TheMarketing Mix, The Environmental Forces? The Strategic Marketing Process-All Phases? Market segmentation / Target Market? Situation Analysis / SWOT? The Product Life Cycle / objectives & 4P strategy?

OneClass: TheMarketing Mix, The Environmental Forces? The Strategic Marketing Process-All Phases? Mar...

8-47 Target costing Mercedes-Benz All-Activity Vehicle(AAV)

Introduction

During the recession beginning in the early 1990s, Mercedes-Benz(MB) struggled with product development, cost efficiency, materialpurchasing, and problems in adapting to changing markets.

In 1993, these problems caused the worst sales slump in decades,and the luxury car maker lost money for the first time in itshistory. Since then, MB has streamlined the core business, reducedparts and system complexity, and established simultaneousengineering programs with suppliers.

In their search for additional market share, new segments, andnew niches, MB started developing a range of new products. Newproduct introductions included the C-Class in 1993, the E-Class in1995, the new sportster SLK in 1996, and the A-Class and M-ClassAll-Activity Vehicle (AAV) in

1997. Perhaps the largest and most radical of MB's new projectswas the AAV. In April 1993, MB announced it would build its firstpassenger vehicle-manufacturing facility in the United States.

The decision emphasized the company's globalization strategy anddesire to move closer to its customers and markets.

Mercedes-Benz United States International used function groupswith representatives from every area of the company (marketing,development, engineering, purchasing, production, and controlling)to design the vehicle and production systems. A modularconstruction process was used to produce the AAV. First-tiersuppliers provided systems rather than individual parts orcomponents for production of approximately 65,000 vehiclesannually.

The AAV Project Phases

The AAV moved from concept to production in a relatively shortperiod of time. The first phase, the concept phase, was initiatedin 1992. The concept phase resulted in a feasibility study that wasapproved by the board. Following board approval, the projectrealization phase began in 1993, with production commencing in1997. Key elements of the various phases are described next.

ConceptPhase,1992-1993

Team members compared the existing production line with variousmarket segments to discover opportunities for new vehicleintroductions. The analysis revealed opportunities in the rapidlyexpanding sports utility vehicle market that was dominated by Jeep,Ford, and GM. Market research was conducted to estimate potentialworldwide sales opportunities for a high-end AAV with thecharacteristics of a Mercedes-Benz. A rough cost estimate wasdeveloped that included materials, labor, overhead, and one-timedevelopment and project costs. Projected cash flows were analyzedover a 10-year period using net present value (NPV) analysis toacquire project approval from the board of directors. Thesensitivity of the NPV was analyzed by calculating "what-if"scenarios involving risks and opportunities. For example, riskfactors included monetary exchange rate fluctuations, differentsales levels due to consumer substitution of the AAV for another MBproduct, and -product and manufacturing costs that differed fromprojections. On the basis of the economic feasibility study of theconcept phase, the board approved the project and initiated asearch for potential manufacturing locations. Sites located inGermany, other European countries, and the United States wereevaluated. Consistent with the company's globalization strategy,the decisive factor that brought the plant to the United States wasthe desire to be close to the major market for sports utilityvehicles.

Project Realization Phase,1993-1996

Regular customer clinics were held to view the prototype and toexplain the new vehicle concept. These clinics produced importantinformation about how the proposed vehicle would be received bypotential customers and the press. Customers were asked to rank theimportance of various characteristics, including safety, comfort,economy, and styling. Engineers organized in function groupsdesigned systems to deliver these essential characteristics.However, MB would not lower its internal standards for components,even if initial customer expectations might be lower than the MBstandard. For example, many automotive experts believed that thesuperior handling of MB products resulted from manufacturing thebest automobile chassis in the world. Thus, each class within theMB line met strict standards for handling, even though thesestandards might exceed customer expectations for some classes. MBdid not use target costing to produce the lowest price vehicle inan automotive class. The company's strategic objective was todeliver products that were slightly more expensive than competitivemodels. However, the additional cost would have to translate intogreater perceived value on the part of the customer.

Throughout the project realization phase, the vehicle (andvehicle target cost) remained alive because of changing dynamics.For example, the market moved toward the luxury end of the spectrumwhile the AAV was under development. In addition, crash testresults were incorporated into the evolving AAV design. For thesereasons, MB found it beneficial to place the design and testingteam members in close physical proximity to other functions withinthe project to promote fast communication and decision making.Sometimes new technical features, such as side air bags, weredeveloped by MB. The decision to include the new feature on all MBlines was made at the corporate

level because experience had shown that customers' reactions toa vehicle class can affect the entire brand.

