles, and so on.

7. Marketing Variable Costs

Marketing costs include branding, advertising, and promotional activities. Variable costs can also include unexpected or fluctuating expenses.

·??Key Components: Campaign costs, market research, and customer engagement initiatives.

·? Marketing Variables Costs estimation: Consider costs based on direct packing costs, labeling, markings, and estimated warranty costs. freight and insurance

·?? Illustration: My Udemy lecture includes such Illustrations for? Marketing Variable Costs for any item depicting costs towards: ?Packaging materials, Protective coatings, Labelling and branding, Mandatory Certification, Costs for freight, Insurance,? Warranty, and so on as applicable

8. Overhead Costs

Overhead costs include administrative expenses, building insurance, and utilities that support the project but are not directly tied to production.

·? Key Components: for offices, HVAC running costs, Depreciation? of buildings, vehicles, office equipment, their repair and maintenance, insurance, lease rentals-others, communications, travel and conveyance, legal and professional, entertainment and so on

• Overheads cost estimation approach: based on actual estimates from financial books
• Illustration: In? my Udemy lecture, overheads are depicted:As % of costs based on the profile? of the vendor/contractor and the technology used

9 Other costs

These may include applicable costs not included in the above? as :

Key Components:

i) a)Installation, testing and commissioning, b) Statutory costs, c) QC costs

ii) Vendor/contractor margin: It must be added as %

iii) Taxes: As per statutory norms

Illustration: My Udemy lecture includes such Illustrations for? various other costs

Negotiation Strategies for Cost Elements-10 nos

To achieve cost-efficient contracts, focus on areas with the highest cost impact.

Ten (10) strategies proposed include:

1.?? Use competitive bidding processes to find the best value.

2.?? Conduct a Thorough Cost Analysis

3.?? Involve Key Stakeholders for cost estimations

4.?? Leverage bulk purchasing agreements for economies of scale.

5.?? Explore outsourcing or subcontracting for non-core activities.

6.?? Offer long-term commitments to suppliers in exchange for better rates.

7.?? Agree on cost-sharing formulas for escalations or any substitute items

8.?? Standardization

9.?? Risk mitigation for rates and payment terms?

10.??Ethical buying at arm’s length

?

?