Project Report

Target Costing in making of Tata Nano

Submitted toDr. K. Singh

ByAnirudh Kanodia (191071)

Manpreet Bedi (191096)Mehak Singla (191097)

Rohit Malik (191109)Sripat Bagla (191116)

Karishma Talwar (191118)FMG-19.Sec-B

F O R E S c h o o l o f M a n a g e m e n t Page


ACKNOWLEDGEMENT

I express heartfelt thanks to Dr. K. Singh, our respected faculty member who has been a constant guide in the conceptual clarity of the subject matter. This report could not have gained its present shape without his constant support and encouragement.

Lastly, I would like to extend my sincere thanks to all those who have directly or indirectly helped me in the completion of this project.



EXECUTIVE SUMMARY

The report is based on the implementation of Target Costing in the making of The Nano Car and explanation of its processes and implications.

The objective of this report is to study the implementation of Target Costing in the making of The Nano Car.

The report is prepared purely for case study basis. A detailed study within the several other

companies using Target Costing has been carried out. The study was conducted on the basis of

primary data available from the internet.

The main focus of the project was on the need of Target Costing in the production process and

how it helped Tata Group. A detailed study on the various Accounting processes used was

conducted with this focus. The various methods of Accounting Methods used have been

discussed.

During the course of study it was observed that the companies using Target Costing have

achieved a higher growth rate through.



Index

Chapter: 1 INTRODUCTION----------------------------------------- (5-10)

CHAPTER: 2 Target Costing--------------------------------------- (11-20)

CHAPTER: 3 Target Costing in Tata Nano--------------------- (20-27)

CHAPTER: 4 CONCLUSION AND FUTURE SCOPE------ (28-28)



CHAPTER 1: INTRODUCTION

1.1 Introduction

This report concerns the use Target Costing used in making of Tata Nano and its implications are discussed in this report.

1.2 Company Profile

The Tata group comprises over 90 operating companies in seven business sectors: communications and information technology, engineering, materials, services, energy, consumer products and chemicals. The group has operations in more than 80 countries across six continents, and its companies export products and services to 85 countries.

The total revenue of Tata companies, taken together, was $67.4 billion (around Rs319,534 crore) in 2009-10, with 57 per cent of this coming from business outside India. Tata companies employ around 395,000 people worldwide. The Tata name has been respected in India for 140 years for its adherence to strong values and business ethics.

Every Tata company or enterprise operates independently. Each of these companies has its own board of directors and shareholders, to whom it is answerable. There are 28 publicly listed Tata enterprises and they have a combined market capitalisation of about $95.13 billion (as on November 25, 2010), and a shareholder base of 3.4 million. The major Tata companies are Tata Steel, Tata Motors, Tata Consultancy Services (TCS), Tata Power, Tata Chemicals, Tata Global Beverages, Indian Hotels and Tata Communications.

Tata Steel became the sixth-largest steel maker in the world after it acquired Corus, later renamed Tata Steel Europe. Tata Motors is among the top five commercial vehicle manufacturers in the



world and has recently acquired Jaguar and Land Rover. TCS is a leading global software company, with delivery centres in the US, UK, Hungary, Brazil, Uruguay and China, besides India. Tata Global Beverages is the second-largest player in tea in the world. Tata Chemicals is the world’s second largest manufacturer of soda ash and Tata Communications is one of the world’s largest wholesale voice carriers.

In tandem with the increasing international footprint of Tata companies, the Tata brand is also gaining international recognition. Brand Finance, a UK-based consultancy firm, recently valued the Tata brand at $9.92 billion and ranked it 51st among the world's Top 100 brands. BusinessWeek magazine ranked Tata 13th among the '25 Most Innovative Companies' list and the Reputation Institute, USA, recently rated it 11th on its list of world's most reputable companies.

Founded by Jamsetji Tata in 1868, Tata’s early years were inspired by the spirit of nationalism. It pioneered several industries of national importance in India: steel, power, hospitality and airlines. In more recent times, its pioneering spirit has been showcased by companies such as TCS, India’s first software company, and Tata Motors, which made India’s first indigenously developed car, the Indica, in 1998 and recently unveiled the world’s lowest-cost car, the Tata Nano.

Tata companies have always believed in returning wealth to the society they serve. Two-thirds of the equity of Tata Sons, the Tata promoter company, is held by philanthropic trusts that have created national institutions for science and technology, medical research, social studies and the performing arts. The trusts also provide aid and assistance to non-government organisations working in the areas of education, healthcare and livelihoods. Tata companies also extend social welfare activities to communities around their industrial units. The combined development-related expenditure of the trusts and the companies amounts to around 4 per cent of the net profits of all the Tata companies taken together.

Going forward, Tata is focusing on new technologies and innovation to drive its business in India and internationally. The Nano car is one example, as is the Eka supercomputer (developed by another Tata company), which in 2008 was ranked the world’s fourth fastest. Anchored in India and wedded to traditional values and strong ethics, Tata companies are building multinational businesses that will achieve growth through excellence and innovation, while balancing the interests of shareholders, employees and civil society.

Tata Motor’s Profile

Tata Motors Limited is India's largest automobile company, with consolidated revenues of Rs. 92,519 crores (USD 20 billion) in 2009-10. It is the leader in commercial vehicles in each segment, and among the top three in passenger vehicles with winning products in the compact, midsize car and utility vehicle segments. The company is the world's fourth largest truck manufacturer, and the world's second largest bus manufacturer.

The company's 24,000 employees are guided by the vision to be "best in the manner in which we operate, best in the products we deliver, and best in our value system and ethics."



