2013 June » Hiller Associates Product Cost Management

The Lake Wobegon effect: there are no laggards in Product Cost Management

Jun 272013

Anyone who has ever heard the famous NPR show the Prairie Home Companion will smile warmly, remembering warm and disarming voice of legendary storyteller Garrison Keilor talking about the fictitious Minnesotan town, Lake Wobegon. Garrison’s sign-off to the show has entered pop culture: “And that’s the news from Lake Wobegon, where all the women are strong, all the men are good looking, and all the children are above average.”

We know of another place called Lake Costbegone. It’s a magical land of companies tightly clustered around a lake of profit. Lake Costbegone is the vacation spot of Product Cost Management. Lake Costbegone (and maybe many other corporate disciplines besides Product Cost Management) are similar to Lake Wobegon.

That’s right. At Lake Costbegone ALL the companies are, at least, average.

The post that we put up a couple days ago (Is the View Worth the Climb in PCM?), showed the effect on a company’s product cost, based on whether a company is best in class, industry average, or a laggard at Product Cost Management. The splitting of the companies into these three categories is almost universal in Aberdeen research reports, and other analyst firms use a similar framework, too. However, we don’t think we had ever met a client or potential client to that thinks that they are in the laggard category.

Sure, there are people that are more realistic and honest within each firm, who will tell you “off the record” that their organization is doing very badly at Product Cost Management, or whatever corporate initiative we are talking about at the time. However, no one wants to proclaim in the sight of others that their organization is a “laggard.” Apparently, admitting that your organization is not, at least, average is the corporate equivalent of a stock analyst giving a sell signal. It’s just not done. Stock analysts typically give only three signals: Strong buy, Buy, and Hold. No one really knows what “Hold” means, but we are all pretty sure it means, “You might wanna think about dumping that stock.”

Being “industry average” might mean exactly that, the organization is industry average in whatever technique on which the firm is evaluating themselves. However, they could also be a laggard in need of great improvement, but just don’t want to admit it.

Hiller Associates effect of Product Cost Management

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The funny thing about the post from a couple days ago is that the gap or potential between industry average and best-in-class companies is actually *bigger* than the gap between the laggards and the industry average (see figure to the left). Therefore, if you are in the industry average, you should be quite excited about getting to best-in-class, because there is a big carrot to do that.

Our opinion is that companies are better off when they mistakenly consider themselves laggards when they are really industry average than when they consider themselves industry average when they are really a laggard. The industry average designation is much more of an invitation to apathy in Product Cost Management. No one wants to be the laggard, and that’s a good thing! What’s the worst thing that can happen, after all? If you misclassify yourself as a laggard and you actually are the industry average, your effort to get out of laggard state will probably move into being best-in-class.

And that doesn’t seem like such a bad thing.

Is the View Worth the Climb in Product Cost Management?

Product Cost in Industry, Product Cost Management, Uncategorized No Responses »

Jun 242013

I worked with a colleague once that used the expression: “Is the view worth the climb?” That’s an interesting expression and a very visceral way of expressing the fear that we all have when undertaking a new project in our companies. New projects always require not only capital in the form of money, but also to human capital in the form of resources, emotion, and hard work. Careers can be made by a successful project… or destroyed by a major project gone awry. Is the view really worth the climb? Will the rewards be worth the effort?

For example, it’s easy to say that people should work on increasing their profit by reducing their product cost. We all understand that this intuitively seems like a good thing to do. Mathematically, who can argue? If you reduce your product cost, you create profit that drops the bottom line. The question is: how much profit will drop to the bottom line? Is the view worth the climb?

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To answer this question, let’s take a look at a graph we made of data from a 2010 Aberdeen study on product cost. The graph shows the average effect on product cost over two year period for companies. The companies were broken into the standard three Aberdeen categories (Best-in-Class, Industry Average, and Laggards) based on other criteria of how they manage their Product Cost Management efforts.

The results were pretty impressive. In two years, best-in-class practitioners of Product Cost Management reduced the cost of their products on average by 7%, whereas companies that were average practitioners of Product Cost Management were only able to reduce cost by an average of 1% .

