CHAPTER 10 COST PLANNING FOR THE PRODUCT LIFE CYCLE: TARGET COSTING, THEORY OF CONSTRAINTS, AND STRATEGIC PRICING QUESTIONS
targ et cost level: 10-1 A firm has two options for reducing costs to a target a. Redu Reduce ce cost costs s to a targ target et cost cost leve levell by inte integr grat atin ing g new new manu manufa fact ctur urin ing g technology, using advanced cost management techniques such as activity-based costing costing,, and seeking seeking higher higher product productivit ivity y through through improve improved d organiza organization tion and labor labor relat relation ions. s. his his meth method od of cost reduct reduction ion is comm common on in speci speciali alized zed equipment manufacturing. b. Reduce Reduce cost to a target cost cost level by redesignin redesigning g a popular popular product. product. his his method is the more common of the two, because it recognizes that design decisions account for much of total product life cycle costs !see "#hibit $%-&'. (y careful attention to design, significant reductions in total cost are possible. his approach to target costing is associated associated primarily primarily with )apanese manufacturers, manufacturers, especia especially lly oyota, oyota, which is credited credited with with developi developing ng the method method in the mid mid $*+%s. his method of cost reduction is common in consumer electronics. 10-2
he sales life cycle refers to the phase of the products sales in the market - from introd introduc ucti tion on of the produc productt to decline decline and and with withdra drawa wall from from the mark market et.. n cont contra rast st,, the the cost cost life life cycl cycle e refe refers rs to the the acti activi viti ties es and and cost costs s incu incurr rred ed in developing a product, designing it, manufacturing it, selling it and servicing it. he phases of the sales life cycle are: hase hase /ne: /ne: rodu roduct ct ntro ntroduc ducti tion. on. n the the first first phase phase there there is littl little e compet competiti ition, on, and sales rise slowly as custom customers ers become aware aware of the new product. 0osts are relatively high because of high R12 e#penditures and capital costs costs for settin setting g up producti production on facilities facilities and marketi marketing ng effort efforts. s. rices rices are relative relatively ly high because because of product product differ differenti entiatio ation n and the high costs at this this phase. roduct variety is limited. hase hase wo wo:: 3rowt 3rowth. h. 4ale 4ales s begin begin to grow rapidly rapidly and product product variet variety y increases. he product product continues continues to en5oy en5oy the the benefits benefits of different differentiation. iation. here is increasing competition and prices begin to soften. hase hree: 6aturity. 6aturity. 4ales continue to increase but at a decreasing rate. here is a reduction in the number of competitors and product variety. rices soften further further,, and differentiation differentiation is no longer important. important. 0ompetition 0ompetition is based on cost, given competitive quality and functionality. hase hase 7our: 7our: 2ecline 2ecline.. 4ale 4ales s begin begin to decli decline, ne, as does does the the numb number er of competitors. rices stabilize. "mphasis on differentiation returns. 4urvivors are able to differentiate their product, control costs, and deliver quality and e#cellent servic service. e. 0ont 0ontrol rol of costs costs and an effe effecti ctive ve dist distrib ributi ution on netwo network rk are key key to continued continued survival.
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he strategic pricing approach changes over the sales life cycle of the product. n the first phase, pricing is set relatively high to recover development costs costs and to take advantage of product differentiation and the new demand for the product. n the second phase, pricing is likely to stay relatively high as the firm attempts to build profitability in the growing growing market. Alternative Alternatively ly,, to maintain or increase market share at this time, relatively low prices !8penetration pricing9' might be used. n the latter phases, pricing becomes more competitive, and target costing and life-cycle costing methods are used, as the firm becomes more of a price taker rather than a At least three factors that make sensitivity analysis prevalent in decision making including the following price setter, and efforts are made to reduce upstream !for product enhancements' and downstream costs.
10-4 At the introduction and into the growth phases, the primary need is for value
chain analysis, to guide the design of products in a cost-efficient manner. 6aster budgets !0hapter !0hapter ' are also used in these early phases to manage cash flows; there are large developmental costs at a time when sales revenues are still relative relatively ly small. small. hen, hen, as the strategy strategy shifts shifts to cost leadership leadership in the latter phases, the goal of the cost management system is to provide the detailed budgets and activity-based costing tools for accurate cost information. 10-5
arget costing is a method by which the firm determines determines the desired cost for the product, given a competitive market price, so that the firm can earn a desired profit. t is used by several manufacturing firms, particularly in the automotive and consumer products industries, such as
10-6
>ife-cycle costing considers the entire cost life cycle of the product, and thus provides a more complete complete perspective of product costs and product profitability profitability. t is used to manage manage the total costs of the product across its entire life cycle. 7or e#ample, e#ample, design and development development costs may be increased in order to decrease manufacturing costs and service costs later in the life cycle.
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here are five steps in /0 analysis: 4tep /ne: dentify the 0onstraint ?se a flow diagram. he constraint is a resource that limits production to less than market demand. 4tep wo: 2etermine the 6ost "fficient ?tilization of "ach 0onstraint roduct mi# decision: based on capacity available at the constraint, find the most profitable product mi#. 6a#imize flow through the constraint: -reduce setups -reduce lot sizes -focus on throughput rather than efficiency 4tep hree: 6a#imize the 7low hrough the 0onstraint
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2rum-(uffer-Rope concept: maintain a small amount of work-in-process !buffer' and insert materials only when needed !drum' by the constraint, given lead times !rope'. All resources resources are coordinated coordinated to keep the constraint busy without without a buildup of work. 4tep 7our: ncrease 0apacity on the 0onstrained Resource nvest in additional capacity if it will increase throughput throughput greater than the cost of the the invest investme ment nt.. 2o not move move to invest investme ment nt unti untill steps steps two two and three three are complete, that is, ma#imize the productivity of the process through the constraint with e#isting capacity capac ity.. 4tep 4tep 7ive 7ive:: Rede Redesi sign gn the the 6anu 6anufa fact ctur urin ing g roc roces ess s for for 7le# 7le#ib ibililit ity y and and 7ast 7ast hroughput 0onsider a redesign of the product of production process, to achieve faster throughput. /ne could argue that any step could be the most important; for e#ample step one one can can be cons consid ider ered ed to be the the most most impo import rtan antt beca becaus use e the the anal analys ysis is under underta taken ken is inten intended ded to impro improve ve the the speed speed of produc productt flow flow throu through gh the the constraint. 10-8
/0 emphasizes the improvement of throughput by removing or reducing the constraints, which are bottlenecks in the production process that slow the rate of output. hese are often identified as processes wherein relatively large amounts of inventory are accumulating, or where there appear to be large lead times. ?sing /0 the management accountant speeds the flow of product through the constraint, and chooses the mi# of product so as to ma#imize the profitability of the product flow through the constraint.
