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Achieving Target Cost / Design-to-Cost Objectives
Kenneth Crow
INTRODUCTION
A competitive product must address
factors such as cost, performance, aesthetics, schedule or time-to-market,
and quality. The importance of these factors will vary from product to
product and market to market. Over time, customers or users of a
product will demand more and more, e.g., more performance at less cost.
Cost will become a more important factor in the acquisition of a product
in two situations. First, as the technology or aesthetics of a product
matures or stabilizes and the competitive playing field levels,
competition is increasingly based on cost or price. Second, a customer's
internal economics or financial resource limitations may shift the
acquisition decision toward affordability as a more dominant factor. In
either case, a successful product supplier must focus more attention on
managing product cost.
The management of product cost begins with the conception of a new
product. A large percentage of the product's ultimate acquisition or life
cycle costs, typically seventy to eighty percent, is determined by
decisions made from conception through product development cycle. Once the
design of the product has been established, relatively little latitude
exists to reduce the cost of a product. Decisions made after the product
moves into production account for another ten to fifteen percent of the
product's costs. Similarly, decisions made about general and
administrative, sales and marketing, and product distribution activities
and policies account for another ten to fifteen percent of the product's
cost.
When a company faces a profitability problem and undertakes a cost
reduction program, it will typically reduce research and development
expenditures and focus on post-development activities such as production,
sales, and general and administrative expenditures. While not suggesting
that these are inappropriate steps to take, the problem is that it is too
late and too little. Most of the cost structure in a company has been
locked into place with the design decisions made about the company's
products. A cost reduction or profitability program has to start with the
design of the company's products at the very beginning of the development
cycle.
DEFINITION OF TERMS
The following definition of terms
will provide a common basis for discussion:
Recurring production cost =
production labor + direct materials + process costs + overhead + outside
processing
Non-recurring costs = development costs + tooling
Product costs = Recurring production costs + allocated non-recurring
costs
Product price or acquisition costs = Product costs + selling, general &
administrative + warranty costs + profit
Life cycle costs = Acquisition costs + other related capital costs +
training costs + operating costs + support costs + disposal costs
TRADITIONAL APPROACH
In many companies, product cost or
life cycle cost considerations are an afterthought. Costs are tallied up
and used as the basis for determining the product's price. The primary
focus is on product performance, aesthetics, or technology. Companies may
get by with this approach in some markets and with some products in the
short term, but ultimately competition will catch up and the product will
no longer be competitive.
In other companies, cost is a more important factor, but this emphasis is
not acted upon until late in the development cycle. Projected costs of
production are estimated based on drawings and accumulated from quotes and
manufacturing estimates. If these projected costs are too high relative to
competitive conditions or customer requirements, design changes are made
to varying degrees to reduce costs. This may occur before or after the
product has been released to production. The result is extended
development cycles and added development cost with these design
iterations.
In some organizations, development costs receive relatively little
attention. There may not be a rigorous planning and budgeting
process for development projects. Budgets are established without buy-in
from development personnel resulting in budget overruns.
DESIGN TO COST
Effective product cost management
requires a design to cost philosophy as its basis since a substantial
portion of the product's cost is dictated by decisions regarding its
design. Design to cost is a management strategy, and supporting
methodologies to achieve an affordable product by treating target cost as
an independent design parameter needs to be addressed during the
development of a product. A design to cost approach consists of the
following elements:
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An understanding of customer
affordability or competitive pricing requirements by the key
participants in the development process;
-
Establishment and allocation of
target costs down to a level of the hardware where costs can be
effectively managed;
-
Commitment by development
personnel to development budgets and target costs;
-
Stability and management of
requirements to balance requirements with affordability and to avoid
creeping elegance;
-
An understanding of the
product's cost drivers and consideration of cost drivers in establishing
product specifications and in focusing attention on cost reduction;
-
Product cost models and life
cycle cost models to project costs early in the development cycle to
support decision-making;
-
Active consideration of costs
during development as an important design parameter appropriately
weighted with other decision parameters;
-
Creative exploration of concept
and design alternatives as a basis for developing lower cost design
approaches;
-
Access to cost data to support
this process and empower development team members;
-
Use of value analysis / function
analysis and its derivatives (e.g., function analysis system technique)
to understand essential product functions and to identify functions with
a high cost-to-function ratio for further cost reduction;
-
Application of design for
manufacturability principles as a key cost reduction tactic;
-
Meaningful cost accounting
systems using cost techniques such as activity-based costing (ABC) to
provide improved cost data;
-
Consistency of accounting
methods between cost systems and product cost models as well as periodic
validation of product cost models; and
-
Continuous improvement through
value engineering to improve product value over the longer term.
