Week 4 - Target Costing and Economic Value to the Customer

Question 1

Importance of early-stage costs

Answer 1

Whilsts design phase of a prouct tends to be a relatively low proportion of cost incurred, the decisions made then have a very large impact on the level of manufacturing costs
that will be incurred subsequently
* This suggests that cost
management has most potential
during the design phase not during the manufacturing phase
* Target costing focuses on cost
management at this design stage

Question 2

Issues with Target Costing/CMS (Davina & Wouters (2004)

Answer 2

Target costing focuses attention on cost drivers away from revenue drivers

• Easy to forget time-to-market is important and undertake a comprehensive analytical process of searching for the “best”
• Large organizations like formal systems and easily forget that the cost of costing must be
  compensated by better decisions
• Target costing is too detailed
• Remember the Willie-Sutton rule. Cost models are frequently limited to manufacturing costs
• Remember the hierarchy of costs and ABC
• Cost models are frequently limited to resources inside the company (restricted by suppliers for cost reduction)
• Developing cost models is time (and resource consuming)

Question 3

EVC Analysis

Answer 3

MAXIMUM amount a fully informed (on benefits of product and competitor offerings) customer should be willing to pay.

Reference product (closest substitute) and Incremental Value ( difference between your offering and substitute)

Question 4

Lifecycle Cost Calculation & EVC Cost Calculation

Answer 4

Purchase Price + Present Value of Running Costs - Present Value of Resale Amount

EVC = LifeCycle Cost (above) - Post purchase running costs + Incremental benefits of product

Question 5

EVC - ceiling price & floor price

Answer 5

Ceiling:
Reference product price + incremental benefits

Floor: Cost to manufacturer

Question 6

Issues in EVC decision making

Answer 6

How long is product lifespan?

How good a fit is the refrence product as substitute

Are there existing relationships with other supplier? This would affect the decision

Difference between cost & ceiling is bargaining power

Question 7

Ceiling Price of new product

Answer 7

LCC cost of current - LCC Cost of new (price will be hidden) + Additional benefits / Number of new ones needed

e.g.
Current costs £10, need 10 & Disposal cost of £3 ,;, LCC = £10+3*10 = £130

New need 8, Disposal of £4 ,’, LCC = 4*8 = 32

130-32 = 98

98/8 = £12.50 Ceiling price for new product

Question 8

Davila & Wouters (2004)

Cost Management Strategies

Answer 8

Target costing ineffective in tech-driven firms due to rapid changes. Focusing on earlay stage cost better

One MCS is:

Parallel cost management teams:
- cost saving opportunities without diverting focus of core team
- Work closesly with core team providing cost insight

Question 9

Target Costing Nissan Example

Answer 9

Success target costing but:

• Supplier resistance to cost reductions
• Culturale barriers adopting cost-conscious mindset
• Difficulty balancing aggressive cost-cutting with maintaining vehicle quality.

Question 10

Davina & Wouters (2004): benefits of target costing

3

Answer 10

Strict cost discipline early in production lifecycle, such as R&D

Fosters collabaration between divisions (Parallel cost teams)

Customer-centric - incorporates Customer preferences and price sensitivity e.g. Nissan