ProductionPhase,1997

The project was monitored by annual updates of the NPV analysis.In addition, a three-year plan (including income statements) wasprepared annually and reported to the headquarters in Germany.

Monthly departmental meetings were held to discuss actual costperformance compared with standards developed during the costestimation process. Thus, the accounting system served as a controlmechanism to ensure that actual production costs would conform totarget (or standard) costs.

Target Costing and the AAV

The process of achieving target cost for the AAV began with anestimate of the existing cost for each function group. Next,components of each function group were identified with theirassociated costs. Cost reduction targets were set by comparing theestimated existing cost with the target cost for each functiongroup. These function groups included the following: doors,sidewall and roof, electrical system, bumpers, power train, seats,heating system, cockpit, and front end. Next, cost reductiontargets were established for each component. As part of thecompetitive benchmark process, MB bought and tore down competitors'vehicles to help understand their costs and manufacturingprocesses.

The AAV manufacturing process relied on high-value-added systemssuppliers. For example, the entire cockpit was purchased as a unitfrom a systems supplier. Thus, systems suppliers were part of thedevelopment process from the beginning of the project. MB expectedsuppliers to meet established cost targets. To enhance functiongroup effectiveness, suppliers were brought into the discussion atan early stage in the process. Decisions had to be made quickly inthe early stages of development. The target costing process was ledby cost planners who were engineers, not accountants.

Because the cost planners were engineers with manufacturing anddesign experience, they could make reasonable estimates of coststhat suppliers would incur in providing various systems. Also, MBowned much of the tooling, such as dies to form sheet metal, usedby suppliers to produce components. Tooling costs are a substantialpart of the one-time costs in the project phase.

Index Development toSupportTarget Costing Activities

During the concept development phase, MB team members usedvarious indexes to help them determine critical performance,design, and cost relationships for the AAV.To construct theindexes, various forms of information were gathered from customers,suppliers, and their own design team.Although the actual number ofcategories used by MB was much greater, Table 1 illustrates thecalculations used to quantify customer responses to the AAVconcept. For example, values shown in the "Importance" columnresulted from asking a sample of potential customers whether theyconsider each category extremely important when considering thepurchase of a new MB product. Respondents could respondaffirmatively to all categories that applied.

To gain a better understanding of the various sources of costs,function groups were identified together with target costestimates. (MB also organizes teams called function groups whoserole is to develop specifications and cost projections.) As shownin Table 2, the relative target cost percentage of each functiongroup was computed.

Table 3 summarizes how each function group contributes to theconsumer requirements identified in Table 1. For example, safetywas identified by potential customers as an importantcharacteristic of the AAV; some function groups contributed more tothe safety category than others. MB engineers determined thatchassis quality was an important element of safety (50% of thetotal function group contribution).

Table 4 combines the category weighting percentages from Table 1with the function group contribution from Table 3. The result is animportance index that measures the relative importance of eachfunction group across all categories. For example, potentialcustomers weighted the categories of safety, comfort, economy, andstyling as 0.41, 0.32, 0.18, and 0.09, respectively. The rows inTable 4 represent the contribution of each function group to thevarious categories. The importance index for the chassis iscalculated by multiplying each row value by its correspondingcategory value and summing the results: (0.50 X 0.41) + (0.30 X0.32) + (0.10 >< 0.18) + (0.10 X 0.09) = 0.33.

As shown in Table 5, the target cost index is calculated bydividing the importance index by the target cost percentage byfunction group. Managers at MB used indexes suchas these during the concept design phase to understand therelationship of the importance of a function group to the targetcost of a function group. Indexes less than 1 may indicate a costin excess of the perceived value of the function group. Thus,opportunities for cost reduction consistent with customer demands,may be identified and managed during the early stages of productdevelopment.

Choices made during the project realization phase were largelyirreversible during the production phase because approximately 80%of the production cost of the AAV was for materials and systemsprovided by external suppliers.

The AAV project used a streamlined management structure tofacilitate efficient and rapid development. The streamlined MBorganization produced an entirely new vehicle from concept toproduction in four years. Using the target costing process as a keymanagement element, MB manufactured the first production AAV in1997.

Required

(a) What is the competitive environment faced by MB as itconsiders launching the AAV?

(b) How has MB reacted to the changing world for luxuryautomobiles?

(c) Using Cooper's cost, quality, and functionality chart, 15discuss the factors on which MB would have to compete with otherautomobile producers, such as Jeep, Ford, and GM.