10-
he purpose of the flow diagram is to assist the management accountant in the first step of /0, to identify the constraints.
10-10 he methods of product engineering and design in life-cycle costing are:
(asic engineering is the method in which product designers work independently from marketing and manufacturing to develop a design from specific plans and specifications. rototyping is a method in which functional models of the product are developed and tested by engineers and trial customers. emplating is a design method in which an e#isting product is scaled up or down to fit the specifications of the desired new product. 0oncurre 0oncurrent nt engineer engineering, ing, or 8simul 8simultane taneous9 ous9 engineer engineering, ing, is an import important ant new appr approa oach ch in whic which h prod produc uctt desi design gn is inte integr grat ated ed with with manu manufa fact ctur urin ing g and and marketing throughout the products life cycle. 10-11 =alue engineering is used in target costing to reduce product cost by analyzing
the tradeoffs between different types and levels of product functionality and total product cost. wo common forms of value engineering are: Blocher,Stout,Cokins,Chen: Cost Management , 4e
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2esign analysis is a process where the design team prepares several possible design designs s of the the produ product ct,, each each havi having ng simi similar lar feat feature ures s but but diffe differen rentt levels levels of performance on these features and different costs. 7unctional analysis is a process where each ma5or function or feature of the product is e#amined in terms of its performance and cost. 10-12 Activity-based costing !A(0' is used to assess the profitability of products, 5ust
as is /0. /0. he he dif differe ferenc nce e is that that /0 /0 take takes s a shor shortt-te term rm appro approac ach h to profitab profitabilit ility y analysis analysis,, while while A(0 develop develops s a longer-te longer-term rm analysis. analysis. he /0 /0 analysis has a short-term focus because of its emphasis on materials related costs only, while A(0 A(0 includes all product costs. /n the other hand, unlike /0, A(0 does not e#plicitly include the resource constraints and capacities of production production operations. hus, A(0 cannot be used to determine determine the short-term best best produ product ct mi#. mi#. A(0 A(0 and and /0 are thus comp comple leme ment ntar ary y meth methods ods;; A(0 A(0 provides a comprehensive analysis of cost drivers and accurate unit costs as a basis basis for for strat strategi egic c decis decision ions s about about longlong-te term rm pricin pricing g and and produc productt mi#. mi#. n contrast, contrast, /0 provides a useful method for improving the short-term short-term profitability of the manuf manufact acturing uring plant plant through through short-t short-term erm product product mi# ad5ustm ad5ustment ents s and through attention to production bottlenecks. 10-13 /0 is appropriate for many types of manufacturing, service and not-for-profit
firms. firms. t is most useful useful where the product product or service is prepared or provided in a sequence of inter-related activities as can be described in a network diagram such as shown in "#hibit "#hibit $%-+. he most most common common users of /0 /0 to date have been been manu manufa fact cturi uring ng firm firms s who who use it to ident identif ify y mach machin ines es or steps steps in the the production process which are bottlenecks in the flow of product and profitability. arget costi costing ng is most most approp appropria riate te for for firm firms s that that are in a very very comp compet etit itive ive 10-14 arget industry industry,, so that that the firms in the industry industry compete compete simult simultaneo aneously usly on price, price, quality and product functionality. n very competitive markets such as this, target costing is used to determine the desired level of functionality the firm can offer for the product while maintaining high quality and meeting the competitive price. 10-15 >ife-cycle costing is most appropriate for firms which have high upstream costs
!i.e. !i.e. design design and devel developm opmen ent' t' and down downst strea ream m costs costs !i.e. !i.e. dist distrib ributi ution on and service costs'. 7irms with high upstream and downstream costs need to manage the entire life cycle of costs, including the upstream and downstream costs as well as manufacturing costs. raditional cost management methods tend to focus on manufacturing costs only, and for these firms, this approach would ignore a significant portion of the total costs.
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10-16 4trategic pricing is used to help a firm develop and implement its strategy for
success as its products and services mature in the market place. he focus for new products is typically differentiation and there is a heavy focus on research and development, while cost control becomes more important as the product matures. n contrast, life-cycle costing is used to manage the costs of the product over its entire cost life-cycle - from research and development and product testing to manufacturing and finally distribution and customer service. 10-17 akt time is the ratio of available manufacturing time for a period to the units of
customer demand for that period. "ach unit must be produced within the akt time to satisfy customer demand. akt time is computed for each manufacturing operation, and those operations with longer akt times are the constraints in the manufacturing process. 10-18 ricing based on the cost life cycle is a common form of pricing. t involves a
markup on full product cost or product life cycle cost. n contrast, pricing based on the sales life cycle bases the product price on competitive factors, including which phase of the sales life cycle !introduction, growth, maturity, or decline' the product is currently in.
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!RIEF E"ERCISES 10-1
0urrent profit per unit @ B% - & - @ CDunit arget total cost @ CB - C @ C$ arget manufacturing cost @ CB - C - @ && 往
10-20 rice @ $.C # !&' @ B&.E% 10-21 rice @ $.$% # !& F ' @ B%.+% 10-22 he introduction phase 10-23
akt time @ +,%%% # C weeks per monthDE%%,%%% units per month @ .$E hourDunit or G.E minutes per unit
10-24
E% - $ @ $* days
10-25
E days in production !6ay E%-6ay E$' !E$-$@E% days cycle time'
10-26
Haizen, continuous improvement
@ .$
10-27 $C% - $C% # !.EB' @ $%B
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E"ERCISES 10-28 T#$%&' C()'*+% 15 *+.