TARGET COSTING AS A
FOUNDATION
Executive management, marketing,
program/product managers, and development team personnel all need to have
an understanding of customer affordability constraints or competitive
market place requirements. Everyday customers buy products with functions,
features and performance in excess of their needs and wonder how much is
money is wasted on these unneeded capabilities. A keener awareness of
design to cost requirements is needed. This happens when product
development team members and executive management have direct contact with
customers to understand their true needs and hear their sensitivity to
costs directly, or when they are exposed to competitor's product pricing
in the market place.
Based on this awareness of customer affordability or design to cost
requirements, cost targets should be formally established. These targets
should be developed based on pricing formulas and strategies and
consideration of price elasticity. Prices and target costs will also have
to consider projected production volumes and amortization of non-recurring
development costs. In a more complex product or system, the top-level
target cost will need to be allocated to lower level subsystems or
modules. This will establish a measurable objective for a product
development team where multiple teams are involved in a development
project.
In an environment where development cost is significant relative to total
recurring production costs, more attention will need to be paid to
managing these non-recurring development costs. Non-recurring development
cost will be a function of the extent of new product and process
technology; and the extent of new materials, parts and subsystems used. If product is an evolutionary step with minimal development risk,
non-recurring development costs will be lower. The use of standard parts
and modules from other existing products will also lower non-recurring
development costs. This suggests a strategy of not letting product and
process technology application get too far ahead of customer affordability
requirements.
Product development team members should buy-in to or commit to these
product cost targets and development budgets to improve the chances of
meeting these objectives. When empowered product development teams
actually develop these budgets and targets, a sense of commitment to these
budgets or targets develops. If the budgets or targets are established by
someone outside the product development team (e.g., by a product or
program manager, a management team, a system integration team, or a
project engineer), the targets and budgets should be carefully reviewed
with the team members to insure they understand these cost objectives and
the assumptions behind them. While competition will generally dictate that
stretch goals be established, these goals should be accepted by the team
as achievable.
COST MODELS AND COST DATA
Once a team has a set of
requirements and a cost target established, they will begin exploring
alternatives as part of the design process. In the absence of other
information, they will tend to evaluate a product concept primarily based
on its performance merits and, at best, secondarily consider a subjective
estimate of the relative costs of the design alternatives. Ad-hoc cost
studies or trade studies may be prepared for significant issues, but tools
to regularly support this process are lacking. Tools and information need
to be provided to a product development team so that they can more
proactively and objectively consider the cost implications of various
design approaches on a regular basis. A product cost model or life cycle
cost model provides an objective basis for evaluating design alternatives
from a very early stage in the development cycle.
As the organization proceeds through the design of both product and
process, the product cost model is used to project and accumulate product
costs to use as a factor in evaluating design alternatives and to refine
the design to meet cost targets. If it is determined after extensive
evaluation that the product requirements cannot be achieved at the target
cost, the requirements and targets will need to be re-evaluated and
modified.
Early in the development cycle, the product cost model will be based
primarily on characteristics of the product design with relatively little
consideration of the actual manufacturing process. The model will be
driven by general design parameters, product/part characteristics, and
critical parameter tolerances. The model will be implicitly based on
assumptions about existing processes and process relationships to types of
materials, sizes and tolerance requirements.
Later in the development cycle, a different type of product cost model
will be used that will consider the specific manufacturing processes. This
type of model will be built around existing processes where relatively
good historical cost data should exist. On occasion, new manufacturing
processes will need to be considered. Data will need to be gathered as a
basis for creating or extending the product cost model for the new process(es). Information to support this model development can be obtained
from equipment suppliers, other users of this manufacturing process,
facility engineers, and manufacturing engineers.
Cost data will also need to be obtained for many purchased parts and
sub-assemblies. This information may be available in the form of catalog
prices or supplier quotations. However, to support cost projections much
earlier in the development cycle, a close working relationship with the
company's supplier base will allow preliminary cost projections to be
obtained without the formalized commitment of a quotation. The supplier
relationship and company information needs may even develop to the point
that the company works with the supplier to develop a supplier cost model
based on the supplier's process capabilities.
A company's initial attempt with a product cost model may utilize a
spreadsheet program or a bill of material cost roll-up capability. The
focus is on accumulating and tracking estimated material, part and
assembly costs. This summarization capability may start with cost
estimates and update the estimates with quoted prices or catalog prices
for purchased items or manufacturing's estimates based on preliminary
drawings for fabricated items and assemblies.
Over time, a more sophisticated product cost model should be developed
that will project costs based on the characteristics of parts and the
overall product design. This type of cost model might be based on
commercially available design for manufacturability (DFM) or design for
assembly (DFA) software packages. These systems typically generate an
estimate of fabrication or assembly labor time and costs or machine cycle
time. and costs as part of their capabilities. In addition, there are
commercially available cost models that allow a company to develop a
custom model of their manufacturing processes and project even more
exacting cost estimates based on their product or part characteristics. These individual packages or modules will be oriented toward a limited
part or product domain, e.g., manual or automated assembly, printed
circuit boards, sheet metal, injection molding, casting, etc. Multiple
modules will typically be needed to support overall product cost modeling. In addition, a database reporting capability or spreadsheet will be needed
to accumulate the many individual elements of cost from these various cost
modeling system components so that effective overall trade-off's can be
made.
