Broader look at profitability Flashcards
(38 cards)
what factors have brought about a change in attitude towards success and profitability?
increasing competition, the need to improve quality whilst keeping prices low, the speed of technological change and shorter product life cycles
what is target costing?
profit planning system not costing system. aims to control costs and manage profit over product’s life cycle.
what does target costing aim to do?
strengthens company’s competitive position by promoting cost consciousness and focusing on profit margins. doesn’t try to slash costs by trimming functions/closing depts, steady and never ending pressure to make sure costs always kept to a minimum
what is the difference between standard and target costing?
standard - starts as product goes into production with main factors predetermined; intentions, design, costs are x. this influences selling price. mgrs expected to keep within standard costs and variances calculated to determine this
target - starts with design concept. selling price then determined, profit requirement set. development of target cost, then design the product. if it doesn’t meet the target cost, aspects are redesigned until met or it isn’t produced at all. continues over product’s lifecycle and pressure to reduce costs is constant.
how should the profit requirement be set in target costing?
target profit requirement should be driven by strategic profit planning rather than a standard markup. in Japan this is done after consideration of medium term profit plans which reflect mgment and business strategies over period. the procedures used to derive the target profit must be scientific, rational and agreed by all staff responsible for achieving it, otherwise no-one will accept responsibility for achieving it.
what is decided in the design stage of a product?
specification of product including extra features - standard product with most of customer requirements met will obviously be cheaper, but does it really meet needs better?
number of components in the product
design of components - should aim for reliability in use and ease of manufacture. where possible use standard parts, and where new parts required make sure manufacturing process considered before design so they can be as cheap as possible consistent with quality and functionality.
type of packaging required
number of spare parts need to be carried - storage costs while product is in production vs disrupt current production to make small batch of past components needed?
how can pre-production stages of a product be categorised?
planning: fixing product concept and primary spec. brief concept. value engineering analysis can identify new cost effective features that would be valued by customers and meet requirements. once concept developed, planned sales volume/selling price (which depend on each other) will be set as well as required profit. then target cost can be ascertained.
concept design: basic product designed. total target cost split up. first, allowance for development costs and manufacturing equipment costs deducted. remainder split into unit costs, manufacturing target cost per unit assigned to functional areas of new product.
basis design: components designed in detail so they don’t exceed functional target costs. value engineering used to get costs down to target. if one function can’t meet, others must be reduced or product redesigned
detailed design: detailed specifications and cost estimates are set down from basic design stage.
manufacturing prep: manufacturing process designed in keeping with target cost. standards for materials/labour hrs set. values presented to factory staff for approval, purchasing dept negotiates prices for bought in components.
what is the cost gap in target costing? how can it be closed?
cost gap = estimated product cost - target cost
to close the gap:
Can any materials be eliminated, e.g. packing?
Can a cheaper material be substituted without affecting quality?
Can labour savings be made without compromising quality?
Can productivity be improved, for example, by improving motivation?
Can production volume be increased to achieve economies of scale?
Could cost savings be made by reviewing the supply chain?
Can part-assembled components be bought in to save on assembly time?
Can the incidence of the cost drivers be reduced?
Is there some degree of overlap between the product-related fixed costs that could be eliminated by combining service departments or resources?
how can target costing be applied to existing products already designed?
for existing products: manufacturing performance measured to see if target being achieved. this shows who is responsible for excess cost and can highlight where help is needed. it also helps judge whether the cost planning activities were effective. if after 3 months target cost is missed by large margin, improvement team is organised which will conduct thorough value analysis and stay in existence for about 6 months. TC used to control production cost and revise budget monthly. all costs including both variable and fixed overheads are expected to reduce on a regular basis, usually monthly.
what is the process of the traditional cost management approach?
- requirements set
- design
- process design and cost estimates
- make/buy analysis
- supplier cost estimates
(is the cost too high)? may have to start again at step 2
until cost acceptable, then
6. production
what three premises is target costing based on?
- orienting products to customer affordability or market-driven pricing
- treating product cost as an independent variable during definition of requirements
- proactively working to achieve target cost during product and process development.
what is the term for the approach target costing takes?
DTC - design to cost, with focus on market driven target prices as basis for establishing target costs.
similar to CAIV - cost as an independent variable approach used by US dept of defence and price-to-win philosophy
what are the ten steps to install a comprehensive TC approach within an org?