$. he unit cost is currently BC.+% @ $&,G$B,%%%DEB,%%% he current profit per item is +$% - BC.+% @ +$.C% hus, the target cost to meet the competitive price is: BB% - +$.C% @ C.+% E. he target cost can probably be achieved by efforts in two areas: a. he standard cost analysis shows an unfavorable materials variance of B%%,%%% !G,%%%,%%% - +,B%%,%%%' or E% per unit, a very significant variance. "fforts to reduce or eliminate this variance will make the firm much more competitive. Iotice that the labor usage variance for indirect labor is favorable, and the direct labor variance is unfavorable. t may be that additional work is needed setting the standards. b. he standard cost shows an unfavorable direct labor variance of $EB,%%% !E,+EB,%%% - E,B%%,%%%', or B per unit, an opportunity for cost savings. c. he remaining manufacturing costs can be considered nonvalue adding costs, since they do not add to the functionality or quality of the product. "fforts can be made to reduce the total cost of these manufacturing costs, which now total a significant C,%*%,%%% or $+&.+% per unit.
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10-2 /#+#'$*+% C& E**&+ 10 *+.
60" @ total processing timeDtotal cycle time @ E&D!E&F&F+F&F$FBFEF+FE' @ E&DB$ @ CBJ Iote that new product development time and order taking time are not considered part of the manufacturing cycle and are e#cluded from cycle time. he level of 60" is best interpreted by reference to the prior 60" values for the firm or to an industry average. A number closer to one is better. Khen comparing to an industry average, management should make sure that the measures are calculated in the same manner. n this case, Kaymouth has improved significantly on its 60" relative to the prior data, and is higher than the industry average.
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10-30 T#' T*& 10 *+. 1. he takt time for this product is the number of available hours D total
demand. otal manufacturing time @ G%hr # +% min # +% sec @ EBE,%%% seconds ,C%% ,C%% @ EBE,%%% C,%%%
@ &% seconds per unit
E. he processing line is not properly balanced. /peration E e#ceeds takt time by C sec. and /peration &s time is somewhat less than takt time. o balance the line, so that products can be e#pected to come off the line every &% seconds as needed, the capacity of operation E should be increased so that it could speed up its operation. 4imilarly, operation & could reduce capacity and resources to save money; we do not need this operation to move so fast. &. he strategic role of takt time is to help operations managers to balance the operations and to improve the speed of throughput and reduce cycle time. he management accountants role is to provide information on the costs of processing time and capacity, and the value of increasing throughput. /0 analysis attempts to accomplish this by ma#imizing the flow through the constraintsDoperations.
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10-31 T#$%&' C()'*+% 30 *+.
$., E. C()' #+ A'**' U)#%& ($ E#9 P$('
2irect 6aterials Iumber of parts 6achine hours nspecting time acking time 4et-ups
0urrent A-$% A-EB $C&.G+ ++.CC $E$ *E + C $ %.+ %.G %.C E $
Revised A-$% AEB G:.+B CE.CB $$% :$ B E $ %.B %.G %.E $ $
A'**'-#)& C()')
2irect 6aterials 6aterials
;
$C&.G+ EGE.EB $C$.%% &%:.BB :*.E% &B.%% $%.B% 1,00026
;
++.CC E%G.%% *C.%% E&C.+% CC.+% E$.%% +.%% 67364
;
G:.+B ECG.B% $$G.B% E:%.B% CC.+% &B.%% $%.B% 81425
;
CE.CB $:E.EB CG.%% E%+.BB CC.+% $G.B% &.%% 54335
$,%B%.%% C*.GC
GEB.%% B$.&+
:EB.%% $%.GB
B*B.%% B$.+B
&. he solution uses 3oal 4eek or trials in the "#cel sheet. he number of parts must be reduced to $%$ or fewer to get at least B% margin. 0urrent
C()' #+ A'**' U)#%& ($ E#9 P$(' 2irect 6aterials
A-$% $C&.G+
Iumber of parts 6achine hours nspecting time acking time 4et-ups
$E$ + $ %.G E
Revised A-EB ++.CC
A-$% G:.+B
101
*E C %.+ %.C $
A-EB CE.CB :$ E %.B %.E $
B $ %.G $
A'**'-#)& C()') 2irect 6aterials 6aterials
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$C&.G+ EGE.EB $C$.%% &%:.BB :*.E% &B.%% $%.B% 1,00026
;
++.CC E%G.%% *C.%% E&C.+% CC.+% E$.%% +.%% 67364
;
G:.+B EEG.EB $$G.B% EBG.BB CC.+% &B.%% $%.B% 77105
;
CE.CB $:E.EB CG.%% E%+.BB CC.+% $G.B% &.%% 54335
$,%B%.%% C*.GC
GEB.%% B$.&+
:EB.%% B&.*B
B*B.%% B$.+B
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P$(& 10-31 (+'*+&.
C. arget costing should be useful to (4 to assist the firm in meeting the new competition by finding new ways to cut costs without reducing product quality or functionality.
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10-32 T$#& C()')< T#$%&' C()'*+% 20 *+.
$. 0ancun P##%& S=&**#'*(+)
/ceanfront room; number of nights 6eals: (reakfasts >unches 2inners 4cuba diving trips Kater skiing trips
?nit 0ost
)amaica
Luantity
0ost
Luantity
0ost
&%
+
$%
C
$E%
B G $% $B $% Airfare !round trip E%% !0ancun', &BB !)amaica' from 6iami' ransportation to $B !0ancun', and from airport $% !)amaica' /A>4
G G + C B
&B C* +% +% B%
B B % E E
EB &B % &% E%
$
E%%
$
&BB
$
$B +C*
$
$% B*B
0ancun: !GB% - +C* total costs'D GB% @ $&.CGJ profit margin )amaica: !+*% - B*B'D+*% @ $&.GGJ profit margin E. 0ancun !G$% - +C* total costs'D G$% @ .B*J profit margin )amaica: !+B%- B*B'D+B%@ .C+J profit margin &. he airfare costs are the largest component of cost and this category could have room for improvement. (y further negotiating group discount rates or searching for lower cost discount carriers, ake-a-(reak could lower its cost in this category. Room costs also comprise a ma5or portion of total package costs. Khile ake-a-(reak could negotiate deals with off-beachfront hotels or opt for nonoceanfront rooms, this might decrease the value of the trip in the eyes of its customers. A better option would be to further negotiate group rates with its current hotel providers.
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1033 T#$%&' C()'*+% *+ A S&$*& F*$ 20 *+.