Established in 1945, Tata Motors' presence indeed cuts across the length and breadth of India. Over 5.9 million Tata vehicles ply on Indian roads, since the first rolled out in 1954. The company's manufacturing base in India is spread across Jamshedpur (Jharkhand), Pune (Maharashtra), Lucknow (Uttar Pradesh), Pantnagar (Uttarakhand) and Dharwad (Karnataka). Following a strategic alliance with Fiat in 2005, it has set up an industrial joint venture with Fiat Group Automobiles at Ranjangaon (Maharashtra) to produce both Fiat and Tata cars and Fiat powertrains. The company is establishing a new plant at Sanand (Gujarat). The company's dealership, sales, services and spare parts network comprises over 3500 touch points; Tata Motors also distributes and markets Fiat branded cars in India.

Tata Motors, the first company from India's engineering sector to be listed in the New York Stock Exchange (September 2004), has also emerged as an international automobile company. Through subsidiaries and associate companies, Tata Motors has operations in the UK, South Korea, Thailand and Spain. Among them is Jaguar Land Rover, a business comprising the two iconic British brands that was acquired in 2008. In 2004, it acquired the Daewoo Commercial Vehicles Company, South Korea's second largest truck maker. The rechristened Tata Daewoo Commercial Vehicles Company has launched several new products in the Korean market, while also exporting these products to several international markets. Today two-thirds of heavy commercial vehicle exports out of South Korea are from Tata Daewoo. In 2005, Tata Motors acquired a 21% stake in Hispano Carrocera, a reputed Spanish bus and coach manufacturer, and subsequently the remaining stake in 2009. Hispano's presence is being expanded in other markets. In 2006, Tata Motors formed a joint venture with the Brazil-based Marcopolo, a global leader in body-building for buses and coaches to manufacture fully-built buses and coaches for India and select international markets. In 2006, Tata Motors entered into joint venture with Thonburi Automotive Assembly Plant Company of Thailand to manufacture and market the company's pickup vehicles in Thailand. The new plant of Tata Motors (Thailand) has begun production of the Xenon pickup truck, with the Xenon having been launched in Thailand in 2008.

Tata Motors is also expanding its international footprint, established through exports since 1961. The company's commercial and passenger vehicles are already being marketed in several countries in Europe, Africa, the Middle East, South East Asia, South Asia and South America. It has franchisee/joint venture assembly operations in Kenya, Bangladesh, Ukraine, Russia, Senegal and South Africa.

The foundation of the company's growth over the last 50 years is a deep understanding of economic stimuli and customer needs, and the ability to translate them into customer-desired offerings through leading edge R&D. With over 3,000 engineers and scientists, the company's Engineering Research Centre, established in 1966, has enabled pioneering technologies and products. The company today has R&D centres in Pune, Jamshedpur, Lucknow, Dharwad in India, and in South Korea, Spain, and the UK. It was Tata Motors, which developed the first indigenously developed Light Commercial Vehicle, India's first Sports Utility Vehicle and, in 1998, the Tata Indica, India's first fully indigenous passenger car. Within two years of launch, Tata Indica became India's largest selling car in its segment. In 2005, Tata Motors created a new segment by launching the Tata Ace, India's first indigenously developed mini-truck.



In January 2008, Tata Motors unveiled its People's Car, the Tata Nano, which India and the world have been looking forward to. The Tata Nano has been subsequently launched, as planned, in India in March 2009. A development, which signifies a first for the global automobile industry, the Nano brings the comfort and safety of a car within the reach of thousands of families. The standard version has been priced at Rs.100,000 (excluding VAT and transportation cost).

Designed with a family in mind, it has a roomy passenger compartment with generous leg space and head room. It can comfortably seat four persons. Its mono-volume design will set a new benchmark among small cars. Its safety performance exceeds regulatory requirements in India. Its tailpipe emission performance too exceeds regulatory requirements. In terms of overall pollutants, it has a lower pollution level than two-wheelers being manufactured in India today. The lean design strategy has helped minimise weight, which helps maximise performance per unit of energy consumed and delivers high fuel efficiency. The high fuel efficiency also ensures that the car has low carbon dioxide emissions, thereby providing the twin benefits of an affordable transportation solution with a low carbon footprint.

In May 2009, Tata Motors introduced ushered in a new era in the Indian automobile industry, in keeping with its pioneering tradition, by unveiling its new range of world standard trucks called Prima. In their power, speed, carrying capacity, operating economy and trims, they will introduce new benchmarks in India and match the best in the world in performance at a lower life-cycle cost.

Tata Motors is equally focussed on environment-friendly technologies in emissions and alternative fuels. . It has developed electric and hybrid vehicles both for personal and public transportation. It has also been implementing several environment-friendly technologies in manufacturing processes, significantly enhancing resource conservation

Through its subsidiaries, the company is engaged in engineering and automotive solutions, construction equipment manufacturing, automotive vehicle components manufacturing and supply chain activities, machine tools and factory automation solutions, high-precision tooling and plastic and electronic components for automotive and computer applications, and automotive retailing and service operations.

Tata Motors is committed to improving the quality of life of communities by working on four thrust areas – employability, education, health and environment. The activities touch the lives of more than a million citizens. The company's support on education and employability is focused on youth and women. They range from schools to technical education institutes to actual facilitation of income generation. In health, our intervention is in both preventive and curative health care. The goal of environment protection is achieved through tree plantation, conserving water and creating new water bodies and, last but not the least, by introducing appropriate technologies in our vehicles and operations for constantly enhancing environment care.

With the foundation of its rich heritage, Tata Motors today is etching a refulgent future.

