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Cost Based Decision Making Dr. Nancy Mangold California State University, East Bay

Strategic Abm Product Development1

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  • Cost Based Decision MakingDr. Nancy MangoldCalifornia State University, East Bay

  • 3 Managerial Use of Cost InformationProduct and customer decisions:Whether to make or abandon a productInfluence the nature of customer relationshipsDevelop a cost basis for a priceIdentify opportunities to improve product or process design and process operation

  • Product Life Cycle-3 Broad Phases The planning phaseThe manufacturing phaseThe service and abandonment phase

  • Life Cycle CostingUsed predominately in the planning phaseIt attempts to estimate the the products cost over its lifetimeExhibit 6-1

  • Target Costing Used during the planning cycle.Drives the process of choosing product and process designs.Will result in a product that can be produced at a cost that will allow an acceptable level of profit, given the products estimated market price, selling volume, and target functionality.

  • Kaizen CostingIdentify opportunities for cost improvement during the manufacturing cycle

  • A Widely Accepted Rule80% of a products costs are committed or locked in during the product design stageDuring the design stage, planners choose the product design and design the process that organization will use to make the productExhibit 6-2

  • Effective Cost ControlDuring the products planning and design phaseNot when the product and process have already been designed and the product is being madeDuring the product manufacturing phase, most of the product costs have been committed and the focus is cost containment

  • Target CostingCost management tool that planners use during product and process design to drive improvement efforts aimed at reducing the products future manufacturing costs.

  • Target CostingPromotes and facilitates communication among the members of the cross-functional team that is responsible for product design

  • Target CostingCustomer orientedBegins with price, quality, and functionality requirements defined by customersPrice-led costing vs cost-led pricing (cost plus approaches to pricing)

  • Two Critical ElementsCustomer (market) defines the price that will be paid for the product and its designated functions.To the extent that there is a market for the same product with different functions (autos), the market or consumer will choose a price that reflects the set of product functions supplied.

  • Target Costing ProcessDriving force behind the product and process design efforts.Iterative process and continues until the design team finds a product design with a projected cost that meets the target cost.

  • Market-Driven CostingStarts by identifying the target selling price- the products anticipated price when launched.The price must reflect.the perceived value of the product in the eyes of the customer,the anticipated relative functionality.the selling price of competitive offering.the firms strategic objectives for the product.

  • Market-Driven CostingConduct extensive market analysis procedures to identify what their customers want and how much they are willing to pay for it.

  • Market-Driven CostingSetting a target profit margin.Historical profit margins for replacement of existing products adjusted for unusual costs at the front end (R&D) or back end (salvage or disposal).Calculate an allowable cost by subtracting the target profit margin from the target selling price.

  • Product-Level Target CostingStarts with the current cost of the proposed product.The costs at which the firm could launch the new product today without undertaking any design changes or introducing any process improvements in existing manufacturing processes.

  • Product-Level Target CostingThe discrepancy between the current cost and the allowable cost gives the project team an estimate of the magnitude of the cost reduction opportunities it must identify to achieve the allowable cost.

  • Product-Level Target CostingCost reduction objective.Achievable.Unachievable.

  • Product-Level Target CostingAchievable.Expend considerable effort during the design process.Value engineering.Quality function deployment.Design for manufacture and assembly.Target costs set properly, should be achieved 80% of time.

  • Product-Level Target CostingUnachievable.Strategic cost reduction challenge.Identify how far the firm is from being competitive.

  • Product-Level Target CostingSetting product-level target costs that are too aggressive will result in unachievable target costs and eventual failure of the target costing process.Setting too high a strategic cost reduction challenge leads to easily achieved target costs but a loss of competitive position.

  • Product-Level Target CostingCardinal rule - Target cost can never be violated.Rule implies that even if engineers find a way to improve the functionality of a product, they can incorporate the improvement only if they can also identify how to offset any additional costs.

  • Component-Level Target CostingThe design team establishes the target cost for every component in the future product.These component-level target costs establish the suppliers selling prices.Target costing transmits the competitive pressure faced by the firm to its suppliers.

  • Component-Level Target CostingProducts are broken down into major functions (Engine, transmission, air condition, audio systems).The chief engineer sets the target cost for the major functions.The engineer decides the theme of the product and that certain functions should be emphasized (high-performance engine).