$. cost per unit @ !C,B%%,%%% F $,GB%,%%% F GB%,%%% F B,%%%,%%%' D ,%%% @ $,B%% per unit profit per unit @ !&,%%% price per unit - $,B%% cost per unit' @ $,B%% per unit E. 6achine setups do not add value to the golf carts. GB%,%%% total cost D ,%%% units @ *&.GB per unit of non-value added costs &. E,B% price per unit - $,B%% profit per unit @ $,&B% per unit target cost C. 0ost must be reduced by &,%%% - E,B% @ $B%. 7irst and foremost, Keekend 3olfer should focus on getting back on budget. nefficiencies in materials usage have led an e#tra &G.B%Dunit in cost !C.B%%.%%%C,E%%,%%%'D,%%%'. Also, getting labor on budget would save an additional C&.GBDunit !$,GB%,%%%D$EB,%%% @ $C per hour; EB,%%% hours e#cess M $C @ &B%,%%%; &B%,%%%D,%%% @ C&.GB'. >abor and materials costs should be reduced by C&.GB F &G.B% @ $.EB. Additional savings could come from reducing the non-value added costs from machine setups. his could be done through product design and manufacturing process reengineering. Also, a careful e#amination of mechanical assembly might reveal cost saving opportunities because this category currently comprises half of the cost per unit. 0utting hours off of mechanical assembly through product innovation or a process change would provide more savings.
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10-34 P$**+% 25 *+.
he price, contribution, and profit information is as follows. $. $G+.$& @ &,C$%,%%% M $.BB D &%,%%% E. $C.+% @ C,E+%,%%% M $.& D &%,%%% &. $*.CCC @ $$&.+G D !$ - .C' C. $*.&&& @ $CE.%% D !$ - .EB' B. E%E.%% @ $CE.%% M !N F .CEEB' Khere: .CEEB @ !$E,%%%,%%%M.$B' D !&%,%%%M$CE' otal =ariable 0osts otal 7i#ed 0osts otal 6anufacturing 0ost otal 4elling and Administrative otal >ife 0ycle 0ost er unit 6anufacturing 0ost er unit >ife 0ycle 0ost
/&'9(: 6arkup on full manufacturing cost 6arkup on life cycle costs rice to Achieve 2esired 36 J rice to Achieve 2esired >00 J rice to Achieve 2esired R/A of
E,B%%,%%% $,G+%,%%% &,C$%,%%% :B%,%%% C,E+%,%%% $$&.+G $CE.%% D&)*$& R#'& ($ /#$= BBJ &%J C%.%%J EB.%%J $BJ CE.EBJ
P$*& $G+.$:& $:C.+%% $:*.CCC $:*.&&& E%E.%%%
ANS>ER TO PART 6???????? C(+'$*'*(+ G$()) O=&$#'*+% /#$%*+ /#$%*+ P$(*' E,G:B,B%% $,:GB,B%% $,%EB,B%% &,%&:,%%% E,$E:,%%% $,EG:,%%% &,$:&,&&& E,EG&,&&& $,CE&,&&& &,$:%,%%% E,EG%,%%% $,CE%,%%% &,B+%,%%% E,+B%,%%% $,:%%,%%%
+. he contribution margin, gross margin, and operating profit are shown in the right-hand portion of the table above. 7or e#ample, E,GB,B%% @ $G+.$& # &%,%%% - E,B%%,%%% he pricing methods yield prices from $G+.%% to E%E.%% he highest price, E%E, has the advantage that it provides the desired return on investment, a more precise statement of the firms goal than in the other methods. /n the other hand, the lower price might be an advantage if the firm is trying to achieve sales growth and is concerned about maintaining or improving market share during turns in the business cycle for its customers. his latter concern is especially important given that the demand for the firms product is a derived demand, and there is little that )ohnson can do to influence total auto sales.
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10-35 L*& C& C()'*+% 20 *+.
otal 7i#ed 0osts
E,&%% &,%%% B,C%% +,*E% +,%%% E$,%%% CC,+E%
otal variable costs E.B% F .B% F .B% @ &.B% >ife-0ycle 0osts @ E$,%%% for fleet of canoes CC+,E%% !annual fi#ed costs # $% years' EEC,%%% !&.B% var. costs # +,C%% rentals per yr # $% years' +*$,E%% >ife-0ycle Revenues needed for E%J profit margin @ +*$,E%% D %.% @ +C,%%% rice per Rental for E%J profit margin @ +C,%%% D +C,%%% rentals in ten years @ $&.B%
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10-36 S#&) L*&-C& A+#)*) 5 *+.
Activities and 6arket 0haracteristics 2ecline in sales Advertising (oost in production 4tabilized profits 0ompetitors entrance into market 6arket Research 6arket 4aturation 4tart roduction roduct esting ermination of roduct >arge ncrease in sales
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>ife 0ycle 4tage 2ecline ntroduction 3rowth 6aturity 3rowth ntroduction 6aturity ntroduction ntroduction 2ecline 3rowth
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10-37 P$**+% /**'#$ C(+'$#') 10 *+.
his is a comple# issue which entagon officers and congressional leaders continue to squabble over. n this particular case, 4enator 6c0ain argued that the contract should be re-written to reduce the fi#ed fee from $%J to &J and the incentive fee should be increased from BJ to $EJ. his means that the total potential fee of $BJ would be retained, but that a much larger portion of the fee would have to be earned on performance measures !the incentive fee'.
4ource: 8he Right 4tuff for the 3s of the 7uture,9 Business Week , August $B, E%%B, pp GC-GB.
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10-38 P$**+% P(@&$ 10 *+.
his e#ercise is intended for a brief class discussion. he ob5ective is to identify the factors that are critical in allowing some firms to have more pricing fle#ibility than others. he discussion should touch on the importance of distinguishing cost leadership firms, for whom the market price is set by low-cost global suppliers, and who therefore have little pricing fle#ibility, versus differentiated firms, who will have more fle#ibility in setting prices because of the innovation and features of their product or service. Also, considering the sales life cycle can help. 7irms in the introduction and growth phases of their product or service life cycle will have more fle#ibility about setting prices than those in the mature phase of the life cycle, where there is more effective price competition. 3eoffrey 0olvin, writing in 7ortune, points out that many firms today have less fle#ibility in setting prices. he factors that have traditionally provided pricing power are brands, intellectual property, and high entry barriers: (rands: 0olvin points out that many brands, including 0oke, Iike, and 6c2onalds, are under attack from a number of sources, including those who are opposed to what they see as the social ills caused by these firms ntellectual roperty: 0olvin points out that firms around the world are having more success at copying, legally or illegally, the patented products such as =iagra, or entertainment products O music and movies
4ource: 3eoffrey 0olvin, 8ricing ower Aint Khat it ?sed to (e,9 Fortune, 4eptember $B, E%%&, p BE.
