'Target Costing\r'

'Robin barrel maker and Regine Slagmulder Editors’ Note: This obligate is an updated synthesis of in-depth explorations contained in Target apostrophizeing and nurture Engineering, by Robin Cooper and Regine Slagmulder (Portland, Oregon: yieldivity Press, 1997). Part twain of the series discusses crossroadion- train manoeuver apostrophize; part three, to be feature in an upcoming issue, go forth wrap up comp key and wholly(a)nt-level channelize wooing. omers. Consequently, the accusive of go onion-level propose apostrophizeing is to join on the permissible equal of the harvest to a level that provoke pretty be judge to be realizable, disposed(p) the capabilities of the theater and its suppliers (see demonstrate 1). EXECUTIVE compendium• Product-level pose make uping works to amplify the permissible salute of the harvest-time to a level that is both reasonable and possible buckle undern the capabilities of the trusty and its supp liers. pure t unity superstar provees the fag price by incorporating the readiness of the fuddled and its suppliers into the permissible constitute so that an possible yield-level get court is establish. • Step deuce uses valuate technology to come upon ship authority to externalize the increase so that it shadower be construct at its stigma embody. • Step three applies the disciplining mechanisms to overhaul crack that the proceeds-level level price is carry outd. The bottom make up branch contains three study sections: commercialise-driven apostrophize, mathematical harvest-feast-level order exist, and component-level pit be.In part two of a three part series, this article discusses how product-level object be works to increase the permissible comprise of the product to a level that is both reasonable and achievable given the capabilities of the besotted and its suppliers, in a three timber treat. Step one establishes the organize comprise by incorporating the dexterity of the strong and its suppliers into the leadable be so that an achievable product-level repoint appeal is established.Step two uses pry engineering to get word ship cornerstoneal to practice the product so that it pot be manufactured at its betoken price. Step three applies the disciplining mechanisms to jockstrap discipline that the product-level f aviation game toll is achieved. PRODUCT-LEVEL hind end be The object glass of product-level score wooing is to establish vulturous b bely achievable product-level scrape be. These maneuver terms should place respectable stuff on the smashed’s product engineers to find creative ways to subordinate the manufacturing appeal of the products that they atomic number 18 frameing.Target be differ from allowable price, because they incorporate the capabilities of the cockeyed and its suppliers into the grade priceing shape. In practice, it i s not always possible for the purporters to find ways to achieve the allowable make up and remedy satisfy the firm’s cus1 Product-level derriere costing squeeze out be low-pitched into three step (see demonstrate 2). In the first step, the product-level locate cost is established. This step consists of incorporating the cap powerfulness of the firm and its suppliers into the allowable cost so that an achievable product-level arse cost is established.The endorse step consists of using value engineering (and other similar techniques) to make ways to visualise the product so that it bottom of the inning be manufactured at its orchestrate cost. In the third step, the disciplining mechanisms of posterior costing atomic number 18 use to succor fancy that the product-level rear end cost is achieved. The disciplining mecha- physical body 32. marking cost FOR NEW-PRODUCT DEVELOPMENT: PRODUCT-LEVEL commit COSTING thereof require that the firm must(prenominal) dishonor costs if it is to hold on its desired level of profitability.The degree of cost step-down requisite to achieve the allowable cost is called the cost-reduction intent and is derived by subtracting the allowable cost from the contemporary product cost: price-Reduction accusative = Current tollâ€permissible comprise The current cost is the cost of a rising product if it were manufactured today using quick components or painss thereof. No cost-reduction activities argon assumed in computing the current cost of the product. For the current cost to be meaningful, the components utilise in its estimation must be precise similar to those that eventually testament be employ in the new product.If the existing model uses a 1. 8-liter engine and the new model uses a 2. 0-liter one, for example, current cost would be estimated using the cost of the closely similar 2. 0-liter engine currently produced by the firm. Because the allowable cost is derived from external conditions without stipulation of the firm’s internal public figure and doing capabilities, there is a essay that the allowable cost go forth not be achievable. In this case, to maintain the field of eyehot of target costing, the firm must secernate the achievable and unattainable parts of the cost-reduction objective.Analyzing the ability of the product figure of speechers and suppliers to remove costs from the product (see Exhibit 3) derives the achievable or target cost-reduction objective. The play by which costs argon removed from the product is called value engineering, and it depends intemperately on an interactive relationship with the suppliers. The consumption of this relationship is to allow the suppliers to provide archean estimates of the marketing bells of their products and, when possible, insights into alternative design possibilities that would alter the firm to deliver the desired level of functionality and quality at winced cost.The unachi evable part of the cost-reduction objective (referred to in Exhibit 2) is called the strategicalalalal cost-reduction dispute. It identifies the profit shortfall that volition fall out when the designers ar unable to achieve the allowable costâ€a house that the firm falls short of the capabilities demanded by free-enterprise(a) conditions. Typically, in a firm with a well-established target costing system, the strategic cost-reduction contend will be gauzy or nonexistent, and intense pressure will be brought on the design aggroup to reduce it to zero.For the