HOW NOT TO ACHIEVE LOW COST

First, let’s look at cost reduction as Dysfunctional Engineering Incorporated:

So let’s look at what is wrong with this very common picture. The first shortcoming of this approach is leaving cost reduction until after the product is designed and already in production. In their haste to rush early production units to market, many companies defer cost concerns until later with “cost reduction” efforts. The first problem with this strategy is that it probably will not happen because of competing priorities, and thus, costs remain high for the life of the product. The second problem is that cost reduction simply cannot be very effective at all!

Cost-Cutting Doesn’t Work

Mercer Management Consulting analyzed 800 companies from 1987 to 1992. They identified 120 of these companies as “cost cutters.” Of those cost-cutting companies, “68% did not go on to achieve profitable revenue during the next five years.”1

There are also intangible impacts of an excessive focus on cost reduction: it absorbs effort and talent that could be applied to more productive activities, like developing better new products and improving operations. One division of a large international company did not have time for the author’s training on low-cost product development because they were too busy with 31 cost reduction efforts!

Why Cost Is Hard to Remove After Design

Cost is very difficult to remove after the product is designed. As shown in the illustration showing when cost is committed in the DFM article, 80% of the cost is designed into the product and is very difficult to remove later. Attempting cost reduction by changing the design encounters the following very common obstacles:

• There is always the common possibility that one change may force other changes.

• Trying to significantly lower cost after production release is usually futile because of many early “cast-in-concrete” decisions, which limit opportunities.

• Finally, the total cost of doing the change may not be paid back by the cost savings within the expected life of the product. Few companies really keep track of the total costs of changing designs.

Cost Reduction Problems of Focusing Only on Parts and Labor

All “cost” initiates should be suspect unless they are based on total cost. Only measuring parts and labor puts the whole cost focus there instead of the total cost which includes many more costs normally lumped together in “overhead.” And contrary to popular myth, overhead is not fixed. If companies implement, and design products for, lean production, floor space needs – normally a “fixed” cost – can be drastically reduced.

Counterproductive effects. Focusing only on parts labor can lead to seriously counterproductive effects. Truly low-cost products do not come from cheap parts, which are often chosen because they appear to lower the reported material costs. And to make matters worse, the internet now offers on-line part “auctions” that effectively steer manufacturers to the lowest bidder. However, cheap parts will usually explode other costs: for quality, service, operations, and other overhead costs.
Low-cost products do not result from “saving” cost by cutting product development and continuous improvement efforts. This may not be a stated policy per se but product development budgets can be impacted by corporate directives like, “all departments will reduce their budgets by 15%.”

Low Labor Rate May Not Lower Labor Cost. Moving production to “low labor rate” countries is another cost reduction fallacy (see Outsourcing article). Lower labor efficiency alone might cancel out anticipated labor rate savings, for instance if labor cost is one third but labor productivity is also one third. And cheap labor rarely stays that way.

Many Designs Are Needlessly Labor-Intensive. Many decisions to move to production to low-labor-rate are based on labor-intensive designs. However, DFM can reduce labor content to the point where moving to low-labor-rate areas can no longer be justified.

Distance Compromises Concurrent Engineering. Greater distance between headquarters and engineers compromises control and concurrent engineering. The effect of separating engineering from manufacturing is discussed in the section, Outsourcing and Product Development, in this site’s article on Outsourcing.

Cheap Parts and Cheap Labor Compromises Quality. Quality may suffer if the cheapest labor plant has not established an effective quality culture. Quality may also suffer if recurring defects are produced overseas and not detected until hundreds of defective products are discovered at the end of the long transoceanic “pipeline.” Overseas production also slows delivery, thus making it hard to implement lean production, build-to-order, and mass customization.

Cutting Corners is No Way to Cut Cost

Similarly, “cutting corners” in any manner will probably end up costing much more later, for instance for quality costs. Omitting features and cheapening the products is an unwise strategy to reduce cost. Sure, the stripped-down product may cost less, but it could ruin a company’s reputation, especially if the brand has a reputation for quality and full-featured products. One highly-respected company decided to offer a stripped-down big-dollar product through Home Depot, but when a magazine compared a single product of eight competitors, it rated this product second to last because of “outmoded features,” which conveyed a poor image for the brand, although, ironically, that brand offers many better products.

Target Costing

There are two ways to determine the selling price. The usual way is to add the desired profit to the cost which gives the selling price. The other way is to first determine the ideal selling price and subtract the desired profit which they yields the "target cost." This appears to be a logical way to sell products at the right price. However, consider the consequences if the engineers do not know how to design low-cost products, or worse, try to take cost out of products after they are designed (see above reasons why this doesn't work).

In the first scenario, a higher cost will result in a higher price, so the product may not sell as well as it should - not good, but not a disaster.

In the Target Costing scenario, if engineers have a fixed cost target but they don't know how to achieve it, then they will cut corners, look for cheaper parts and low-bid vendors, or move production offshore to low-labor-rate locations, none of which will really lower the total cost. And these can severely compromise quality, delay delivery, and, ironically, raise prices or lower profits because these problems raise the total cost - and this can be a disaster that can threaten the reputation of the brand and the company. For example, Mercedes had a good reputation for reliability. After Mercedes embarked on Target Costing, its J.D. Powers long-term reliability ranking slipped from # 1to # 27! Consumer Reports now ranks Mercedes near the bottom of is reliability lists; See http://www.consumerreports.org/cro/cars/types/reliability-comparison-index.htm. This happened because its engineers didn't know how to achieve real cost reductions and did "whatever it took" to reach the cost targets (as mentioned above).

Another problem with most Target Costing programs is incomplete definitions of "cost," usually parts and labor, or in some cases, just parts (one large multi-national company forces its divisions conduct Target Costing workshops, where they march down each line on the Bill-of-Materials for four days, recording the sum of their cost reduction estimates for each part). However, in order to have a meaningful "target," the "cost" must be based on total cost. If quality costs are not quantified, then people may be tempted to specify cheap parts or low-bid vendors, which will probably raise the total cost more than the expected "savings."

If companies really know how to develop low cost products by design, then, and only then, can they effectively use target costing, but only if (1) "cost" include all the costs and (2) the focus must be on all the cost reduction strategies presented on this site's home page, not just on the targets, which, unfortunately, is the focus in most Target Costing programs.

Correcting counterproductive policies may be a prerequisite to designing Half-Cost Products.

REFERENCES

1. Robert G. Atkins and Adrian J. Slywotzky, “You Can Profit From a Recession,” Wall Street Journal, February 5, 2001, p. A22.

For more information call or e-mail:

Dr. David M. Anderson, P.E., CMC
www.HalfCostProducts.com
phone: 1-805-924-0100
fax: 1-805-924-0200
e-mail: andersondm@aol.com

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