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he Consortium for Advanced Manufacturing—International (CAM-I), the American Institute of CPAs, and the Univer- sity of Akron recently sponsored a major study to benchmark best practices in target costing. This study examined the ways in which target costing has been applied in a variety of industries, the level of success and measurable improvements achieved, and the factors that influenced the success of these applications. The study began with a survey to collect information about target costing practices throughout the United States. After analyzing the survey results, conducting telephone interviews, and reviewing secondary research, the research team selected four companies as having best practices in target costing. The team then conducted site visits at each of the “best practice” com- panies, namely The Boeing Company, Caterpillar, DaimlerChrysler, and Continental Teves (a supplier of automotive brake systems). The results of the study are discussed here.
T A R G E T-C O S T I N G P R I N C I P L E S Target costing can best be described as a systematic
process of cost management and profit planning. The six key principles of target costing are:^1
1. Price-led costing. Market prices are used to deter- mine allowable—or target—costs. Target costs are calculated using a formula similar to the following: market price – required profit margin = target cost. 2. Focus on customers. Customer requirements for quality, cost, and time are simultaneously incorporated in product and process decisions and guide cost analy- sis. 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. 3. Focus on design. Cost control is emphasized at the product and process design stage. Therefore, engineer- ing changes must occur before production begins, resulting in lower costs and reduced “time-to-market” for new products. 4. Cross-functional involvement. Cross-functional product and process teams are responsible for the entire product from initial concept through final production. 5. Value-chain involvement. All members of the value chain—e.g., suppliers, distributors, service providers, and customers—are included in the target costing process.
Best Practices in
Target Costing
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VOL.3 NO.
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HERE IS HOW FOUR “MODEL” COMPANIES—THE BOEING COMPANY, CATERPILLAR,
DAIMLERCHRYSLER, AND CONTINENTAL TEVES—APPLY THIS COSTING TECHNIQUE.
B Y D A N S W E N S O N , P H. D. , C M A , C P A ; S H A H I D A N S A R I , P H. D. ;
J A N B E L L , P H. D. , C P A ; A N D I L - W O O N K I M , P H. D.
6. A life-cycle orientation. Total life-cycle costs are minimized for both the producer and the customer. Life-cycle costs include purchase price, operating costs, maintenance, and distribution costs.
T H E T A R G E T C O S T I N G P R O C E S S Essentially, companies use target costing to establish concrete and highly visible cost targets for their new products. To maximize cost control and enhance profit improvement, most companies set relatively aggressive targets. The process begins when top management establishes a target cost for a new product, for example, a Chrysler Neon or a Caterpillar Excavator. A cost esti- mating group will then decompose the target cost for the product as a whole into cost targets for subassem- blies and individual component parts—engine, trans- mission, seats, and so on. Frequently a “gap” exists between the target cost and cost projections for the new product based on cur- rent designs and manufacturing capabilities. Closing the gap through cost reduction is central to the target cost- ing process. This is accomplished through cross-func- tional target costing teams, which analyze the product’s design, raw material requirements, and manufacturing processes to search for cost savings opportunities. The cross-functional teams employ a variety of management tools and initiatives to help them achieve their objec- tives. The following section describes some of these tools and initiatives and other characteristics of success- ful target costing companies.
T A R G E T C O S T I N G E N A B L E R S The best practice companies demonstrated certain commonalities in their operations and the way in which they supported the target costing process. They all had very effective organizational structures, responded to the “voice of the customer,” streamlined their product development process, and actively engaged their supply chain to achieve target costing objectives. To better understand these practices, we visited the four compa- nies that had achieved the most success in each area. Our objective was to document “best practices” in deploying these key elements of target costing. At each best practice company, target costing is sup- ported by a matrix organizational structure where a ver-
tical, functional organization combines with horizontal, cross-functional teams. For example, U.S. Operations for DaimlerChrysler has five platform teams that cover large cars, small cars, mini-vans, trucks, and jeeps. Each team is cross-functional and includes members from design engineering, manufacturing engineering, pur- chasing, production, and finance. The target costing system determines cost objectives and performance goals for each platform team, and meeting these goals is an important component of team members’ annual per- formance reviews. The target costing system at DaimlerChrysler makes use of a “toolbox” of management initiatives to improve productivity and reduce costs. The toolbox includes value engineering/value analysis, design for manufactur- ing assembly, paper kaizen, and lean manufacturing. Each initiative is implemented through workshops com- posed of multifunctional teams. The teams vary from five to 30 individuals and meet anywhere from one to five days. The workshops are “working” sessions where participants brainstorm, troubleshoot, and generally try to solve problems and improve operations. ◆ Value Engineering/Analysis is used to increase the