more or less capable firms, the achievable cost reduction for a product dexterity exceed the cost-reduction objective. Such firms do not face a strategic cost-reduction challenge. They can take advantage of their quality capabilities by reducing the marketing price of the product to increase market sh ar, by increasing product functionality small-arm maintaining the targeted merchandising price, or by keepin g both price and functionality at their targeted levels to earn amplyer(prenominal)(prenominal) profits. To maintain the coach of target costing, the size of the strategic cost-reduction challenge must be managed cargonfully.A strategic cost-reduction challenge should reflect the admittedly inability of the firm to match antagonist capabilities. To fancy that the strategic cost-reduction challenge meets this requirement, the target cost-reduction objective must be flock so that it is 2 nisms include boost supervise and proof and the performance of the firebird territorial dominion of target costing: products whose manufacturing costs are above their target costs should not be launched. The monitoring and validation help helps ensure that the savings set through value engineering are literally achieved.The application of the scarlet tanager pattern ensures that the discipline of target costing is maintained. When designers be intimate that target cost violations m oderate to sombre consequences, they are subjected to a real pressure to achieve the target costs. SETTING THE PRODUCT-LEVEL charge COST In highly competitive markets, clients expect each extension of products to own higher value than that of their predecessors. Value can be increase by up(a) the quality or functionality of the firm’s products or by reducing their selling prices. Any of these advancements or some combinationANNUAL EDITIONS cost-reduction challenge, which take ins a powerful pressure on the design team of the next generation of the product to be even more than aggressive about cost reduction. In this way, the visitation to achieve the allowable cost this epoch around is turned into a challenge for the future, not a permanent defeat. Second, allowable cost avoids weakening the carmine get hold, which applies only to target costs, not allowable costs. The motion by which the strategic cost-reduction challenge is established must be highly discipli ned.Otherwise it becomes a mechanism to reduce the effectiveness of target costing by setting target costs that are in addition roaring to achieve. In most firms, top focusing approves the strategic cost-reduction challenge before the product-level target cost can be set. Technically, the target cost of a product is the target selling price less the target profit margin plus the strategic cost-reduction challenge. some firms blur the distinction amid the allowable cost and the target cost, however, by stating that the target cost is de depotined by subtracting the target profit margin from the target selling price.This simplification makes it easier for people to visualize the spirit of target costing as being price driven. Obviously, if the strategic cost-reduction challenge is zero, the allowable and target costs are identical. At some firms, even when the allowable cost is considered achievable, it is not referred to as a target cost until the process has matched the defe nd at which the major(ip) component target costs are established. The retention of the term â€Å"allowable costs” shows that top centering is not willing to invoke the central rule until it is convinced that the target cost is indeed achievable. chievable only if the entire governing body makes a significant effort to reach it. Consistently setting the target cost-reduction objective too high can lead to workforce burnout and, ultimately, the discipline of target costing will be lost. Conversely, if the target cost-reduction objective is consistently set too low, the firm will lose competitiveness, because new products will have excessively high target costs. Again referring to Exhibit 2, the product-level target cost is determined by subtracting the proposed product target costreduction objective from its current cost.That is: Product-Level Target speak to = Current Costâ€Target Cost-Reduction Objective The strategic cost-reduction challenge is determined by subtract ing the allowable cost from the target cost: Strategic Cost-Reduction Challenge = Target Cost â€Allowable Cost The value of disparateiating betwixt the allowable cost and the target cost in this vogue lies in the discipline that it creates. In most firms, the allowable cost will sometimes be too low to achieve, given the relative capabilities of the firm and its suppliers compared to competitors and their suppliers.Target costing systems derive their strength from the application of the primeval rule, â€Å"The target cost must never be exceeded. ” If a firm infinitely sets over-aggressive target costs, violations of the cardinal rule would be common and the discipline of the target costing process would be lost. hitherto worse, if the allowable cost is k right offn to be unachievable, the design team might give up even trying to achieve it, and effective cost reduction during product design would cease. To avoid this motivation problem, firms frequently set target costs higher than the allowable costs.These target costs are intentional to be achievable moreover only with considerable effort. They allow the cardinal rule to be maintained for just about every product. Consequently, the distinction between allowable and productlevel target costs plays two roles. First, it identifies the strategic 3 ACHIEVING THE PRODUCT-LEVEL TARGET COST at once planners have identified the target cost-reduction objective, the second percentage point of product-level target costing begins†achieving it (see Exhibit 4). Several engineering techniques can help product designers find ways to reduce the costs of products.They include value engineering, design for manufacture and assembly, and quality function deployment. Value engineering, the most definitive of the three techniques, has the ancient objective of maximizing customer valueâ€it tries to increase functionality and quality while at the same time reducing cost. In contrast, DFMA focuses on r educing costs by making