Contents Target Costing ‘STRATEGIC IMPLICATIONS OF TARGET COSTING 1 PURPOSE OF THIS MODULE 2 HISTORY AND BACKGROUND OF TARGET COSTING — 2 NEED FOR TARGET COSTING — 3 TARGET COSTING—KEY IDEAS 3 THE TARGET COSTING PROCESS 6 ESTABLISHING TARGET COSTS 8 TARGET COSTING—AN ILLUSTRATION 9 ATTAINING TARGET COSTS 10 Computing the Cost Gap. 11 Designing Costs Out, 13 Release Design and Undertake Continuous Improvement. 18 HOW COST REDUCTION OCCURS INPRACTICE 14 Design Product and Processes. 14 Perform Cost Analysis, 14 Do Value Engineering (VE). 19 Estimate Achievable Cost. 21 MANAGEMENT ACCOUNTING AND TARGET COSTING 23 Role of Management Accountants. 23 Management Accounting Information. 23 ‘TECHNICAL PROPERTIES OF TARGET COSTING 24 BEHAVIORAL ISSUES IN TARGET COSTING — 25 Behaviors Needed. 25 Behavioral Consequences. 26 (CULTURAL IMPLICATIONS OF TARGET COSTING — 27 Creating a Receptive Culture for Target Costing. 27 Sustaining Values that Support Target Costing. 28 LESSONS LEARNED — 28 COMMONTERMS — 30 PROBLEMS AND CASES—INTRODUCTORY LEVEL 32 PROBLEMS AND CASES—ADVANCED LEVEL 33 Case I: SmartCOM, Inc. 35 Case 2: Modern Office Machines. Case 3: Dragon Development. 38Target Costing* | TARGET COSTING GLOWS WITH THE "NEON" n 1290 Chnelr Corton found ea na ver rtappy fran suc. Pots wore enn cash tow war Wht and hw sock wos wang a ow pn of $10 per exe. The aporoe ao mcusty ova oarave Peat, Coe a tong Yen thy Ra cape ans Sirinced iopreneve ahealty share oth 5. elmore Creyt management cela ros te to crags soratn to new cat Soran. Thay epee camp weoen Pa he varanse suo nd nad used any yess ale apt cost, Target cosing WS pled al proce Seven eet ine Conean/ naan the NEON, now al cat Sovsoge ha loner aoe range. Ape an lt patna ere ca anit was the ‘Sed to mest ht pol out serena mao toner aguranens. The eas ‘ang tare cotrg on be NEON wre ingress. The NEON. | Proved tu tag ed pono eng fr ara cs ‘Wa omega oh Youn 1298. {Hog lately aba devetepent mesons tom product concept to mata ‘A cae nw epost devant and meinen tug 1k teoroca nan fsa cars ads in USAIN ais a postive rum {Ale onvnmaray ry bl wong a eyebieacke and nono mates ‘Sco te ration lege costing, Onysars pot hee eens scanty, Hs share pe mnt pom 6106" char 10001 858 pear 1088 A. STRATEGIC IMPLICATIONS OF TARGET COSTING. target cost ste allie amount of cont tha can be incured a product and stil ont fequied profit fom tht oduct Ts market driven ctting. The Chaser sry Shows fom arg! costing process then Well exzcutad, ca impor a fins competing ston by improving qual reducing costs nd accelerating the ime wo make. ‘A Quality Target costing improves product quality by making tan expt jee ofthe prot development nd costing processes. Cos ages cant be achieved by compromising he estes that cisoter desires ry edn the perfomance eat ofa prac. ‘A.Cost Redicng cos tthe eat of target coting Uke waional methods, wees, argt costing dos nat wit for production fo start efore maging To costs. It makes cos planning a par of profit planning and uses an intelligent, customer-focused design process to manage costs before they are incurte. ‘A Time. Target costing reduces the time from concept to marketing of products because products and processes are designed simultancously. No time is lost in ‘eying to determine how to manufseture a product after itis designed or in correcting design errors A PURPOSE OF THIS MODULE ‘This module explain the use of target costing a a strategic profit planing and cost man- agement tool, We will identity its key principles, contrast it wih traditional cost manage- ment tools, show the critical steps in the process, and demonstrate its functioning in practic. After you stad this mode, you will understand ‘A.A brief history and background of target costing. 44 The ned for target costing. ‘4 The key ideas underlying target costing. ‘A.A description of the target costing proces. ‘A How to attain target costs for products. 4. How cost reduction occurs in practice. ‘4 The management accounting implications of target costing. ‘4 The technical, behavioral, and cultural implications of target costing. A HISTORY AND BACKGROUND OF TARGET COSTING ‘Target costing originated in Japan inthe 1960s. As it did with quality Japanese industry took a simple American idea called value engineering and transformed it into a dysamic cost reduction and profit plannng system, Valu engineering originated at General Electric during World War I. It was an organized engineering approach to determining Row to pro- duce prot in the face of pas shortages. The practice was instituted to design products ‘that could do more with exer pans. Later it became an organized effort to examine how 10 rovide the needed features or function in a product at the lowest posible cost. U.S. industry didnot realize the potential of value enginoering sa systematic profi and cost planning fool and did litle with it afer World Wa TI. Japanese industry expanded the basic concepts of value engineering into the target-costing process. Today more than 80 per- cent of all assembly industries in Japan, such as automobiles, electronics, consumer appli- ances, and machine tools and dyes, use taget costing! Natually, some of the best practioners of target costing are leading Japanese companies such as Toyota, Nissan, Sony, Matsushita, Nippon Denso, Daihatsu, Cannon, NEC, Olympus, Koma, and many ober, Inthe United Stats, target costing as been used ony since the late 1980s. The loss of ‘marketshare to Japanese companies, as n Chrysler’ case, has been a major motivation for adopting target costing. Adoption of target costing inthe United States remains slow for several reasons. Some managers fail to appreciate its strategie importance. Others mistake Te2It for a narrow cost reduction technique and confuse the simplicity of is ideas for asim- Plistic process, Still others use some elements of target costing but mistakenly think they have adopted the entre process. ‘A NEED FOR TARGET COSTING ‘What makes target costing so important today? The answer lies inthe nature of the con temporary industrial environment. Today businesses face a global environment that has four characterises Iti: ‘A Competitive, because prices cannot be increased in many key industries. Many new producers, some with lower cos of dong busines, have entered the lobal marketplace, ‘A Rapidly changing, eeause the dissemination of technology and knowledge has sccelerated considerably. This faster pace makes it difficult to use any one fatoe, Such as quality, fora long-lasting competitive advantage. ‘4 Unforgving of mistakes or delays since shorter product lives leave lite time to respond to changes inthe markerpaoe orto recover from mistakes, ‘A Deinanding, because sophisticated consumers have knowledge of many produc and want beter quality products at an affordable price. It is difficult o sell inferior prodets with reduced Features ata lower price. In short the environments dealing a CRUD hand. Target costing responds by coming ‘up with ACES, Target costing isa process thar ‘A Anticipates costs before they ate incurred. ‘A Continually improves product and process design. ‘A.Exterally focuses on customer requirements and competitive threats. ‘A Systematically links an organization tits suppliers, dealers, customers, and recyclers in a cohesive and integrated profit and cost planning system. & TARGET COSTING—KEY IDEAS ‘Achieving target costs requires a formal process. The most comprehensive definition of the target costing process comes from the Consonium for Advanced Manufacturing International (CAM-D; ‘Target costing i 2 system of prof planning and ost management ta i price ed cus tomer focused, devign centered sod ross rca Tat costing inates cost management fhe enn sages of product evelopment and apple throughout the product eect by etvely involving thee alu ain? ‘The purpose of target costing i o ensure adequate profits by undertaking simultaneous profit and cost planning. The CAML definition contains sx key ideas that provide the con- ‘eptual foundations for taret costing, Each ofthese sx foundations is explained below. | Price led costing means that arget cost are established by frst determining a competitive market price and dhen subtracting the requted profit margin fom i ‘This is summarized inthe equation: 7S Aa eta et Cre Ne Sm Pte, 98 0-3 cHaP-n where (C= Target cost In target costing, market price isthe independent variable; costs allowed for ‘designing, manufacturing, marketing, and other functions (he target costs) are ‘dependent on the market price. For example, ifthe competitive price fora product is $100, and the company roquites a 15 percent profit margin, then the target cost for this product is set at $85 (100-15), ‘Customer driven means that customer requirements shout product quality, price, and timeliness guide cost analysis. Its essential understand what quality fea {ures and timeliness customers expecta a given market price and what competi tion is currently doing or might do to respond to a company's product offerings ‘The target cost must not only yield dhe target profit but also allow the manufae= turer to match competitive product dimensions. The target cost cannot be attained by sacrificing the features that customers want, lowering the performance or reliability ofthe product, or delaying its introduction in the marketplace. Design of product and processes isthe key to cost reduction efforts. Target cost systems design products and their manufacturing and delivery processes simulta- ‘neously. This is sometimes called concurrent engineering. Traditional cost redue- tion methods focus on production efficiencies such as waste reduction or buying {in quantity to reduce cost. This i not the prime focus of target costing. Target costing focuses on product design because most cots, nearly 70-80 percent, are committed atte design stage, while oaly 10-20 percent ofthe costs ae incurred at this stage. Exhibit I shows the typical relationship between committed and incurred product costs. As depicted there, the majority ofthe costs are commit ted atthe design stage, while the majority of cost are incurred after production starts. The best opportunity to manage costs is while a product is stil in design, ‘Concurrent engineering design eliminates costly Features and minimizes the need for engineering changes after production begins. 