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10-3 T#$%&' C()'*+% U)*+% QFD 20 *+.
$. he calculations are shown below:
E. he cost inde# for wait staff is somewhat less than the importance inde#, which indicates that
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PRO!LE/S 10-40T#$%&' C()'*+% *+ # S&$*& F*$ 20 *+.
$. 0? $%% ?nit 0ost Luantity 0ost =ideo camera $B% $ $B% =ideo monitor GB $ GB 6otion detector $B B GB 7loodlight & EC Alarm $B $ $B Kiring .$%Dft G%% G% nstallation E%Dhr $+ &E% otal GE*
0? *%% Luantity 0ost & CB% $ GB $E% G B+ E &% $,$%% $$% E+ BE% $,&+$
0? $%%: !$% - GE* total costs'D $% @ $%J profit margin 0? *%%: !$,BE% - $,&+$'D$,BE% @ $%.C+J profit margin E. 0? $%%: !GB% - GE* total costs'D GB% @ E.J profit margin 0? *%%: !$,&*% - $,&+$'D$,&*% @ E.%*J profit margin &. he installation costs are the largest component of cost and this category could have room for improvement. (y redesigning the layout of the systems or finding components that integrate more readily, the installation times could then be reduced. Also, costs could be lowered by contractual bargaining with electricians to reduce the per hour rates for installation. he video equipment and motion detectors are sources of significant costs, but decreasing the quality or quantity of these items would substantially change the effectiveness and value of the security systems.
Blocher,Stout,Cokins,Chen: Cost Management , 4e
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10-41 T#$%&' C()'*+%, S'$#'&% 15 *+.
$. cost per unit @ !E,G%%,%%% F $,%%%,%%% F &%%,%%% F C,%%%,%%%' D $%,%%% @ %% per unit profit per unit @ !GB price per unit - %% cost per unit' @ GB E. 6achine setups do not add value to the tables. &%%,%%% total cost D $%,%%% units @ &% per unit of non-value added costs &. %% price per unit - GB profit per unit @ GEB per unit target cost C. 0ost must be reduced by %% - GEB @ GB. 7irst and foremost, (enchmark should focus on getting back on budget. nefficiencies in materials usage have led to an e#tra $B.Dunit in cost P Q!EB,%%%DCEB,%%%' # E,G%%,%%%D$%,%%% @ $B.S. Also, getting labor on budget would save an additional $BDunit P Q$,%%%,%%% # !$B,%%%D$%%,%%%'D$%,%%% S. his would get costs down to G+*.$E per unit !%% - $B - $B.'. art of the additional CC.$E !GB - $B - $B.' of savings needed to attain the GEB target cost could come from reducing the non-value added costs from machine setups. his could be done through product design and manufacturing process reengineering. Also, a careful e#amination of mechanical assembly might reveal cost saving opportunities because this category currently comprises half of the cost per unit. 0utting E T hours off of mechanical assembly through product innovation or a process change would provide more than &% of savings !at C,%%%,%%%D&E%,%%% @ $E.B% per hour; savings of E T hours per unit would save E T # $E.B% @ &$.EB per unit'
Blocher,Stout,Cokins,Chen: Cost Management , 4e
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10-42 T#$%&' C()'*+% 20 *+.
$. he target cost, at the price of $,B%% and the desired margin of E%J would be 0 @ $,B%% - .E # $,B%% @ $,E%% E. 6anufacturing 0ost 6arketing 0ost 34A 0ost otal 0ost
C$$&+'
>*'9 C()' R&'*(+)
S#*+%)
$,%%%
&B
B-EBF$%B @ $+B
E%% EEB $,CEB
E%% $GB $,E
%$B% E$B
he cost savings of E$B are not sufficient to get the product total cost !$,E$%' down to the desired target cost of $,E%%. 3iven that Iational might be willing to pay a higher price, and since the cost difference is relatively small, it seems that 6orrow should in fact pursue the order.
Blocher,Stout,Cokins,Chen: Cost Management , 4e
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b. 6orrow appears to compete in what Robin 0ooper calls the 8confrontation9 strategy ! When Lean Enterprises Collide,
Blocher,Stout,Cokins,Chen: Cost Management , 4e
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10-43 T#$%&' C()'*+%< H&#'9 C#$& 20 *+.
$. he unit cost is B @ GG,$G,B%%D*$B,B%% he current profit per item is $$B - B @ &% he target cost to meet the competitive price is $%* - &% @ G*. E. he unit cost is +.C+ @ &,$%*,%*%D*+$,EGB Iote: GG,$G,B%% F !GG,$G,B%%M+.J' @ &,$%*,%*% he current profit per item is $EB - +.C+ @ &.BC he target cost is $EC - &.BC @ B.C+ A critical success factor is the relationship with network providers. "stablishing a good working relationship with its providers improves the likelihood that the clinicians will follow the <6/s protocols. 0ustomer satisfaction is essential, so 62 lus should measure and monitor the satisfaction levels of their patients, employees, network providers and referring physicians. 4ince quality of care is a critical component of customer satisfaction, a continuous quality improvement department could be established to monitor the organizations effectiveness and efficiency. $!
Blocher,Stout,Cokins,Chen: Cost Management , 4e
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10-44 T#$%&' C()'< >#$&9()*+% 20 *+.
