May 202013
 

In the last few weeks, there has been a hearty discussion on this blog about controlling costs before versus after a product launches.  This got us thinking about this situation, we thought that it could be plumbed to greater depth.

Therefore, Hiller Associates is proud to announce its latest article in IndustryWeek, entitled:

If Your Company Does Product Cost Reductions, It’s Already Too Late

If you would like to read the article, click the link above to go to IndustryWeek.com.  Later in the week, we will post the article, in it’s entirety, on this blog.

 

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May 062013
 

In last week’s post we talked about where Product Cost Management sits in the organization . We concluded that Product Cost Management lives in a weird no man’s land between purchasing, engineering, finance, and manufacturing. Because the area is a wilderness, we used the analogy the people seriously pursuing Product Cost Management in companies are similar JRR Tolkien’s legendary Rangers in the Lord of the Rings trilogy . The Rangers go about doing good and benefiting the general public, even when the public does not recognize the good they are doing.  Sometimes, the general public even considers these solitary trackers and warriors as meddling, or even, sinister. We even compared the best product cost management folks to the most famous of all Rangers, Aragorn, son of Arathorn .

Several people wrote us about this article, very pleased with the analogy comparing product cost management people to Tolkien’s Rangers. They also validated our assertion that Product Cost Management in the organization, lives between other major functions.  We must say that EVERYONE was on board with the post and feeling very good about it.

This week we’re going to burn through all that good will and make everybody angry!

We’ll do this by explaining why people from every one of the major functions in a manufacturing company are ill-equipped for Product Cost Management.  Are we doing this for the schadenfreude* of internet lulz? No, we’re doing it because we believe these paradoxes are true. These are the unspoken but often thought, truths that need to come to the light of day.

*For a PG-13 musical definition of schadenfreude from Avenue Q, click here.

It’s unfortunate we have to say this, but we’re not embarrassed of it either.  First, one disclaimer:

The statements below are obviously generalizations of the functions within the organization, as well as of the people of that make up those functions. Throughout our firm’s long experience in industry with Product Cost Management, we have met many individuals within each of these functions that do not fit the stereotypes below. However, the paradox below truths hold in general.  Any resemblances to any person, living or dead, is purely coincidental.

Why each major function in a manufacturing company is so poor at Product Cost Management

Engineering

The short answer is, that engineering really doesn’t care about product cost that much. Product cost is a distant second or third , or maybe a fourth priority, compared to other product attributes such as time-to-market, quality , or performance.   We say this despite the fact that we have data of our own, as well as data from other analyst firms, that show that when asked about product cost, product development executives will prioritize it near the top (usually 1st or 2nd). However, our experience in practice is that when the rubber meets the road, product cost is not the first or second priority. On a personal level, the paradoxical thing is that engineering is actually better equipped than almost any other function to do a good job at Product Cost Management.

Product Cost Abilities by Functional Group

CLICK TO ENLARGE

The reason for this is that a major challenge of Product Cost Management is linking the physical characteristics of a part (e.g geometry, features, mass , time to produce the part, etc.) to the financial (dollars and cents). Engineering lives and breathes the physical world. Engineers are trained to understand the physical world and to control it from the very first day they stepped foot into engineering school . They’re not afraid of the physical world . The problem is that product cost, despite the statements of most engineering executives, really is one of the last priorities to address when you’re in the middle of a product development program.

Finance

Finance relationship to PCM is the exact opposite of engineering . Finance DOES have the incentive to control product costs. In fact it, it’s their whole world.  The problem is, most finance people are not from an engineering background, and are, quite frankly, terrified of the physical world of 3D CAD , features , and even if the manufacturing floor.  To them, it is very uncomfortable to leave the safety of dollar numbers on an excel spreadsheet. They are also often hampered by the accounting classes they took in college.  Specifically, Financial Accounting thinking has come to dominate the way they perceive Managerial Accounting in a way that is wholly inappropriate.  Accounting , in reality, has a backwards looking allocation-of-cost viewpoint, rather than the forward looking predictive cost paradigm, which is needed for product cost management . The problems with the current accounting paradigm are certainly worth a future blog post, if not magazine articles or whole books !