4, Cross-funetional product teams with members representing design and manu facturing engineering, sales and marketing, material procurement, cost accounting, service, and suppor typically are jointly responsible fr attaining target costs “The teams also include outside participants such as suppliers, customers, dealers, and recyclers. The teams are responsible fora product from inital concept through production. A cross-functional eam is mot a set of specialists who contribute their ‘expertise and leave. They are responsible for the entire product! A good example ‘of product team participation occured during the development of Chrysler's Neon, During the development of this car, the financial analysts assigned to the team had to tavel © Nova Scotia inthe winter to observe crash testing,” ‘5. Life eyele costing considers all costs of owning a product over is life, such as purchase price, operating costs, maintenance and repairs, and disposition costs, Life eyetecosting’s goal is to minimize the cos of onnership to & customer, For heh acuminate i crn xing itm he tnd oe prs we ert ft ent epee ing tomate cyt ‘Srey med onents n rce tsg TosExhibit 1 ‘ypleal Product Cost Curves ‘Committed Costs i Incured Costs Lod Produdion —Distibuton ‘Service ~ Dispostion ‘example, when a customer owns a reftigeratr, he or she pays more than the initial purehase price, The customer must pay for electricity (operating cost), repairs, and any final disposition cost of removing the refrigerator atthe end of its useful life From a producer's point of view, life eycle costing means design ing products that minimize all costs from birth (R&D) to death (disposition or recycling costs), In the case of the refrigerator, a design that reduces weight, Jocates parts so that they are easy to access during repairs, and uses remanufsc turable material will decrease delivery, installation, repair, and disposition costs, 6, Value chain members suchas suppliers, dealers and service and support relate part ofthe target costing process and help to focus cost eduction efforts throughout the valuo chain. Target costing systems involve an active and collabora- tive relationship in which costreduction techniques are shared by all members of this extended enterprise. target costing system is based on Tong term, mutually ‘beneficial relationships with suppliers and other members ofthe value chain such as distributors and recyclers, ‘These six features distinguish target costing from traditional cost-plus systems ‘Traditional costplus systems typically start with costs and then add profit margin to obtain a market price. Ifthe market is unwilling to pay the rice, the firm tries to find ‘cost reductions. Target costing stars with a market price and a planned profit margin fora product and establishes an allowable cost forthe product. Product and process design are ‘sed thereafter to reduce product cost soit sequal this allowable cost 10-5 Exhibit2 ‘Comparison of Target Costing and Cost-Plus Approaches: Target Costing Cost Plus CCompeive market consideretions drive | Market considerations are nel part of ‘cost planning. ‘cos planing. Prices determine costs. Costs determine price Design is key to cost reduction. ‘Waste and inetsoncy are focuses of cost reduoton efforts Customer input guides cost recuction. | Cost reduction isnot customer dtven. Uses cross-unctonal teams to manage | Cost accountants are responsible for costs. cost reduction. ‘Suppliers involved early. ‘Suppliers volved atter product designed Minimizes cost of ownership to customer. | tinenizes inal price paid by customer, Involves he value chain in cost planning, | Lite orno volvement of the value chain in cost planing, Exhibit 2 provides a comparison of the traditional cost-plus approach with the target costing approach, A THE TARGET COSTING PROCESS Since target costing relies on design for cost reduction, its applied primarily to new prod uct development efforts. Most products are developed in four stages: 1. Produet planning during which a product and customer niche are defined. 2. Concept development anc feasibility testing during which a product concept is developed and is feasibility is tested, 3. Design development, during which a feasible concept i tured into & detailed product design 4, Produetion, which occurs after a final design is released ‘Target costing occurs in two phases that correspond oughly tothe first and second halves ofthis product development cycle. They are called the establishment phase andthe ‘ainment phase of taryet costing. The establishment phase occurs during the product planning and concept development stages ofthe product development cycle and involves establishing a target cost. The attainment phase occurs during the design development snd production stages of the cycle and involves achieving a target cos. The relationship of ta get costing othe product development eycle is shown in Exhibit 3, 4 ESTABLISHING TARGET COSTS ‘Target costs ae established within the parameters defined by a firm's product strategy and long-term profit plans. These plans define new markets, customers, and products that a ‘company plans to pursue, Product concepts aimed at specific customers ae tested for fear sibility and then target costs are set fr feasible products. Exhibit 4 provides an overview To*exit Target Cosng and to Product Dovetopmont Cycle enn ‘The Eataishment Phase of Target Costing ofthe establishment phase of tage costing It shows hat thee ae seven major actives that mus be performed o eb age cot |. Market research gis infomation aboot unmet needs a wats fcstomer ‘Tie eeuch fies the market andlor produc niche tata company plant exploit Typkalls, amit niches a roy defined cls of customer sach os el conscious enters” “opwarly mae pofessionals” Competitor analyse dtemsines wha compton’ prot ae curently axa thle wou ret casos, haw the ester elt hve ther prs a bow our compen might eat oo company’s pew rode aeons A customer or practice sen by nang mare nd compen information to decide what parca customer segment opel A cistoner ‘chs ea more spoil deindcusomer, such as "you, profesional, vo Jncome fay bemecn the age of $0 and $5 Tor 4. Customer requirements sre determined by introducing an initial product concept and asking customers for thet reactions Preliminary designs are then refined, based on continued input from customers, until the product meets their requirements 5. Product features are defined by seting specifi requirements fr the featares the product will have an the levels of performance of each featre 6, A market price is established that is aecepable to customers and capable of with- sanding competion. Market prices ean be established in many different ways ‘Three common methods are: 4. Existing price plus the market value of new features added. For example, if new car model has dual air bays, we might take the price ofthe previous model and add the value ofthe airbags to determine the new price, The projected market price that wll provide a target marketshare, For example, ACD player manufacturer may set price that will give them a25 percent marketshare, Existing price plus the value of added physical attributes. This method is typi- cally used for products for which a customer's desired performance is captured by some physical characteristic ofthe product. A good example isa lawn ‘mower. A customer's performance requirement for how fast and cose the lawn ‘mower cus the grass i closely related tothe engine horsepower. Therefore, fa lawn mower with a two-horsepower motor sells for $200, then we might be able to charge $250 fora thre-horsepower motor if we can establish thatthe market ‘ays $50 per horsepower: ‘The required profit target is st. This isthe profi that a product must yield. Kis ‘typically expressed asa return on sales (ROS) percent. This ROS percent depends ‘upon the long-term profit plans andthe financial return on assets a company must carn in given industry. common practice in Japan isto use a weighting scheme that combines a company’s historical ROS withthe average industry ROS and the ‘company’s projected ROS to yield the requited ROS fora product, Japanese com. panies typically ignore the return on asses sine its difficult to determine and complicates the caleulaton of target profit. The following formula reflects this practices’ Target ROS = w, ( where torical ROS) + w, (Industry ROS) + w, (Projected ROS) For example, assume that the historical ROS of a TV manufacturer has averaged 12 percent. Further assume that the industry average is LO percent and tht this manufacturer plans to increase their ROS to 15 pereent in the next few years. Their target ROS for this, yea’ TV production may be: (BOM X 1255) + (205 x 10%) + (S08 % 1584) = 13.15 In this example, notice that 50 percent ofthe weights placed onthe future ROS, and the remaining weight is divided between past (30 percent) andthe industy's average (20, Percent). As ine passes, the weights asigned to past experience and 10 the industry ROS. Te-8O Koy Point sre designed 1 goto 20. Only the projected ROS becomes the key vaible in deter ‘mining &prodect's target ROS." is pin! note at pois, pos ard