Kaizen Costing and Target Costing - Essay Example

Kaizen Costing and Target Costing The paper revolves around two costing techniques Kaizen and Target costing. In the Kaizen costing, actual costs are compared with target cost reductions under dynamic conditions. The employees are considered to be of vital importance in the process, where as in the former approach, employees are neglected. The basis of Kaizen costing is continuous improvement. Target costing is a process that determines and realizes total cost in a way that the total cost of producing a product must be traded off with the desired profit at its expected selling price in the future. Two companies for each of the aforementioned process are chosen and critically evaluated on the basis of their application of these cost principles. These two companies include Daimer Chrysler and Caterpillar for Target costing and Daihatsu and Toyota for Kaizen costing. How the techniques are employed is studied over. At Daihatsu, Continuous improvement is sought for throughout the year to achieve the targeted profit and to reduce the gap between targeted profit and estimated profit. A cost variance analysis is then done that includes both the target costs as well as the actual costs reduction accounts. If target Kaizen costs are not attained then an investigation follows. At Toyota, the upper management decides on the short term target profits as well as the expected long-term sales-to-profit ratio. This is decided a year in advance. The cost is then made using the profit target and the volume of production is divided according to variable and fixed cost budgets which are then further reduced using their budgeting system. At Daimer Chrysler, cross functional teams are used to curb costs and evaluate future profits. The cost estimating group in the company will break the costs for the whole product into cost targets for sub-assemblies and individual components of the product. These could be engine, the transmission seats, the steering, the gear, the covers, the paddle, the clutches etc. Further the paper also discusses management implications of applying these techniques in each of the aforementioned companies. TOPIC: Target Costing and Kaizen Costing Techniques Target costing is a process that determines and realizes total cost in a way that the total cost of producing a product must be traded off with the desired profit at its expected selling price in the future. In other words it is a systematic process, in which costs are determined and profits managed. It is governed by six key principles which are as following: 1. Price led costing. 2. Focus on customers. 3. Focus on design 4. Cross functional involvement 5. Value chain involvement. Under the price-led costing principle, markets play the primary role in determining allowable and target costs. Target costs are henceforth, calculated using the following formulae: Market price-required profit margin = target cost; The formulae takes into account, the current market price, the projected profit that the company wishes to acquire and the eventual target cost after subtracting the two. Target costing method also takes into account the requirements of the customer. This includes the quality aspired for by the customers, their cost and time constraints inclusive. Literally speaking the method ensures that the value provided to the customer for incorporating any feature and/or functionality into a product should out class the cost associated with providing that particular feature/functionality. The third principle states that the focus should be on design. Cost control needs to be taken care of at both the product as well as process design stage. Thus engineering changes should be incorporated before as well as well after the production begins. The primary idea, behind doing this ensures low costs and less "time-to-market" for new products. The fourth clause stipulates cross-functional teams. Cross functional teams are important from the initiation of the product till the final concept is conceived. They make sure that creativity circulates, different ideas from different team members are incorporated and the final product has the desired level of quality while keeping the costs under control. Target costing also takes into account members associated with value chain. These include suppliers, distributors, service providers and customers. Their stake in the product is also included in target costing. Life-cycle orientation associates cost minimization with both, the producer as well as the customer. The costs include purchase price, the operating costs, the maintenance as well as the distribution costs. Target Costing Process: Mostly companies use target costing to project visible cost targets for any new products they seek to establish in the market. The targets set by companies are very aggressive. The idea behind this approach is to maximize cost control and ensure that profit is as steep as possible. The process begins when a companys top management establishes its target cost for the new product. For instance a Chrysler Neon or Caterpillar Excavator. The cost estimating group in the company will break the costs for the whole product into cost targets for sub-assemblies and individual components of the product. These could be engine, the transmission seats, the