How to Set Up Product Costing for Subcontracted Materials

  • by Sanjay Wagh, Vice President, Elephanta Technology, Inc.
  • August 11, 2010
More businesses are evaluating their procurement options to focus on core business processes. As a result, subcontracting is becoming one of the popular procurement alternatives. The costing process for subcontracted materials is transparent to the end users and therefore requires only a little change management and no process disruptions. By setting up the correct configuration and master data for a material, you can easily switch product costing to a subcontracting process from in-house manufacturing.
Key Concept
Subcontracting is a business strategy that both the prime contractor and subcontractor can use to overcome capacity and skill constraints experienced when meeting customer requirements. It involves outsourcing certain parts of a given process while keeping most of a project in house.

Most manufacturers prefer to manufacture an entire product in house, including the components and subassemblies. Some of the reasons for manufacturing in house are greater control over the manufacturing process and the fact that there is no need to share proprietary information with the outside world. However, in spite of these benefits, managers always evaluate a make-or-buy decision for components and subassemblies — and sometimes even for the end products. The major drivers for companies to consider buying from an outside business are lower cost and a lack of competency and capacity to manufacture these materials in house.

Subcontracting is one of the options for companies making the make-or-buy decision. It is a hybrid of the pure make or pure buy process. Unlike the pure buy process, where the responsibility of manufacturing a material is entirely with the vendor, with subcontracting the buyer has a responsibility to supply the vendor with some or all raw materials that go into the manufacturing of the subcontracted material. For example, say that a vendor provides a service of coating metal parts by a process of anodizing. In this case, this vendor receives metal parts of different shapes and sizes from customers and then coats them based on the buyer requirements using a process of electrolysis.

The SAP system helps you implement the subcontracting process with integration across various business functions, including purchasing, engineering, costing, and finance. To enable the subcontracting process, you need to specify parameters in certain master data and in relevant configuration tables in the system. This enables a company to run the various steps of the subcontracting process, including the creation of a purchase order for the subcontracted material, the issuing of necessary input materials to the vendor, and receipt of the subcontracted material. Along with the process execution, the system posts material and accounting documents to record the quantities and related values.

The master data and configuration data required to enable running subcontracting process in the SAP system is part of various SAP modules, including materials management (MM), purchasing, product costing (PC), and production planning (PP). It is really an interplay of components of these modules that produces an integrated subcontracting process.

I’ll talk more generally about the subcontracting process as it relates to costing next, before moving on to how to calculate the standard cost in your SAP ERP system.

Sanjay Wagh

Sanjay Wagh has 28 years of professional experience in manufacturing, banking, and consulting in global companies. Sanjay started as a product engineer and corporate finance specialist and seamlessly transitioned to a consultant, assisting other companies in implementing software systems. Sanjay combines his experience in manufacturing and finance with consulting experience to help clients design and implement business processes using best practices in a cost-efficient, risk-free manner with a long-term perspective. Sanjay has 16 years of SAP software implementation experience in the areas of FI and CO along with several end-to-end SAP project life cycles. He has participated in conducting requirements gathering and business blueprinting workshops, realization, testing, end-user training preparation and delivery, and post-implementation support. He is a certified SAP solution consultant.

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