Areas of business



Tata Motors makes passenger cars, multi-utility vehicles and light, medium and heavy commercial vehicles.

Passenger cars: The company launched the compact Tata Indica in 1998, the sedan Indigo in 2002 and the station wagon Indigo Marina in 2004. Tata Motors also distributes Fiat’s cars in India.

Utility vehicles: The Tata Sumo was launched in 1994 and the Tata Safari in 1998. Commercial vehicles: The commercial vehicle range extends from the light two-tonne

truck to heavy dumpers and multi-axled vehicles in the above 40-tonne segment. Passenger buses: The company also manufactures and sells passenger buses, 12-seaters to

60-seaters, in the light, medium and heavy segments.

Joint ventures, subsidiaries, associates

Tata Motors has joint ventures with Marcopolo, the Brazil-based maker of bus and coach bodies, and with Fiat Auto (to build a commercial vehicle at Fiat's facilities in Córdoba, Argentina). Other associates include:

Tata Daewoo Commercial Vehicle Company, a 100-per cent subsidiary of Tata Motors in the business of heavy commercial vehicles

Tata Motors European Technical Centre is a UK-based, 100-per cent subsidiary engaged in design engineering and development of products.

Telco Construction Equipment Company makes construction equipment and allied services. Tata Motors has a 60 per cent holding; the rest is held by Hitachi Construction Machinery Company, Japan

Tata Technologies provides specialized engineering and design services, product lifecycle management and product-centric information technology services.

Tata Motors (Thailand) is a joint venture between Tata Motors (70 per cent) and Thonburi Automotive Assembly Plant Co (30 per cent) to manufacture and market the company’s pickup vehicles in Thailand.

Tata Cummins manufactures high horsepower engines used in the company’s range of commercial vehicles.

HV Transmissions and HV Axles are 100-per cent subsidiaries that make gearboxes and axles for heavy and medium commercial vehicles.

TAL Manufacturing Solutions is a 100-per cent subsidiary that provides factory automation solutions and designs and manufactures a wide range of machine tools.

Hispano Carrocera is a Spanish bus manufacturing company in which Tata Motors has a 21-per cent stake.

Concorde Motors is a 100 per cent subsidiary retailing Tata Motors’ range of passenger vehicles.

Tata Motors Finance is a 100 per cent subsidiary in the business of financing customers and channel partners of Tata Motors



1.3 Michael Porter’s Five Force Analysis on Tata Motors

Competitive rivalry

Buyer powerSupplier power

Threat of new entry

Threat of

substitution

Buyer power:Bulk consumers ( SEBs)Price differences between competitorsHigh Cost of switch overLow buyer power.

Supplier power:Uniqueness of productCost of switching supplier ( high )Threat of substitution:

Threat of new entry:Time and cost of entry (High initial investment)Economies of scale(Low margin)

Competitive Rivalry:No. of competitors(Bajaj, Maruti etc)Switching cost (high)



Figure 1.3 Five Force Analysis Diagram for Tata Motors

CHAPTER 2: What is Target Costing?



2.1 Target Costing

A manufacturing business is devoted to the production of tangible objects that are high in quality and competitive in cost, meet customers' expectations for performance, and are delivered in a timely manner. Finding and achieving the appropriate balance among these attributes—quality, cost, performance, and time to market—challenge all manufacturing businesses. Those companies that are successful in meeting that challenge remain in business; those that are not usually disappear.

In a manufacturing environment that is perhaps changing more rapidly now than during the Industrial Revolution, competing successfully will require manufacturers increasingly provide customers with shorter times between order and delivery and between product conceptualization and realization, greater product customization, and higher product quality and performance, while meeting more stringent environmental constraints. Accomplishing these goals will require major changes in current manufacturing practices; such changes include the use of new and/or more complex manufacturing processes, greater use of information to reduce waste and defects, and more flexible manufacturing styles.

An enormous amount of information is generated and used during the design, manufacture, and use of a product to satisfy customer needs and to meet environmental requirements. Thus it is reasonable to suppose that the use of information technology can enable substantial improvements in the operation, organization, and effectiveness of information-intensive manufacturing processes and activities, largely by facilitating their integration.

In today’s rapidly changing business environment, product innovation is one of the keys toa company’s survival and competitiveness. Manufacturers can no longer produce andmarket large volumes of standard products with a relatively stable market and technologicalclimate. There has been a shift toward unstable, rapidly changing markets andtechnologies. To implement market-driven management across the organisation,measurement and cost control systems must be designed to motivate the desiredconsumer-oriented behaviour. The strategies that determine the direction of productinnovation have become crucial to corporate management. Industrial marketers play amajor role in product innovation, and cost accounting must support this role. Costmanagement methods must help with the production of new products that meet customerdemands at the lowest cost, as well as with cost reduction of existing products byeliminating waste.

Japan’s Competitive Thinking Triggers Target Costing

One of the most influential changes in the practice of management to emerge is kaizen - thephilosophy of continuous improvement. Originally a Japanese idea, it is being adoptedaround the world as an integral part of management strategy.A variation of this concept is that of ‘kaizen costing’, in which the emphasis is on gradualongoing cost reduction. Deriving from the thought of continuously improving costing,Japanese organisations are moving to a more radical approach referred to as target costingin a move to maintain the competitive edge.