markt shares a arts tbe actiowd ano ‘tol sept estes ct nanagomor or rable echt abou ure eae thee ‘vets Tept conga, morte. eon lan equi comment by cman: ‘onal members A TARGET COSTING—AN ILLUSTRATION ‘We il sete the Key ation teach stage ofthe get costing process withthe help ‘ofa hpotietical company Kitchens, ne: Ritshensip is a manufseturerof small kchenapplianes such a oases, colle makers, grinds, lends, jules lve carving hives, can openers, and ther items {Compstion fs tugh several ther major brand names on the market include Me Cafle, “Moulinex, Braun, Krups, Shap, and Tsuba. Te company is loking for markt oppor ites to exploit intel various products. One auch product their coffecraker tine. (Cures, Kichenelp makes conventional dip coffesmakor and an espressocappuc ino maker. How ean the company apply the target costing sep in Exhibit 410 is ceeraer ie? ‘You wil recall rom Exhibit 4 chat thers thee steps in tet costing equi that the company eondoet market reeuch and competive analysis in order to define & rake ice. “Assume that Kitcenbelps makat reseuch and analysis sbow that thee is an ‘upwardly motile, college educaed consumer who sintered ia more gourmet ype of food at home. The oman docies ogo afer this “home gourmet” market niche Farther ‘market esearch eal in the discovery tt one ean which the home gourmet market che ean be exploited is though is coeemaker line. Kitcenhelp has determined that there sa market fora ofeemiker that provides espresso quality eotes but snot s com lex and time-consuming 0 operate as an esprssaeappuceino maker. Tere is also ile ompetiton in this marke sezment ‘itcenbelp ust ora coss-funeonl tam wo core up with an ntl product on cep an to ets feasibly. Assome tae Kitchens product eam peoposes a itil ‘roduc concept tat combines coffe grinder and a dp systm into a single coffe Iker. The new design wil grind rsh ce beans and push xia hot water Dough te ‘ender ask to make regular coe small an ste more ike espe I ihis type of eofeemaker is tecncally and financially feasible, then the sex. steps forthe product tam are to understand customer requirements and define product features. ‘Marke esearch aimed at eof inking consumes is needed 1 better understand astmerrgirements, Assume ta, sed on surveys and Toes groups, Klthonep has ‘dented eight features portato eustoms, These ae: ang ps sy es ee a wi a aie 1-9 ‘A Coffee tastes and smells ike espresso, ‘A The units easy to take apart and clean ‘A Capacity i at least six cups ‘A Coffeemaker looks nie, ‘A Unie has a clock timer to start automatically at designated time, ‘A Grinder performs well wit different kinds of coffe beans. ‘A Coffeemaker keeps the coffee warm after making it ‘A Unit automatically shuts of after 2 designated time petid. ‘These customer requirements become the basis for the engincering design of the coffeemaker. Engineers must ensure thatthe product encompasses all the features that are important to customers. Ths intial set of features becomes the first product definition for design purposes. The product team now must convert this customer input into a more pre- cise product definition. For the proposed coffeemaker, te product definition will inelude specific items such ws an eight-cup coffee carafe, grinder size, blade rotation speeds, size and shape of coffeemaker, the heating unit size, the water heater specifications and so on. ‘A product definition is typically inthe form of a blueprint, a computer designed drawing or ‘model, or an actual sale model The last two steps in establishing the target cost for this proposed coffeemaker are to set market price and profit margin. Ktchenhelp’s market research shows that the market price for an eight-cup dip coffeemaker with a clock timer is currently $69. A stand-alone coffee grinder sells for S15. Since the two features are being combined and the coffe taste is being enhanced, Kitchenhelp can charge a price slightly higher than $84, Given ther desire to capture a 20 Percent market share, assume that Kitchenhelp can set the target price at $100,” ‘The final sep isto establish a target profit by determining the desired return on sales for the coffeemaker. The common return on sales inthe small appliance industry is 7-10 Petcent. Kitchenbelp decides to set atargt profit margin of 10 percent om the product. The ‘target cost fortis new coffeemaker, therefore, is $90 (100 — 10). This is also referred to asthe allowable cost fr the product. 4 ATTAINING TARGET COSTS ‘The second phase of target costing addresses how to attain the $90 target cost; that i, how to tum this altowable cost into an achievable cost. There are thee seps in attaining target ost: (1) compute cost gap, (2) design costs out ofa product, and (3) release design for ‘manufacturing and perform continuous improvement. These three steps are shown ia Exhibits. "Toe te amp single wehne ates muy iy Cel hice js wl nee the itis jist witb ening ene ont ean a te ps ok ‘en ih nga pn an feo, Te-10‘The liainmant Phase of Target Coting ‘Comparing Alowable ane Curent Cost ite Cycle and Vale Chin Breskdowns Value Chain ine Outside Total “Aion: ar ‘Alon Cur ‘low Gar Lite Gye ‘able rent Gap | “able ront_Gap | “able rent Gap Resowsh and devclopnent | $360 4%) SS S140 pe so Nanwactng 1520(17%) 2 470 | sau S99 se40| s890 50. 1310 er) Saingencasriuion | S40 ex) 6 080 | t2m 17 440| 1900 28 500 es) ‘Senco ana eupeot e00(io%) i +00 90 10 1.00 Generalbusinss wwihead | 1800(20%) 19 100 1m 19100 eoyaing eae 450 6) 7 250 4m 7 26 Teta ‘soso (62%) ser 31:20 | sa420 ser srzm0 | $0000 si so1.00 (oon) ‘Compating the Cost G Computing te diferene between th silonble cst andthe carvent coat the ft ep fn asinng target cons For Kichentps coer, the aowable (rg) om 1 80. Nate tht thi total product ox, att monafactaring est The cnn os {steal "ais" estmat ofthe cost of pring the cffecnaer bas cen ‘cot factors of model, The ovr gup between allowable and ures must be decom posed by ifecyele an by vale chai A Ij eee decomposition asia tl prota, otto the bit-odeathceegoris of revere, anulcarin, dation, service sven spar, and poral Value chain deeomposion beaks down the cost by Shether ii inured by Kitcheaelp of by oe o is value ehain members sok 3 ‘ples, dealer or disposer “Tre two teow ae he sare ll cea andre ro ere aloe ew he posi coe Ech epsoiohoM wher ssi dican efits reed ibe toewes Te ‘Think Along Computing cost gap—an itstraton "Exhbi6provides an asso breakdown of the allowable ad curentcosts by ifeeyele tnd by vale chain fr Kitchenel's ofcemak. How di he company ave a tie ‘ost reakdowns? The breakdown of allowable conte by life eye yell equies ‘stimting the costs tobe icured on research and develo, mafactring make ing, istibuon, eps and oter supper. and cspsiton a the endo the pits Iie. The valu chain regues esting the ets hata incur within ih and those incre by ts suplirs, deals, ad reyelers. A company can Wei Pastis ical average as an na estimate fortes costs. For example, Rthenelps past expe rience shows th mancfactring cons re pally 41 percent of ol product ess for Small appliances. Prt, ofthe 4 percent, sie cows ve 17 pects the rer ‘ng 24 percent represent compoacats purchased from supplies Ths peesntagencan be ‘sed as tating pi to sete llomable cost forthe cfm or cach agar In theif yee and valve cai of costs Exhibit 6 shows these etimats for Kitchenlps prone fei. shows the life cjle breakdown ar perce ofthe llawabl cont of 0 as fllows: RAD (4 pr eat manufcturing (81 porend.selng and dstboon (20 percent, seri and op ot (10 persed, general barnes ved (20 perce and reeling (3 perce) Hao ‘hows hat 62 percent ofthe allowable ext of S80, or S358, win Kitelp and Pret or $3420, inthe vale chan, Kichenbp'snkia estimate abo shows hath tl pot costo the ew cal. maker will be S114 a gap of S24 (14 ~ 9) The ttl S114 cosas of $67 inside (exp ~ S120) and S47 eunide (gap = 5 12.8, Exit 6 also sows Unt the large ‘ost gp isin manufcing cont, flowed by matting an ditoton cos ‘Ho dese frmaon tit ha yo ox or cost edu s? “The nfomation in Exhibit shows shat the dhe lanes os gps exist in extra mamuscturing cots ($8.40), ner anaataring con (94.70) a extol sling and To?0 Key Point sibtion ($4.40). is clea tht Kitchens os reduction efforts must be external as wells ineral. The company nes to work ceuly wih epplirs and dealers and imolve tem actively in ost planning and seduction eos. This wil equ parwerships ‘ad tal rsa sharing of information among these various entities, Designing Costs Out. Reduction of cn tg pat designs th mont ical sep in ating tpt costs ‘Thc hyo cost edctonin atk one inl urn How does he dei of hs prod tet aft alconts netted withthe patito ts cep foo pa ince ail cu, not st manutcing cont nay ape fred a fist. However, ry “dou oats auch as dion, ing wateousng, Vc, spr od ‘eyeing an beet impacted by pod dein Comer for xem spat sich a imection ovens Wei nd cont pane! ar wo leet fond by dng. The doin ccs Spas manta {many ects well A hey machin linen louing cots aceporaon Cos nslaton sot since people te fone may Be nee to han ‘ancy sora contol ae ll inset ine sexe ves dete explain ing eastomes bow Be oven wots ay ao leis peat Suppo an rep cons beau both secre an mechanical components may il in peaon Fil, the fates Yo give ithe ex weight may pose an eniomenal hazard ht ‘egies lap tthe ine of npr Al hese ato a rocco. Many of ese cows can be odes hey ae antic and exp comedy prob a focen dupes Coa sttctoe elie on ow mijor actives pre design cot aly, vane caging, ant cot etinaton, These for actives wl Be explained Ia rater det tern he module nen we css how ent reaction actualy nce place in race. Cont reaction eeu ine he avi le Dock sever Hn a he oduct goes rom a nl concept to a inal design. The recursion ea character Stage conng, Recursion est fo generis