0urrent Vear /perating ncome 4ales E% # $%%,%%% @ E,%%%,%%% 0osts: urchase $% # $%%,%%% @ $,%%%,%%% urchasing order $B% # $,%%% @ $B%,%%% Karehousing &% # ,%%% @ EC%,%%% 2istributing % # B%% @ C%,%%% 7i#ed operating cost EB%,%%% $,+%,%%% /perating income &E%,%%% arget 0ost 4ales E%.%% # $%%,%%% # .*% @ 2esired profit otal cost allowed otal costs e#cluding warehousing: urchase $,%%%,%%% # .* @ urchasing order $B% # G%% @ 2istributing GB # B%% @ 7i#ed operating cost 6a#imum warehousing cost
$,%%,%%% &E%,%%% $,C%,%%% *%,%%% $%B,%%% &G,B%% EB%,%%% $,&GE,B%% $%G,B%%
Karehousing costs must be reduced from EC%,%%% to $%G,B%%, a reduction of $&E,B%%.
Blocher,Stout,Cokins,Chen: Cost Management , 4e
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T#$%&' C()'*+%< I+'&$+#'*(+# 20 *+.
$. arget manufacturing cost @ 0urrent manufacturing cost F 8?.4. 2ifferential9 @ B+ F rice differential - 0ost differential @ B+ F $+ - $% @ +E /r: arget cost @ target price O differential advertising and shipping O desired ?4 profit +E @ *% - $% - $ E. he cost differential is +E - B+ @ +
Blocher,Stout,Cokins,Chen: Cost Management , 4e
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1046 T#$%&' C()'*+%< Q#*' F+'*(+ D&=(&+' QFD. 30 *+. 1
Blocher,Stout,Cokins,Chen: Cost Management , 4e
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P$(& 10-46 (+'*+&.
E. Khen the value inde# is compared to the target cost, the percentage investment in hull 1 keel and standing rig looks too low O he value inde# for hull 1 keel is &B.BJ while the cost inde# is &%J; the value inde# for the standing rig is E%.$J while the cost is only $BJ. Ranger might benefit from additional design enhancement of features related to these two components. n contrast, the e#penditures for electrical equipment are somewhat higher than would be indicated by customer preferences. /verall, this suggests that consideration be given to redesign of the boat to bring it more in line with customer value.
Blocher,Stout,Cokins,Chen: Cost Management , 4e
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10-47 T9&($ ( (+)'$#*+') 25 *+.
7irst, identify the constraint:
Receiving and testing 6achining Assembly 7inal Assembly
ime Required "0-$ "0-E C%#$% F C% # $B#EB@&GB EB@$,C%% C%#%@&,E%% C%#CB@$,%% $B#!CBF&%' @$,$EB C%#+%@E,C%% $B#C%@+%%
otal $,GGB
ime Available E,%%%
&,E%% E,*EB
&,B%% E,%%%
&,%%%
&,B%%
(y inspection, the constraint is Assembly, where there are E,%%% minutes of time available, but E,*EB minutes required, a deficit of *EB minutes 4econd: 2etermine the most profitable product mi# rice 6aterials cost hroughput margin 0onstraint time !min' hroughputDminute
PEC-1
PEC-2
E%% $$% *% CB E.%%
EB% $&G.B% $$E.B% GB $.B%
(ased on the profitability analysis, "0-$ is the most profitable product, given the constraint on Assembly time. 4o the most profitable product mi# is C% units of "0-$ and E units of "0-E: 2emand roduction plan, "0-$ 0onstraint time used, remaining roduction plan, "0-E otal hroughput
PEC-1
PEC-2
C% C% C%#CB@$,%%
$B E,%%% -$,%%@E%%
C% # *% @ &,+%%
E%%DGB@E.++G; round to E E # $$E.B% @ EEB.%%
Blocher,Stout,Cokins,Chen: Cost Management , 4e
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10-48 T9&($ ( C(+)'$#*+') 30 *+. 7irst, summarize key information and obtain hours capacity in each process:
4econd, identify the constraint. n this case the constraint is staining time, where there is a need for B more hours of capacity
Ie#t, determine the most profitable product, as determined by the requirements of the staining operation. 4ince the sofa requires substantially less staining time, and because it has higher throughput, it is the most profitable product.
P$(& 10-48 (+'*+&.
Blocher,Stout,Cokins,Chen: Cost Management , 4e
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7inally, determine the most profitable product mi#. 4ince sofas are the most profitable through the staining constraint, we fill the sofa demand first, and then with the remaining staining capacity, fill as much of the table demand as possible. 4ee below for calculations.
E. art one above solves the first two steps of the /0, to identify the constraint and determine the most profitable product mi#. he third step, to ma#imize flow through the constraint, would require 0olton to look for ways to speed up the staining operation, by simplifying it, by training the operator, or other means. n the fourth /0 step, 0olton could consider adding a part time employee to add capacity at the constraint, though it might be difficult to find a skilled employee who wanted part time work. Adding a full time employee would be unnecessary and wasteful, unless the motel contract works out. n the final /0 step, 0olton should consider the possibility of re-design, by for e#ample using a different type of stain that requires less time and skill.
Blocher,Stout,Cokins,Chen: Cost Management , 4e
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Kith the information available 2on can complete the first two steps of /0 as shown below. he analysis shows that the reactor process is the constraint, and that in the short run, olymer $ is the most profitable product. he most profitable product mi# is +% units of olymer $ and &B units olymer E. ?ntil the production delays can be dealt with !/0 steps &-B', 2on should advise 0 to meet all the sales demand of olymer $ and to advise customers of olymer E there would be some delays in the shortOterm. hen, 0 should work quickly to relieve the constraint, reactor time, by applying the third, fourth and fifth /0 steps. Kithout specialized technical knowledge of the manufacturing processes in this industry, one can only speculate about what these steps might be. F*$)': I&+'* '9& C(+)'$#*+'
otal ime Required for "ach activity for 3iven 2emand ime Required for otal olymer $ olymer E ime 7iltering +%#E@ $E% 4tripper +%#!$F$'@ $E% Reactor +%#&@ $% 7inal 7ilter +%#E@ $E% 6i#ing +%#&@ $%
C%#!EFE'@ $+% C%#!EF$'@ $E% C%#B @ E%% C%# $ @ C% C%#& @ $E%
E% EC% &% $+% &%%
ime 4lack Available ime &E% &E% &E% $+% &E%
he reactor is the constraint , since there is a demand of &% hours but only &E% hours available.
