Target Costing

If you cannot find the time to do it right, how will you find the time to do it over?

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General Concept

 Target cost is the cost that can be incurred while still earning the desired profit  Selling price – desired profit = target cost  The customer sets the price  Profit must be achieved through cost control 2

Target Costing Characteristics

 Contradicts the traditional approach: design product, determine cost, set price  Intense customer focus  What do they want?

 How much will they pay for it?

 Can we make a profit on it?

 Want answers to these questions before committing to the project 3

Target Costing Characteristics

 Cost control from the beginning  70-90% of costs are committed to at the design stage  Focus on product and process design to engineer out costs from the beginning  Saves costly changes later on 4

Target Costing Characteristics

 Product, manufacturing process, delivery process designed simultaneously  Ensures features customers demand, but within acceptable cost parameters  Eliminates the temptation to add costly features  Customers may not value the added features  Forces consideration of manufacturability  Reduces the need for subsequent changes 5

Target Costing Characteristics

 Cost control at all phases of the product life cycle  Design  Production  Delivery/setup  Customer’s cost of ownership  Emphasizes future sales instead of current cost savings  Service and repair  Disposal and recycling 6

Cross-Functional Team

 Marketing  Design/engineering  Manufacturing  Purchasing  Including suppliers  Distribution  Service/support  Cost accounting  Finance  Legal 7

Target Costing Process

 Two stage process  Establish the target cost  Market research  Product planning, concept development stages  Achieve the target cost  Value engineering, continuous improvement  Design stage  Continuous improvement in later stages 8

Establishing the Target Cost

 Determine the product and its market  Who is the target market?

 What do they want?

 What do competitors offer?

 Introduce concept or prototype  Evolutionary or revolutionary?

 Refine until it meets customer needs 9

Establishing the Target Cost

 Determine the selling price  Must be acceptable to the customer  Must be able to withstand competition  Techniques  Existing price +/- value of features added or deleted  Consensus of focus group  Price predicted to achieve a desired market share 10

Establishing the Target Cost

 Determine the required profit  Return on sales  Desired return  Historical return for similar products  Industry average for similar products  Return on sales will fluctuate over the life of the product  Price and costs fluctuate 11

Establishing the Target Cost

Product Life Stage 12

Establishing the Target Cost

Gradual decline as volume increases Competitors enter market, straining supply of resources Unexpected events affect cost of resources Product Life Stage 13

Establishing the Target Cost

 Unit price, cost and profit are almost meaningless because they fluctuate  Life cycle totals are more meaningful Total expected revenue throughout product life - Total desired profit throughout product life Total target cost 14

Achieving the Target Cost

 Must include the features the customer wants while maintaining cost at or below target  Want to meet the customers needs, but not exceed them  Eliminating desired features will result in an undesirable product  Adding unwanted features will increase cost  Failing to keep cost at or below target will result in unacceptable profits 15

Achieving the Target Cost

 Rank customer requirements (exhibit 1)  What does the customer want?

 How important is each function to the customer?

 What do we and our competitors currently offer?

 Competitive evaluation (exhibit 1)  Do our current product features meet the customer needs?

 Are the customers’ needs met, unmet or exceeded?

 What can we learn from our competitors’ products?

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Achieving the Target Cost

EXHIBIT 1 CUSTOMER REQUIREMENT RANKINGS Customer Requirement Multiple speeds Horizontal oscillation Vertical oscillation Light weight Adjustable height Airflow capacity Quietness Compact size Looks nice Total Less Important 1 2 Ranking 3 More 4 Important 5 4 3 1 4 1 4 5 3 2 Raw Score 4 3 1 4 1 4 5 3 2 % of Total Raw Score 1 Competitive Comparison 2 3 4 5 14.8% 11.1% 3.7% 14.8% 3.7% 14.8% 18.5% 11.1% 7.4% 27 100% Us Competitor Both 17

Achieving the Target Cost

 Determine the cost gap between current cost and allowable cost  Current cost is based on  Currently used components  Current suppliers  Current manufacturing processes  Current distribution network  Etc.

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Achieving the Target Cost

 Decompose the cost gap (exhibit 2)  Life cycle decomposition  Cost reduction goals are divided among the functions in the product’s life cycle  Design/engineering  Manufacturing  Sales/distribution  Service/support  General administration  Etc.

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Achieving the Target Cost

 Value chain decomposition  Cost reduction targets are divided among internal and external activities  Internal costs  Labor, overhead, selling and administrative costs, etc.

 External costs  Components and services acquired from suppliers, etc.