  • Component-Level Target CostingOnce the major function target costs are established, the design team for each major function must find ways to design that function so that it can be produced at its target cost.The team breaks the major function down into its components and then distributes the major function-level target costs to component-level costs.

  • Component-Level Target CostingThe sum of the component-level target costs must equal that of the major function that contains them.

  • Component-Level Target CostingThis establishes the allowable selling prices of suppliers.The assembly companies do not want to squeeze the profits of their component suppliers to zero.They bring their major suppliers into the product design process as early as possible.

  • Component-Level Target CostingThe suppliers provide and receive inputs on how to reduce costs.The suppliers also estimate costs for each component.These estimates are imputed into the component-level target-costing process subject to the constraint of the cardinal rule.

  • Chained Target CostingIn todays highly competitive environments it is not enough to be the most efficient player.It is also necessary to be part of the most efficient supply chain.One of the ways to achieve increased supply chain efficiency is through the use of chained target-costing systems.

  • Chained Target CostingThe output of the buyers target-costing system becomes the input to the suppliers target-costing system.The buyers component-level target costs become the suppliers target selling prices.The suppliers target-costing system develops both product-level and component-level target costs, thus transmitting the buyers competitive pressure to the suppliers product designers.

  • Chained Target CostingIf the suppliers suppliers also use target costing, the chaining continues down the supply chain. Thus, chained target-costing systems can transmit the competitive pressure from the buyer down the supply chain, making the entire chain more efficient.

  • Chained Target CostingThe intense cost reduction pressure that is characteristic of target costing thus permeates the whole supply chain.

  • Major Strength One Team Concurrent Design Team environmentCross functional team members:Design engineerProcess engineerPurchasingManufacturingMarketing

  • Major Strength One Team Concurrent Design Concurrent designObjective-to deliver a product with the target functionality, quality, and price to a specific market segment

  • Major Strength One Team Concurrent Design No room for individual groups to specify product features that reflect a functional fixationEliminate product functions or features that add cost but provide no market price increment (no value to customers)

  • Major Strength One Team Concurrent Design Avoid Engineers may design a production process that uses the latest production technology without regard for its effects on cost or manufacturabilityMarketing group might specify many product features that customers would like to have but do not consider essential in the product and would not pay to have them included in the product design

  • Major Strength One Team Concurrent Design Reduces product development time and cost by reducing required designed changes

  • Major Strength One Team Concurrent DesignEach subgroup within the team is assigned cost reduction targets that is expected to meet in order to achieve the teams overall target cost objective.Assign individual responsibilities but within an overall structure of group objectives relating to product quality, functionality and price.

  • Major Strength Two Deployed at Design StageDeployed at the product and process design phase when design choices can have a maximum impact on a products cost.

  • Suppliers on Design TeamInclude suppliers as active members of the product design teams to elicit their expertise.This approach requires a sharing of ideas and information requires trust.

  • Suppliers on Design TeamPayback for suppliers are long-term contractsParticipate in the cost savings they generateReduce product costs but not by squeezing the suppliersUse lower-cost commodity components rather than custom-designed componentsImplementing process improvementsChrysler supplier recommended an exterior molding-cost less, offer same function

  • Suppliers on Design TeamJapanese keiretsu, South Korean chaebolsAffiliations of companies interrelated by supplier-purchaser relationshipsDoes not always workSeveral large keiretsu were disbanded because the protected suppliers and had become inefficient and noncompetitive

  • Chrysler ApproachChrysler to avoid this byDrop poorly performing suppliersPerformance based on cost savings resulting either from design proposalsManufacturing process improvementsQualityOn-time delivery

  • Design TeamHuge pressure on the design team to meet target cost.Product will not be launched unless the team meets the target cost.Ultimately target cost reflects what the customer demands and what the suppliers of capital expect as a reasonable return on their returns.

  • Target Costing in Action-Toyota MotorsToyota Motors seems to have invented the process of target costing during the 1960s.Market group specifies the target price.

  • Target Costing in Action-Toyota MotorsThe market value of additional functions added to existing vehicles determines the increment of the price of the new model over the existing model.Planners multiply this price by the estimated production volume over the products life cycle to determine the total product revenue.

