Total cost model for making sourcing decisions

Abstract

This thesis develops a total cost model based on the work done during a six month internship with ABB. In order to help ABB better focus on low cost country sourcing, a total cost model was developed for sourcing decisions. Because the products that ABB manufactures have a high material cost component, effective sourcing is critical to overall profitability. The model presented in this thesis is loosely based on financial statement projections, and uses that framework to help capture all of the relevant hidden costs. This model does not consider absolute cost, but instead analyzes the change in cash flows over time. The net present value of the future marginal cash flows is calculated to determine if changing suppliers will create value or destroy it. The incentive issues surrounding supplier selection are discussed. Using this model can help to mitigate some of the incentive issues; however some managers may be incentivized to reject the model. A case study that analyzes the benefit of sourcing a copper pin from China is presented to illustrate how the model works.