By Marshall Andrews and Serge Le Berre Target Costing White Paper Many contemporary manufacturing organizations put a great deal of time and effort into cost reduction activities. But there are several significant questions that organizations need to ask themselves regarding their performance in cost reduction: 1. Are they getting an appropriate bang for the buck with their resources applied to cost down efforts? Are their costs lower than your competition? 2. Is their organization aligned in this effort across functions? 3. Are the cost reduction activities sufficient to meet the company s target margins over the product life cycle horizon? 4. Is there a structured management process to ensure cost reduction activities are identified and executed to plan? In this white paper we will discuss a tool target costing that addresses these questions, and describe how implementing this tool can dramatically improve an organization s cost reduction results. Target costing highlights include: 1. Actual implementations have resulted in doubling to quadrupling the cost reduction performance in business lines. 2. The tool is applicable for products in the development phase and in production. 3. Target costing aligns the organization and involves all levels from the shop floor to senior Executives. 4. Drives market based realities into the organization to reflect dynamic pricing over time. Current Environments Many mid to large size manufacturing organizations have very active cost down efforts. In many cases, a great deal of time, cost and effort are dedicated to this activity. This usually involves employees in manufacturing, purchasing, and engineering. Sometimes this effort is lead by one of these functions, sometimes by a central cost down group like Industrial Engineering, or sometimes by a product line organization. But usually there is misalignment; it is not a cohesive, holistic, effort focused on a specific product line. (To test your organization s alignment see how many departments have separate lists of cost down activities.) Consistent with the multiple lists of cost reduction ideas is a lack of understanding by the organization of how all the ideas fit together, how important are each of the ideas, and are some ideas better to work on than others are. And across the organization; does the sales department understand all the ideas, and how they could affect quality and design for the customer? In many tiered manufacturing companies, process or product change must be approved by the customer. Therefore it is necessary to have a long lead time ahead of implementation for validation and testing before a change can be implemented. Copyright, Marshall Andrews, Target Achievement LLC. All rights reserved 1
A potentially catastrophic manifestation of this misalignment is that the sales department is disconnected from the cost outlook for a product. Either way this can be devastating. If costs ideas are flowing and product costs are coming down, there is potential for more profit, or a more aggressive market share campaign. Conversely, if costs are going up, the sales department needs to have that view to determine future pricing and product line strategy. Despite the organizations efforts, in most cases, the teams are driving to amorphous cost down targets. Simply stated, many targets are opportunity and idea driven, but not necessarily target driven. Or frequently, they may be a peanut-butter approach set by Corporate HQ like 5% per year for all products, or 2% for materials, and 3% for manufacturing, etc. So the danger here is twofold. One is targets that are insufficient for a product line to be competitive in the market. They are functionally sufficient, but in total, you have a product line underwater. Secondly, there is an opportunity cost. If the targets are overly aggressive for a product line, the people required to attain the targets might be better used elsewhere. (This is most applicable to end of life product lines.) Another underlying issue understands the true costs of a product line. Does a product line team really understand the costs of their products? Clearly, there is an accounting cost in the financial ledger. But, does this really represent the best practical estimate of actual costs and serve as the basis to develop the array of opportunities to tackle cost reduction? Furthermore, many organizations use standard costs, planned costs, actual costs, and target costs, etc. These multiple costing platforms can confuse the organization, and lead to multiple and incorrect costing assumptions for future business quoting. Again, there can be substantial differences in costs based on product life cycle, allocations, wrong costing in cost files, etc. Now, we recognize that pursuing true costs to some is consistent with the search for the Holy Grail, but to have pragmatic cost reduction efforts require that these efforts are put towards identifiable costs, and that realized cost reductions show up in the monthly P+L report. Furthermore, in many companies, the organization does not have good visibility to the sufficiency of cost reduction activities, and therefore the viability of product line strategy. It is imperative that organizations have a comprehensive understanding of the future pricing dynamics for a product line, and this pricing projection needs to be the foundation for setting cost reduction targets. And, given the pricing scenarios, are there sufficient cost reduction ideas in the pipeline to achieve the necessary profitability and ROI over the life cycle of the product line. A common manifestation of these typical environment problems is the need to do a special study any time a question is asked about a product line s outlook. Obviously this gets back to sufficiency of ideas, but these questions are common and necessary in a company. But typically, the same people you need to be working on the cost reductions are often the same people who are needed to answer the questions. Very simply, they are directed from value-add activity to non-value added question answering. Copyright, Marshall Andrews, Target Achievement LLC. All rights reserved 2
And lastly, another common symptom today is a lack of top management engagement in the cost reduction process. It is often delegated, or assumed, by lower levels of management, with only a cursory review of progress on any formal scheduled basis. This is very understandable given the multiple pulls on executive s time. But, a simple look at the profit equation; Price Cost is a good indication of the appropriate level of attention that should be given. In summary, many organizations have a cost reduction process that is inefficient, ineffective, and is a carryover from years of tradition. They have not updated their process to the latest tool available. And consequently, their results are below what their organization should expect. What is Target Costing? Target costing is a tool, and inherent process, that dramatically improves an organizations capability to reduce costs and improve the bottom line. This tool can more than double a company s cost reduction performance. The tool addresses all of the fundamental issues discussed previously to improve a company s efficiency and effectiveness in cutting costs. There are several key components of target costing as well both in the forms and standard work that are used to drive execution, as well as the standard management practices that are required to guide and lead the team. Firstly, target costing is target driven, and, properly implemented, it is relentless in pushing the organization to establish and achieve the target. The Sales department establishes the market price for the product line. There can be discussion on this, but it cannot be overruled. This target setting