Blocher,Stout,Cokins,Chen: Cost Management , 4e
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C% % -+% % E%
P$(& 10-4 (+'*+&. S&(+: I&+'* '9& ()' =$(*'#& =$('
T9*$, I&+'* '9& ()' =$(*'#& =$(' *
4ince olymer $ is the most profitable product, its total demand of +% is filled first. he remaining time on the reactor is used to complete as many units of olymer E as possible: 0apacity of reactor available for olymer E @ &E% O +% # & @ $C% $C%DC @ &B units of olymer E
Blocher,Stout,Cokins,Chen: Cost Management , 4e
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$. (akker will not be able to meet the demand. 2epartment $ is a constraint, based on machine time. Ke do not consider labor time because (akker is able to hire and retain all the labor it needs. $ 6achine
E $,%%%@ B%%#E C%%@ C%%#$ E,%%%@ $,%%%#E &,C%% &,%%% !C%%'
2epartments & B%%@ B%%#$ C%%@ C%%#$ E,%%%@ $,%%%#E E,*%% &,$%% E%%
$,%%%@ B%%#E % $,%%%@ $,%%%#$ E,%%% E,G%% G%%
C $,%%%@ B%%#E %%@ C%%#E $,%%%@ $,%%%#$ E,%% &,&%% B%%
E. he best product mi# is C%% units of roduct +$&, B%% units of product +$$, and %% units of product +$B. 611
613
615
rice $*+ $E& =ariable 0ostW $%& G& hroughputDunit *& B% 6achine hours in 2ept $ E $ hroughputDhour C+.B% B%.%% W 7or e#ample, variable cost for +$$ @ !GF$EFE$FECF*FEGF&'
$+G *G G% E &B.%%
roductionDsales lan 7irst: 4econd:
otal hours available in 2ept $ C%% units of +$&; C%%#$ hours B%% units of +$$; B%%#E hours
&,%%% C%% $,%%%
$,+%% hird: %% units of +$B; $,+%%DE hours per unit @ %% All &,%%% hours used
Blocher,Stout,Cokins,Chen: Cost Management , 4e
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10-51
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$. Katers analysis based on the prepared report fails to consider the very significant amount of research and development and selling costs. t is unlikely that the two products consumed equal shares of these costs. As the calculations in part E below illustrate, the determination of profitability can be significantly affected by the tracing of these non-manufacturing costs each product. he idea is that lifecycle costing, including upstream and downstream costs !research and development, and selling costs, respectively' as well as the manufacturing costs, is necessary to get an accurate picture of each products overall profitability. E. 4ales 0ost of goods sold 3ross profit Research and dev. 4elling e#penses rofit before ta#es
Mderm &,%%%,%%% $,*%%,%%% $,$%%,%%% !GE%,%%%' !%,%%%' &%%,%%%
Vderm E,%%%,%%% $,+%%,%%% C%%,%%% !$%,%%%' !E%,%%%' E%%,%%%
otal B,%%%,%%% &,B%%,%%% $,B%%,%%% !*%%,%%%' !$%%,%%%' B%%,%%%
he life-cycle product line profitability analysis shows a much different result. &.Iow, the two products have the same return on sales. his illustrates that including the upstream and downstream costs can be very important in getting a useful analysis of product profitability. 7ailing to include these non-manufacturing costs, as Katers did at first, may lead to incorrect marketing and management decision making, as the firm may have a biased and incorrect idea of the most profitable product!s'. 0alculation return on sales !not required' shows that each product has the same return under life cycle costing. Return on 4ales
&%%,%%% &,%%%,%%% @ $%J
Blocher,Stout,Cokins,Chen: Cost Management , 4e
E%%,%%% E,%%%,%%% @ $%J
10-
%$ B%%,%%% B,%%%,%%% @$%J
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$. A product life cycle statement would aggregate the three years into one that shows the totals in each category for the life of the product. E. >B% appears to be more profitable; GG$ vs +G% life cycle profits. >C% Revenues 0osts Res earch and 2evelopment rototypes 6arketing 2istribution 6anufacturing 0ustomer 4erivce otal 0ost
2005 :%%
2006 E,&%%
$, C%% &B% +% +% E% $,:*%
B% +%% $E% GG% +% $,+%%
$,C%% C%% $,$&B &$% E,$C% $CB B,B&%
G%%
$,%+%
+G%
2005 *%%
2006 $,*%%
2007 E,E%%
T('# B,%%%
+B% &%% $EC $G% :B $,&E*
&% E%% E%% G%% E% $,$B%
$% E+% C$% GG% &%% $,GB%
+B% &C% B:C G:% $,BBB &E% C,EE*
CB%
GG$
/perating rofit
!$,%*%'
!CE*'
Blocher,Stout,Cokins,Chen: Cost Management , 4e
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GB%
T('# +,E%%
CGB $&% $,&B% :B E,%C%
/perating rofit
>B% Revenues 0osts Research and 2evelopment rototypes 6arketing 2istribution 6anufacturing 0ustomer 4erivce otal 0ost
2007 &,$%%
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&. >C% Revenues 0osts Res earch and 2evelopment rototypes 6arketing 2istribution 6anufacturing 0ustomer 4erivce otal 0ost
/perating rofit
>B% Revenues 0osts Research and 2evelopment rototypes 6arketing 2istribution 6anufacturing 0ustomer 4erivce otal 0ost /perating rofit
2005 :%% % $, C%% &B% +% +% E% $,:*%
J GC.$J $:.BJ &.EJ &.EJ $.$J %.%J
2005 *%% +B% &%% $EC $G% :B $,&E*
G%%
!$,%*%'
2006 E,&%% J % B% +%% $E% GG% +% $,+%%
C:.*J EE.+J *.&J $E.:J +.CJ %.%J
!CE*'
2006 $,*%% % &% E%% E%% G%% E% $,$B% GB%
%.%J &.$J &G.BJ G.BJ C:.$J &.:J
2007 &,$%% J % %.%J %.%J CGB E&.&J $&% +.CJ $,&B% ++.EJ :B C.EJ E,%C% $,%+%
%.%J E.+J $G.CJ $G.CJ +%.*J $.GJ
2007 E,E%% % $% E+% C$% GG% &%% $,GB%
%.%J %.+J $C.*J E&.CJ CC.%J $G.$J
CB%
he analysis shows how the distribution of costs for both products shifts from research and development in the first year to manufacturing and customer service in the last year. he shift is most pronounced for >C% which has high development costs.
