IE 475 Advanced Manufacturing Costing Techniques

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IE 475Advanced Manufacturing Costing
Techniques

• Lecture Notes 6
• Japanese Cost Management Techniques

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Learning Objectives

• Understand the philosophy of Japanese Cost
  Management Techniques (JCMT)
• Understand the use of Management Accounting
  Practices (MAPs) in Japan
• Understand how to use Japanese Cost Management
  Techniques (JCMT) to facilitate strategic
  management
• Target Costing

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JCMT Philosophy

• Used to influence activities which support the
  strategic plan
• High quality
• On-time delivery
• Low-cost production
• Measurement of long term, not just present
  performance
• Not simply numbers for senior management

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JCMT Philosophy

• Improvement in operational measures will lead to
  long term improvement in financial measures
• Performance measures focus on market share and
  growth rather than on profits and ROI
• Increasing profits receives more emphasis than
  cost reduction
• Cost planning (i.e., cost reduction) receive more
  emphasis than cost control

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JCMT Philosophy

• Prefer simple allocation systems as opposed to
  ABC
• Use absorption costing method and tend to use
  direct labor as an allocation basis
• Examines entire product life cycle with focus on
  cost reduction at the design stage
• Movement towards estimated rather than actual
  costing

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Current MAPs in Japan

• The U.S. dominated the world economy in the 1950s
  and early 1960s
• Japanese accountants learned several techniques
  from U.S. counterparts after WWII
• Responsibility accounting
• Capital budgeting
• Accounting for capacity cost
• Direct standard costing
• Linear programming and profit planning
• However, there has been less to learn from the
  U.S. since the 1970s (Johnson Kaplan 1987)

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Current MAPs in Japan

• Japan began to lead the world in factory
  automation (FA) in the 1980s
• World robot population in 1993 ? 610,000
• 60 operated in Japan (368,000)
• 8 operated in the U.S. (50,000)
• Shift in manufacturing technologies necessitated
  adjustments to management accounting practices
• In the 1990s, Japans management accounting
  framework broke away from that of the U.S.
• Unique management accounting and engineering
  tools such as target costing and JIT

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Japanese Management Accounting
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Target Costing

• Systematic profit planning and cost management
  system that is
• price led,
• customer focused,
• design centered, and
• cross functional
• Its objective is to reduce costs while producing
  high quality products containing the features and
  functionality desired by customers

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Target Costing

• Spread of target costing in Japan was driven by
  many factors including diversifying consumer
  needs, which led to
• Shortened product life cycles
• Intensified international competition

Traditional product (1960s)
RD
Planning Design
Mfg
High-Tech product (1990s)
RD
Planning Design
Mfg
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Target Costing

• Fits nicely with general approach most Japanese
  companies take toward operational and strategic
  cost management
• Management effort in Japan generally focuses on
  three areas
• Innovation
• Kaizen (or continuous improvement)
• Maintenance

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Target Costing Characteristics

• Engineering-oriented technique
• Directs and focuses the decision process for
  design specifications and production engineering
• It harmonizes with other Japanese management
  engineering techniques such as value engineering,
  TQC, and JIT
• Works better in high variety/low volume
  production
• Standard costing is most effective when applied
  to standardized mass production

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Target Costing Principles

• Price-led Costing
• Market prices are used to determine allowable
  cost or target costs
• Focus on Customers
• Customer requirements for quality, cost and time
  are simultaneously incorporated in product and
  process decisions and guide cost analysis
• The value (to the customer) of any features and
  functionality built into the product must be
  greater than the cost of providing those features
  and functionality

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Target Costing Principles

• Focus on Design
• Cost control is emphasized at the product and
  process design stage
• Engineering changes must occur before production
  begins, resulting in lower costs and reduced
  time-to-market of new products
• Cross-functional Teams
• Cross-functional product and process teams are
  responsible for the entire product from initial
  concept through final production

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Target Costing Principles

• Value Chain Involvement
• All members of the value chain, e.g., suppliers,
  distributors, service providers, and customers,
  are included in the target costing process
• Lifecycle Cost Reduction
• Total lifecycle costs are minimized for both the
  producer and the costumer
• Lifecycle costs include purchase price, operating
  costs, maintenance, and distribution costs

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Target Costing Process

• Determine the market price
• Determine the desired profit
• Calculate a target cost at market price less
  desired profit
• Use value engineering to identify ways to reduce
  product cost
• Use kaizen costing and operational control to
  further reduce cost

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Price, Profit and Target Cost

• The essence of target costing is captured by the
  equation
• Target Cost Market Price Desired Profit
• Market Price
• Desired Profit

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Price, Profit and Target Cost

• When a customer request is received, the
  allowable cost is calculated
• Allowable Cost Market Price Desired Profit
• a.k.a. Maximum permissible manufacturing cost
• Next step is to figure out if product can be made
  for this amount
• Drifting cost is calculated for each part
• Referred to as drifting because is recalculated
  continuously
• Also called an estimated or base cost and it is a
  current estimated cumulative cost with no target
  in mind

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Price, Profit and Target Cost

• Target costs are typically very aggressive
• There is usually a very sizable gap between the
  initial cost and the target cost
• Main reason is the desire to provide all customer
  requested features in the product concept stage

Target profit (Target ROS 20) 4
Planned sales price 20
Allowable cost
-

Cost reduction program (VE)
Drifting cost
Target cost
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The Target Costing Process
Current Production Economics
Expected Costs
The Design Challenge Closing the Competitive Gap
Product Definition and Positioning
Market Mapping
Quality and Functionality Targets
Price (Volume and Timing) Targets
Target Costs
Corporate Financial Requirements
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Value Engineering

• Developed at GE in the 1940s
• Part shortages created by WWII led to a movement
  by GE engineers to provide more for less
• Method or tool for reengineering the functions or
  purposes of a product or service in order to
  improve its quality or value and achieve customer
  satisfaction with the lowest cost
• Used in target costing to reduce product cost by
  analyzing the trade-offs between
• Different types of product functionality, and
• Total product costs

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Value Engineering

• Begins with consumer analysis performed during
  the design stage of the new or revised product
• To identify critical consumer preferences that
  define desired functionality for the new product
• Type of VE depends on the products functionality
• Functionality can be added/deleted relatively
  easily
• e.g., automobiles, computer software, consumer
  electronics
• Functionality must be designed into the product
• e.g., Construction equipment, heavy trucks,
  specialized medical equipment

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Value Engineering Tools

• Functional Analysis
• Benchmarking is often used to determine which
  features give the firm a competitive advantage
• Examine each major function or feature for
  value/cost
• Calculate the value index for each component or
  function
• VI value / cost
• value and cost are a of the total
• Value can be calculated using rank-order methods
• Utility theory
• Analytical hierarchy process (AHP)

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Value Engineering Tools

• Design Analysis
• Try and analyze different designs
• Reduce the number of parts
• Use standard parts
• Increase modularity and subassemblies
• Benchmarking and value chain analysis are
  typically used here
• Other cost reduction tools include
• Group Technology
• Cost Tables

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Target Costing and Kaizen Costing

• Kaizen
• Japanese word which means continual improvement
• Kaizen costing occurs at the manufacturing stage
• The role for cost reduction at this phase is
• To develop new manufacturing methods
• To use new management techniques
• e.g. operations control, total quality
  management, TOC

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Target Costing Benefits

• Increases customer satisfaction
• Design is focused on customer perceived values
• Reduces costs
• More effective and efficient design
• Helps the firm achieve desired profitability on
  new and re-designed products
• Can decrease the total time required for product
  development
• Time-to-market

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Target Costing Benefits

• Can improve overall product quality
• Facilitates coordination of design,
  manufacturing, marketing, and cost managers
  throughout the product cost and sales life-cycles

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References

• Additional material for this module was extracted
  from the following sources
• Sakurai, M. (1996). Integrated Cost Management A
  Companywide Prescription for Higher Profits and
  Lower Costs. Portland, OR Productivity Press,
  Inc.
• Ansari, S., Bell, J., Swenson, D. (2006). A
  Template for Implementing Target Costing. Journal
  of Cost Management, Vol. 20, Issue 5, pp. 20-27.
• Cooper, R., Chew, W.B. (1996). Control Tomorrows
  Costs Through Todays Designs. Harvard Business
  Review, Vol. 74, Issue 1, pp. 88-97.