Let’s put this in perspective. The table below shows an example company with $10 billion in revenue, 80% product cost (as a percent of sales), and a 5% net margin. On an annualized basis, the difference between best-in-class and the industry average is the difference between $560 million and $80 million, respectively, of extra profit. Note also that the laggard’s product costs increased 3% per year equating to a $240 million profit loss.

Hiller_Associates_profit_from_Product_Cost_Management

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These numbers represent the view (the results), but what about the climb (the investment)? The Aberdeen study does not investigate this. However, one should ask: how much money *should* the company be willing to invest to capture an incremental $480 million per year of profit? 100 million? 50 million? $25 million? What about $10 million? Would your company even invest $10 million?

It’s something to think about.

Crossing Over from Classical Product Cost Management to being a PCM Rock Star

Product Cost Culture, Product Cost Management, Uncategorized 6 Responses »

Jun 172013

We spend a lot of time thinking about how organizations can improve Product Cost Management. After all, it’s our job at Hiller Associates, but we’re also very passionate about it. We’ve often wondered, why is it that there are so many people in Product Cost Management who are very intelligent and hardworking individuals, and yet the field, in most organizations, does not advance.

Why is this?

We don’t think it’s due to lack of effort.
We don’t think it’s due to lack of intelligence.
It may be due, in part, because the tools in the area are not that great, at least until recently. However, we don’t think that’s the cause either.

We have concluded that one of the biggest problems is that most Product Cost Management Experts are independent acoustic live performers.

Sing me a song!

What do we mean by that ? Well, if you go into the average product company and meet the Product Cost Management organization, it usually consists of a very small group of experts. They typically are sequestered in some back office. They appear to be a covert operation of some large organization, such as purchasing. When you meet them, they are almost always hardworking people , who looked frazzled, but still have their noses to the grindstone. They are busily trying to avoid product cost before launch and wringing cost out after the start of operations.

Traditional PCM experts are like solo classical musicians. They improvise solo (excel spreadsheets) or play an expensive instrument (an expert tool). They play for command performances before the nobles. In this case, the noble is whatever manager is in the most desperate trouble at the time. The PCM guys are always overworked, but their solution to this is to work harder. Just like a classical live musician, they can only be at one place at one time. Their performances are beautiful to listen to, but there is no recording, nor is there a broadcast, so that others in the world can hear the wonderful music they make. They really are a solo act.

We show this on the diagram below by showing the simple sine wave representing the music they sing. Pound for pound, person for person, no one can save more cost than these soloists, singing their song live and alone. However, as with any organizations that relies on people to scale, it can all only scale so large, and it can only scale so fast . That is why professional services companies are typically very small. The growth of the company is limited by the expert resources they can find. Think of this versus a product company, where once the product is designed, it can be replicated very quickly through the magic of manufacturing.

Product Cost Management Rock Star Hiller Associates

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Time to Crossover to Being a Rock Star

It’s time for product cost management groups to stop being solo live classical musicians and crossover, as they say in the music biz, to be rock stars. On the diagram to the right, look at the traditional path vs. a maximum performance path. It’s time for PCM experts to spend less time playing alone and move to being Rock Stars (and maybe the director of the band). In this arrangement, the musician continues to do a lot of what he does today. He composes and produces the music. The music itself is the technical expertise needed for product cost management, but the expert should be sharing it with the entire organization, not just a few people in solo performances. This requires that he have a *vision* for Product Cost Management. This is not a vision for how to cost model the next part or assembly, but where the organization is today and where he wants it to get to in the future.

This Amp Goes to 11

The key to success is to amplify the music made by the Product Cost Management expert. To do this, you need to find the right management champion. Management is an amplifier, because their job is to receive the good ideas that their people bring them and then boost the signal on the idea to the rest of the organization. Management also parses the signal to the right speakers in the organization that can most beautifully and powerfully and produce that signal. Think about a modern 5.1 or 7.1 home theater system, where the amp or receiver parses the signal and sends the right frequencies to the right speakers.