(d) How does the AAV project link with MB's strategy in terms ofmarket coverage?

(e) Explain the process of developing an importance index for afunction group or component.

How can such an index guide managers in making cost reductiondecisions?

(f) How does MB approach cost reduction to achieve targetcosts?

(g) How do suppliers factor into the target costing process? Whyare they so critically important to the success of the MB AAV?

(h) What role does the accounting department play in the targetcosting process?

blackoyster4

8-47 Target costing Mercedes-Benz All-Activity Vehicle(AAV)

Introduction

During the recession beginning in the early 1990s, Mercedes-Benz(MB) struggled with product development, cost efficiency, materialpurchasing, and problems in adapting to changing markets.

In 1993, these problems caused the worst sales slump in decades,and the luxury car maker lost money for the first time in itshistory. Since then, MB has streamlined the core business, reducedparts and system complexity, and established simultaneousengineering programs with suppliers.

In their search for additional market share, new segments, andnew niches, MB started developing a range of new products. Newproduct introductions included the C-Class in 1993, the E-Class in1995, the new sportster SLK in 1996, and the A-Class and M-ClassAll-Activity Vehicle (AAV) in

1997. Perhaps the largest and most radical of MB's new projectswas the AAV. In April 1993, MB announced it would build its firstpassenger vehicle-manufacturing facility in the United States.

The decision emphasized the company's globalization strategy anddesire to move closer to its customers and markets.

Mercedes-Benz United States International used function groupswith representatives from every area of the company (marketing,development, engineering, purchasing, production, and controlling)to design the vehicle and production systems. A modularconstruction process was used to produce the AAV. First-tiersuppliers provided systems rather than individual parts orcomponents for production of approximately 65,000 vehiclesannually.

The AAV Project Phases

The AAV moved from concept to production in a relatively shortperiod of time. The first phase, the concept phase, was initiatedin 1992. The concept phase resulted in a feasibility study that wasapproved by the board. Following board approval, the projectrealization phase began in 1993, with production commencing in1997. Key elements of the various phases are described next.

ConceptPhase,1992-1993

Team members compared the existing production line with variousmarket segments to discover opportunities for new vehicleintroductions. The analysis revealed opportunities in the rapidlyexpanding sports utility vehicle market that was dominated by Jeep,Ford, and GM. Market research was conducted to estimate potentialworldwide sales opportunities for a high-end AAV with thecharacteristics of a Mercedes-Benz. A rough cost estimate wasdeveloped that included materials, labor, overhead, and one-timedevelopment and project costs. Projected cash flows were analyzedover a 10-year period using net present value (NPV) analysis toacquire project approval from the board of directors. Thesensitivity of the NPV was analyzed by calculating "what-if"scenarios involving risks and opportunities. For example, riskfactors included monetary exchange rate fluctuations, differentsales levels due to consumer substitution of the AAV for another MBproduct, and -product and manufacturing costs that differed fromprojections. On the basis of the economic feasibility study of theconcept phase, the board approved the project and initiated asearch for potential manufacturing locations. Sites located inGermany, other European countries, and the United States wereevaluated. Consistent with the company's globalization strategy,the decisive factor that brought the plant to the United States wasthe desire to be close to the major market for sports utilityvehicles.

Project Realization Phase,1993-1996

Regular customer clinics were held to view the prototype and toexplain the new vehicle concept. These clinics produced importantinformation about how the proposed vehicle would be received bypotential customers and the press. Customers were asked to rank theimportance of various characteristics, including safety, comfort,economy, and styling. Engineers organized in function groupsdesigned systems to deliver these essential characteristics.However, MB would not lower its internal standards for components,even if initial customer expectations might be lower than the MBstandard. For example, many automotive experts believed that thesuperior handling of MB products resulted from manufacturing thebest automobile chassis in the world. Thus, each class within theMB line met strict standards for handling, even though thesestandards might exceed customer expectations for some classes. MBdid not use target costing to produce the lowest price vehicle inan automotive class. The company's strategic objective was todeliver products that were slightly more expensive than competitivemodels. However, the additional cost would have to translate intogreater perceived value on the part of the customer.

Throughout the project realization phase, the vehicle (andvehicle target cost) remained alive because of changing dynamics.For example, the market moved toward the luxury end of the spectrumwhile the AAV was under development. In addition, crash testresults were incorporated into the evolving AAV design. For thesereasons, MB found it beneficial to place the design and testingteam members in close physical proximity to other functions withinthe project to promote fast communication and decision making.Sometimes new technical features, such as side air bags, weredeveloped by MB. The decision to include the new feature on all MBlines was made at the corporate

level because experience had shown that customers' reactions toa vehicle class can affect the entire brand.