The Japanese believe that the key to achieving a competitive edge is simplicity. They arebeginning to realise there can be too much of a good thing, too much variety, too muchflexibility and even too much customer satisfaction. Organisations such as Nippondensowere cited as using target-costing principles to reduce its product range, increaseproductivity and profitability. Additional Japanese companies utilising target costing to seek a competitive edge include:

Isuzu Motors Toyota Motor Corporation NEC Sony Sharp Nissan

Target costing, although its concept is used throughout the product life cycle, is primarilyused and most effective in the product development and design stage. Born out of themarket-driven philosophy, target costing is based on the price-down, cost-down strategy,which has allowed companies to win considerable share of their respective markets.In companies where target costing is used, there seems to be a different culture andattitude. They place more emphasis on their relative position in the market and productleadership. Since more than 80% of product cost is already determined by the time productdesign and processing is complete, cost management must start (and done substantially) atthe design stage.

What is Target Costing?

There is no clear definition to target costing. Organisations that have implemented it havehad to apply their own unique approach to the concept. In essence, it is a philosophy inwhich product development is based on what the market will pay for it, not on what it hascost to produce. In other words, market price becomes the determinant of cost and not theother way around, as is the practice with most organisations.Target costing is a strategic management tool that seeks to reduce a product’s cost over itslifetime. Therefore, the target cost is not necessarily the cost to currently build the product.Target costing presumes interaction between cost accounting and the rest of the firm; wellexecuted,long-range profit planning; and a commitment to continuous cost reduction. Itsapplication in Japan has been well documented, but Western World firms also can use it tounderstand costs better and to enhance long-term profitability.

Breaking the Corporate Western World Mindset

Typically, Western World manufacturers have said: Here is my cost (Amount X). I have toreceive a certain profit contribution rate above that, so that consequently I must sell myproduct for this price (Amount Y or X/1-needed profit margin). Target costing reversesseveral decades of Western World pricing strategy by taking into account that ourcustomers do not care about our costs-only about their own. Our selling price is their cost,and there the customer’s concern ends.



Traditional CostingBefore target costing is addressed further, it is necessary to understand the current statefor the majority of Western World firms. The traditional costing approach has themanagement accountant contributing only as a cost accountant, working with historicalinformation and subsequent to many significant decisions, which have already been made.The management accountant may then provide information that in today’s competitiveenvironment triggers an after-the-fact response, often too late to contribute cost savingsvalue to the company.In the traditional model of costing, costs are the driver. As costs increase, prices areincreased to sustain profit margins. Tried, but determined to not be so true, traditionalcosting abides by the following steps:

Assess market needs Evaluate competing products Develop new products Decide whether to make or buy products or components Calculate how much to invest in new processes Set up new processes Manufacture new products Cost products Set price



The Process of Implementation - Target Costing into a New Product

The target costing approach brings the management accountant into the process at theearly planning stage. The management accountant is contributing to the early decisions—should the company be making this kind of product? What constraints need to be appliedin the design stage? Is the market demand consistent with our projections? Can we achievethe determined return in this competitive of a market?

Market Driven Selling Price - Desired Profit = Target Cost

In the target costing model and opposed to the traditional method of costing, costs are notthe driver rather they are driven. The market sets the price, management sets the profitmargin, and the difference becomes the allowable cost—cost defined and constrained byprice realities and profit goals. New and increasingly necessary, target costing abides to thefollowing logical flow and procedures:



Establishing a Selling Price for the Product

The target costing process begins by establishing a selling price, based on marketresearch, for the new product. From this target-selling price, the desired (target) profit issubtracted to determine the target cost. In all likelihood, this target is below the company’scurrent manufacturing cost. Teams from many departments then perform functional costanalysis in an attempt to reduce costs to a level in the acceptable range. If the current costestimate is at the target, the firm must decide whether or not to introduce the new product.If the current cost estimate is above the target, functional cost analysis is used to makechanges and prepare another cost estimate.

Establishing a Target Profit for the Product

Marketing plays a crucial role in the determination of the target cost. The starting point for atarget cost is the estimated selling price for the product determined by market analysis.Sales volume is also estimated and, from the total estimated sales revenue, the desiredprofit is subtracted. Management determines this desired profit margin in reference to thecompany’s long-term strategy. Retail prices and sales volumes are proposed by themarketing function based on its research and the company’s desired market share. Totalsales revenue for each new product over its life can now be estimated. The target profit,usually determined by using return on sales, is subtracted from the total sales revenue. Thetarget cost is now determined.

Determine the Target Cost

The target profit is subtracted from the target price to arrive at the target cost. Managementaccounting can play an important role in effectively determining target profits and targetcosts. Accountants can supply the information required to support marketing analysis for anew product and relate it to existing products. After the target cost is determined bysubtracting the target profit from the target price, functional cost analysis is used to achievethe target cost. Functional cost analysis is a group activity typically involving employeesfrom different departments (such as marketing, design, engineering, production,purchasing, and accounting) and is aimed at proposing alternatives for reducing overallproduct cost.This team-oriented approach requires that the employees of different departments bringtogether their knowledge and experience in the organisation to contribute to the costreduction process. Working with product designers, their motivation is not only to cut thenumber of parts but also to work toward the use of standard parts in designs that giveproducts desired functions at a lower cost.

Perform Functional Cost Analysis and/or Value Engineering

Functional cost analysis requires the preparation of a logical diagram for each function ofthe product. It should be noted that this is not a diagram of each part of the product since itis the functions of a product that determine its success in the market. Each function andsub-function of the product is defined to show the various operations of the product.Functional analysis is closely linked to value engineering. Functional analysis is a cost



management system that focuses on the various functions of each product. The individualfunctions of a product become the set of cost objectives and provide the basis for thecosting system. Value Engineering (VE) involves designing a product from different anglesat a lower cost by reviewing the functions needed by customers. VE is used for purchasing,planning, design, production, and other processes on a company-wide basis. There are avariety of methods for conducting value engineering. The process generally starts withperformance checks on test parts. Designs are changed to give each part a specific degreeof performance. Then discussion turns to ways to cut costs while maintaining performance.The aim is to use the information provided by the functional analysis to propose alternativesfor improving costs.