  • Target Costing in Action-Toyota MotorsEstimate the cost of the new product.Estimated by adding.The cost base of the existing product.The incremental costs of the design changes associated with the new product.Compares revenues and costs to compute an estimated margin.

  • Target Costing in Action-Toyota MotorsA margin that fails to achieve the target return on costs needed to provide an appropriate return on investment triggers a redesign process.

  • Toyota Motors Redesign ProcessCompute the required cost reduction.The leader of the design team then distributes this target cost reduction among the members of the design team.Assembly division.Redesign the assembly process.Reduce the number of parts by increasing the number of pre-assembled modules or components.

  • Tear Down AnalysisReverse engineering.A process of evaluating a competitors product to identify opportunities for product improvement.The competitors product is taken apart piece by piece to identify the products functionality and design and to make inferences about the process that made the product.

  • Tear Down AnalysisProvides insights into the cost of the product.Suggests the relative advantages or disadvantages of the competitors approach to product design.Benchmarking-compare the tentative product design with the designs of competitors.

  • Quality Function DeploymentQFD is a management tool developed during the 1970 in Japans Kobes shipyards.Provides a structure to identify customer requirements a key input into the target costing process.

  • Quality Function DeploymentOrganizations use QFD to identify what customers want from a product before the product design is undertaken.The process then compares what the customer wants with how the design team proposes to satisfy those requirements.QFD supports the process of value engineering.

  • Value EngineeringA team based, systematic value analysis.To evaluate a products design in order to identify alternatives that will improve the products value.The ratio of functionality to cost.

  • Value Engineering Hold functionality constant and reduce cost.Hold cost constant and increase functionality.Looks at all of the products elements including.the raw materials.the manufacturing process.the type of labor and equipment used.the balance between purchased and self-manufactured components.

  • Value Engineering-Two AlternativesIdentify improved product designs that reduce component and manufacturing cost while not sacrificing functionality.Eliminating unnecessary functions that increase the products cost and complexity.

  • Value Engineering-Two AlternativesIdentify improved product designs that reduce component and manufacturing cost while not sacrificing functionality.Eliminating unnecessary functions that increase the products cost and complexity.

  • ReengineeringThe tear-down and value-engineering approaches focus mainly on the product design.Another critical element in determining the cost of a product is the the process.Reengineering is the activity of redesigning a planned or existing process.Is driven by the desire to improve a products cost or quality attributes.

  • Kaizen CostingOperating the process in the most efficient way.Focuses organizations attention on things that managers or operators of an existing system can do to reduce costs.

  • Kaizen CostingTarget costing.Planners use before the product is in production.Driven by customer consideration.Kaizen costing.Operations personnel use when the product is in production.Driven by periodic profitability targets set internally by senior management.Similar targets drive both.

  • Kaizen CostingIncremental improvements to the current production process or product design.Developing improved setup processes.Improving machine performance to reduce waste.Increasing employee training and motivation to encourage employees to identify and implement the incremental daily changes that can improve cost and quality performance.Focus on process not the product itself.

  • ABC and Target CostingJapanese target-costing processes focus on saving in materials, labor, assembly, and machining costs, the unit level cost drivers in traditional cost systems.

  • ABC and Target CostingAs the focus of target costing extends beyond direct manufacturing costs to include supplier, distribution and customer relationships, the capabilities of the total or ABC cost model should enable an integration between ABC and target costing.

  • ABC and Target CostingIntegrating ABC and target costing designers can make trade-offs between direct and indirect costs that are impossible with only target costing or with a combination of target and traditional costing.

  • ABC and Target CostingSome western firms are already using ABC for target costing purposes.An electronic assembler of data communication devices incorporated its manufacturing ABC model into its target-costing process.Selection of electronic components.Packaging materials.

  • ABC and Target CostingIn general, ABC works very compatibly with target costing.The ABC gives product designers and developers a model of manufacturing support costs that enables them to balance the functionality and quality of the final product with economics-based decisions about component selection and design characteristics.

  • Operational Activity-based ManagementDrives the process of reengineering.Maps out the steps or activities in an existing or proposed process.Process mapping.Flowcharting.Planners then look for opportunities to reduce cost by eliminating factors that cause delay or waste in the planned process design.

  • Operational Activity-based ManagementActivities that consume resources without adding functionality to the product that the customer values are called nonvalue-added activies.Moving, storing, and inspecting are all activities that cause delay or waste in the manufacturing process while consuming resources.