process brings the factory floor together with the other departments so there is total understanding of the market price for a product. This approach drives blunt force pragmatism about market realities. There are no functional hard targets in target costing. It is acceptable to look at rough guidelines, such as historical data, manufacturing productivity assumptions, supplier cost reduction guidelines, etc. But, every person associated with a product line needs to be pushed to produce the most ideas possible. There is no hiding behind functional histories or silos. With this approach, it is common to redeploy some talent in the organization to projects with the most opportunity to reduce costs. This may be in manufacturing, in purchasing, in design, or even in sales. But the tool drives the organization to efficiently allocate talent to the most productive projects for the company. The tool is most productive when product line driven. Now, this does require that one person in the organization be responsible for Target costing for a product Line. It is not necessary to have a Product Line Value Stream organization, although that helps. However, it is necessary to have one person who is accountable for the target costing results, and is seen by the organization as having the necessary authority to get this done. (Formal or ambiguous.) This single point authority is central to the point of having an enterprise wide process, and getting away from functional silos. A strong benefit of this approach with target costing is that is also ties together other contemporary Copyright, Marshall Andrews, Target Achievement LLC. All rights reserved 3
management tools such as Lean, 6-Sigma, etc. In fact, target costing brings these tools out of a tool silo, and into the mainstream of necessary cost reductions. When an idea is bought off as a key element in the Target Cost reduction plan, the implementation team is signing up to be accountable for the project savings. Target costing also ties in all the necessary components of cost from design to purchased components to manufacturing to shipping to sales. It also ties in all the internally manufactured components in a product line, even if they are not all produced under one roof. It also includes overhead costs, although there are several ways to deal with this for indirect allocated costs as many companies handle SG&A. This approach gives the team a complete cost profile to work from. All of the above is preamble to the heart of target costing execution. The key tools for review of the plan are: 1. Element Tracking List (ETL) this is the master list of each cost reduction project that the team is working on for the Product Line. This tracks project number, description, project owner, implementation date, savings/unit, customer approval requirements, implementation status, and other data. 2. Key Task Monitor (KTM) There is a KTM for each project. This is the implementation schedule for the project. It includes the owner, each individual task that needs to be accomplished, with dates. The KTM s track back to the ETL. 3. Sufficiency Chart (SC) The Sufficiency Chart is the highest level of monitoring for target costing. This tracks actual costs, projected costs based on the ETL projects, profit margin actual, profit margin target, and price outlooks. In the context of target costing, the SC is the key report card for the product line on actual profit performance and future product line performance to target margins. A very formal standard management plan and review is paramount to the success of target costing. The keys to this are constant checking of plan versus actual, corrective actions being addressed with no delay, and multiple levels of management involvement in the process. The standard processes behind this standard work include: 1. Regular team/cross-functional workshops to develop and improve the project list. A monthly workshop is mandatory if the ETL projects do not achieve sufficiency to meet the Target costs. A quarterly workshop is required for all product lines. 2. Weekly project reviews with the Product Line leader of all projects to ensure they are on track to meet the implementation date. And, required corrective actions to get back on track if an element has slipped. 3. Monthly updates to the Sufficiency Plan for actual costs as reported and achieved. This results in a constant touch point with reality. 4. Monthly review with Senior Executives to review the Sufficiency charts for actual performance, and ensure that plans are sufficient, being executed, and resources allocated to achieve the plan. Copyright, Marshall Andrews, Target Achievement LLC. All rights reserved 4
5. For those companies that have implemented Lean practices, they will have the discipline to maintain the standard work and standard processes that are fundamental to target costing. Also of note in target costing is the applicability of the tool for both the product development phase and in-production phase. In fact, this is the most effective application of the tool. Now clearly there is no ability to validate actual costs for a product not yet in production, but there are means to ensure that the forecast costs are in line with current costs. Additionally, when the product exits the development phase and starts production, the team has a blueprint of ongoing cost reduction projects. In summary, target costing is a tool that includes standard work and standard management to significantly improve an organizations ability to drive cost reduction performance. Is Target Costing Right for Your Organization? Ask yourself if you are getting the performance you expect from your organization? Are your costs competitive in your markets? Review the four questions at the beginning of this paper. If your answer is No to two or more of these questions, then target costing is definitely a tool that would significantly improve your Company s bottom line. This author s experience with target costing is that it can minimally double a company s cost reduction performance. Very simply, this is accomplished through clear target setting and communication, organizational alignment, and standard work and standard management tools. The tool drives the effort and efficiency in cost reduction that is necessary to meet targets. It provides the framework and forces individuals and teams to put the detailed planning in place for execution, and the constant attention and review of performance. Time equals effort, effort equals results. About the Authors Marshall Andrews worked for over 30 years in the automotive industry for General Motors and Delphi Corporation. He has had responsibilities in manufacturing, finance, planning, and general management. His last assignment was as vice-president of Delphi Thermal Division responsible for the Thermal Automotive Systems business line, a $2 Billion revenue business. He has over 10 years experience in global organizations that have used target costing as their key cost reduction tool. He is now the owner of Target Achievement LLC consulting in target costing implementation. Serge Le Berre worked for over 35 years in the manufacturing industry, mainly in electronics and automotive. Serge has had responsibilities in R & D, industrial engineering, manufacturing, and general management. He spent more than 10 years with Valeo, where his last assignment was group technical vice-president in charge of quality, logistics and manufacturing. Serge spent 10 years as president for the Kaizen Institute of Europe. He is now acting as an independent consultant (SLB Consulting). You can reach Marshall Andrews at marshall.andrews@targetachievementllc.com, or http://www.targetachievementllc.com/. Copyright, Marshall Andrews, Target Achievement LLC. All rights reserved 5