Determine the Cost Estimate

Functional analysis requires information concerning engineering specifications andaccounting data. The actual manufacturing and the target cost for each product’s functionsare compared. Alternatives are identified to bring each function’s actual cost estimate to itstarget cost.Management accountants provide information on the cost effects of the proposedfunctional modifications. When needed, they prepare very detailed sets of cost tables thatinclude the costs of alternative materials, of using different types of manufacturingtechnologies, and so on.

Decision: is the Cost Estimate on Target ?

After the team consisting of members from the various functions of the company have usedvalue engineering (as discussed in the following section) and functional cost analysis todetermine the new product’s estimated cost, the estimate is compared with the target cost.If the cost estimate exceeds the target cost, functional cost analysis is used again toreduce the estimated cost to the target cost.It must be understood that this is not always a ‘yes/no’ decision model. Although functionalanalysis is performed to determine if the product can be produced for less than the targetcost, often product introductions are accepted when the initial review has the actual costexceeding the target. This subjective approach is taken when it can be determined that,over the life of the product, the firm will be able to produce it for less than currentlypossible, and less than the target cost.

Make the Final Decision

Once the cost estimates are on target, management makes the final decision to introducethe product based on manufacturing feasibility, market needs and consumer acceptability.If the decision is to go ahead with the product, manufacturing is instructed to proceed withproduction.Once the decision has been made to manufacture the new product, there are otherconsiderations necessary for successful implementation of the process. Since the targetcost is often below the actual cost based on the current production technology, a teameffort is required to enable the organisation to achieve the target cost. Teams of peoplefrom marketing, engineering, purchasing, manufacturing, and accounting work together to



assure that a cost position on the product is such that the company can sell the product atits required market price to insure the desired target return on the product.Finally, target costing does not end once the decision has been made to move the productinto the production stage. The standard manufacturing cost of the product depends onspecific production line conditions. For example, production on lines below capacitypushes costs up, while production on lines near full capacity leads to the best-costperformance. Often during the planning stage, it is difficult to visualise the line conditionsand thus reflect accurately these conditions in cost estimates. Therefore, once the initialtarget cost has been calculated, the manufacturing division then initiates an effort toimprove on the standard cost, in order to get it down to the target cost.

Achieving the Best Target Cost Possible

Potential world-class manufacturers have the resources available to lead the way in workingtowards the lowest target cost. Target costs can only be achieved and eventually improvedupon when more people are involved in the design improvement process and work tofurther refine the responsible design engineer’s best effort. To achieve the best target costspossible, these practical guidelines should be followed:Do not spend man-years developing the ultimate product costs. Rather, allocate time tosimply estimating or prorating these costs;Ensure that each component and assembly design is reviewed by a cross functional groupof managers. The intent of this review is not to design by committee but to generate newideas on how the design engineer can achieve the target cost;Provide the appropriate checks and balances within your product design department. Donot have the original engineer try to improve upon his product, assign a design engineerother than the original designer to improve the design;Assign responsibility for pursuing cost opportunities to the specific group membersaccording to their own areas of expertise.

Which Type of Company Would Benefit From Target Costing?

Whenever a new and innovative approach to doing business is discovered, the questionarises as to which clients and potential clients might this methodology provide anappropriate fit. In addition, and consistent with many new financial or operationalapproaches, target costing may not be for everyone. Some companies, which seem tobenefit most from target costing, are those, which maintain the following criteria:Assembly-oriented industries, as opposed to repetitive-process industries that producehomogeneous products;Involved heavily with the diversification of the product lines;Use technologies of factory automation, including computer-aided design, flexiblemanufacturing systems, office automation, and computer-aided manufacturing;Have experienced shorter product life cycles where the pay-back for factory automationtypically must be achieved in less than eight years;Must develop systems for reducing costs during the planning, design and developmentstages of a product’s life cycle;Are implementing management methods such as just-in-time, value engineering, and totalquality control



Additional Factors Which Promote the Usefulness of Target Costing

The above listing is not completely exhaustive as a variety of factors are at work to promotethe usefulness of target costing in other companies. First, products are experiencingshortening life cycles, so the design phase of a product is critical to managing costs.Manufacturing costs are driven primarily by the characteristics of the products and theprocess used to manufacture them. Manufacturing processes are determined by the nature

of the product and the expected volume to be produced. Therefore, to a great extent, costsare determined in the design stage.Another factor which encourages the use of target costing is product diversity. The types ofproducts manufactured by companies have increased rapidly in recent years. Targetcosting, in both the design and production stages, helps manage costs effectively.However, applying target costing in the design stage has the greatest cost reductionpotential and bottom-line impact.

What are the obstacles in target costing? It takes time and money to bring sweeping changes into an organization. There's also the problem of changing workers' behavior. Why rock the boat if things are going well? The answer, target costing proponents say, is simple: In the long run your company will be better positioned to compete in the marketplace with target costing than without target costing."Most American companies are working in silos," says Keith Hallin, senior manager of finance in the Boeing Commercial Airplane Group in Seattle, who has introduced pilot programs in target costing at his company. "For instance, engineers focus on the specifications of the product. Target costing requires them to think beyond those traditional tasks and factor in the cost of the engineering, to perform cross-functionally."