a cont elective dexan nt 1 comet design evo Release Design and Undertake Continuous Improvement. The Sal stage in attuining target cot sto continue to make product and process impeosemens that can rede costs beyond thal which possible trough design sone Ie nclues steps sich as eliminating waste, improving prodicton yields (ue. geting more production from raw material) and other such measures. Japanese companies refer otis proces as laien costing, Some U.S. companies refer to ita alu anal ‘others eer ot as coarhuous inprovemen Ip afer production stars hat seul ost an be compared against ages and lessons learned canbe applied othe nex gener thon of products developed “The achevate costs rel an aa nce predate cost Ris an estat, po othe srt peicton, of wheter he arget cost canbe achieved Esraing al he gt Coats achevie is py siglo elese the post desi er actual posucien. To13 4 HOW COST REDUCTION OCCURS IN PRACTICE (Cost reduction would bea trivial task if there were no constraints onthe features and fun: tions offered ina product or onthe time available to develop it. For example, Kitchenbelp ‘could simply delete the coffee grinder from its coffeemaker and probably reach it arg, cost of $90. However, this would defeat the basic product concept of providing a fresh expresso taste in the coffe. The challenge, therefore, iso reduce costs without sacrificing any ofthe features that are important 0 a customer. ‘This section describes in greater detail the process of cost planning and reduction. We tse the Kitchentielp example wo illustrate what happens in the recursive fourstep sctivity cycle of design = cost analysis = value engincering —> cost estimation. The put ose is to describe what happens during these four cost reduction riviies and the key ‘cost reduction fools that are used. Using the data in Exhibit 6, we wil illustate how these setivities lead to reducing the curently estimated manufacturing cost of $50 tothe target «ost of $36.90. Note thatthe target includes both inside and outside manufacturing costs, ‘because suppliers are part of the product team during this cost eduction phase, Design Product and Processes. An initial product concept design starts the cost planning eyle. It is important to note that both the product and the process are concurrently designed. In out Kitchenblp example, the coffeemaker and manufacturing process that wil be use to produce the coffeemakers are designed and considered at the same ime. This avoids costly changes later because machines may not be aailable or capable of executing a product as designed. Common Wools used at this stage are Computer-Aided Design (CAD) and Computer-Aided “Manufacturing (CAM). Cost parameters ate sometimes built into these computer models 0 cost impact of design changes can be simulated concurrently.’ A product design goes ‘through several iterations before iis released for manufacturing Perform Cost Anal ‘The activites here consist of analyring what components to target for cost reduction and ‘ssgning individual cost targets to the major subcomponents and parts of a prodt. For Kitcheahelp it means deciding what components of the coffeemaker (heating element, ‘control panel, grinder) to target for cost reduction and then assighing a cos target to each ‘ofthese components, Cost analysis also focuses on the interaction between components ‘and parts. Often a reduetion inthe cost of ene component is more than offet by a cost increase elsewhere. For example, decreasing the cost of the outer shell of the coffeemaker bby making it small may increase the costs of the contrl panel, electronic eicuitr, and heating clement. Cost analysis requires five majoesubact ities. These are 1. Developing « list of produet components and fenctions. Cost rediction efforts start by listing te various product components snd identifying the functions that they Ane sf opus aed MADE Mann al Din i) i sng ToExhibit? Major Components of Kitchenhelp's Proposed Cotfoomaker? Exhibit 8 Funetional Cost Breakdown for Kitchenholp's Cotteemakor Cost ‘Component Function “Amount | Percent Brow basket ‘Grinds and titer cof 9 18 Carafe Holds and keeps coffee warm 2 4 Cottee warmer oops cottee warm 3 6 Body shape and water well | Holds water and encasement ° 18 Heating eloment | warms water and pushes it 4 8 Electronic cgplay panel | Contos arindorciock sotings 2B 46 Total {| sso | 100 perform and their curent estimated cost The ial product design and cos estimates ‘provide this information, The list els us what components and functions are needed. to satisfy customer requirements and what it might cost to provide these functions. Exhibit 7 shows a diagram ofthe various components of the proposed coffeemaker Doing a functional cost breakdown. Each ofthe various pars und components of the coffeemaker performs a specific function. Te next step isto identify that Tune tion and to estimate its cos. The functional cost breakdown i shown above in [Exhibit 8, For example, the function ofthe brew basket sto grind and iter coffee. “The current estimated cost is $9 forthe basket, which represents 18 percent ofthe total manufacturing cost for this produet.To keep the example simple, we have ‘combined several functions and components fr the coffeemaker. Ata deal level, the brew basket or the electronic contr pune will be broken into several subeot ponents, The total fr all components is $50, which isthe seme asthe manufactur ing cost estimate shown in Exhibit 6 Tos Exhibit 9 (Customer Feature Ranking for Kitchenhelp's Coffeemaker Relative (Customer Requirements Customer Ranking Ranking 7 5 Not Very | Raw Important Important | Score | % ‘Gofee tastes and smells ike espresso 5 | 5 | 2 Cotfeemaker is easy to clean 4 4 | 16 Looks nice 2 2| 8 Has 6+ cup capacity 8 3 | 2 Starts automatically at designated time 4 4 | 16 Works well ih afferent coffee bears | 4 teed Keeps the cote warm 3 a | 2 Automatically shuts off 3 3 | 2 ‘Total 26 | 100 3. Determining relative ranking of customer requirements. Engineers view a product in terms of is functions Ths is nota customer’ view. You will recall that Kitcheahelp had identified eight features that were important to its customers. The engineer's view ofa product as functions must be reconciled with a customers view of a product asa set of features. We must relate product functions to Features customers want, To do this we must first assess the relative importance that cus tomers place on te various features. A formal survey of prospective customers asking them to rank the importance of these eight features can be used 0 rank customer requirements. An assumed ranking fr each feature, based on survey resuls, is shown in Exhibit9 above. The importance ranking i based on a five point scale. A score of five means the feature is very important, a score of one indiates tat its very unimportant. For instance, taste and smell of coffe is ‘most important feature and multiple grinder setting is the least ‘The last column of Exhibit 9 convers the raw scores fo the importance of| features into a relative ranking of features. This is done by first adding together the raw scores fo the eight functions (5 +4 +2+3+4+1+3+3=25) Each function’ score is then expressed as a percentage of this tol score of 25, For example, coffee taste has a score of 5 out of 25. The relative ranking, there- fore, i 525 = 20 percent. It says that ofthe total value a customer drives from this coffeemaker, 20 percent comes from the way the coffee tastes. 4, Relating features to functions. The relative rankings of features must be converted into an importance ranking fo each function, Since components cary out the functions of a product and are the key design parameters, this step relates customer rankings tothe components that best meet that particular requirement. tool called Quality Function Deployment (QFD) is typically used for systematically arraying information about these three variables—features, Functions compo: nents) and compotitive evaluation—in a matrix format." “The QFD matrix isa useful too! for target costing because it highlights the relationships among competitive offerings, customer requirements, and design the ec FD cas mh gly en. ceil ii hp feng a pra gn sn gay net comme ogame Teeny rr ig tte. To-16enti 10 ‘NGFD Metre For Ktchenhalp's Cottemaker ‘tehenhep Ctfeemaker—Porcent Contibution of Esch Component to Customer Requirements Components | Brew | Carafe | Cote | Boay/ | Heating | Diepy | Roiave ‘Components r | Bion | Carsio] Cato | oy! [Honina] Depa] Comparison Backer Warmer | Water | Element | “Pana!” | Festurs Functons 9 | Gasket \iarmes| We [Elmer Pent Customer customer Wet enking Wet Coroatori, | Festie Foquierents| i SERN) Fert Tuswnatite ince | e0x20-10 on me Thats es ocr roxienta | soxinte ove ® toa ren wonteue was | 6 Trtessmets he expresso | a a =o 5 ross cn erety sosie-s sano 2 = Fi ‘ss eseatzly en tne seowiecte| 6 acy dear elie = £ acount wouras | 4 ae a z anal) reaper cree wa anera-24 | eoxi2-06 2 Has 6+ cup capacty ‘ a mo 2 ConannsConpewtfaning [150 100 fae | zoe | ta | 80 10% ‘Stas aomataly on ire “ aol Works win ateent beans | O a[oaa 1 THN AON [Gen youl iad aie nor cbt eso cana abn a ~ ig avomsty cacao ra? Roepe ne cote war ofa safe Ses r 4 5. Developing relaivefscional ranking. The QFD mati provides valuable ‘Automatic shat a. alo Information hal allows wt comer etre rankings it fantom or em ponent akin. This excl Roca customer hin i tr features, — but press re designed in ems of fnetions and components. To do this we ‘Corton cf gn paramos and custamer requerent. ‘ormparave competion need one oe piece of inforation: the percentage contibton of exch com 22 Song cormaton ‘ning 15 Comettr ranking prams Atypical OFD mats for Kitchentep's coffeemaker is shown a Exhibit 