Critical to Cost requirements relate to a customer’s needs around the cost of your product. Remember that ‘cost’ to the customer doesn’t only involve the end price tag you put on the product. It might also include:
- Shipping costs
- Labor charges
- Quality assurance time and outlay
- Cost of keeping inventory
- Commissions
- Taxes and duties
- Legal fees (setting up a supply agreement)
- Procurement costs: research and negotiation time and effort.
How to Develop CTC Requirements
To put together CTC requirements, you need to:
- Determine what your customers are likely to need to pay in the categories mentioned above.
- Know what they’re willing to pay for each of those costs.
- Work backward from those costs to an end price that you can charge.
- Subtract your profit margin and any other post-production costs.
- Arrive at a per-product cost of manufacture.
Note that we’re moving from a customer need to an internal requirement. This is similar to the process used in developing Critical to Quality requirements from customer drivers.
It’s also important to note that in this style of requirement building, we’re basing our calculations primarily on external factors – the costs to the customer. This is directly opposed to many other formulas for calculating end prices, which tend to start with a company’s break-even point. Instead, the Critical to Cost approach requires figuring out what your market will pay, then deciding if you can meet that price point.
Also, see Financial Measures for an explanation of some of the cost-related metrics used in Six Sigma.
Critical to Cost Example
For example, take a business that manufactures sheet metal. The following costs to its customers apply:
- Current market wholesale price for 0.5 inch thick hot-rolled, uncoated raw steel is $100-120/sheet.
- Delivery costs are $100 per 100 sheets.
- If the customer uses one of the company’s resellers, they’ll pay a 7-10% markup.
- Customers will need to perform sampling and inspections on each load to ensure quality control. Estimated cost–materials, labor, and time–or this QC is $100 per 100 sheets.
- Because it provides wholesale products only, and most customers are in the same country, there are minimal taxes and duties.
- Most of its customers use only one or two resellers for their sheet metal, so the cost of procurement is not high.
From this, the company can see that its end pricing to resellers needs to be around $90-105 per sheet to stay competitive while allowing for the markup.
Maximum end pricing = max wholesale price - (max wholesale price * max markup) Maximum end pricing = 120 - (120 * 0.10) Maximum end pricing = 108 Minimum end pricing = min wholesale price - (min wholesale price * min markup) Minimum end pricing = 100 - (100 * 0.7) Minimum end pricing = 93 Competitive end pricing range = end pricing range - 3 Competitive end pricing range = 90 to 105
Post-production costs add up to about $5 per sheet. These include:
- Internal quality control
- Marketing
- Other non-manufacturing costs
Once post-production costs are taken out, the company would get about $85-100 per sheet.
Post production gain = competitive end pricing range - 5 Post production gain = (90 to 105) - 5 Post production gain = 85 to 100
The company has a profit margin goal of 10%. Taking 10% from the previous figures, the manufacturing cost must be under $76.50 – 90 per sheet.
Min manufacturing cost = min post prod gain - (min post prod gain * 0.10) Min manufacturing cost = 85 - (85 * 0.10) Min manufacturing cost = 76.50 Max manufacturing cost = max post prod gain - (max post prod gain * 0.10) Max manufacturing cost = 100 - (100 * 0.10) Max manufacturing cost = 90
CTC Six Sigma Project Examples
Some examples of Six Sigma projects that address Critical to Cost requirements are:
- Setting up a more flexible just-in-time ordering and delivery service to lower customer warehousing needs.
- Researching budget freight options.
- Decreasing the cost of producing an item so that you can lower the end price to the customer.
