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Ch 8 Measuring and Managing Life-Cycle Costs.docx

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Susan Lade

BU247 Lecture 14 Chapter 8 – Measuring and Managing Life-Cycle Costs  Companies should create new products and services; innovation drives customer acquisitions and growth, margin enhancement, and customer loyalty  Companies must be concerned about environmental impact from their innovations  Total life cycle costing (TLCC): the approach companies use to understand and manage all costs incurred in product design and development, through manufacturing, marketing, distribution, maintenance, service, and disposal  A.K.A. managing costs from the cradle to the grave  Ex: initial life-cycle cost of the product are high, but unit manufacturing costs are low. Also consider the opportunity costs of committing scare resources for new product.  Costs may be collected and traced to each organizational function, but companies need a total life cycle perspective that integrates the trade-offs and performance over time, across functional units  TLCC integrates RD&E, manufacturing, and post-sales service and disposal  Breakdown of costs for each of the functional life cycles differ depending on industry & product RESEARCH, DEVELOPMENT, & ENGINEERING STAGE (RD&E)  Consists of 3 substages 1) Market research: emerging customer needs are assessed, ideas are generated for new products 2) Product design: develop technical specifications of products 3) Product development: create features critical to customer satisfaction, design prototypes, production processes, and any special tooling required  80-85% of a product’s TLCC are committed by decisions made in this stage of the product’s life  most product costs are designed during the research & development stage.  After products reach the manufacturing stage, opportunity for cost reduction is limited.  For moderate to long life-cycle products, costs incurred during RD&E is < 10% of TLCC  The decisions made in RD&E determines 80% of the costs that will be incurred in later stages  An understanding of TLCC encourages product engineers to select product designs that make it easier to service and less costly to dispose of at the end of the product’s useful life  It can cost 100x more to correct a software defect during operation stage (vs. preventing it now) MANUFACTURING STAGE  company spends money to produce and distribute the product  materials, labour, indirect costs  this stage offers little opportunity for engineering decisions to reduce product costs through redesign decisions, since most costs have already been determined in the RD&E stage  Traditional cost accounting and process improvement methods focus on manufacturing stage  for product and process costing, facilities layout, just-in-time manufacturing, etc.  focusing on this stage ignores potential for effective cost mgmt. during the RD&E stage POSTSALE SERVICE AND DISPOSAL STAGE  Product take-back: Plan for postproduction costs of retrieving, recycling, and salvaging products after customers are done using them  The service stage begins once the first unit of a product is in the hands of the customer  this stage overlaps with manufacturing stage. This stage has 3 substages: 1) rapid growth from first time the product is shipped through the growth stage of its sales 2) transition from the peak of sales to peak in the service cycle 3) maturity from the peak in the service cycle to the time of the last shipment made to a customer; disposal occurs at end of product life and lasts until customer retires the final unit of a product 1 | N A T A S H A P A R K BU247 Lecture 14  disposal costs includes eliminating any harmful effects related to the end of the product’s useful life TWO IMPORTANT DEVELOPMENT METHODS  Western Companies use this traditional product development method: (left column of next figure) 1) market research into customer requirements for new product 2) price customers are willing to pay for this product with its requirements 3) determine product specifications to deliver desired performance 4) perform detailed product design and engineering for the product to meet its specifications 5) request prices from suppliers 6) request production cost estimates from manufacturing engineers 7) the first estimate of the product cost C (t=product cost estimate derived from this traditional sequential design & development process) from estimates from step 5&6 8) estimate product’s profit margin P = stlling price S – ptoduct cost C t o selling price Sthas been determined during initial market research  cost-plus method: selling price S cpexpected product cost C + decpred profit margin P cp  in both the traditional and CP methods, product designers don’t try to achieve a particular cost target. The company either accepts profit margin, or tries to set price high enough to earn desired margin over the product cost (regardless of customer willingness to pay). In either case, they accept the costs as consequence of their design and development decisions. TARGET COSTING – A BETTER DEVELOPMENT METHOD  invented by Japanese engineers to help consider manufacturing costs early in their design decisions  goal: design new products that meet customer expectations, that can be manufactured at desired cost  important mgmt. accounting method that can explicitly help mage TLCC  Target costing strives to actively reduce a product cost during its RD&E stage (right-hand column of the figure below). Both the sequence of steps and the way of thinking about determining product costs differ from traditional costing. Some differences are: 1) Market research under target costing is not a single event. Here, approach is customer driven, with customer input obtained continually throughout the process 2) Product engineers try to design costs out of the product before design& development ends 2 | N A T A S H A P A R K BU247 Lecture 14 3) Target costing uses the total life cycle concept by adopting the perspective of minimizing cost of ownership of a product over its useful life  consider cost of initial purchase price AND cost of operating, servicing, maintaining, repairing, and disposing the product  In a third target costing innovation, engineers set an allowable cost for the product that enables the targeted product profit margin to be achieved at a price that customers are willing to pay o Target selling price and target product volume are chosen based on company’s perceived value of the product to the customer. o Target profit margin results from LR profit analysis, based on return on sales (net income/sales) because ROI can be linked most closely to profitability for each product o Target cost Ctc target selling price tc– target profit margin Ptc  Once target cost has been set for the entire product, the engineers determine the target costs for each component in the product  Value engineering process examines the design of each component to determine whether it’s possible to reduce costs while maintaining functionality and performance  change product or component design, sub new materials, or modify/improve manufacturing process  Ex: product redesign may enable same functionality with fewer parts  Recall from ABC costing that it’s cheaper to produce 10% more from existing production run than to change over to switch to a low-production run for a specialty component  similarly, it’s cheaper to order 10% more of a component from existing supplier than to find new vendor to order low quantity of a specialty component  Several iterations of value engineering are needed before the final target cost gets achieved  Two other differences characterize the target costing process 1) Cross-functional product teams made of people representing the entire value chain (inside/ outside the organization) guide the entire process  engineers, mgmt. accounting, customers 2) Suppliers play a critical role on making target costing work. Companies can offer incentive plans for suppliers to find ways to reduce the cost of specific components or an entire subassembly or module  supply-chain mgmt. is a set of methods that develops cooperative, mutually beneficial, LT relationships between buyers and suppliers.  In supply chain mgmt., a supplier may assign a worker to work with the buyer to understand a new product, or the buyer may expend resources to train supplier’s employees 3 | N A T A S H A P A R K BU247 Lecture 14  See example on page 308-314 for a target costing example TARGET COSTING EXAMPLE – P308-314  These customer requirements = basis for engineering design of the coffeemaker  Assume current coffeemaker unit costs $50 to manufacture  reduce the cost of new unit to broaden appeal to a larger customer audience reduce component cost Cost analysis  Cost analysis: determine what components of the coffeemaker (heating element, control panel, grinder) to target for cost reduction, and assign a cost target to each component o Often, reduction in cost of one component may be offset by cost increase elsewhere 1) Develop a list of product components and functions: what components and functions are needed to satisfy customer requirements, and what it might cost to provide these functions 2) Perform a functional cost breakdown: each component performs a specific function. Identify this function and estimate the cost (the cost of component, and its % of total component cost) 3) Determine the relative importance of customers’ requirements: engineer’s view of a product as a collection of functions must be reconciled with a customer’s view of a product as a set of performance features. Engineers first assess relative importance that customers place on various features. They survey customers to rank relative importance of all features.  express the rankings so each feature is expressed as a % of total value a customer derives from product 4) Relating features to functions: convert relative rankings of features into an importance ranking for each product function. Relate customer rankings to the components that best meet that particular requirement.  use a quality function deployment (QFD) ma
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