Blocher,Stout,Cokins,Chen: Cost Management , 4e
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10-53 L*& C& C()'*+%< H&#'9 C#$&< D*)(+'*+% 30 *+.
f 0ure-all were to manufacture the drug themselves, at a sales price of E&B, the li)e-c*cle costs woul+ e the )ollowin: rice E&B ?nits 4old &,%%%,%%% Revenues G%B,%%%,%%% 0osts R12 0linical rials 6anufacturing 7i#ed =ariable ackaging 7i#ed =ariable 2istribution 7i#ed =ariable Advertising 7i#ed =ariable otal 0ost
$,%%%,%%% E,$%,%%% B,%%%,%%% # B @ EB,%%%,%%% +#&,%%%,%%% @ E%C,%%%,%%% &%,%%% # B @$,*%%,%%% E% # &,%%%,%%% @ +%,%%%,%%% $,$EB,%%% # B @ B,+EB,%%% +.B% # &,%%%,%%%@ $*,B%%,%%% E,E%,%%% # B @ $$,C%%,%%% $E # &,%%%,%%%@ &+,%%%,%%% &++,B&&,%%%
/perating ncome
Blocher,Stout,Cokins,Chen: Cost Management , 4e
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/utsourcing the manufacturing would result in the following life cycle costs assuming the cost as E&B per unit and the changes in the manufacturing costs: rice ?nits 4old Revenues 0osts R12 0linical rials 6anufacturing 7i#ed =ariable ackaging 7i#ed =ariable 2istribution 7i#ed =ariable Advertising 7i#ed =ariable otal 0ost
E&B &,%%%,%%% G%B,%%%,%%% $,%%%,%%% E,$%,%%% $,B%%,%%% # B @G,B%%,%%% % # &,%%%,%%%@ EC%,%%%,%%% &%,%%% # B @ $,*%%,%%% +%,%%%,%%% $,$EB,%%% # B @B,+EB,%%% $*,B%%,%%% E,E%,%%% # B @$$,C%%,%%% &+,%%%,%%% &B,%&&,%%%
/perating ncome
&$*,*+G,%%%
/utsourcing the manufacturing results in a lower operating income than manufacturing the drug themselves.
Blocher,Stout,Cokins,Chen: Cost Management , 4e
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t appears that selling the drug patent is the best alternative since receiving CEB,%%%,%%% !&%%,%%%,%%% F EB,%%%,%%% # B' over the five year period is greater than the operating incomes of both the other options.
Blocher,Stout,Cokins,Chen: Cost Management , 4e
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10-54C(+)'$#*+' A+#)*)< F(@ D*#%$# A==&+*. 60 *+.
3race =anders accelerated delivery schedule is unsatisfactory in cutting $% days from the total pro5ect schedule because not all of her crashed activities are included on the critical path. n order to reduce the completion time for a pro5ect, activities along the critical path need to be chosen to be crashed or reduced. =anders selection of activities 7), "7, and (3, which are on the critical path A(3"7)H, will reduce total pro5ect completion time only by three days but her selection of activities <), 3<, 02, and 2" have no impact on the critical path and thus will not reduce pro5ect time. 1!
E. (elow is a revised accelerated delivery schedule that meets both ob5ectives: !$' delivery of the first plane two weeks !$% working days' ahead of schedule, and !E' at least incremental cost to 0oastal. All the paths need to be evaluated when reducing a pro5ects completion time.
a*s e+uce+
1 1 1 " 4 1
ncremental Cost per +a* 6 400 #00 (00 1,000 1,"00 1,$00
Blocher,Stout,Cokins,Chen: Cost Management , 4e
ncremental Cost
6 400 #00 (00 ",000 4,#00 1,$00 610,"00
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.BG235
&% &4 &$ &" &0 %& %%
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he second path, A(02"7)H, which crashes less e#pensive activities, is less e#pensive overall, and thus a better crash schedule. he A(02"7)H path, before crash, has a time of +C, so that the table begins with +C. .cti/it* Crashe+ ST.T 3 23 5 .B C Total
a*s e+uce+
1 1 1 4 "
ncremental Cost per +a*
ncremental Cost
6 400 #00 (00 1,"00 '00
6 400 #00 (00 4,#00 1,400 6#,$00
.BC235
&4 &$ &" &1 %' %%
Iote that the activities (3 and 3" are not crashed in the final solution because they are not on the critical path. Reducing time on these activities will not reduce the overall pro5ect time. &. he total incremental costs (ob eterson will have to pay for this revised accelerated delivery schedule amount to ,&%%, or a new total pro5ect cost of G&,C%% from the original +B,$%%, and a saving of $% days.
Blocher,Stout,Cokins,Chen: Cost Management , 4e
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10-55 P$('*(+ P#++*+% #+ C(+'$( 30 *+.
here may be a happy ending to this story if Hristen and (ryan change the focus in the plant from productivity at each work station and meeting budgets to a focus on speed and throughput. he current emphasis on productivity at each work station has the effect that each employee has the incentive to work very hard to meet their productivity targets, without a consideration of the overall productivity of the entire plant. his is why work-in-process inventory builds up in places. 4ome operators are keen on moving the product through their work stations, and not concerned about what happens to it downstream. Also, the emphasis on meeting cost budgets !as in the case of the purchasing department manager', creates incentives to reduce costs in ways which can cause delays and defective products. he purchase of discounted material which apparently led to product defects is an e#ample. he emphasis on individual productivity has other effects. 4ince it creates a focus only on moving product through individual processes, inadequate attention appears to be given to equipment maintenance or to the prevention of defects. here is insufficient attention to preventing quality defects. n contrast, there is e#cessive attention to correcting defects !re-work'. o speed up the process, the rate of defects has to be reduced. he emphasis on correcting defects merely slows things down. 4i#-sigma firms such as oyota and 3" have learned it is less costly as well as faster to prevent defects rather than to spend time on inspection and re-work. nspection and re-work are non-value adding processes that should be eliminated. Another unfortunate result of the cost allocation method in the plant is that department managers apparently have the incentive to reduce the amount of space in which they operate in order to reduce the overhead costs allocated to them. his means that some work stations, for e#ample "ds, are possibly too small for efficient processing, leading to lower productivity and increased defects. Again, the focus of the accounting system has set things awry, and provided a dysfunctional incentive.
Blocher,Stout,Cokins,Chen: Cost Management , 4e
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