10. The QFD matric surmaies the nformaton aout product fnctions from Exhibit with estore rankings om Fab 9. ads wo other pees of information that are collected i th mare reset pis, Fn he colton ‘between a componcit or design parte and cusome equemeats Secon Isinformation aout hw cusomer evlunte competitor oerngs on these same feats, The mati shows, fr instance, tht the requirement that coffee tase ike ‘sreso has igh colton with he design the bre base nthe Resting ‘lem Simla, how! many aps the oe on Rods conlaedo the ‘ate well and th cara size. also shows tht ust. the most inert fear toa costomer, current ated at hee for Kicebelp ad wo forks compet toe This tls Ktcenlp hat while ts thea ofthe competion, tile ar from wat the aniomer wou ie wo sc a far se poe. On appears ‘ompetton obviosy as abet looking product wit rating of ve. Hower, {ecastmer raking Fortis eat is wo, which upg tht ts mt worth Spending too many sburces in improving the appearance ofthe coer. Te17 nent oa caso fete. This formation i shown agence eal tion Exhibit 10. Eglaets ave wo comer this orelaton data nto spe ‘contribution percentage. Such a breakdowa fer or coffer shown ia Exhibit 1 and itp lls. The feat “ise ike expresso isa futon of the re base! ad beating element design. You can vey his from Exhibit 10) Engineers fee that both hee componeate cot ihut ally tothis “ast” feature Thetefore they assign each component» 50 perce co tibation ro tase, The rlave value eaking of he tase” etre 20 pret, Therefore since bth components cote equ, we assign each ofthe to omponcs vale king o 10 peer, Te at ow of Ei 1 asthe ‘ale consibwton of acomponeat ol fates to ave a tat component's "pprximat elu vo a customer. The be basket row sito hae ale 5 percent oa custome, the arte has vale of 10 pert, od 9 on Nove tha the srw sn fast column bh a wp to 100 prc. Theyre simply deen views of casomervales. The clams rset vale of Feats andthe row represents the vale of compooets ToeExhibit 13 ‘Value tndex Chart for Kitchenheip's Coffeemaker Exhibit 12 Value Index for Kitehenhelp's Coffeemaker Relative ‘Component Component | importance | Value or Cost(Exs) | (EX.11) | Index | Action Function Geottoray | (int) | (Col3~2)| Implied ‘Brow basket 18 180 083 | Reduce cost Carato 4 100 250 | Entance Coffee warmer 6 96 1.60 | Enhance Body shape and waterwell| 18. 204 113 | OK. Heating element 8 100 1.25 | Enhance Electronic alsplay panel 46 35.0 078 | Reduce cost 100% 100% Do Value Engineering (VE). ‘Value engineering is an onganized effort directed at analyzing the fanctions of the various components forthe purpose of achieving these functions at the lowest overall cost ‘without reductions in required pecformance, reliability, maintainability, quality, safety recyclbilty, and usability. For example, the purpose of «heating element isto bring water temperature toa specified level. This is called its “function.” Value engineering asks how this function of raising water temperature to 110° ean be achieved in thee minutes at & lower cost. Itanalyzes both product and manufacturing process design and reduces cost by _generating ideas for simplifying both.!! Value engineering isa the core of target costing. It ‘consists of the three major subactivtes discussed below: 1. dentying components fr cost reduction is the first activity. Choosing which components wo select requires computing a value index. This is ratio ofthe value (degree of importance) to the customer and percentage of total cost devoted 10 ach component. For our coffeemaker, the value information isin the last row of Exhibit 11, and the relative cost information isin the lst column of Exhibit 8 Both these quantities are expressed as percentages. Exhibit 12 computes the value index and shows its implications for cost reduction ‘As Exhibit 12 shows, components witha value index of less than one are typically prime candidates for value engineeing. Components with high value are candidates for enhancement since we are spending fr too litle fora feature that is important o customer, These componens present an opportunity to enhance the Tat nl resign ce ior ufc and ely AMA) ets casing pc oped opi: ep hacen aera ut, ain oes, The Stoenan os cat asa ad tere devon beng emir tment emer To19 Exhibit 14 kitchenhelp Cottoomaker—Electronic Display Pane! ‘Value Engineering ideas to Reduce Cost Panel Sub-Component (Cost Reduction idea ower supply Reduce watiago—more than needed In curent design. Flexible cult Eliminate flexible crcut. Uso whing harness. Pind wire board ‘Standardize board spocticatons. Use mass-produced unt Glock timer ‘Combine wit printed wire boars. ental processor chip | Substitute standard 8088 chp instead of custom design. Heater connector Rearrange layou! of board to heater connection, product. The 1wo variables inthe value index, cost and relative importance, are plotted on a graph shown in Exhibit 13. ‘The opsimal value zone in Exhibit 13 indicates the value band in which no action is necessary. The optimal value zone is based on experience and opinions of the target costing team members. The zone is usually Wider at the bottom of the value index chan, where low importance and low cost occur, and narrower atthe top, where features are important and cost variations larger. The area of the graph above the optimal value zone indicates components that are candidates for cost reduction. tems below the zone are candidates For enlancement. 2, Generating cost reduction ideas, the second activity, requires creative thinking and brainstorming. The purpose isto ask what can be reduced, eliminated, combined, substituted, rearranged, or enhanced 10 provide the same level of functionality {from a component at less cos. Exhibit I lists some sample cost reduction ideas that Kitchenhelp may consider to reduce the cost ofthe electronic display panel, the prime target for cost reduction idee by the value index. Note that the cos reduction ideas in Exhibit 14 contain some general principles that can be applied to many different situations. These ideas focus Te-20{Component interaction Mare ‘Components | Baskot | Cafes | Warner | Boa | Hear | Opty | Coot | avananie Carte ‘aut Brow baskt . | mo ‘ates ware * 3 | 20 00) » | ipay pet ‘cn edcig the minber of ats simplitying the asembly, end nt ovr ‘ngiseing the rodt Dood what will met aeusiome’s peed. Across fanaa eset Decase tse types of engineering design choles ube uid by cuscmer ans sre pa "the onan of management accounts nealing cost ection eas inert Engineers ne kom quickly an rlably wheter ert rection ‘este are omsirng te worl fom ancl standpein. Fer xa, {oconsider nether to clint the exible cei, we mint haves pod eno ae coat wells god cot tates tht allow o fo deeming what a exe [ret as thee mantacrng costs of oer. Tening ander iors the last tivity wit ae eninering ‘Promibing eas ar valu t nsr tht hy otc fee ad teceple estore, Thos ia tht fable ad seepale to esemers tne devsloped ang incorporates it the rodust x process desgn and xtaloged in AVE tdeat databases they are sible for fare desig eas. One tol fen "hed fore the fens of en he erponcn steractn mats Tis train, wich lps identi he pact of amp one component oo ee owiponets ules cov dat Kenseth 0 cree or soon et pac- tio comments af wd. The ase of sch components an ncrese poet cows Signifcaly, Esai 1S shows a sumlecompooent meron ma for [Kitchens cffemaker The Cost cola of Exh 5 shows the cst of a ‘ponent The Aviable Until cola bots tering ie in yeas before the componett may be abot orn loner vale. ety ineates| ‘whether ere eltonsip between Ie components Eaimate Achievable Cost. ‘Cont eimai ian important civ in ret costing Thi activity mes pace at ach fenton ofthe padut design eee, At the posit concep slags, os esas ae rough approximations a pel we few produc pciesions aod sine no change To-21 in wechnology. New designs are generated a value engineering ideas are implemented Each revised design requires a new estimate of achievable target cost. Each new cost ex mate sdfferent from prior cost estimates. Early cos estimates ae typically performed on a concept drawing, while later estimates use a more developed design in which many of the pars and processes have been specified. Consequently, thes later estimates of ahiey- ale costs are expected to be more accurate since more data is avilable. Many Japanese ‘companies require estimates of achievable cost at the design development stage wo be ‘within 3-5 percent of actual cos. The following are cost extimation methods used in the “compute cost gap” and “design costs out” phases of target costing. Estimating (initial) current cost. ‘The current oe initial cost estimate is generated by using simple but reliable cost estimation ‘methods. There are several cost eximation tools used in practice, They include statistical regression, leaming euves, and parametric estimations? The levels of accuracy required in cost estimates increases as the product moves from concept 0 completed design. Estimating manufacturing costs. For estimating manufacturing costs, (wo methods are commonly used in practice: 1. ‘The physical attribute method typically establishes a relationship between physical characteristics ofa product and its manufacturing cost, Some common physical parameters use in industry ar: ‘Square fect, used fr estimating construction cost, ‘Wing lift, load, and seats, used in the commercial arraf ersepowter, used inthe mechanical equipment industry ust, 2. Cost tables are common in Japanese industry. They are databases of detailed cost information that enable timely cost estimates for new products, Cost ables include sata on cost elements suchas material, purchased pars, processing cost, over- ned, and depreciation on new investments as well as cost models Well designed cost tables usally contain very specific information om bot intemal an supplier ‘manufacturing processes. Information includes machine hou ates, labor rte, scrap rates, eycle times, and cost of operations. It also identifies the major factors (Givers) that cause cast to change. While cos tales are more useful in generat ing detailed manufacturing cost estimates, they can be used to generate an inital cost estimate for anew product that is likely to use existing materials and manu facturing processes, Estimating other costs. For other costs such as distribution, marketing, and suppor, two methods are used as wel: |. Actvity-based costing (AIBC) is used for items such as manufacturing overead, ‘marketing, distribution, service and support, and some business overhead The han pis py exes > Spat nore fonction -5 pce when ‘hon nat ype al ilo i res mt bil of et Sage ascoc pp ape pet arpa los pet tat tans mone TT at nahn ocr ory bas ao ABM a ay aA 8 To-22key isto trace activities needed to sell or support the product and assign a cost ‘based on the consumption of sctvities to the produet. 