  • Operational Activity-based ManagementA product or process redesign that eliminate the need for non-value-added activities will reduce costs and cycle time and often will increase product quality.

  • Operational Activity-based Management - StepsChart the process to identify each activity.Identify the cost of each activity.Identify opportunities for improvement.Reengineering to eliminate the need for non value-added activities and.Continuous improvement to improve the performance of value-added activities.

  • Operational Activity-based Management - StepsSet priorities for improvement.Provide the financial justification (business plan) for reengineering efforts.Identify what need to be done to eliminate or otherwise reduce the activitys cost.Make the required changes.Track the benefits to compare them with the costs.

  • Life Cycle CostingProcess of estimating and accumulating costs over a products entire life.Important in environments in which there are. large planning and development costs (developing a new jetliner).Large product abandonment costs (decommissioning a nuclear generating facility).

  • Life Cycle Costing- 3 PurposesHelps to develop a sense of the toal costs associated with a product in order to identify whether the profits earned during the active, manufacturing phase will cover the costs in the development and decommissioning phase.

  • Life Cycle Costing- 3 PurposesIt will identifies products that are no longer profitable when their decommissioning costs are factored into the product evaluation process.

  • Life Cycle Costing- 3 PurposesBecause of its comprehensive consideration of costs, it will identify a products environmental cost consequences and will spur action to reduce or eliminate those costs.

  • Life Cycle Costing- 3 PurposesIt helps to identify the planning and decommission costs during the product and process design phase in order to control and manage costs in that phase.

  • Life Cycle Costing A comprehensive accounting of a products costs,both manufacturing and environment.From cradle to grave.To help decision makers understand the cost consequences of making that product and to identify areas in which cost reduction efforts are both desirable and effective.

  • Quality CostApproaches to monitor and control the cost of quality.Four types of quality costs.

  • Quality Cost Prevention CostsPrevention costs the costs of preventing quality problems.Cost of designing improved processes that reduce quality failure.Employee training.Supplier training.

  • Quality Cost Appraisal CostsAppraisal costs the costs of finding quality problems.The cost of the equipment and personnel who perform quality checks on work in process.

  • Quality Cost Internal Failure CostsInternal failure costs The costs of fixing quality problems that are found when the product is still in the manufacturers handsOut of pocket and opportunityPersonnel and materials and machine time used to rework the product into a saleable condition

  • Quality Cost External Failure CostsExternal failure costs.The costs of fixing quality problems that are found when the product is in the hands of the consumer.Warranty-related costs.Profits on sales lost when the organizations image is damaged by quality problems.Costs of lawsuits prompted by product failure.

  • Quality Cost To manage the total cost of qualityPercentage of salesTo provide a shifting standard as sales level rise or fallTo invest in preventing and finding quality problems as long as the cost incurred is less than the cost of fixing quality problems that would other wise occur.

  • Taguchi CostJapanese academic approach.Output failing to meet the target value of the characteristic creates quality losses.Quality losses increase quadratically with the deviation from the target characteristic.Prefers choice with smaller variance.

  • Environmental, Salvage and Disposal CostsRapid rise in environmental costs.Chemical industry- normal for a firm to spend greater than a billion on environmental costs.Old emphasis- Accept environmental costs as an inevitable part of doing business

  • Environmental, Salvage and Disposal CostsOld emphasis-. Accept environmental costs as an inevitable part of doing business.New emphasis-.With appropriate management to reduce business-related environmental costs.

  • Managing Environmental Costs Develop detailed cost records that attribute environmental costs to activities and ultimately to products.In order to identify the processes and products that create environmental costs.

  • Managing Environmental Costs Reduce or eliminate the drivers of environmental costs.Base part of incentive compensation on steps employees have taken to reduce environmental costs.Bonuses based on measures of environmental performance (level of waste discharged).

  • Managing Environmental Costs Effects of recognizing and accounting for environmental costs are toProvide an accurate picture of product profitabilityCurrently charged to corporate overhead, obscuring the nature and source of these costs.

  • Managing Environmental Costs Focus attention on developing products that have lower decommissioning and take-back costs.By identifying the magnitude of these costs.Increase efforts to recycle or otherwise remanufacture existing product waste.