Student Assignment Questions

(a) What is the competitive environment faced by MB?

Students may identify a number of changes, including significant market share
lost to Japanese companies such as Lexus. Stress the importance of a cultural
change taking place within top management at Mercedes. Reinforce that
Mercedes is a company that had never lost money until 1993. They simply
built the best car their engineers could design and priced it above cost.
Demand often exceeded supply. As a result, cost had never been a primary
consideration. Changes include:
cost competition;
product innovation;
new segments (sports utility vehicle);
new market niches.

(b) How has MB reacted to the changing world market for luxury automobiles?
Students should identify the following changes implemented by management at
Mercedes; try to get them to explain how different these approaches were from
traditional strategies at Mercedes:
many new product introductions;
partnering with suppliers;
reduced parts and system complexity;
new emphasis on cost control;
layers of management reduced;
lead time from concept to introduction reduced.
(c) Using Coopers cost, quality, functionality chart, discuss the factors on which
MB competes with other automobile producers such as Jeep, Ford, and GM. (If
the instructor wishes to give a brief mini-lecture on Robin Coopers survival
triplet and confrontation strategy,1 this is a good point in the case discussion to
do so.) The factors are:
priceat mid to upper range of zone;
qualityat upper range of zone;
functionalityat upper range of zone.
An interesting point to discuss is that Mercedes does not produce the most
expensive sports utility vehicle. This distinction is reserved for the Land Rover;
however, they strategically placed themselves toward the luxury end of the
spectrum. Also, unlike many Japanese examples, Mercedes does not use target
costing as a strict cost control mechanism to produce the lowest priced product
in its class.

Robin Cooper, When Lean Enterprises Collide, Boston: Harvard Business School Press, 1995.

(d) How does the AAV project link with MB strategy in terms of market coverage?
The new introductions expand the product line of the traditionally luxuryoriented manufacturer. Recent product introductions include the following:
A Class;
C Class;
SLK;
E Class;
M Class.
These new introductions include new sports cars and off-road vehicles. The C
Class is a mid-sized vehicle sometimes referred to as the baby-Benz.
Lets discuss the elements of the target costing model and how these
elements are developed.
At this point in the discussion I usually write the target costing formula on
the board and ask students to consider sources of various inputs:
target selling price;
target profit margin;
target cost.
What are the sources of input for the projected target selling price?
Students will most likely identify the following sources of information:
customer focus groups;
comparable products:
existing,
potential.
Stress the broad, cross-functional aspects of acquiring consumer
information. To compare products, the company had to evaluate existing
competitive vehicles as well as vehicles under development.
What factors are considered when developing the required target profit
margin?
This question provides a link to finance classes. Most students have studied
the concepts of weighted-average cost of capital. I recommend spending a
few minutes reviewing these concepts and linking cost of capital to net
present value (NPV) analysis. Because of the capital-intensive structure of
automobile manufacturing, production volume is a critical factor in
determining each models NPV. Students may identify the following points
for determining a required target profit margin.
long-run profitability;
cost of capital;

profitability across the entire product mix (classes of vehicles);

sales volume by class.

The MB case suggests the target cost is alive. Is this consistent with the
ideals of target costing?
I generally emphasize that Mercedes did not consider the target cost to be
locked in. It was a moving target. As engineering changes became
necessary, the target cost was allowed to move. However, before making a
change, market forces were considered. For example, changes included the
addition of side airbags. In addition, the European press was critical of a
simulated wood-grain part. Management decided the part would remain
plastic because costs could not be passed on to the consumer. The main
point to emphasize is the design of the vehicle is dynamic, thus costs must
evolve to reflect the changing design characteristics.
(e) Explain the process of developing an importance index for a function group or
component. How can such an index guide managers in making cost reduction
decisions?
The index development process has five steps, as follows:

consumer importance category rankings;

target cost and percentage by function group;

category vs. function group matrix (function group contribution

to customer requirements);

importance index of the various function groups;

target cost index.

The instructor can make slides of Tables 1-5 to facilitate discussion. Index
development is an important element in the early conceptualization phase of
the AAV. The indexes help to quantify some very abstract concepts.
Table 1. From conversations with potential consumer groups, a list of key
categories was developed. Next, potential customers were asked to rate the
importance of each category. Their responses were computed as a percentage.
Thus, safety and comfort of the AAV were viewed as significantly more
important than economy and styling.
Table 2 represents a rough estimate of the target cost by function group and the
relative percentage of each group of total target costs. The information is used
later to create a target cost index.
Table 3 is best understood by reading each category as a column. The rows
explain the relative importance of each function group to satisfying each
category defined by customers. An interesting aspect of this table is that the

link between consumer preferences and engineering components is made

explicit.
Table 4 builds on Table 3 by weighting the percentages computed in Table 3 by
the importance percentages calculated in Table 1. The key point is to
understand which function groups contribute the most (least) to important (less
important) consumer categories.
Table 5 results in a target cost index for each function group that attempts to
capture cost and benefit trade-offs. As discussed in the case, this index may
indicate a cost in excess of the perceived value of a function group. Thus,
opportunities for cost reduction (aligned with customer requirements) may be
identified.
(f) How does MB approach cost reduction to achieve target costs?
At this point, ask students to identify various value-engineering strategies. At
Mercedes, reducing the cost of each function group was accomplished by
reducing costs of various components that make up the function group. Stress
the importance of this approach over an across-the-board cut.
(g) How do suppliers factor into the target costing process? Why are they so
critically important to the success of the MB AAV?
From the conceptual phase through the production phase, the suppliers of
systems for the AAV truly were partners. Suppliers attended regular meetings
with the cost planners throughout the entire process. Thus, suppliers were:
design and development partners from very early stages of
development,
responsible for meeting cost targets.

 Why is the relationship with suppliers a crucial element in the success of

the AAV?
Suppliers provide entire systems for the AAV.
The facility uses a JIT production system. In fact, many suppliers deliver
directly to the assembly line, rather than to a small warehouse.
The Black Warrior River separated Mercedes and a major system supplier.
This supplier built a new production facility on the same side of the river as
the Mercedes Benz plant to avoid possible delays associated with accidents
on a major bridge.
(h) What role does the accounting department play in the target costing process?
Stress the fact that accountants were watchdogs in the target costing process.
Their primary responsibility was to ensure costs did not exceed targets during
the production phase. Thus, the accountants role was as follows:
cost control;
actual costs versus target costs:
- development stage,
- production stage.
What are some of the organizational barriers that may challenge managers
attempting to introduce target costing systems?
Try to get students to identify various impediments to target costing systems
in the United States. Examples may include:
willingness to share cost data with suppliers;
suppliers treated as adversaries;
government regulations affecting exchange of information.