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Control Tomorrow's Purchasing Costs Through Today's Specification
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Procurement Matters A series on effective Procurement for Professionals Part 3: How to control tomorrow’s costs through today’s design In recent times organisation after organisation has learned that quality must be designed into products or services. Today, the most innovative ones are applying the same logic to determine the price of new products … so says Prof. Robin Cooper, author of “When Lean Companies Collide” an article published by Harvard Business Review. Senior managers determine the ideal selling price of a product or service (or in the case of a public sector or not-for- profit organization, set the budget they can afford) then establish the feasibility of meeting that price and control costs to ensure that the price is met. This is a process known as Target Costing. Why does this continue to be a hot topic? The answer lies in the way that organisations have traditionally made money over the lifecycle of a product and how that has now changed. In the past, many companies, particularly those led by technical differentiation, believed that being first to market was most important and that it could carry a comparatively high price. Initial users would pay a premium for first generation product and help create excitement for its new features. The mass market would then be the source of most profits – indeed revenues from innovators and early adopters would hardly cover the cost of developing the product. Today, that strategy can be disastrous. Global markets no longer allow a company the time to introduce a product or service and then scale up. Imitators can bring a “me too” product to market so rapidly that those first to market have no time to establish a brand and brand loyalty. Hence the focus on target costing. One supplier I know uses target costing approaches to reduce the costs of supplies. Throughout the entire product development process they pose a challenge to their suppliers; to maintain the performance specifications of components and deliver prices consistent with the overall target costs. To develop system and component targets for its suppliers, they rely on data on historical performance and costs that it has recorded in function and cost tables.
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http://a4pe.com In the past, many companies believed that being first to market was most important because initial users would pay a premium for first generation product and help create excitement for its new features. The mass market would then be the source of most profits – indeed revenues from innovators and early adopters would hardly cover the cost of developing the product. Today, that strategy can be disastrous. Global markets no longer allow a company the time to introduce a product or service and then scale up. Imitators can bring a “me too” product to market so rapidly that those first to market have no time to establish a brand and brand loyalty. Hence the focus on target costing.
Transcript of Control Tomorrow's Purchasing Costs Through Today's Specification
ProcurementMattersA series on effective Procurement for Professionals
Part 3: How to control tomorrow’s costs through today’s design
In recent timesorganisation afterorganisation has learnedthat quality must bedesigned into products orservices.
Today, the most innovativeones are applying thesame logic to determinethe price of new products… so says Prof. RobinCooper, author of “WhenLean Companies Collide”an article published byHarvard Business Review.
Senior managersdetermine the ideal sellingprice of a product orservice (or in the case of apublic sector or not-for-profit organization, set thebudget they can afford)then establish thefeasibility of meeting thatprice and control costs toensure that the price ismet.
This is a process known asTarget Costing.
Why does this continue tobe a hot topic?
The answer lies in the waythat organisations havetraditionally made moneyover the lifecycle of aproduct and how that hasnow changed.
In the past, manycompanies, particularlythose led by technicaldifferentiation, believedthat being first to marketwas most important andthat it could carry acomparatively high price.
Initial users would pay apremium for firstgeneration product andhelp create excitement forits new features.
The mass market wouldthen be the source of mostprofits – indeed revenuesfrom innovators and earlyadopters would hardlycover the cost ofdeveloping the product.
Today, that strategy can bedisastrous.
Global markets no longerallow a company the timeto introduce a product orservice and then scale up.
Imitators can bring a “metoo” product to market sorapidly that those first tomarket have no time toestablish a brand andbrand loyalty.
Hence the focus on targetcosting.
One supplier I know usestarget costing approachesto reduce the costs ofsupplies.
Throughout the entireproduct developmentprocess they pose achallenge to theirsuppliers; to maintain theperformance specificationsof components and deliverprices consistent with theoverall target costs.
To develop system andcomponent targets for itssuppliers, they rely on dataon historical performanceand costs that it hasrecorded in function andcost tables.
Function tables, containinginformation about thephysical characteristics ofeach component helpdesigners to determine thebest performingcomponents.
Cost tables containinginformation about the costsof components helpdesigners identify low costcomponents. By overlayingone table with the other,engineers identify thetarget cost of the bestcomponent for a givenproject.
Target costing can also beused in service industrieswhere the focus is on thedelivery system.
In people intensive,customer responsiveservice delivery systems itis not only possible to addnew services, it can behard not to. Menus areeasy to extend, roomservices can easily beadded, consulting or lawfirms can always enter newareas of practice.
The challenge for thesefirms (and for the buyer ofthese services) is to havethe disciplines andsystems to ensure that
these extensions arecharged at a fair price –one that gives a fair profitfor the supplier but withoutover-recovering fixedoverheads.
Because a single servicedelivery system may beused to deliver a widerange of services,determining the profitabilityof individual servicesbecomes an exercise inthe arbitrary allocation andapportionment of costs.
In services, particularlythose in which waiting timeis crucial, it is the systemiceffects of individual newservices (for instance, theextent to which they makethe process more complex)that determines whethertheir revenues and value tothe customer offset theircosts.
Target costing can open upthe discussion with yoursupplier as to theappropriateness of the newservice to you and whetherthe cost of providing thatservice is fair to bothparties.
For target costing tosucceed, the targets youset with your suppliersmust be valid … they mustnot be seen as being
forced on them. The marketanalysis that sets the targetprice, the financial analysisthat generates the targetcosts and the dis-aggregation procedures thatallocate costs to activitiesmust all be trusted by bothparties.
Moreover, cost reductionobjectives must beachievable most of the time.Setting the bar too high canbe as damaging as havingno bar at all.
Many firms set a series of“tip toe” objectives … targetsthat may be reached bystanding on metaphorical tiptoes, a stretch that strainsthe supplier but does notdefeat them.
Also, requirements forproduct and servicefunctionality must be clearlyand publicly articulated sothat nobody tries to achievethe cost reduction targets bycompromising quality.
When target costing workswell quantifiable hurdles areestablished in a transparentprocess to which suppliersare committed. A supplierthat meets those goals is notguaranteed a victory … butit should earn the right tocompete for your business.
Then download my free booklet “57 Top Tips for Sourcing
Strategies” by going to ...
http://academyforprocurementexcellence.com/sourcing-tips/
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