Advantages of Target Costing

If you are successful in implementing and maintaining an effective target costing system, you may be able to:

1. Determine an expected cost of manufacturing a product or providing a service. 2. Achieve greater cost efficiencies. 3. Spend money where it will have the greatest impact. 4. Identify customers' real needs. 5. Match your firm's activities to your customers' requirements. 6. Increase customer satisfaction. 7. Give co-workers a better understanding of cost objectives. 8. Allow co-workers to participate in setting quality, cost and time targets. 9. Transform your image of "policeman" into that of a valued partner working on everyone's

behalf. 10. Become more competitive globally.

OBSTACLES



American companies tend to build something and discover after it's produced that the price they need to charge to make a profit is too expensive for their customers. Then they try to find piecemeal solutions for reducing the cost. The target costing process requires that the desired cost to manufacture a product be spelled out ahead of time.Since target costing is customer-driven, it can improve customer satisfaction. It also allows more people in the company to understand the company's objectives and how they are going to be achieved, because it encourages people with different functions to work on the same team to meet the collective target costing goals. Target costing, ideally, arrives at a price that works for the company as well as the customer. That makes it a more effective way to do business, and companies that have used target costing have indeed found that they reach their profit goals more effectively.Controllers who introduce target costing successfully into their organization may change how co-workers perceive financial types, from a policeman or someone with a big stick to a valued partner working on everyone's behalf. Workers can understand that the reasons behind your cost objectives are directly related to gaining a competitive advantage, not merely a dictum from senior management.



CHAPTER3: Target Costing in Tata Nano

3.1 Target Costing in Tata Nano

In January 2008, Tata Motors India made breaking news when they presented the model of Nano as the world's cheapest car at INR 100,000 only ($ 2500 at that time).

A competitive product must address factors such as cost, performance, aesthetics, schedule or time-to-market, and quality. The importance of these factors will vary from product to product and market to market. And, over time, customers or users of a product will demand more and more, e.g., more performance at less cost.

Cost will become a more important factor in the acquisition of a product in two situations. First, as the technology or aesthetics of a product matures or stabilizes and the competitive playing field levels, competition are increasingly based on cost or price. Second, a customer's internal economics or financial resource limitations may shift the acquisition decision toward affordability as a more dominant factor. In either case, a successful product supplier must focus more attention on managing product cost.

The management of product cost begins with the conception of a new product. A large percentage of the product's ultimate acquisition or life cycle costs, typically seventy to eighty percent, are determined by decisions made from conception through product development cycle. Once the design of the product has been established, relatively little latitude exists to reduce the cost of a product. Decisions made after the product moves into production account for another ten to fifteen percent of the product's costs. Similarly, decisions made about general and administrative, sales and marketing, and product distribution activities and policies account for another ten to fifteen percent of the product's cost.

When a Tata Motors faces a profitability problem and undertakes a cost reduction program, it typically reduced research and development expenditures and focus on post-development activities such as production, sales, and general and administrative expenditures. While not suggesting that these are inappropriate steps to take, the problem is that it is too late and too little. Most of the cost structure in a Tata Motors has been locked into place with the design decisions made about the Tata Motors's products. A cost reduction or profitability program has to start with the design of the Tata Motors's products at the very beginning of the development cycle.

DEFINITION OF TERMS

The following definition of terms will provide a common basis for discussion: Recurring production cost = production labor + direct materials + process costs +

overhead + outside processing

Non-recurring costs = development costs + tooling

Product costs = Recurring production costs + allocated non-recurring costs



Product price or acquisition costs = Product costs + selling, general & administrative + warranty costs + profit

Life cycle costs = Acquisition costs + other related capital costs + training costs + operating costs + support costs + disposal costs

DESIGN TO COST

Effective product cost management requires a design to cost philosophy as its basis since a substantial portion of the product's cost is dictated by decisions regarding its design. Design to cost is a management strategy and supporting methodologies to achieve an affordable product by treating target cost as an independent design parameter that needs to be achieved during the development of a product. A design to cost approach consists of the following elements:

An understanding of customer affordability or competitive pricing requirements by the key participants in the development process;

Establishment and allocation of target costs down to a level of the hardware where costs can be effectively managed;

Commitment by development personnel to development budgets and target costs; Stability and management of requirements to balance requirements with affordability and

to avoid creeping elegance; An understanding of the product's cost drivers and consideration of cost drivers in

establishing product specifications and in focusing attention on cost reduction; Product cost models and life cycle cost models to project costs early in the development

cycle to support decision-making; Active consideration of costs during development as an important design parameter

appropriately weighted with other decision parameters; Creative exploration of concept and design alternatives as a basis for developing lower

cost design approaches; Access to cost data to support this process and empower development team members; Use of value analysis / function analysis and its derivatives (e.g., function analysis system

technique) to understand essential product functions and to identify functions with a high cost to function ratio for further cost reduction;

Application of design for manufacturability principles as a key cost reduction tactic; Meaningful cost accounting systems using cost techniques such as activity-based costing

(ABC) to provide improved cost data; Consistency of accounting methods between cost systems and product cost models as well

as periodic validation of product cost models; and Continuous improvement through value engineering to improve product value over the

longer term.



TARGET COSTING AS A FOUNDATION

Executive management, marketing, program/product managers, and development team personnel all need to have an understanding of customer affordability constraints or competitive market place requirements. Everyday customers buy products with functions, features and performance in excess of their needs and wonder how much is money is wasted on these unneeded capabilities. A keener awareness of design to cost requirements is needed. This happens when product development team members and executive management have direct contact with customers to understand their true needs and hear their sensitivity to costs directly, or when they are exposed to competitor's product pricing in the market place.

