1. 5 © The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin 5 5 Slide 5-1 Target Costing,Theory of Constraints, and Life-Cycle Cost

2. 5 © The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin 5 5 Slide 5-2 Upstream Activities Downstream Activities Cost Life Cycle of a Product or Service R&D R&D Design Design Manu- facturing Manu- facturing Marketing and Distribution Marketing and Distribution Customer Service Customer Service

3. 5 © The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin 5 5 Slide 5-3 Introduction GrowthMaturity Decline Time Sales Sales Life Cycle of a Product Important strategic cost management issues arise in each activity of the life cycle.

4. 5 © The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin 5 5 Slide 5-4 Target Costing Target cost = Competitive price – Desired profit A firm has two options for reducing costs to a target cost level:  Integrate new manufacturing technology, using advanced cost management techniques such as activity-based costs, and seek higher productivity.  Redesign the product or service, because design decisions account for much of the total product life cycle costs. A firm has two options for reducing costs to a target cost level:  Integrate new manufacturing technology, using advanced cost management techniques such as activity-based costs, and seek higher productivity.  Redesign the product or service, because design decisions account for much of the total product life cycle costs.

5. 5 © The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin 5 5 Slide 5-5 Target Costing R&D R&D Design Design Manu- facturing Manu- facturing Marketing and Distribution Marketing and Distribution Customer Service Customer Service Target Costing Lower cost design is a definite goal that appears to be achievable and often motivates employees.

6. 5 © The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin 5 5 Slide 5-6 Managing Target Costing  Determine the market price.  Determine the desired profit.  Calculate a target cost at market price less desired profit.  Use value engineering to identify ways to reduce product cost.  Use kaizen costing and operational control to further reduce cost.  Determine the market price.  Determine the desired profit.  Calculate a target cost at market price less desired profit.  Use value engineering to identify ways to reduce product cost.  Use kaizen costing and operational control to further reduce cost.

7. 5 © The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin 5 5 Slide 5-7 Value Engineering R&D R&D Design Design Manu- facturing Manu- facturing Marketing and Distribution Marketing and Distribution Customer Service Customer Service Value Engineering

8. 5 © The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin 5 5 Slide 5-8 Value Engineering o Value engineering begins with consumer analysis performed during the design stage of the new or revised product. o Benchmarking is used to determine which features give the firm a competitive advantage. o Value engineering begins with consumer analysis performed during the design stage of the new or revised product. o Benchmarking is used to determine which features give the firm a competitive advantage.

9. 5 © The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin 5 5 Slide 5-9 Target Costing and Kaizen Costing  Kaizen, which means “continual improvement,” costing occurs at the manufacturing stage.  The role for cost reduction at this phase is to develop new manufacturing methods and to use new management techniques such as operations control, total quality management, and the theory of constraints.  Kaizen, which means “continual improvement,” costing occurs at the manufacturing stage.  The role for cost reduction at this phase is to develop new manufacturing methods and to use new management techniques such as operations control, total quality management, and the theory of constraints.

10. 5 © The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin 5 5 Slide 5-10 The Theory of Constraints cycle time Constraints are those activities which slow down the total cycle time of the product. The amount of time between the time a customer order is received and the time the order is ready for shipment. Manufacturing Cycle Efficiency The ratio of processing time to total cycle time Throughput Margin Price less materials costs, including all purchased components and materials handling costs

11. 5 © The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin 5 5 Slide 5-11 The Theory of Constraints  Identify the constraints.  Determine the most profitable product mix given the constraint.  Maximize the flow through the constraint.  Add capacity to the constraint.  Redesign the manufacturing process for flexibility and fast throughput.  Identify the constraints.  Determine the most profitable product mix given the constraint.  Maximize the flow through the constraint.  Add capacity to the constraint.  Redesign the manufacturing process for flexibility and fast throughput.

12. 5 © The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin 5 5 Slide 5-12 Flow Diagram for HPI, Inc. Electronic Components Price = $300 Electronic Components Price = $300 Assemble Earpiece 110 min. Assemble Earpiece 110 min. Install Other Electronics 40 min. Install Other Electronics 40 min. 1 st Assembly and Test 30 min. 1 st Assembly and Test 30 min. Pack and Ship 25 min. Pack and Ship 25 min. Computer Chip Price = $450 Computer Chip Price = $450 Test and Program 30 min. Test and Program 30 min. Install Other Electronics 40 min. Install Other Electronics 40 min. Electronic Components Price = $300 Electronic Components Price = $300 Assemble Earpiece 130 min. Assemble Earpiece 130 min. Last Assembly and Test 60 min. Last Assembly and Test 60 min. Pack and Ship 25 min. Pack and Ship 25 min. HPI-2HPI-2HPI-3HPI-3