2. Historical burden rates are used for items for which itis dificult to establish a direct relationship between costs and activities, Typically these are general busi ness support costs such as accounting, data processing or legal services, which are slificult to trace to products. For example, if Kitchenhelp's pet experience sug gests that accounting legal and other general support costs are 20 percent of prod- ‘ct cost, then the 20 percents called a burden rate It cam be used to generate an inital cost estimate forthe product. ‘& MANAGEMENT ACCOUNTING AND TARGET COSTING ‘Traditionally, management accountants have been functional experts who do not have much contact with their marketing and production counterparts. They see their role as pro- viding financial data, measuring performance after te fact, and auditing resource usage. “Target costing requires a change inthe traditional role of management accountants and the type of information they provide Role of Management Accountants. ‘Target costing systems require management accountants to have early involvement with a roduet and to lear to function as cross-functional eam members. Early involvement means starting when the product is stil inthe concept stage and it forthe rest ofthe development cycle. Management accountants need 1 pro- vide good cost estimates for each design iteration. They must look ahead and provide information about product costs from incomplete design daa. I not helpful to wait unit the product specifications are final. Frtet, each successive cost estimate must be more accurate as the design maves from concept to release for manufacturing, The focus is on estimation and not on actual costs. ‘As a erass-functional team member, 2 management accountant must help other team ‘members from engineering and marketing to do ther jobs. For example, engineers need 10 ‘know the financial implications of their value engineering ideas. Inthe Kitchenhelp exam ple, design engineers need to know what cost savings will result from the redesign of the heating element. Siailary, marketing must know what the company can afford to spend on feature so they do not promise customers something that a company cannot deliver. For ‘example, many customers probably desire a VCR and a TV in their minivans. Car compa- nics such as Chrysler, Ford, and GM must have good cost data to se if the feature is affordable for them ata price a customer is willing to pay. ‘Management Accounting Information. ‘Tuget costing requires a shift away from traditional responsibilty (department-focused) accounting systems to more process-oriented accounting information. In esponsibility ‘accounting the prime focus of accounting isthe organizational unt. Process oriented data focuses om interunit and interorganizational relationships. It collects cost data by how a ‘product flows across the unitsorganizations, what activities it requires, and what drives T0238 costs at each stage. In particular, six types of cost data not routinely collected by most ‘management accounting systems are critical fr target costing, Life eycle costing focuses on how each stage From birth (R&D) to death (4isposi- tion) contributes toa product’s cost. Life eycle costing requires cost accumulation by life stages of a product instead of using traditional cost objects suchas depart- ‘mens or products 2. Value chain costing requires cost accumulation across traditional organizational boundaries to include suppliers, dealers, and others. Ithelps to focus on the contri- botion each member ofthe value chain must make to achieve target cost and how their actions are co dependent on each other. Exhibit 6 shows an example of value chain costing. 43, Featureffunction costing is ilustated in Exhibits 10-12 of this module. This type ‘of costing requires a management sevountant wo decompose and assign cost targets ‘0 product components based on how each component i related to acustomer reqqirement and how much importance customers place on that requirement of feature. 4. Design driver costing focuses attention on the impact of design onthe lite cycle and value chain costs It collects data on bow and what changes inthe physical attributes ofa product (design) lead to chunges in cost. For example in the case of ‘a tactor, Caterpillar considers weight, horsepower and bucket capacity tobe the primary design drivers. Changing these parameters leads to an increase of decrease in the numberof pats used, number of manufacturing processes used, and the extent 10 which common or standard pats can be used. These latte ean be consid ered secondary or derivative design drivers. 5. Operations costing provides Jaa about the cost of using a particular manufietur- ing operation. Accounting team members prove this information to designers, ‘who can ue ito design products that use les time in costly operations. For exam ple, a final step in semiconductor manufacturing is “burnin” (ets, These tests are performed using electic ovens to test the resistance and performance ofa chip ‘under heat, Since the primary cost driver isthe numberof hours in an oven, over- specifying the burn-in test hours can increase costs for products that do not operate ‘under or generate high est. 6, Actvity-based costing is particularly valuable for identifying divers for indirect ‘manufactoring costs soch as material handling and for marketing, distribution, service, an support activities. Iisa valuable cost management tool because it ocuses atention on how product design leads tothe consumption of various activ: ities and therefore increases cost. For instance, materials handling is related tothe ‘numberof unique parts purchased, which isa function of design complenity. 4 TECHNICAL PROPERTIES OF TARGET COSTING ‘As acost and profit management oo, target costing must possess two important echnical properties. [t must lead to better decisions, and it must provide a good process under- Standing of cost drivers and work flows in an organization. It performs well on both these criteria To-28Decision Relevance. The six fundamental ideas of target costing, discussed eaie in this module, show how target costing brings together five critical management decisions under one umbrella, These are: iow to increase profits and return. How to react to competition ‘What prices to charge for products. ‘What features to provide and what specifications to use for those features, ‘When o introduce new products and stop building old products “Target costing integrates cost, quality, and time related issues ito a single decision around product design. Managers consider profits and competitive reaction as part of se ting prices. Costing is almed at achieving target profits and etums. New products are timed by considering lifetime profitability and technology cycles of new products, Process Understanding. Enbancing process understanding is atthe heart of target costing. As this module shows, target costing focuses on the product as it moves through time, across units, across organizations, and across activities, All ofthis is accomplished by cross-functional teams who have a produet and process focus, nota responsibility uni ‘or single organization focus. Infact target costing cannot Function in an organization that is not ready to adopt a process orientation. ‘4 BEHAVIORAL ISSUES IN TARGET COSTING ‘There are two sets of behavioral issues in target costing. The frst is the Behaviors needed for successful target costing. The other isthe behavioral consequences of using target costing. Behaviors Needed. ‘Target costing requires different behaviors from all members of an organization. In this ‘module we focus only on the behavioral implications for management accountans.