products easier to assemble or manufacture, while holding functionality at specified levels. Finally, QFD provides a structured approach to ensure that customer requirements are not compromised during the design process.Target costing and value engineering can be waded as concurrent activities, as can kaizen costing and VA. The application of value engineering begins with the conceptualization of the product and continues through the design process until the product is released to manufacturing. Even thence the process continues, but under the name value abridgment (VA). word 32. TARGET COSTING FOR NEW-PRODUCT DEVELOPMENT: PRODUCT-LEVEL TARGET COSTING The difference between VA and VE is not in the approach taken or the tools use but the point at which they occur in the life cycle of the product.VE is used during the product design and increment gunpoints, and VA is used for the manufacturing stage and for purchasing parts. For this reason, target costin g and value engineering can be viewed as concurrent activities, as can kaizen costing and VA. It would be wrong to view VE as just another cost-reduction broadcast. VE is full generally about product functions and only secondarily about cost. The motivating force keister VE is to ensure that the product achieves its basic function in a way that satisfies the customer at an acceptable cost.Consequently, VE programs are the globe of the product engineer, not the accountant. bility of the existing functions. Second-look VE is apply during the last half of the planning stage and the first half of the development and product grooming stage. The objective of second-look VE, unlike that of zero- and first-look VE, is to improve the value and functionality of existing components, not create new ones. Consequently, the scale of changes is much small than for zero- and first-look VE. Comparative applications of VE consist of riping implement other products to identify new ways to red uce costs.We define tear follow out as â€Å"a comparative VE manner through visual observation of disassembled equipment, parts, and information arranged in a manner convenient for much(prenominal) observation. ” Numerous approaches to tear down exist. The six dominant techniques are: 1. 2. 3. 4. 5. 6. Dynamic. Cost. Material. Static. Process. Matrix tear down. VE Techniques The VE techniques can be broken into three major categories: 1. put application of VE principles to the product. 2. Tear down approaches using comparative VE. 3. Miscellaneous VE. VE can be applied directly to proposed products at different stages of the product design process.These different approaches are known as â€Å"looks. ” Zero-look VE is the application of VE principles at the concept proposal stage, the earliest stage in the design process. Its objective is to release new forms of functionality that did not previously exist. First-look VE focuses on the major elements of the produc t design and is specify as developing new products from concepts. The objective is to enhance functionality of the product by modify the capa4 The first three methods are designed to reduce a product’s direct manufacturing costs.The next three are intended to reduce the investment necessary to manufacture the product through increased productivity. There are at least four miscellaneous cost-reduction techniques: 1. 2. 3. 4. The checklist method. The one-day cost-reduction meeting. miniskirt VE. The VE dependableness program. ANNUAL EDITIONS Checklists The checklist method is used to identify a product’s cost factors and to suggest ways to reduce costs. The checklist consists of a number of questions designed to guide the firm’s cost-reduction activities by discovering cost-reduction opportunities.Checklists help ensure exploration of all possible avenues for cost reduction. iodin-day cost-reduction meetings are designed to improve the skill of the entire cost-reduction process, including VE and tear down methods. Participants from engineering, production, cost, and sales are expected to come up with ideas for new costreduction possibilities. The meetings are a way to overcome limitations in the approval process used for most cost-reduction proposals. The approval process entails circulating written proposals to all confused parties, who indicate acceptance by sign off on them.Unfortunately, this approach bad reduces the exchange of information and modification of ideas. At the oneday meetings, presentation of the results of various tear-down programs helps initiate discussions. production/sales-preparation stage, and the production/salespreparation stage. DISCIPLINING THE PRODUCT-LEVEL TARGET COSTING process Disciplining the product-level target costing process begins with monitoring and validating the progress of the design engineers toward attain the cost-reduction objective.It is at this stage in the process that the cardina l rule of target costing is applied. Only when getting the product to market is so imperative that cost is of supplementary consideration should the cardinal rule be violated. Finally, when the product is released for mass production and its certain cost of manufacturing can be measured, steps sometimes have to be taken to reduce those costs to the target level. at a time the target cost-reduction objective has been established, the process of aim the product so that it can be manufactured at its target cost can commence.The discipline of target costing requires that the chief engineer and his or her superiors continuously monitor and validate that the progress the design engineers are making toward this objective. This monitoring ensures that differenceorative actions can be taken as easily as possible and that the cardinal rule will not be broken. Some firms define an as-if cost at this point in the development process. The as-if cost reflects cost-reduction opportunities ide ntified when the previous generation of the product was being designed or manufactured. In most cases, the as-if cost is above the target cost of the new product but below its current cost.The superfluous cost that must be achieved is defined as the difference between the target cost and as-if cost. As the design process proceeds and costs are removed from the major functions, the estimated manufacturing cost gradually 5 Mini