And, if you’re going to be a Product Cost Management rock star, you want the biggest and highest quality amp you can get. You would be pitching your vision at the VP or C-level. Remember the movie Spinal Tap? You want the amp that goes to 11!

The Recording Industry

Every rock star is going to both tour and record. The management amplifier lets you to play to stadiums full of people. But you also need to record it, so that your fans can hear it over and over. To generate maximum profit for the organization, the fans (engineering, purchasing, manufacturing, etc.) needs to be able to execute on your PCM vision. Many times that music will need to play when you can’t be there. You record by (1) changing the culture and (2) designing a PCM process that the organization can follow.

Money for Nothing and Your Savings for Free

The rewards to the organization when the PCM team moves from live classical performers to rock stars are very enticing. Although the results of the individual product cost manager experts will certainly be smaller, the rest of the organization now is producing results as well. Together, they will produce many more cost savings and far more the cost avoidance than the Product Cost Management expert could do alone.

The Path to Stardom

We realize that moving to the rock star model will initially be uncomfortable for some people who are experts. It’s hard for experts to let go of control, especially on a complex set of activities like Product Cost Management. There will be mistakes by the organization. There will need to be teaching. The system may be chaotic at first. That’s OK. This is the only way to get to a better state. It also means that the individual product cost expert will have to spend LESS time actually producing results on his own. His time needs to be used developing vision, casting vision, teaching, strategizing, and leading the organization. He doesn’t have to compose that vision and record it alone. His executive sponsor can help get him some great song writers and producers, both internal to the organization and through external consulting partners. And the executive champion will also fund these resources.

Therefore, it is critical to find the right management sponsor who understands the benefits of moving from a solo live performance model to the recorded rock star model. The management sponsor needs to have the authority to reduce the individual PCM demands on the expert. The expert must produce less individually so the organization can produce more as a whole.

Product Cost Management – Behind the Music…

Sadly, looking back at my time as a CEO and then the Chief Product Officer at a company that made Product Cost Management software , and in my current roll as a strategic consultant, I have never seen this rock star transition be driven by the musician (the Product Cost Management expert). Every time I’ve seen organization move the needle on Product Cost Management, the impetus for that change was an executive sponsor who had a vision for a better world. The executive sponsor (typically in engineering, purchasing, or a product owner) was poking his nose into the world of product cost, sometimes knowing very little about it. Paradoxically and sadly, often the existing Product Cost Management organization, instead of being grateful for the help and wanting to get made into a rock star, was resistant or even resentful of the help. That’s too bad, because rock stars make a lot more money than classical musicians, and often have far better job security. (People are going to pay to see Aerosmith until they die.)

So, my advice to you is that if you want to become critical to your management, be noticed in the organization, see your organization produce far better results, and get rewarded for doing it, it’s time to stop playing acoustic solos live.

It’s time for you to become a rock star.

Blog remoras and redirects to unrelated topics

Uncategorized 3 Responses »

Jun 042013

If you have ever written a blog, an article for a magazine, or anything else on the Internet in a forum in which people can comment, you’ve probably experienced the following phenomenon. You put a lot of time and effort into writing an article that you feel is insightful on a particular topic or set of topics. You post that article. You distribute it to a variety of media outlets, such as Facebook, Twitter, Google Plus, LinkedIn groups, etc. Comments start to arise. You’re very excited that someone is commenting, because it appears that people actually are responding to what you have said. Someone is listening!

But then… you read the comments…

Suddenly, you realize that, apparently, these commenters really don’t care about the subject you wrote about at all. They make comments about totally unrelated topics. This is what I like to call blog remoras and redirects.