Based on this awareness of customer affordability or design to cost requirements, cost targets should be formally established. These targets should be developed based on pricing formulas and strategies and consideration of price elasticity. Prices and target costs will also have to consider projected production volumes and amortization of non-recurring development costs. In a more complex product or system, the top-level target cost will need to be allocated to lower level subsystems or modules. This will establish a measurable objective for a product development team where multiple teams are involved in a development project.



In an environment where development cost is significant relative to total recurring production costs, more attention will need to be paid to managing these non-recurring development costs. Non-recurring development cost will be a function of the extent of new product and process technology and the extent of use of new materials, parts and subsystems. If product is an evolutionary step with minimal development risk, non-recurring development costs will be lower. The use of standard parts and modules from other existing products will also lower non-recurring development costs. This suggests a strategy of not letting product and process technology application get too far ahead of customer affordability requirements.

Product development team members should buy-in to or commit to these product cost targets and development budgets to improve the chances of meeting these objectives. When empowered product development teams actually develop these budgets and targets, a sense of commitment to these budgets or targets develops. If the budgets or targets are established by someone outside the product development team (e.g., by a product or program manager, a management team, a system integration team, or a project engineer), the targets and budgets should be carefully reviewed with the team members to insure they understand these cost objectives and the assumptions behind them. While competition will generally dictate that stretch goals be established, these goals should be accepted by the team as achievable.

COST MODELS AND COST DATA

Once a team has a set of requirements and a cost target established, they will begin exploring alternatives as part of the design process. In the absence of other information, they will tend to evaluate a product concept primarily based on its performance merits and, at best, secondarily consider a subjective estimate of the relative costs of the design alternatives. Ad-hoc cost studies or trade studies may be prepared for significant issues, but tools to regularly support this process are lacking. Tools and information need to be provided to a product development team so that they can more proactively and objectively consider the cost implications of various design approaches on a regular basis. A product cost model or life cycle cost model provides an objective basis for evaluating design alternatives from a very early stage in the development cycle.

As the organization proceeds through the design of both product and process, the product cost model is used to project and accumulate product costs to use as a factor in evaluating design alternatives and to refine the design to meet cost targets. If it is determined after extensive evaluation that the product requirements cannot be achieved at the target cost, the requirements and targets will need to be re-evaluated and modified.

Early in the development cycle, the product cost model will be based primarily on characteristics of the product design with relatively little consideration of the actual manufacturing process. The model will be driven by general design parameters, product/part characteristics, and critical parameter tolerances. The model will be implicitly based on assumptions about existing processes and process relationships to types of materials, sizes and tolerance requirements.

Later in the development cycle, a different type of product cost model will be used that will consider the specific manufacturing processes. This type of model will be built around existing processes where relatively good historical cost data should exist. On occasion, new



manufacturing processes will need to be considered. Data will need to be gathered as a basis for creating or extending the product cost model for the new process(es). Information to support this model development can be obtained from equipment suppliers, other users of this manufacturing process, facility engineers, and manufacturing engineers.

Cost data will also need to be obtained for many purchased parts and sub-assemblies. This information may be available in the form of catalog prices or supplier quotations. However, to support cost projections much earlier in the development cycle, a close working relationship with the Tata Motors's supplier base will allow preliminary cost projections to be obtained without the formalized commitment of a quotation. The supplier relationship and Tata Motors information needs may even develop to the point that the Tata Motors works with the supplier to develop a supplier cost model based on the supplier's process capabilities.

A Tata Motors's initial attempt with a product cost model may utilize a spreadsheet program or a bill of material cost roll-up capability. The focus is on accumulating and tracking estimated material, part and assembly costs. This summarization capability may start with cost estimates and update the estimates with quoted prices or catalog prices for purchased items or manufacturing's estimates based on preliminary drawings for fabricated items and assemblies.

Over time, a more sophisticated product cost model should be developed that will project costs based on the characteristics of parts and the overall product design. This type of cost model might be based on commercially available design for manufacturability (DFM) or design for assembly (DFA) software packages. These systems typically generate an estimate of fabrication or assembly labor time and costs or machine cycle time. and costs as part of their capabilities. In addition, there are commercially available cost models that allow a Tata Motors to develop a custom model of their manufacturing processes and project even more exacting cost estimates based on their product or part characteristics. These individual packages or modules will be oriented toward a limited part or product domain, e.g., manual or automated assembly, printed circuit boards, sheet metal, injection molding, casting, etc. Multiple modules will typically be needed to support overall product cost modeling. In addition, a database reporting capability or spreadsheet will be needed to accumulate the many individual elements of cost from these various cost modeling system components so that effective overall trade-off's can be made.

Over the course of the development cycle, several different costing tools may be used by an organization. In the early stages of product development, an estimating system may be used to respond to a customer request for quotation or request for proposal or to develop an internal estimate to prepare a cost justification for the development project to management. This cost model would be based on parametric or analogy techniques. Parametric techniques would take general characteristics about the product such as size, weight, number of functions, etc., and use these parameters to develop a general cost estimate. Analogy techniques would take a similar product's cost and use a "same as except for" approach to develop a cost estimate based on the cost of an existing item.

As the development cycle moves into the product design phase, cost models and DFM/DFA tools as just described would be used. These estimates would be more refined since more is known about the design of the product and its cost drivers. Once the product design is essentially complete, tools and methods such as computer-aided and manual process planning and tools to



support the development of labor standards would be used to develop even more refined cost estimates. Finally, as the product moves into production, cost accounting systems would collect costs by product, assembly, part, and operation. These costing tools are illustrated below.

