Stories From the Field # 1 - February, 2004
Using Target Costing to Increase Value
by Brian H. Maskell, President BMA Inc.
Recently, I was working with a client helping them with Target Costing for a standard product they have just started selling to a new OEM customer.
The company, Major-Cable, has beaten their competitors owing to ease of use of their patented cable products. The OEM uses these cables on the industrial machines they manufacture. Major-Cable is excited about this opportunity because it is their first sale to this OEM which is a very large user of specialized shielded cables.
In order to capture this business marketing had authorized a very low price. The Target Costing project was designed to improve the profitability of these cables to this customer and other OEM customers.
- Identifying the customer; and the people within the customer that affect the value created for the customer.
- Reviewing the customer’s stated needs in detail. In preparation for the Target Costing event, the marketing team had conducted several interviews with the customers. The interviews included purchasing, engineering, materials handling, production, and sales personnel.
- Linking the customer’s needs to the features of the company’s products and service to understand how Major-Cable fills the customer’s needs.
- Understanding the amount of value created by each of the customer’s needs and converting them into hard dollars.
We began the next Target Costing step where we nail down the customer’s needs by specifying them exactly. One need from this customer was to have cable with a minimum of 20 meters length. This has been a problem for the client because delivery is made from their centralized distribution center which cuts the cable to the customers required length and they can not always guarantee to have the right quantity of 20 meter lengths. The plant provides the distribution center with much longer lengths, but the specific 20 meter length is difficult to maintain.
The initial solution to this problem was for the production plant to create a new product number for 20 meter lengths and manufacturing these specially for the OEM customer. The team then asked the question; “Why does the customer need 20 meter minimum lengths?” It turned out that the machines the customer manufactures require several pieces of cable and the total amount of cable for any machine never exceeds 20 meters. They wanted the 20 meter lengths so they can issue those to the manufacturing location that then cut them into the lengths they require for the specific machine they are currently manufacturing.
Our client’s plant has “off-cuts” of cable that are too short to send to the distribution center. These off-cuts are stored as finished goods in case there is occasional demand for a short length; but these off-cuts are mostly scrapped at year-end.
The customer’s need for short lengths interested the production manager. He suggested that instead of supplying the product from the distribution center, they deliver directly to the customer. Instead of delivering 20 meter lengths, they can deliver the cable cut to the precise lengths required by the customer that day. Instead of supplying the product on large round spools, they can place the cut pieces into production kits in cardboard tubes or boxes to suit the customer's needs.
After this was discussed and agreed with the customer, the result was:
- The customer is delighted to have just-in-time deliveries of cable kits. This reduces their manufacturing costs.
- The customer is paying a higher price because they are receiving kits instead of spooled cable.
- Many of the cable lengths can be provided from the off-cuts that previously were mostly scrapped. The cost of these pieces is effectively zero.
- The cardboard boxes or tubes are much less expensive than the previously used spools and the overall cost of the packed product is less.
The sales people were also delighted. They did not know the production plant could supply cut pieces. They thought the production plant would only make long lengths (economic order quantities) on large spools.
The Power of Target Costing
This is an example of how Target Costing creates more value. Many people think of Target Costing as a method for cost cutting. We always focus on increasing value as well as reducing cost. Without Target Costing this company would not have had the opportunity to bring together the cross-functional team needed to understand the customer’s needs and find manufacturing, logistics, and marketing methods to create more value for the customer.
Everybody has “won”. The customer has reduced their costs, their inventory, and their production lead time. The production plant has reduced it’s material costs and scrap. The company's revenues (and sales commissions) have increased owing to the higher price of the cut piece kits. This shows the power of Target Costing in practical action.
Click here to view a diagram we use to guide this process.
NOTE: For competitive reasons, the customer does not want to be identified. I have changed some of the facts of this story to ensure anonymity. The substance of the story and the issues addressed remain accurate