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

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

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

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

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

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

Cross-Functional Team Marketing Design/engineering Manufacturing Purchasing Including suppliers Distribution Service/support Cost accounting Finance Legal

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

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

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

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

Establishing the Target Cost Unit Selling Price Product Life Stage

Establishing the Target Cost Gradual decline as volume increases Competitors enter market, straining supply of resources Unexpected events affect cost of resources Unit Cost Product Life Stage

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

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

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?

Achieving the Target Cost

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.

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.

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

Achieving the Target Cost

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.

Achieving the Target Cost

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

Achieving the Target Cost

Achieving the Target Cost Contribution weight assigned to the component * importance to the customer (exhibit 1)

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

Achieving the Target Cost

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.

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.

Achieving the Target Cost

Make the Decision Begin Value engineering Repeat value engr.? Close enough? Achieve target cost? Yes No No Yes Yes No Abort project Release design for production

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