° They need to change their behaviors in two ways: ‘4 Management accountants must learn to get involved early and develop a tolerance {or ambiguity. Design is by nature an incomplete process. tis forward looking and requires many estimations. Accountants always want verifiable data ‘They mus shed this desire ‘A Team playing isan important attribute for management accountants. They need 19 get involved with other diseipines, understand the technical dimensions ofthe product, and know what customers require. They must lear to tak to other team ‘members from marketing, engineering, and procurement, and explain to them the financial implications of design decisions in an easy and understandable way. fective communication isan essential behavioral requirement for management accountants who participate in target costing. "SFr dsuson oe thn inion rath pital wei eA Tet Coin T0258 ‘One reason target costing has been hard to implement in U.S. firms is because these two behaviors are not curently ingrained in these firms. Most managers tend tobe fue tional specialists who know a ft about their own areas such 3s marketing, engineering or accounting and do not feel the need to communicate with managers in other areas. In adi- tion, performance evaluation has not depended on team performance. Behavioral Consequences. ‘Target costing can lead to undesirable behavioral consequences if not employed carefully Kalo etal." report four behavioral problems experienced by Japanese companies who have installed target costing. These ae discussed below, Longer development times. In some companies, an overemphasis on design led to a longer product development cycle and delayed the product from reaching the market on time, This behavioral dysfunction ‘a be avoided by seting simultaneous targets for quality, cost, and time. Behavior must be driven to all thre targets, not jut cost! Employee burnout. Pressure to attain targets, particulary demanding ones, can cause employee burnout and frustration, Failure to atin targets despite working many hours of overtime and doing their best is likely to reduce employees" future aspiration levels or lead them to reject the targets as unattainable, There are thee ways to reduce the likelinood of these adverse ‘behavioral consequences 1. Use employee participation in seting targets. Research onthe effect of participa: tion are mixed!” However, it does suggest that employees, particularly profession als suchas engineers, are beter motivated to attain targets when they have a voice in setting those targets. 2. Create and manage slack. In thei pioneering work on organizations, March and ‘Simon argued that «certain amount of slack is functional because i allows organi- “ations t harness extra energy for crisis periods. It may be in an organization's best interest not to operate in a constant crisis mode but instead to create a certain amount of “acceptable” slack in targets whenever possible, 3. Facus on continuots improvement and no radical changes. Learning reinforcement theory suggests that frequent postive reinforcement is useful way to motivate and keep behaviors on a desired path. Continuous improvement is one way to use fre= ‘quent positive reinforcement, Making small incremental improvements provides employees a sense of accomplishment inthe near term. Individuals do not have to ‘meet an entire target before they are reward for their efforts. This incremental rove toward targets can mitigate some of the pressure for meting targets. Market confusion. ‘Too much attention to customers can cause “feature creep.” That is, additional features, ‘are added on without regard to cost, anda proliferation of product models eauses market "tds te acme cae i Ks, Bw ad Chow. “eet Csi A ge "Fens edge cis prion se eer vel Pap n he aey sehen sn Whe De nme ang aoe Seg 2p 1215 10-28confusion, Management accountants can help to avoid this by making certain that eng ‘neers are aware ofthe cost of new features and that marketing does not just produce a cus- tomer “wish lis.” Both disciplines should be guided to consider cost trade-offs so that features are added only when customers are willing to pay for them. A good example is a Danish manufacturer of optical scanners who has adopted the slogan “state-ofthe-market” technology. What they mean is that new technology is introduced in their products not ‘because itis “state-of the-art.” bu because customers will purchase those feature. Organizational conflict. The traditional focus of target costing is product design. Other costs, such as marketing or ‘general business support (overhead) are cither exempt from cost targets or are treated as “fixed” by prior decisions and part of the “legacy” of the existing cost system, Design engineers fel that other parts of the organization are getting a freeride while they try to squeeze every penny out ofa product. This leads o internal confit, There are two ways of avoiding tis problem. 1. Ser targets for ll costs. All costs, including marketing, logistics, and suppor, must be pat ofa product's target cos. Ths makes sense from both a cost management and a behavioral perspective, Jus as We cannot exceed a certain amannt to manufie- ‘ure a produet, we cannot excood a target for adverising and promoting that product either: These costs noed tobe managed as par of echieving overall profit targets. 2, Use target costing philosophy to manage all costs. Target costing represents & philosophy that says costs are driven by the way we design our products and ‘procestes, This philosophy can be used to manage the “fixed” or “legacy” costs by looking at the design of these suppor functions and processes. Indeed, activity based management and business process reengineering are two techniques that employ a design orientation to manage processes. ‘& CULTURAL IMPLICATIONS OF TARGET COSTING In adtion to right behaviors, introducing and sustaining target costing in an organization requires appealing to and creating @ sot of shared cultural values, beliefs, and mindsets ‘within an organization Creating a Receptive Culture for Target Costing, Introducing a new process in an existing organizational culture is always hard, People have ‘their existing beliefs, values, and mindsets. A new process that does not appeal r0 shared ‘organizational values is unlikely to take hold. A good example of appealing to shared cul tural values is Chrysler's launeh of target costing on their Neon car project ‘When the Neon was launched, Chrysler was ina difficult financial situation. General Manager Robert Marcell introduced the need for target costing by showing Neon project team members sles of life in is hometown of Iron River, Michigan, where he grew up. ‘These slides showed Lron River, named alter its principal industry, iron mining, as a pros- perous community located amidst beautiful lakes and woods. Later inthe talk he shoved pictures of Iron River as itis today-—a ghost town of largely abandoned mine shafts and a population less than half of whatitwas in the early 1960s, with more than 75 percent of the residents below the povery lin. The reason: Iron River was unable to compete against T0-27 impons from Brazil and Canada. As Marcel pt it, ron River's inability to compete made itimto “an economic Chernobyl.” The talk ended with Marcell asking the team members if the present day auto industry in America and Chrysler in particular are likely wo become Iron River. Can they rise to the challenge and disprove critics who think the U.S. auto industry i “soft, lazy, dumb ... and can't compete"? Can they compete and save the auto {industry and maybe ina small way make a significant contribution tothe U.S. as well? ‘The Marcell presentation launched what Chiysler described as a cultural appeal of| “dare to be different!” The presentation is a powerful evocation of symbols and values Important to Chrysler workers, driving home the necessity for building small cars cost effectively. It has all the lements of an appealing story. The slides of small town US.A. invoke the symbols of a nostalgic past. These are the images that Ne ‘burned into our consciousness forever Add to this an element of ch and European auto makers. The image ofa sleeping giant awakening provides a rich sub text There isa villain tobe proven wrong, The villain is the infamous “they” (the media, foreign erties, our own etizens and top management) who have los faith in ou a do things right. Finally it ends with a Kennedy’style sppeal to do something forthe coun- try. The Chrysler speech has all the images, symbols, values, and emotions that appeal to “Midwestern work fore. Its not surprising that Chrysler's introduction of target costing has been very successful Sustaining Values that Support Target Costing. Introducing target costing is only a beginning. To sustain target eostng, an organization also needs a supportive culture. It must either create a st of shared values if absent or nourish them if present. While the ene organizational eulture must change, our focus here is only onthe cultural values and beliefs that are part of the management aceounting function, Traditionally, accountants have been tained tobe neural and distant. They fune tion as technical specialists rather than volved team members. Management accountants ‘who paricipate in target costing need a different mindset. They must internalize three {important values: ‘Customer focus means that their work mus always focus on how it creates value for a ‘customer. Serving and listening to the customer must be more than a marketing gimmick. must be an interalzed bli ‘Cross functional cooperation is another important value to be internalize. The man- ‘agement accountant must set aside narrows parochial concems in favor of cross-funetonal ‘cooperation. Teamwork must be the norm. The management accountant must not operate ‘as corporate policeman, Open sharing of information is an important part of creating an open culture Management accountants must provide information to team members and not wse it as a source of power ‘These thre values and beliefs are the comerstone of a culture supportive of target costing, A LESSONS LEARNED “There are six key lessons we want you to learn from this module: a Target costing is powerful strategic too! that allows an organization to address all thyee dimensions of quality, cost, and time simultaneous. 