value of DaimlerChrysler’s products to consumers through improved designs. Changing a part’s design can be quite expensive because it generally requires new tooling. Therefore, the benefits of the new design to the consumer must more than offset the cost of the new tooling. ◆ Design for Manufacturing Assembly (DFMA) occurs throughout product design but before the first pilot vehicle is built. Essentially, DFMA evaluates the effec- tiveness of the design with regard to assembly opera- tions. One benchmark is to minimize the number of vehicle components and to simplify the assembly processes. The result is fewer assembly errors and improved reliability and serviceability of the vehicles. ◆ Paper Kaizen is the term used to promote the con- cept of continuous improvement. It is most effective immediately after a new part is designed but before the manufacturing process begins. During this stage in a product’s life cycle, workstation setups, assembly steps, and process flows are simulated and optimized on paper before expenses are incurred. ◆ Lean Manufacturing occurs after product launch
To encourage process improvements among its sup- pliers, DaimlerChrysler rates the performance of each supplier on a yearly basis. A major component of the rating system is the “SCORE” (Supplier COst Reduction Effort) program. Each supplier is asked to achieve the equivalent of a 5% annual cost reduction based on its total annual sales to DaimlerChrysler. This cost reduction goal includes any supplier suggestions that result in lower costs for DaimlerChrysler. For example, one supplier suggested changing a vehicle’s front rail system from several pieces to one unit. While the new design did not reduce the supplier’s cost, it did improve the unit’s quality and reduce Daimler- Chrysler’s assembly costs. Under DaimlerChrysler’s SCORE system, the supplier received credit for this innovation. Continental Teves has developed a cost-modeling tool to determine target costs for the components it out- sources. The cost targets are based on material costs, cycle times, labor rates, overhead, and other characteris- tics. The model is sophisticated, and it adjusts wage and occupancy rates to correspond with the appropriate rates for the region of the country in which the supplier
operates. Furthermore, the model’s overhead allocation rates differ based on the type of supplier. Full-service suppliers, responsible for product research and design, are allowed higher overhead allocation rates than sup- pliers that simply “build to print.” If a supplier is unable to meet its target costs, Continental might ask to send a team there to view its operations. Continental will then analyze the supplier’s manufacturing processes, tolerances, and material content and general- ly verify the assumptions in its cost-modeling tool. After negotiations, however, if Continental still believes the supplier’s costs are too high, it might consider bids from other suppliers.
T A R G E T C O S T I N G S T E P S AT C AT E R P I L L A R Once companies have the tools and systems in place to support target costing, they often develop a standard- ized approach for achieving their target costing objec- tives. Caterpillar offers a good illustration to highlight the target costing process for one of its new products. For this particular vehicle, management set the target cost at 94.6% of a comparable model, creating an initial gap of 5.4%. The cost of the comparable model is based
Table 1: Modification of Current Product: Known Adjustments
Current Projected Adjusted
Costs Savings Costs Explanation of Known Adjustments
Assembly 5.4% 1.5% 3.9% Efficiency improvements due to redesigning
sheet metal, as documented on current
production models.
Cab 7.9 .8 7.1 Replace current cab with the “Classy Cab.”
PF quote already received.
Engine 8.6 .7 7.9 Cost estimate from Engineering for switching to
different configuration.
Hydraulics 19.1 1.6 17.5 New pump design.
Power Train 12.0 0 12.
Structures 20.0 0 20.
Linkage 18.0 0 18.
Other 9.0 0 9.
Total 100.0% 4.6% 95.4%
on current manufacturing capabilities. Therefore, to achieve the target, costs must be reduced by 5.4%.
Current costs for a comparable model 100.0% Target cost for new product 94.6% Cost gap 5.4%
A cost improvement team is then assembled from product design, manufacturing engineering, production, marketing, and purchasing to determine how to close
the gap. Initially, the group evaluates component part substitutions that would reduce costs but still provide the product features and benefits necessary to satisfy customer requirements. The group also considers opportunities to reduce costs through efficiency improvements. Table 1 shows that the cost improve- ment team identified 4.6% in “known” savings through an initial evaluation of cost savings opportunities. Having reduced the gap by 4.6%, the team must find an additional 0.8% in savings to achieve the 5.4% cost
Table 2: Modification of Current Product: Sample Questionnaire*
1. Are there more than five suppliers from whom
you can purchase materials? 0 0 0 1 1 1 1 0
2. Are you more costly than best-in-class supplier
(either Caterpillar or non-Caterpillar)? 0 0 0 1 0 0 0 0
3. Do you plan to survey your supplier
cost breakdown? 0 0 0 1 0 0 1 0
4. Is the current manufacturing process
younger than two years? 0 0 0 1 0 0 0 0
5. Does labor represent more than
40% of your total cost? 0 0 1 1 0 0 1 0
6. Is your “unit setup cost/total unit cost”
ratio greater than 5%? 0 0 1 1 0 0 0 0
7. Do you see potential for material
specification changes? 0 0 0 1 0 0 0 0
8. Do you see potential for tolerance loosening? 0 0 0 1 0 0 1 0
9. Does the current family of parts contain
nonapproved parts? 0 0 0 1 0 1 1 0
10. Can the current design or manufacturing
processes be subjected to emerging
innovative technologies? 0 0 0 1 0 0 0 0
Total 0 0 2 10 1 2 5 0 20
Relative Proportions 0% 0% 10% 50% 5% 10% 25% 0% 100%
Distribution of .8% in Cost Reduction .0% .0% .08% .40% .04% .08% .20% .0% .80%
*Yes = 1; No = 0
AssemblyCab EngineHydraulicsPower TrainStructuresLinkageOther TOTAL