13. 5 © The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin 5 5 Slide 5-13 Maximize Flow Through the Constraints  Simplify the operation: *simplify the product design *simplify the manufacturing process  Look for quality defects in raw materials that might be slowing things down.  Reduce set-up time.  Reduce other delays due to unscheduled and non-value-added activities, such as inspections, machine break-downs, etc.  Simplify the constraint by removing all activities from the constraint that will not reduce the function of the operation.  Simplify the operation: *simplify the product design *simplify the manufacturing process  Look for quality defects in raw materials that might be slowing things down.  Reduce set-up time.  Reduce other delays due to unscheduled and non-value-added activities, such as inspections, machine break-downs, etc.  Simplify the constraint by removing all activities from the constraint that will not reduce the function of the operation.

14. 5 © The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin 5 5 Slide 5-14 Drum Computer Chips and Components Process 4: Final Assembly and Test Rope Process 1: Assemble Process 2: Test and Install Chips Process 3: Test and Install Components Small amount of Work in Process Inventory Small amount of Work in Process Inventory Buffer Process 5: Packing and Labeling Finished Goods Drum-Buffer-Rope System for Production Flow Management

15. 5 © The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin 5 5 Slide 5-15 The Main Objective TOC ABC Short-term focus; through-put analysis based on materials and materials related costs Long-term focus; analysis of all product costs; including materials, labor and overhead ABC and Theory of Constraints

16. 5 © The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin 5 5 Slide 5-16 Resource Constraints and Capacities Included explicitly; a principal focus of TOC Not included explicitly TOC ABC ABC and Theory of Constraints

17. 5 © The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin 5 5 Slide 5-17 Cost Drivers No direct utilization of cost drivers. To develop an understanding of cost drivers at the unit, batch, product and facility levels TOC ABC ABC and Theory of Constraints

18. 5 © The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin 5 5 Slide 5-18 The Major Use Optimization of production flow and short-term product mix Strategic pricing and profit planning TOC ABC ABC and Theory of Constraints

19. 5 © The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin 5 5 Slide 5-19 LIFE CYCLE COSTING Life-Cycle Costing Upstream Activities Downstream Activities R&D R&D Design Design Manu- facturing Manu- facturing Marketing and Distribution Marketing and Distribution Customer Service Customer Service

20. 5 © The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin 5 5 Slide 5-20 Upstream Costs: Research and development Design: prototyping, testing, concurrent engineering, quality development Upstream Costs: Research and development Design: prototyping, testing, concurrent engineering, quality development Manufacturing Costs: Purchasing Direct manufacturing costs Indirect manufacturing costs Manufacturing Costs: Purchasing Direct manufacturing costs Indirect manufacturing costs Downstream Costs: Marketing and distribution-- packaging, shipping, samples. promotion, advertising Service and warranty--recalls, service product liability, customer support Downstream Costs: Marketing and distribution-- packaging, shipping, samples. promotion, advertising Service and warranty--recalls, service product liability, customer support Life-Cycle Costing

21. 5 © The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin 5 5 Slide 5-21 Critical Success Factors at the Design Stage  Reduce time-to-market  Reduce expected service costs  Improve ease-of- manufacture  Process planning and design  Reduce time-to-market  Reduce expected service costs  Improve ease-of- manufacture  Process planning and design

22. 5 © The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin 5 5 Slide 5-22 Characteristics of the Four Design Methods

23. 5 © The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin 5 5 Slide 5-23 Life-Cycle Costing in a Software Firm ADI-1 Appears More Profitable Incomplete Analysis

24. 5 © The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin 5 5 Slide 5-24 Life-Cycle Costing in a Software Firm Complete Analysis

25. 5 © The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin 5 5 Slide 5-25 Introduction Time Sales Sales Life Cycle and Strategic Pricing There is little competition, and sales rise slowing as customers become aware of the new product or service. R&D and capital costs are high and product variety is limited.

26. 5 © The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin 5 5 Slide 5-26 Growth Time Sales Sales Life Cycle and Strategic Pricing Sales begin to grow rapidly and product variety increases. There is increasing competition and prices begin to soften.

27. 5 © The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin 5 5 Slide 5-27 Maturity Time Sales Sales Life Cycle and Strategic Pricing Sales increase but at a decreasing rate. Prices soften further, and differentiation is no longer important.

28. 5 © The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin 5 5 Slide 5-28 Decline Time Sales Sales Life Cycle and Strategic Pricing Sales decline, as do the number of competitors. Cost control and effective distribution are keys to survival.

29. 5 © The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin 5 5 Slide 5-29 The Sales Life Cycle for a Manufacturer of Computer Processors

30. 5 © The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin 5 5 Slide 5-30 End of Chapter 5