These costing tools should have a consistent basis for accounting for costs and a consistent set of rates. In addition, the organization should establish procedures to periodically validate the cost models by comparing the projected costs with actual costs and adjusting parameters in the model to yield projections closer to actual experience.

In some cases, life cycle costs may need to be considered as the basis for making design decisions. This will add to the complexity of a cost model. Data will need to be gathered on operating costs (e.g., facilities, training, manpower, fuel or energy consumption, etc.), maintenance costs, and disposal costs. While these costs can be modeled, historical data related to operations, reliability and maintenance often is needed. This means that a customer will need to provide this data or that the Tata Motors have close working relationships with customers where this data is routinely gathered.

To support the operation of these cost models, cost data will need to be readily accessed. Some companies try to restrict access to cost data to prevent this information leaking out to competitors. This restricted access undermines a design to cost methodology and empowerment of the product development teams. This data needs to be made available to support cost modeling. Typical data required will be labor rates, overhead rates, learning curves, efficiencies, historical and projected parts costs, and escalation projections for labor and materials.

Traditional approaches to allocating overhead or burden costs generally based on direct labor. However, direct labor is becoming an insignificant cost component in many products. Further, there is frequently a lack of understanding of sunk costs and fixed versus variable indirect costs. All of this has led to distortion of overhead cost allocations and inappropriate design and sourcing decisions. As companies move toward activity-based costing, the quality of the cost data will improve. Costs will be more closely based on the consumption of resources and the aberrations associated with allocating indirect costs will diminish.

DECISION-MAKING

In the absence of product cost models and product development teams, each functional organization will make decisions from their own perspective, trying to manage the elements of cost that they are responsible for. For example, decisions to minimize non-recurring design engineering expenditures may result in a less producible product, driving up material and labor costs in manufacturing. Decisions to minimize tooling capital expenditures may also have the



same effect in manufacturing costs. Test engineering may try to minimize its non-recurring development budgets and capital expenditures resulting in a less automated test process and higher recurring test costs for production verification.

Product development teams provide the organizational mechanism to bring the various disciplines together to optimize product costs from an enterprise perspective. Cost models provide the means for the team to objectively consider the implications of various development decisions. A Tata Motors operating philosophy that emphasizes cost as a factor in the development decision-making process is a final requirement.

Access to product cost projections early in the development cycle will improve decision-making about design alternatives and lead to refinement of the design to come closer to the established cost targets. These costs projections will aid decisions about the design of the manufacturing process as well, focusing attention of elements of the product costs that do not meet the target and allowing consideration of alternative processes while it is still early enough in the development cycle to introduce new processes. The key is to emphasize management of product costs during development, not merely accumulating costs as designs are completed.

SUMMARY

Since the decisions made during the product development cycle account for seventy to eighty percent of product costs, product cost management must begin with the start of product development. Product development personnel must understand competitive pricing or customer affordability requirements. Target costs must be established at the start and used to guide decision-making. Development personnel must operate as entrepreneurs in making hard decisions about the product and process design to achieve target costs. Cost models must be provided to support decision-making early in the development cycle. And the quality of information and the cost models must be continually improved and refined. This increased focus on product or life cycle costs will lead to significantly reduced costs and more satisfied customers.

3.2 Cost Price Structure

We gather from press reports that Tata Motors have been driving hard bargains with the state governments to try and obtain as much subsidies as possible for the small car project. The subsidies they had obtained from West Bengal Government, as enumerated by the Economic Times of 25th September 2008, in an article "El Nano: A Perfect Storm" by Arvind Panagariya, are as follows -

a) land lease at throw-away prices (Rs 1,260/- only per acre per month)b) a soft loan of Rs 2 billion for 20 years at interest rate of 1% per annumc) concessional tariff of electricity at Rs 3 per kwhd) VAT waiver for some Rs 10 billion or soe) subsidised rates of water, stamp duties and other infrastructural facilities at nil or very low costs.



A recent press report says that it has been claimed that the amount of subsidy works out to Rs 60,000 per car, which is as high as 60% of its retail selling price.



CHAPTER 6: CONCLUSION AND FUTURE SCOPE

In the end, we have to say that Tata Nano is an exemplary example of target costing and Tata motors should keep the following points in mind for the future:

Intensity of competition

The intensity of competition apparently influences how much attention the firm ispaying to competitive offerings in the target costing process. All of the firms studied couldidentify four to six direct competitors who were fairly evenly technologically matched. Thesefirms had adopted a confrontational strategy because they lacked the ability to developsustainable competitive advantages over each other.Three product-related characteristics, referred to as the survival triplet, play a criticalrole in determining the success of firms. The survival triplet comprises the product price,quality and functionality. Quality is defined as conformance with product specification.Functionality, which includes service, refers to the degree of success in designing the productto meet the specifications that customers require.

Nature of customer

There are many characteristics of customers that can influence the intensity ofconsumer analysis that is undertaken by firms, but evidence suggests that three areparticularly important in helping determine the benefits derived from target costing. The first8is the degree of customer sophistication, the second is the rate at which future customerrequirements are changing, and the final characteristic is the degree to which customersunderstand their future product requirements. These three characteristics appear to helpdetermine the benefits that a firm can potentially derive from target costing because they dealwith the width, rate of change of location, and ease of predicting the location of survivalzones. Analysis of the practices observed in the six companies suggests that target costing isparticularly valuable for firms that have to compete in environments that have narrowsurvival zones, whose locations are changing rapidly, but are relatively predictable.

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