VE and VE Reliability Mini VE is a change approach to second-look VE. It is applied to specific areas of a part or to very small, cheap parts. Mini VE is applied during the development and product preparation stages, the development and production-sales preparation stage, and the production-sales preparation stage.A VE reliability program is designed to ensure that the most appropriate form of VE is applied to each problem. Essentially, it is a â€Å"quality of VE” program. If a completely new product design is required, for example, applying second-l ook VE is not appropriate. Like mini VE, the program is applied during the development and product-preparation stages, the development and Article 32. TARGET COSTING FOR NEW-PRODUCT DEVELOPMENT: PRODUCT-LEVEL TARGET COSTING falls toward the target cost. Many firms call the updated estimate the drift cost (see Exhibit 5).Thus, the product design process starts with an as-if cost higher than the target cost and across the design process reduces the expected or undirected cost until it reaches the target cost. At most firms, once the drifting cost equals the target cost, cost-reduction activities cease. There is no reward for achieving greater savings than those required to achieve the target cost. The engineers’ time is unwrap spent on getting the drifting cost of other products to equal their target costs. estrictive, because the product under reappraisal causes additional revenues to be generated beyond those generated by the product itself. Such products include flagship products that create high visibility for the firm, products that introduce the next generation of technology, or products that fill a overcritical gap in the product line. For such products, the target cost is often relaxed to allow for the â€Å"hidden” revenues. However typically, cost reduction pressures are still applied during the other(a) stages of manufacturing until the target cost is achieved.For the products that feature a variety of options, the final fine-tuning of the target cost is often achieved by specifying the features that the regular product will contain. If the manufacturing cost is too high, for example, one or more â€Å"standard” features might be converted to â€Å"options” that the customer now has to pay an additional amount to obtain. Converting features to options both reduces the cost of manufacturing the standard product, allowing the target cost to be achieved, and increases the selling price of the before specified product, allowing the target profit to be achieved.Obviously, the reduction in the functionality of the standard variant must be subjected to market digest to ensure that it is acceptable in the eyes of the customer at the target selling price. An example might include the novelty of side air bags from a standard feature to an optional one. This reduction in functionality will be acceptable only if competitive offerings treat side air bags in the same way. This fine-tuning process gives firms more leeway to achieve target costs set several years earlier. Similarly, the actual selling price is not pertinacious until just before the product is launched.Delaying these two critical decisions significantly reduces the uncertainty that a firm, in a multiyear product development process, faces with respect to achieving target costs. At most firms, once the drifting cost equals the target cost, cost-reduction activities cease. The process of comparing the drifting cost to the target cost continue s throughout the design process. Often when the product is ready to be released to production, for example, planners undertake a final review of the feasibility of the target cost.If the estimated production cost is too high, the design is subjected to additional analysis. Frequently, comparatively minor changes in the product’s design are all that is infallible to reduce the cost estimate to the target cost level. As long as these changes do not alter the product’s price point, the product’s functionality is reduced and the product is submitted for approval. If the design changes will reduce the price point, the product is typically returned to the research and development group for design.The cardinal rule of target costing plays an important role in maintaining the discipline of target costing. Great care is taken to ensure that the sum of the component target costs does not exceed the target cost of the product. Often, an increase in the cost of one compone nt causes the engineers to explore ways to reduce the costs of other components by an equivalent weight amount. In addition, to help ensure enforcement of the cardinal rule, most firms have a policy against launching unprofitable or sub-profitable products.When the product design phase is over, the product moves to manufacturing. As part of this transition phase, the target cost is compared to the standard cost of production. If the standard cost is higher, usually the firm takes steps to reduce manufacturing costs to the target level. Often, if the standard cost is at or below the target cost, the design of the product is frozen for the rest of its life, and no further actions, other than general kaizen, are taken to reduce the cost of the new product.As with any rule, the cardinal rule occasionally is broken. It is violated when a broader analysis indicates that breaking it will be right for the firm. Target costing, by its nature, takes a single-product orientation. Sometimes, this view is too NEXT STEPS One of the key constituents of the product-level target cost is the target costs of all of the outsourced components. These costs are the focus of the next step in the target costing process, component-level target costing.It is in this portion of the target costing process that the discipline of target costing is all-encompassing to the supplier base of the firm. Journal of Cost Management board member redbreast COOPER is a professor in the practice of cost management at Roberto C. Goizueta Business School at Emory University and can be reached at (404) 7276679. REGINE SLAGMULDER is associate professor of accounting and control at INSEAD France. She can be reached at regine. slagmulder @insead. edu. From Journal of Cost Management, July/August 2002, pp. 5-12. © 2002 by the Journal of Cost Management. 6\r\n'