- re-orient culture and attitudes - customer needs > technical requirements
- establish a market-driven target price - market share, elasticity of demand, penetration, targeted market niche. if responding to RFQ target price based on price to win
- determine target cost - subtract std profit margin, warranty reserves, uncontrollable corp reallocations and non-recurring dev costs from target price
- balance TC with requirements
- establish TC process and team-based org - integrate marketing/eng/manufacturing/finance/purchasing
- brainstorm and analyse alternatives
- establish product cost models to support decision making - ensure comprehensive.
- use tools to reduce costs
- reduce indirect cost application - use of ABC and understanding of cost drivers can provide basis for understanding how design impacts indirect costs and allow their avoidance
- measure results and maintain mgment focus
what is the difference between Kaizen and target costing?
Kaizen costing is applied during the manufacturing stage of the products life cycle, and therefore focuses on achieving cost reductions through the increased efficiency of the production process. Through continual efforts significant reductions in cost can be achieved over time. In order to encourage continual cost reductions an annual (or monthly) Kaizen cost goal is established. Actual results are then compared with the Kaizen goal and then the current actual cost becomes the base line for setting the new Kaizen goal the following year. however as the products are already at the production stage the cost savings under Kaizen costing are smaller than target costing. Because cost reductions under target costing are achieved at the design stage where 80–90% of the product costs are locked in, more significant savings can be made
what is are the stages in a product lifecycle?
development = setup costs, R&D, building facilities. introduction = launch, advertising expenditure. growth = steady and often rapid increase, cost per unit falls. Maturity = demand slows. decline = market saturation, price wars with elastic demand products.
why is lifecycle costing important?
when viewed as whole, cost reduction and minimisation opportunities as well as revenue extortion opportunities present themselves. unlikely to be found when mgment focusing on period by period basis. mgment of time is particularly important in LCC if profit to be maximised. increase in time during development can increase cost/decrease revenue. time is often causal factor in reduction of profits.
how important is time wasted to a product’s profit?
A McKinsey study revealed that if a product was launched six months behind schedule 33% of after-tax profit was lost. If, on the other hand product development cost 50% more than planned, profits reduced by just 3.5%. All new product developments should have a planned time to market and events should be monitored closely to make sure that the planned timing is adhered to.
how can maximise length maximise return over the product lifecycle?
one way to max products return is maximise length of lifecycle itself, assuming production ceases once product goes into decline. this means quick to market and finding other uses for the product.
go to market as quickly as possible because can generate profit ASAP. Also because competitors will launch rivals asap so first org needs as long as possible to establish the product in the market.
find other uses/markets, may not be obvious when still in planning stage and needs to be planned later on. can stagger entry into different markets to reduce costs/increase revenue/prolong overall life, e.g. new films released in the US way before UK to increase hype and revenue.
what factors other than increasing the lifecycle length can in maximise returns over the lifecycle?
skimming market - charge high prices initially and bring down once market grows, like high tech where first customers less price sensitive.
design costs out of the product. don’t commit to costs. design teams work across functions. 80-90% of product cost is incurred and design and development.
cross functional development teams can shorten time to market
what did HP add to lifecycle costing theory?
the return map -
developed to minimise time to market and maximise return over life cycle. helps employees focus on developing products with most profit in smallest time. measures both money and time and plots cumulative sales, profits, investment. y axis is money and logarithmic to capture cumulative nature. measures several key time periods: time to market (TM), breakeven time (BET), breakeven time after release (BEAR), return factor (excess profit over investment, RF).
why can customer LCC be useful?
not all investment decisions involve large initial capital or the purchase of physical assets. to serve and retain customers can also be a capital budgeting decision even though the initial outlay may be small, there may be registration costs. research has also shown the longer a customer stays with the company the more profitable that customer becomes.
how can customer LCC be implemented?
a customers life can be discounted and decisions made as to the value of, e.g., a five year old customer. eventually the profit no longer grows and plateau is reached, usually 5-20 yrs depending on nature of business. those with large amounts of customers cannot easily analyse each one, in this case similar customers are grouped together to form category types and these can then be analysed in terms of profitability.
what is a lifecycle cost budget? What does it aim to do?
necessitates identification of costs with particular products. actual costs incurred i respect of the product are then monitored against life cycle budget costs. A company is in a weak position if all products are at same phase of life cycle. if all in growth there are problems ahead, and if all in another there are immediate difficulties.
what are the classifications of lifecycle costs?
development costs
design costs
manufacturing costs
marketing costs
distribution costs