ProductionPhase,1997

The project was monitored by annual updates of the NPV analysis.In addition, a three-year plan (including income statements) wasprepared annually and reported to the headquarters in Germany.

Monthly departmental meetings were held to discuss actual costperformance compared with standards developed during the costestimation process. Thus, the accounting system served as a controlmechanism to ensure that actual production costs would conform totarget (or standard) costs.

Target Costing and the AAV

The process of achieving target cost for the AAV began with anestimate of the existing cost for each function group. Next,components of each function group were identified with theirassociated costs. Cost reduction targets were set by comparing theestimated existing cost with the target cost for each functiongroup. These function groups included the following: doors,sidewall and roof, electrical system, bumpers, power train, seats,heating system, cockpit, and front end. Next, cost reductiontargets were established for each component. As part of thecompetitive benchmark process, MB bought and tore down competitors'vehicles to help understand their costs and manufacturingprocesses.

The AAV manufacturing process relied on high-value-added systemssuppliers. For example, the entire cockpit was purchased as a unitfrom a systems supplier. Thus, systems suppliers were part of thedevelopment process from the beginning of the project. MB expectedsuppliers to meet established cost targets. To enhance functiongroup effectiveness, suppliers were brought into the discussion atan early stage in the process. Decisions had to be made quickly inthe early stages of development. The target costing process was ledby cost planners who were engineers, not accountants.

Because the cost planners were engineers with manufacturing anddesign experience, they could make reasonable estimates of coststhat suppliers would incur in providing various systems. Also, MBowned much of the tooling, such as dies to form sheet metal, usedby suppliers to produce components. Tooling costs are a substantialpart of the one-time costs in the project phase.

Index Development toSupportTarget Costing Activities

During the concept development phase, MB team members usedvarious indexes to help them determine critical performance,design, and cost relationships for the AAV.To construct theindexes, various forms of information were gathered from customers,suppliers, and their own design team.Although the actual number ofcategories used by MB was much greater, Table 1 illustrates thecalculations used to quantify customer responses to the AAVconcept. For example, values shown in the "Importance" columnresulted from asking a sample of potential customers whether theyconsider each category extremely important when considering thepurchase of a new MB product. Respondents could respondaffirmatively to all categories that applied.

To gain a better understanding of the various sources of costs,function groupswere identified together with target costestimates. (MB also organizes teams called function groups whoserole is to develop specifications and cost projections.) As shownin Table 2, the relative target cost percentage of each functiongroup was computed.

Table 3 summarizes how each function group contributes to theconsumer requirements identified in Table 1. For example, safetywas identified by potential customers as an importantcharacteristic of the AAV; some function groups contributed more tothe safety category than others. MB engineers determined thatchassis quality was an important element of safety (50% of thetotal function group contribution).

Table 4 combines the category weighting percentages from Table 1with the function group contribution from Table 3. The result is animportance index that measures the relative importance of eachfunction group across all categories. For example, potentialcustomers weighted the categories of safety, comfort, economy, andstyling as 0.41, 0.32, 0.18, and 0.09, respectively. The rows inTable 4 represent the contribution of each function group to thevarious categories. The importance index for the chassis iscalculated by multiplying each row value by its correspondingcategory value and summing the results: (0.50 X 0.41) + (0.30 X0.32) + (0.10 >< 0.18) + (0.10 X 0.09) = 0.33.

As shown in Table 5, the target cost index is calculated bydividing the importance index by the target cost percentage byfunction group. Managers at MB usedindexes suchas these during the concept design phase to understand therelationship of the importance of a function group to the targetcost of a function group. Indexes less than 1 may indicate a costin excess of the perceived value of the function group. Thus,opportunities for cost reduction consistent with customer demands,may be identified and managed during the early stages of productdevelopment.

Choices made during the project realization phase were largelyirreversible during the production phase because approximately 80%of the production cost of the AAV was for materials and systemsprovided by external suppliers.

The AAV project used a streamlined management structure tofacilitate efficient and rapid development. The streamlined MBorganization produced an entirely new vehicle from concept toproduction in four years. Using the target costing process as a keymanagement element, MB manufactured the first production AAV in1997.

https://drive.google.com/file/d/0B7DlLcOZwfeKXzdfbVQwMlVteUE/view?usp=sharinglink to required tables