What do I mean? Well, have a look at the diagram below. In the middle is an orange circle that represents the subjects about which you wrote. For example, let’s say that you write an article about Product Cost Management. Someone comments on your blog site or on a linkedin group where you share the article, etc. They may write about the same topic as the article, but just a different viewpoint on it. Therefore, they’re still in that orange circle However, other people will comment about other topics that I like to call the ring of the adjacent subset and super set topics (shown in blue). For example, using the Product Cost Management example, someone may talk about target costing, design for manufacturing, design for assembly, feature based costing, etc. These are all subsets of Product Cost Management or maybe some would consider them adjacent topics. Then there’s a third level ring around your topic, shown in brown. It’s not directly related to the topic that you wrote about (e.g. product cost management), but it may be related to that second ring of adjacent subset, or super set topics. Maybe the commentor is talking about manufacturing in general, or product design, lean, etc.

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And then, you finally get to the bizarre unrelated topic redirects. Let’s call these the “asteroid below of totally unrelated topics about which someone wants to talk.” For example, you write an article called “XYZ of Product Cost Management.” Someone responds with a comment that starts out with glowing praise, such as, “I found this article really insightful. I totally agree and that reminds me about psychoanalytic trouser sprites.” or about “how see CRM will save the world.”

These redirect topics seem to have no apparent connection to anything that you talked about in the initial article. To be fair, perhaps I am not the smartest bear the forest? Perhaps, there are complex connections that my small brain is just too tiny to understand.

However, I think something else is actually going on here. What you’re picking up is a blog remora. This is a person who wants to get their intellectual ideas out. However, they really don’t have the intellectual property developed, or maybe just don’t have the time to write the intellectual property. Therefore, they will attach to your intellectual property like a remora does to a whale or a shark. Some might say they are even parasitically feeding off your work. It doesn’t matter whether you’re talking about Product Cost Management or the price of tea in China. These people will redirect the conversation to whatever topic they want to talk about.

This phenomenon is very similar to what you see in political candidate debates. For example, the moderator asks the presidential candidate, “What is your position on the problem of millions of illegal immigrants in the United States?” The candidate smiles, pauses, and says “I’m glad you asked that question, Jim. That’s very important. If in my last four years, I’ve instituted policies to help the economy in order to grow home ownership for good hardworking Americans.” What?! Huh?! What does your home ownership policy remotely have to do with the question that you were asked? I don’t know if the problem of political candidates not answering the question that was asked and the similar problem of blog remoras, are isolated problems or if it is a sad commentary on our society, in general.

I hope I am not guilty of this problem myself. I mean, I get it. These people want to talk about what ever floats their boat (and, whatever topics are the focus of THEIR product or consulting service) . It’s a goal that we all have. I write articles on Product Cost Management for several reasons. One of those reasons is because I’m just passionate about the topic. But let’s be honest, I also do it because it’s good marketing for my consulting practice. Authors, including people that write blogs, are flattered and glad when people respond with comments to the article’s, even when those comments are disagreements with what the author said. Most authors also are happy to get comments that link the author’s article focus to the blue adjacent topic ring, and even to the brown tertiary adjacent ring, IF the commenter CLEARLY explains the link between the author’s topic and the tertiary ring of subjects. However, it’s really insulting when someone brings up a topic in their commentary to your article that has nothing whatsoever to do with the topic that you talked about and is not adjacent to it.

Perhaps, it’s not a good idea for me to bring up this problem in the public forum. Perhaps any comment, no matter how unrelated, is a good comment that will help your search engine optimization. However, I don’t see how this helps advance the community knowledge on the topic about with you have written an article, whether that topic is product cost management or anything else. I don’t hang out on LinkedIn groups dedicated to quantum physics and push product cost management. E.G. “That’s a great point Professor Poindexter on the Higgs Boson. But, what is really important is to subjugate the ideas in your article to Product Cost Management.” This behavior is just intellectually dishonest and it’s vacuous for me to try to hock my wares in a forum that is completely wrong for the topic.

However, let me pause my rant and open this topic to the general community: I’d like to hear from other people that blog, who write articles on specific topics, and even from those people that are just frequent commenters on blogs or articles.

What do you think about blog remoras and redirects to other topics?

Do you find unrelated commentary useful and interesting, or insulting to the author??

Is there any way to stop blog remoras and redirects?