Over the course of the development cycle, several different costing tools
may be used by an organization. In the early stages of product
development, an estimating system may be used to respond to a customer
request for quotation or request for proposal or to develop an internal
estimate to prepare a cost justification for the development project to
management. This cost model would be based on parametric or analogy
techniques. Parametric techniques would take general characteristics about
the product such as size, weight, number of functions, etc., and use these
parameters to develop a general cost estimate. Analogy techniques would
take a similar product's cost and use a "same as except for" approach to
develop a cost estimate based on the cost of an existing item.
As the development cycle moves into the product design phase, cost models
and DFM/DFA tools as just described would be used. These estimates would
be more refined since more is known about the design of the product and
its cost drivers. Once the product design is essentially complete, tools
and methods such as computer-aided and manual process planning and tools
to support the development of labor standards would be used to develop
even more refined cost estimates. Finally, as the product moves into
production, cost accounting systems would collect costs by product,
assembly, part, and operation. These costing tools are illustrated below.
These costing tools should have a
consistent basis cost accounting and a consistent set of rates. In addition, the organization should establish procedures to periodically
validate the cost models by comparing the projected costs with actual
costs and adjusting parameters in the model to yield projections closer to
actual experience.
In some cases, life cycle costs may need to be considered as the basis for
making design decisions. This will add to the complexity of a cost model. Data will need to be gathered on operating costs (e.g., facilities,
training, manpower, fuel or energy consumption, etc.), maintenance costs,
and disposal costs. While these costs can be modeled, historical data
related to operations, reliability and maintenance often is needed. This
means that a customer will need to provide this data or that the company
have close working relationships with customers where this data is
routinely gathered.
To support the operation of these cost models, cost data will need to be
readily accessed. Some companies try to restrict access to cost data to
prevent this information leaking out to competitors. This restricted
access undermines a design to cost methodology and empowerment of the
product development teams. This data needs to be made available to support
cost modeling. Typical data required will be labor rates, overhead rates,
learning curves, efficiencies, historical and projected parts costs, and
escalation projections for labor and materials.
Traditional approaches to allocating overhead or burden costs generally
based on direct labor. However, direct labor is becoming an insignificant
cost component in many products. Further, there is frequently a lack of
understanding of sunk costs and fixed versus variable indirect costs. All
of this has led to distortion of overhead cost allocations and
inappropriate design and sourcing decisions. As companies move toward
activity-based costing, the quality of the cost data will improve. Costs
will be more closely based on the consumption of resources and the
aberrations associated with allocating indirect costs will diminish.
DECISION-MAKING
In the absence of product cost
models and product development teams, each functional organization will
make decisions from their own perspective, trying to manage the elements
of cost that they are responsible for. For example, decisions to minimize
non-recurring design engineering expenditures may result in a less
producible product, driving up material and labor costs in manufacturing. Decisions to minimize tooling capital expenditures may also have the same
effect in manufacturing costs. Test engineering may try to minimize its
non-recurring development budgets and capital expenditures resulting in a
less automated test process and higher recurring test costs for production
verification.
Product development teams provide the organizational mechanism to bring
the various disciplines together to optimize product costs from an
enterprise perspective. Cost models provide the means for the team to
objectively consider the implications of various development decisions. A
company operating philosophy that emphasizes cost as a factor in the
development decision-making process is a final requirement.
Access to product cost projections early in the development cycle will
improve decision-making about design alternatives and lead to refinement
of the design to come closer to the established cost targets. These costs
projections will aid decisions about the design of the manufacturing
process as well, focusing attention of elements of the product costs that
do not meet the target and allowing consideration of alternative processes
while it is still early enough in the development cycle to introduce new
processes. The key is to emphasize management of product costs during
development, not merely accumulating costs as designs are completed.
SUMMARY
Since the decisions made during
the product development cycle account for seventy to eighty percent of
product costs, product cost management must begin with the start of
product development. Product development personnel must understand
competitive pricing or customer affordability requirements. Target costs
must be established at the start and used to guide decision-making. Development personnel must operate as entrepreneurs in making hard
decisions about the product and process design to achieve target costs. Cost models must be provided to support decision-making early in the
development cycle. And the quality of information and the cost models must
be continually improved and refined. This increased focus on product or
life cycle costs will lead to significantly reduced costs and more
satisfied customers.
ABOUT THE AUTHOR
Kenneth A. Crow is President of
DRM Associates, a management consulting and education firm focusing on
integrated product development practices. He is a distinguished speaker
and recognized expert in the field of integrated product development. He
has over twenty 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 IPD to specific development projects.
Mr. Crow 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, 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.
Establishing a Design-to-Cost Process
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