 Often represent a large proportion of total cost 20

Achieving the Target Cost

EXHIBIT 2 COST GAP BREAKDOWN BY LIFE CYCLE AND VALUE CHAIN Life Cycle Research and development Manufacturing Marketing and distribution Service and support General administration Target Internal Costs Current $ 0.30

4.00

1.50

0.25

0.75

$ 0.50

5.00

2.00

0.50

1.00

Gap $ 0.20

1.00

0.50

0.25

0.25

Value Chain Target External Costs Current $ 13.00

4.50

$ 15.00

5.00

Gap $ 2.00

0.50

Target $ 0.30

17.00

6.00

0.25

0.75

Total Costs Current $ 0.50

20.00

7.00

0.50

1.00

Gap $ 0.20

3.00

1.00

0.25

0.25

Total $ 6.80

$ 9.00

$ 2.20

$ 17.50

$ 20.00

$ 2.50

$ 24.30

$ 29.00

$ 4.70

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Achieving the Target Cost

 Perform value engineering to design out costs without sacrificing needed features  Perform a cost analysis of major components and activities  List components or activities and their functions  Calculate a cost breakdown (exhibit 3)  Determine the current cost of each component or activity and convert to percentage of total cost  Costs include materials, labor, overhead, etc.

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Achieving the Target Cost

EXHIBIT 3 COMPONENT COST BREAKDOWN Component Motor Transmission Speed control/switch Body Blade Blade guard Total Function Turns blade Provides oscillation capabilities Controls blade speed Houses motor, transmission, speed control Moves air Protects blade from contacting objects Cost $ 8 4 3 2 1 2 Percent of total cost 40% 20% 15% 10% 5% 10% $ 20 100% 23

Achieving the Target Cost

 Relate the components to customer requirements (exhibit 4)  Develop Quality-Function-Deployment matrix  Indicates which components have the greatest impact on customer requirements  Develop a functional ranking (exhibit 5)  Indicates the importance of each component to the customer  Based on the component’s contribution to providing the desired functions 24

Achieving the Target Cost

EXHIBIT 4 QUALITY-FUNCTION-DEPLOYMENT (QFD) MATRIX Customer Requirements Multiple speeds Horizontal oscillation Vertical oscillation Light weight Adjustable height Airflow capacity Quietness Compact size Looks nice Strong correlation Moderate correlation Weak correlation Motor Transmission Components Speed control Body Blade Blade guard 25

Achieving the Target Cost

EXHIBIT 5 COMPONENT CONTRIBUTION TO CUSTOMER REQUIREMENTS Customer Requirements Multiple speeds Horizontal oscillation Vertical oscillation Light weight Adjustable height Airflow capacity Quietness Compact size Looks nice Total contribution percentage Motor 40 X 14.8 = 5.92

70 X 14.8 = 10.36

50 X 14.8 = 7.40

40 X 18.5 = 7.40

5 X 11.1 =0.56

31.64% Transmission 80 X 11.1 = 8.88

80 X 3.7 = 2.96

10 X 14.8 = 1.48

5 X 11.1 =0.56

13.88% Components Speed control 60 X 14.8 = 8.88

Body 20 X 11.1 = 2.22

20 X 3.7 = 0.74

20 X 14.8 = 2.96

100 X 3.7 = 3.70

Blade 30 X 11.1 =3.33

50 X 7.4 = 3.70

50 X 14.8 = 7.40

60 X 18.5 = 11.10

30 X 11.1 =3.33

8.88% 16.65% 21.83% Blade guard 30 X 11.1 =3.33

50 X 7.4 = 3.70

7.03% Contribution weight assigned to the component * importance to the customer (exhibit 1) 26

Achieving the Target Cost

 Identify components for cost reduction  Calculate a value index for each major component (exhibit 6)  Component cost as a percentage of total cost divided by the component’s relative importance to the customer  Index greater than 1   Disproportionately high cost in relation to its importance Implies cost reduction should be considered  Do not manage by the numbers alone 27

Achieving the Target Cost

EXHIBIT 6 CALCULATION OF VALUE INDICES FOR COMPONENTS Component Motor Transmission Speed control Body Blade blade guard Percent of Total Cost (Exhibit 3) 40% 20% 15% 10% 5% 10% Contribution Percentage (Exhibit 5) 31.64% 13.88% 8.88% 16.65% 21.83% 7.03% Value Index 1.26

1.44

1.69

0.60

0.23

1.42

Action Implied Reduce cost Reduce cost Reduce cost Improve Improve Reduce cost 28

Achieving the Target Cost

 Generate cost reduction ideas  Eliminate over-engineering  Eliminate, replace, combine, rearrange  Seek ways to accomplish the goal at less cost  Consider the process as well as the product  More efficient manufacturing processes  Better logistics  Etc.

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Achieving the Target Cost

 Test the ideas  Will they be effective?

 Are they technologically feasible?

 Is there a domino effect?

 Construct a component interaction matrix (exhibit 7)  Do activities interact?

 Estimate the achievable costs  Use activity-based costing, cost tables, etc.

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Achieving the Target Cost

EXHIBIT 7 COMPONENT INTERACTION MATRIX Component Motor Transmission Speed control Body Blade Blade guard Motor X X Transmission X Speed control X X Body X X X X Blade Blade guard X X X 31

Make the Decision

Begin Value engineering Yes Repeat value engr.?

No Abort project No Close enough?

Yes No Achieve target cost?

Yes Release design for production 32

Organizational Impact

 Positives  Customer focus  Cross-functional integration  Open sharing of information  Better process understanding  Negatives  Too much customer focus  Potential organizational conflict  Too much pressure to attain targets  Longer development times 33