10-28‘A Target costing is essential for coping with today's globally competitive ‘A Target costing controls costs before they are incurred; that is, atthe design stag. ‘A Castomer requirements must deve all target costing activities. ‘A Target costing wses cross-functional teams that include suppliers, dealers and others. ‘A Target costing requires change in behaviors and can lead to employee frustration and burnout if not sed earful ‘A Tuget costing requires a culture that velues customer input, cross-functional cooperation, and open sharing of information. To-29 ‘& COMMON TERMS Aatvty The series of related tasks that ate pat of work performed in an organization. It represents what is dane such asthe Several things needed to Toad a truck with goods to be shipped, or responding toa customer complaint. (See process diagram.) ‘Activity Based Costing (ABC) A method of costing in which activities ae the primary cost, ‘jects, ABC measures cost and performance of setivtes, and assign the costs of those scivites to other cost objects, such as products or customers, based on their use of Allecaion The epportionment or disrbution of a common cost between two oF more ‘cost abjects, In accounting, allocation is usually a way of assigning a cost between cost ‘objects (products, departments or processes} that share that common cost. An allocation involves dividing the cost needed to allocate by some physical quantity (ideally a cost riven Benchmarking The process of investigating and identifying “best practices” and using them as standard to improve one's own processes and activities [Budget A quantitative plan of action that helps an organization coordinate resource inflows and outflows fora specific time period. Budgets are usually financial but may also inelude nonfinancal operating information, ety The physical facilities, personne, supplier contacts, and processes necessary to meet the product or service needs of customers, Cost A monetary measure of the resources consumed by a product, service, function, or activity, Italo refers tothe price paid for acquiring a product or service Cost Driver An event or factor that has systematic relationship to a particular type of cost and causes that cost tobe incurred. CostManagement The systematic analysis of cos drivers forthe purpase of understand ing how to reduce or maintain costs. Cost Object Any item (activity, customer, project, work uni, product, channel, or service) for which a measurement of cost is deste. Competitive Analysis ‘Tools that enable companies to quantify how performance and costs ‘compare against competitors, understand why performance and costs ae different, and apply that insight to strengthen competitive responses and implement proactive plans. Continuous Improvement _ program to improve the sratesic variables of quality, cost oF time in small incremental stepson a continuous bass Culture The collective values, elif, ethics, and mindsets of the members of an organi- zation, clan, or society which i subconsciously sed to interpret events and take ation Wis often called the collective programming of the subconscious mind. Extended Enerprise The extended enterprise includes an organization's customers, suppliers, dealers and recyclers. It captures the interdependeneis across these separate onganizatons I is also refered to as the value chin, Fixed Cost A cost element that doesnot vary with changes in production volume in the shortrun. The property taxes on 8 factory building is an example of a fixed production cost. Incremental Cost 1. The cost associated wit increasing the output of an activity project above some hase level. 2. The aditional cos associated with selecting one ‘economic or business alternative over another, such a difference between working over- ‘ime o subcontracting the work To-30Indieet Costs. Costs that are not directly assignable or traceable to a cost object. Le cyele Costs Accumulation of costs for setvitis that occur over the entte lifecycle ‘of a product from inception to abandonment. Process series of linked activities that perform a specific objetive, A process has a beginning, an end, and clearly identified inpus and outputs Process Activites 6-0-0-6-0 Tasks Quality A customers total experience with a product or service. It includes features and the performance dimensions of those features suchas eiability usability, safety, and repairability Suategy The way that an organization postions and differentiates itself from its com- pettrs. Positioning fefers othe seletion of target customers. Distinetions typically are ‘made onthe dimensions of quality, cos, and time. Time The time it takes a firm to develop and produce new products o to provide exist ing products when customers need them. Variable Cost A cost clement that varies directly and proporionatly with changes in production volume, Value Chain See extended enterprise To-31 ‘4 PROBLEMS AND CASES—INTRODUCTORY LEVEL 1. Self-test questions. 1, What sa target cost? How ist diferent from a budgeted cost? ‘What are the sx fundamental principles of target costing? ‘Why isi important to manage costs before products have been produced? ‘What ae the different ways in which you can seta target market price for a product? ‘What isthe difference between cost estimates done at various stages ofthe product development cycle? [At what stage ofthe product development cyele does target costing lay a key role? ‘What is the diference between an allowable cost and an achievable cost? Explain how target costing is different from cost plus pricing. ‘What does a value index of less than one imply? Target costing is the process of translating a customer's view ofa product into an engi- neers view ofa product. Tlustate what this statement means using a product. (Hint: Use a product you ar familiar with such asa telephone, a watch, a radio, a cassette player. and soon.) i, Explain how a well executed target costing process can help a frm achieve its quality, ‘cost, and time objectives simultaneously, ‘What is meant by concurrent engineering of products and processes? How does this lead to cost reduction? 2. “HP's new Vectra 486N uses an 85-watt power supply ... contains 450 pars, a 46 per cent reduction... has just one serew (Dell has 25 serews)."l# Explain how these redesign steps reduce the cast of Hewlet Packard's Vectra 486N personal computer List the types of costs saved 3. Whats the target profit that you would recommend for a product that has the following, retum on sales (ROS) profile? (Consider the tree items together) (@ Industry average return on sales for this typeof produet—I1 percent i) Company average for this product line—I4 percent. (Gi) Company's future plans fortis product line—16 percent. Explain your recommendation. 4. Listed below are several design choices for manufacturing « dishwasher, Comment fon how each design choice will impact costs. List which costs will be impacted and in what dcection a. Steel versus PVC tub for dishwasher. '. Electronic versus nonelectronic control panel. Hint: Electronic panels require circuit boars that cam take high heat, humidity, and vibration.) « Subassembly for blades and rotor redesigned 1 use 30 percent fewer pants. 4. Rinse and hold and plate warmer cycles eliminate €. Use of a power supply used by the firm's existing lines of garbage disposers and trash compactors. ‘Use ofa 10-year power supply rather than one that ass 25 years. ° Fm ey Pci Pe Mow Tey Did” RTE Magi Noe 1959.13 To-325. Ariane Eletronies makes power supply devices in their plant located in Malayasis. The power supplies are used in various produets such a har dryers, electric knives, ils, and ‘0 on. The power supplies vary primarily by the wats of output they produce. They range from 5 watts to 30 watts. Ariane’s main competitor is Nikko Electrical. Nikko sells a 45, wat power supply at a price of $22. Ariane currently has only a 30 watt power supply that sells for $16. Ariane’s engineers think they can produce a 40 watt power supply that can compete with Nikko. The company's market research indicates that prices sre adjusted for wattage differences between power supplies. The adjustment formula is as follows (Competitor's wattage/Our wattage)*0.79, where.79 isthe customer's perceived value for wattage ‘Based on tis relationship, what isthe target market price for Ariane’ 40 watt power supply? 6, Assume that you worked for Cheysler in 1990 and were assigned tothe development twam for the Neon project. This project was developed under the target costing approach rather than the tational eostplus approach. Answer the following questions regarding the development ofthe Neon car. Be creative, using your knowledge of ears in general in answering the questions. You should provide car specific examples. Required: ‘a, Identity the seven steps inthe establishment phase of target costing. Provide specific ‘examples of activites undertaken foreach ofthe seven steps. ». Discuss how each ofthe three steps in attaining target costs might have applied to the Neon project. Also discuss how Chrysler could design eosts out or reduce costs through design improvement, «, List some behavioral problems that may occur when target costing is used, Provide an example of bow these problems may have impacted the Neon project, A PROBLEMS AND CASES—ADVANCED LEVEL 27. Quote from a senior manager of a major company: “Our frm has always had a design to ‘cost philosophy. Our engincers have to achieve very tight cost standards when designing new products, Target costing is just the new fashionable term for something we have done all slong” Do you agree wit this statement? Has the firm been practicing target costing? ‘8 Hightech manufactures color printers. tis in the process of planning the production and Numeral Rating = & {Weak Coneaton ‘3 Skong Coreason =? Nurereal Aang Ca conpeto’s Proouct B 8. Can somebody's standard item be used? Could less cost tooling or fotures be used? ‘Does it cost more than wo feels reasonable? 9, Ara we buying too much reliably? 40, Using my money, woul refuse the price? To-42 HITTIN Decorate fish Burge Alame Freploces Koy to Symbol: