As a totally new product and its industry develops, it starts to compete
based on its new technology, concept, and/or service. Competitors emerge
and the basis for competition evolves to other areas such as cycle time,
quality, or reliability. As an industry becomes mature, the basis of competition
typically moves to price. Profit margins shrink. Companies begin focusing
on cost reduction. However, the cost structure for existing products is
largely locked in and cost reduction activities have limited impact. As
companies begin to realize that the majority of a product's costs are committed
based on decisions made during the development of a product, the focus shifts
to actions that can be taken during the product development phase.
Until recently, engineers have focused on
satisfying a customer's requirements. Most development personnel have viewed a product's cost as a
dependent variable that is the result of the decisions made about a
products functions, features and performance capabilities. Because a product's costs are often not
assessed until later in the development cycle, it is common
for product costs to be higher than desired. This process is represented
in Figure 1.
Target costing represents a fundamentally different approach. It is based
on three premises: 1.) orienting products to customer affordability or market-driven
pricing, 2.) treating product cost as an independent variable during the
definition of a product's requirements, and 3.) proactively working to achieve
target cost during product and process development. This target costing
approach is represented in Figure 2.
Target costing builds upon a design-to-cost (DTC) approach with the focus
on market-driven target prices as a basis for establishing target costs.
The target costing concept is similar to the cost as an independent variable
(CAIV) approach used by the U.S. Department of Defense and to the price-to-win
philosophy used by a number of companies pursuing contracts involving development
The following ten steps are required to install a comprehensive target
costing approach within an organization.
- Re-orient culture and attitudes. The first and most challenging
step is re-orient thinking toward market-driven pricing and prioritized
customer needs rather than just technical requirements as a basis for product
development. This is a fundamental change from the attitude in most organizations
where cost is the result of the design rather than the influencer of the
design and that pricing is derived from building up a estimate of the cost
of manufacturing a product.
- Establish a market-driven target price. A target price needs
to be established based upon market factors such as the company position
in the market place (market share), business and market penetration strategy,
competition and competitive price response, targeted market niche or price
point, and elasticity of demand. If the company is responding to a request
for proposal/quotation, the target price is based on analysis of the price
to win considering customer affordability and competitive analysis.
- Determine the target cost. Once the target price
is established, a worksheet (see example below) is used to calculate the
target cost by subtracting the standard profit margin, warranty reserves,
and any uncontrollable corporate allocations. If a bid includes
non-recurring development costs, these are also subtracted. The target
cost is allocated down to lower level assemblies of subsystems in a manner
consistent with the structure of teams or individual designer
- Balance target cost with requirements.
Before the target cost is finalized, it must be
considered in conjunction with product requirements. The greatest
opportunity to control a product's costs
is through proper setting of requirements or specifications. This requires a
careful understanding of the voice of the customer, use of conjoint
analysis to understand the value that customers place on particular
product capabilities, and use of techniques such as
quality function deployment to help make
these tradeoff's among various product requirements including target cost.
- Establish a target costing process and a team-based organization.
A well-defined process is required that integrates activities and tasks
to support to support target costing. This process needs to be based on
early and proactive consideration of target costs and incorporate tools
and methodologies described subsequently. Further, a team-based organization
is required that integrates essential disciplines such as marketing, engineering,
manufacturing, purchasing, and finance. Responsibilities to support target
costing need to be clearly defined.
- Brainstorm and analyze alternatives. The second most significant
opportunity to achieve cost reduction is through consideration of multiple
concept and design alternatives for both the product and its manufacturing
and support processes at each stage of the development cycle. These opportunities
can be achieved when there is out-of-the-box or creative consideration
of alternatives coupled with structured analysis and decision-making methods.
- Establish product cost models to support decision-making. Product cost models and cost tables provide the tools
to evaluate the implications of concept and design alternatives. In the
early stages of development, these models are based on parametric
estimating or analogy techniques. Further on in the development cycle as the product
and process become more defined, these models are based on industrial
engineering or bottom-up estimating techniques. The models need to be
comprehensive to address all of the proposed materials, fabrication processes, and assembly process
and need to be validated to insure reasonable accuracy. A
target cost worksheet can be used to capture the various elements
of product cost, compare alternatives, as well as track
changing estimates against target cost over the development cycle.
- Use tools to reduce costs. Use of tools and methodologies related
to design for manufacturability and assembly,
design for inspection and test, modularity and part standardization, and
value analysis or function
analysis. These methodologies will consist of guidelines, databases, training,
procedures, and supporting analytic tools.
- Reduce indirect cost application. Since a significant portion
of a product's costs (typically 30-50%) are indirect, these costs must
also be addressed. The enterprise must examine these costs, re-engineer
indirect business processes, and minimize non-value-added costs. But in
addition to these steps, development personnel generally lack an understanding
of the relationship of these costs to the product and process design decisions
that they make. Use of activity-based costing and an understanding of the
organization's cost drivers can provide a basis for understanding how design
decisions impact indirect costs and, as a result, allow their avoidance.
- Measure results and maintain management focus. Current estimated costs need to be
tracked against target cost throughout development and the rate of
closure monitored. Management needs to focus attention of target cost
achievement during design reviews and phase-gate reviews to communicate
the importance of target costing to the organization.
See target costing tools
ABOUT THE AUTHOR
Kenneth A. Crow is President of DRM Associates,
a management consulting and education firm focusing on lean product
development practices. He is a distinguished speaker and recognized expert
in the field of integrated product development. He has over thirty-five years
of experience consulting with major companies internationally in aerospace,
capital equipment, defense, high technology, medical equipment, and transportation
industries. He has provided guidance to executive management in formulating
a integrated product development program and reengineering the development
process as well as assisted product development teams applying LPD to specific
He has written papers, contributed to books, and given many presentations
and seminars for professional associations, conferences, and manufacturing
clients on integrated product development, design for manufacturability,
design to cost/target costing, product development teams, QFD, and team
building. Among many professional affiliations, he is past President and
currently on the Board of the Society of Concurrent Engineering and is a
member of the Product Development Management Association and the Engineering
Management Society. For further information, contact the author at DRM Associates,
2613 Via Olivera, Palos Verdes, CA 90274, telephone (310) 377-5569, fax
(310) 377-1315, or email at firstname.lastname@example.org.
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