business

Profitability objectives definition

INTRODUCTION A competitive product must address factors such as cost, performance, aesthetics, schedule or time-to-market, and quality. The importance of profitability objectives definition 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.

Cost will become a more important factor in the purchase or 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 is 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. The management of product cost begins with the conception of a new product. Typically sixty to seventy percent of a product’s cost or life cycle costs are committed based on decisions made during concept or architecture development. Eighty-five to ninety percent of a product’s cost or life cycle cost is committed by the time that the product has been designed and its manufacturing process has been developed. When a company faces a profitability problem and undertakes a cost reduction program, it will typically reduce 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. In other companies, cost is a more important factor, but this emphasis is not acted upon until late in the development cycle. Projected costs of production are estimated based on drawings and accumulated from quotes and manufacturing estimates. If these projected costs are too high relative to competitive conditions or customers requirements, design changes are made to varying degrees to reduce costs. This may occur before or after the product has been released to production. In some organizations, development costs receive relatively little attention as well.

There may not be a rigorous planning and budgeting process for development projects. Budgets are established without buy-in from development personnel resulting in budget overruns. 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. Continuous improvement through value engineering to improve product value over the longer term.

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. 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 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.

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. 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. 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 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. 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 company’s supplier base will allow preliminary cost projections to be obtained without the formalized commitment of a quotation. A company’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.

These systems typically generate an estimate of fabrication or assembly labor time and costs or machine cycle time. 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.