How do we hold people to a higher standard that helps everybody?

Product Cost Management Precision… Ignorance is Bliss

Product Cost Management 22 Responses »

Jun 032013

Numbers. They have such a comforting certainty to them, don’t they?

Words can be interpreted. But, numbers, they have that beautiful mathematical ring of truth. I was thinking about this the other day, when I got a number from a friend. I was helping him review a model he had made, and I asked him what the median result was from the model. He told me 16.42%. I ask him, “Do you believe it’s 16.42%?” He responded, “Yes, 16.42%.” This was a very smart guy, with multiple advanced degrees in engineering from a great school. However, the data set from which he was calculating this percentage came from a group of people who are giving him estimates of the money they had spent on certain activities, as well as data from an accounting system. And yet, he was quite positive that the result was 16.42%. I.e., he thought that the result he calculated from the inputs had enough precision to generate FOUR significant figures.

Now, I’m sure that he would have realized, if he had sat down and thought about it for a second, that expecting this kind of precision when the inputs had virtually no precision of all, at least not the precision of four significant figures, was ludicrous. However, that’s the great thing about computers, especially when using spreadsheets like Microsoft Excel. They will give you as much precision as you want. In fact, to what does Excel default… two significant digits behind the decimal point.

What I find really funny about this is that most engineers have learned the hard way, over time, that there is this thing called “tolerance stack-up.” In other words, no matter what you specify on a CAD model or drawing, a machine only has so much physical capability to hold that dimension. Therefore, engineers become very proficient at specifying tolerances. In recent years, they have even become much better at understanding the stack up of these tolerances on the final dimensions of a part. In fact, there are very sophisticated software packages dedicated to helping engineers do this.

In more general usage, Monte Carlo modeling became all the rage 10 to 20 years ago. Monte Carlo was an attempt to recognize the inherent noise in numbers that we measure, and how that uncertainty affects the models that we make, especially financial models. However, the funny thing is that when it comes to calculating product costs, people ignore the precision question, and just assume they have the precision they wish they had.

Take a look at the figure below . Let’s go through a simple product costing in concept. For the part we are looking at, we first need to know the physical quantities that are used in making it. For example, we need to know the mass of the part, but that’s a tricky thing, because we have scrap and varying amounts of mass could be used up in certain processes. So, we might be +/-1-3% in our estimate of how much was used. Similarly, we need to know how much time is actually spent on each machine. However, this varies batch to batch, and measurements aren’t always so accurate. There may be many processes that make up the part, including extra inspections and re-work. Let’s say our measurement of the time it takes has a range of 5 to 15%.

Until this point in the analysis, at least we’ve been dealing with physical quantities, not financial quantities. But, if we move to financial qualities, the problem gets much worse. Even material rates are not such a certain thing. They move around over time with various surcharges for this and that from the different material providers. And, the number depends on what material is sent t0 what lines, etc. Labor rates and overhead rates are far more black magic. Accountants with green eye shades spend endless hours calculating these rates from monstrous ERP systems, using Byzantine Activity Based Costing allocation schemes. We hope that the allocated rates are accurate to the real truth on the floor, but I don’t think we can really expect them to be more than +/- 10-20% from what’s really going on.

Never fear though! At the end of the calculation, we have calculated that this particular part cost is $93.45. Why $93.45? Well, that’s what our spreadsheet model or our product cost management software told us. And, of course, a cost NEEDS to be within 10% of what we think the real cost is.

If the product cost management user actually calculated the tolerance stack-up of the uncertainties of the inputs that went into that cost, they would probably find that the costs are more than +/-10% from the true cost. If they seriously considered the possible precision, would they say the part cost $93.40-93.50? I doubt it. Would they say it costs $92.00-93.00? Nope . They probably would say that the part could cost between $88-$97. But, a range like that is not very comforting . It’s much more fun to hit that little “$” format button on Excel or cut & paste the number from the product cost management software .

It’s $93.45. That’s what it is. Because ignorance is truly bliss in the world of Product Cost Management.