steering, the gear, the covers, the paddle, the clutches etc. Mostly a gap exists between the target costs as well as the cost projections for the new product based on current designs and manufacturing capabilities of the product. The real deal lies in narrowing down the gap that exists between the cost projections and target costs through cost reduction. This is where the cross functional teams come into play. By analyzing modes of manufacturing involved, process associated with the product, the raw material requirements and the costs, they figure out the cost saving opportunities. The following paragraphs will focus on the approach applied by DaimlerChrysler and Caterpillar deployed target costing in their companies. In these companies, target costing is supported by a matrix organizational structure which has both horizontal as well as vertical functional teams. Daimler Chrysler had been operating under five cross functional teams. These were focused on large cars, small cars, mini-vans, trucks and jeeps. The team involved was cross functional and included people from various genres such as design engineering, manufacturing engineering, purchasing, finance, marketing, production and procurement. The applied target cost method system had to determine had to determine cost objectives of each time. Daimler Chrysler used a tool box which focused on management initiatives to improve productivity and reduce costs. The tool box incorporated value engineering, manufacturing design, paper kaizen and lean manufacturing. The initiative was implemented through a number of workshops that consisted of various multi-functional times. The workshops were brain storming sessions where aspiring participants participated, brainstormed, trouble shooted and generally tried to solve problems. The Value Engineering Analysis component aimed at increasing the value of the product offered by Daimler Chrysler by working on designs. The main focus was to ensure that the new design benefits outweighed the costs of implementing it. In the Design for Manufacturing Assembly, the design effectiveness against assembly operations was evaluated. One aim could be reduce the number of vehicle components to as little as possible and to simply assembly processes. As a result less assembly errors would follow and simpler vehicles. Lean manufacturing takes place after the product has been launched as practiced at Daimler Chrysler. It extends beyond the scope of the company and aims to reduce set up times and un-necessary inventory movement. Customer inputs are frequently taken in before they implement any new design innovation. It is first figured out if they will even pay for the new design. An approach which is somewhat on the same lines is also followed at Caterpillar. They first put in place their tools associated with target costing and then develop a standardized approach for achieving their target costing objectives. Let’s explore how they do it. For instance, the target cost of a particular vehicle is set to be at 94.6%. This gives them an initial gap of 5.4%. The cost of the comparable model is specified on the basis of the current manufacturing capabilities of the company. Thus it’s obvious that to reduce target costs, they must be decreased by 5.4%. (Cost of the model is 94.6% and cost of the product is 5.4%) This is followed by the establishment of a cost improvement team that works on to improve product design, manufacturing engineering, marketing products and devises various ways to narrow down the gap. The group also considers ways to improve efficiency by reducing costs. Cost saving is done in various stages and at each step it is figured out how much of 5.4% has been reduced and how much more of it has to be reduced. For instance after assembly analysis, it was figured out that 4.7% could be saved, then it was to be evaluated again how the remaining 0.8% should be saved. The techniques followed at both Caterpillar as well Daimler Chrysler are more or less similar. They use a cross functional team structure; emphasize more on the “voice of the customer”, stress more on removing costs through the supply chain as well. For these companies target costing has proven to be a very effective method at reducing costs and building up on profits. Kaizen Costing: Kaizen costing is a relatively simple concept. The word has been derived from two Japanese words, “kai” and “zen”. “Kai” means “change” where as “zen” means “good”. Juxtaposing the two gives us the meaning of the word Kaizen that means “changing for the better” or “continuous improvement”. The concept was created by Late Dr W. Edwards Deming who was an American statistician. His work has widely been conceived as the primary driving force behind the evolution of Japanese economy during his time. It was not until 1970s did the Americans begun showing interest in Kaizen practices which was precisely when Japanese products started making an impact in the market. (Cane) In the simplest of words, kaizen costing is divided into 4 steps. 1) Every step of the process is critiqued and scrutinized to the minutest of details 2) How each of these parts of processes can be further improved. 3) How employee’s actions, equipment and materials can be worked upon. 4) How time can be saved and waste minimized. (Horngren) This practice revolves around the belief that the people actually working on a particular job are better informed compared to their superiors. (M) (Castells) They know better how the practices can be improved and who should be given the responsibility for making these improvements. Small cost improvements are obtained in the incremental cost reductions in the production stage of the life cycle of a product. (Ciborra) . The causes of waste, excess, and variation can be continually reduced over time. In the traditional approach of costing, actual costs are looked at against standard costs. In the Kaizen costing, actual costs are compared with target cost reductions under dynamic conditions. The employees are considered to be of vital importance in the process, where as in the former approach, employees are neglected. (Bell) Kaizen Costing at Daihatsu: At Daihatsu, cost reduction targets are set before hand and they are applied on a monthly basis. Continuous improvement is sought for throughout the year to achieve the targeted profit and to reduce the gap between targeted profit and estimated profit. A cost variance analysis is then done that includes both the target costs as well as the actual costs reduction accounts. If target Kaizen costs are not attained then an investigation follows. (James)For every new product, a new product is project is established. During the design stage, the actual costing system is implemented using the following six plans: Under Plan number 1, production, distribution and sales are looked at. Under plan number 2, projected parts and material costs are focused upon, plant rationalization plan in plan number 3, and plan number 4, facility investment plan and fired expansion plan in plan number 5 and plan number 6 respectively. (Abrahamson.E) (E) The six plans become the basis for annual profit budget. Cost improvement is then obtained through Kaizen. Under this method, variable and fixed costs are reduced. Functional analysis is then done for the design of every product. At each of these stages, the target cost is set along with the function cost. The functional costs are then added up to give the product target costs. After the first year of production with the new product, the actual cost of the previous period is then set to be the starting point for further cost reduction. This way of continuous cost improvement is known as Kaizen costing and it influences continuous improvement by making standards as stiff and tight as possible. Variable costs and fixed costs are calculated using different methods. Variable costs are equivalent to previous year’s production cost. Cost reduction rate is then determined and changing rates are monitored. The total budgeted amount is then lowered by a peculiar reduction rate. (Michael) The figure shown below is an illustration of Daihatsu’s cost reduction approach: Kaizen Costing at Toyota: Toyota also uses Kaizen costing for their budgeting system. At Toyota, the upper management decides on the short term target profits as well as the expected long-term sales-to-profit ratio. This is decided a year in advance. The cost is then made using the profit target and the volume of production is divided according to variable and fixed cost budgets. The fixed costs are further divided into controllable and uncontrollable costs. (Archibugi, A review of the methodologies movement) Uncontrollable costs are those which can’t be further reduced. Kaizen costing tries to reduce the controllable costs. It is understood in advance that the cost of raw materials cannot be further depreciated. This is because they involve negotiations and a lot of other intricate considerations that are associated with these purchase transaction. The other left over variable costs which include direct manufacturing labor, utilities and manufacturing over head are controlled using the kaizen budget. (Muridth) Performance is then evaluated in terms of Kaizen value which is considered to be the cost reduction that takes place after varying the standard cost of each procedure. To reach the desired level of target profit, it is important to increase sales revenues per output. It is realized that variable costs increase as production increases, so a more wise approach would be to increase revenue earned by increasing the sales cost per unit sold. (Mary)This is the practice adopted at Toyota. To cut down on costs, Toyota tries to reduce variable controllable costs for production. There are cost cuts that are applied across the board to improve cost standards for each associated production process also called Kaizen units. (Thompsons) Thus Kaizen units are merely the segments of the production process that are there only for Kaizen value distribution processes. After the goals have been established and a plan chalked out, the managers submit it to achieve improvements at least twice a year. Improvements would be in daily operating procedures, manufacturing and assembling process. At Toyota assembly work was particularly re-measured and re-evaluated for further improvements. (Archibugi) Bibliography Abrahamson.E. "Academy of Management Review,." ``Managerial fads and fashions: the diffusion and rejection of Innovation" (1991): 586-612. Archibugi, D. and Michie,J. A review of the methodologies movement. Journal of Costing techniques. —. 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