Purchasing

Purchasing often suffers from the same malady as finance. They don’t understand the physical world very well. Many buyers also have a bit of a multiple-personality problem when dealing with product cost. On one hand, buyers are suspicious that the supplier is not telling them the truth and charging them too much. On the other hand, if a Product Cost Management person or another should-cost source provides the buyer with a product cost for a part that doesn’t match with the supplier gives them, the buyer often immediately concludes that the should-cost (not the quote) must necessarily be wrong . Riddle me that? They also have a a commodity worldview.  It’s more beneficial for them to focus on large groups of parts within a commodity, as opposed to single parts within a product that is being developed.  Finally, the incentive of RELATIVE cost reductions (i.e. “year over year” cost reductions) sets up a very bad dynamic with Product Cost Management.  PCM is first focused on making sure the product comes to launch AT the right cost, rather than reducing cost year over year later.  All these topics are worthy of extensive articles, in and of themselves, but that must wait.

Manufacturing

In some ways, manufacturing is probably currently better equipped to deal with Product Cost Management than anyone else in the organization .  Manufacturing people are usually comfortable with the physical attributes of the product, just as engineering people are (although they do not have the depth of knowledge in this respect that engineering typically does). Manufacturing does care about cost, just as finance does. They also have a practical nature like purchasing and are quite likely to be comfortable dealing with suppliers.  However, there are PCM challenges and paradoxes for manufacturing, as well.  First of all, due to rampant outsourcing in most organizations, the only manufacturing left in many companies is final assembly. Therefore, the manufacturing guys are often absent from the PCM ballgame. Their concern about how they’re going to assemble the parts together for the final product, not how to make the parts. Secondly, manufacturing is a very busy place, concerned with the here and now and fighting fires, rather than more strategic pursuits such as Product Cost Management.

What to do?

PCM_Funtion_SummarySo, we’re all in a bit of a pickle functionally with Product Cost Management. The table to the right gives a summary of the paradoxes we face functionally. It also adds one global problem that we talked about last week, which is  that PCM doesn’t really fit nicely within any of these functions.

Given these structural problems in the organization’s functional cultures, is it any surprise that most companies struggle with Product Cost Management?

What’s the solution? It’s probably too complex of a problem for one Silver bullet. However, hopefully in the next post we can propose at least one possible way to move beyond the organizational problems and paradoxes discussed today.

 

 

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Apr 222013
 

 

Good Morning PCM world,

Another reader sent in questions with respect to the article 2012 revenues of the Product Cost Management market.   However, this question was a little more broad:

 

Is there any difference between Project cost management and Product cost management from your your point of view?

That’s a very simple but good question.  We had not considered addressing it before the question came in.  The short answer is “YES!,” there is a big difference.  The big difference is as simple as the two words:

PRODUCT vs. PROJECT

We have defined Product Cost Management before here as:

Product Cost Management – An agreed, coherent, and publicized system of culture/goals, processes, people, and tools following the product lifecycle, that ensures the product meets its profit (or cost) target on the day that it launches to the customer.

The definition of “Project Cost Management” is more murky.  The wiki entry on Project Cost Management is less than satisfying.  Here is the main definition portion of the entry:

“Project cost management (PCM) is a method which uses technology to measure cost and productivity through the full life cycle of enterprise level projects.[citation needed] PCM encompasses several specific functions of project management that include estimating, job controls, field data collection, scheduling, accounting and design.”

Other resources for a definition are Ecosys EPC, the Project Smart blog, Hard Dollar Software, and TutorialsPoint.  Based on the knowledge from these sources, we would define Project Cost Managemenet as:

Project Cost Management – Project cost management is a group of techniques, including budgeting, forecasting/estimating, change control, field data collection, scheduling, accounting and design, and reporting that are used together to ensure that a project is completed at its target cost and on schedule.  It is most often associated with the construction industry.  In construction projects, it would include tracking of both project costs and the costs of the materials for structure being built.  In the world of manufacturing, it would only include the costs of the project such as R&D and SG&A.

Note that in the definition we make a distinction between two very different industries:  Manufacturing vs. Construction.  In construction, we are most often making one thing — some sort of structure WHILE we are in in the midst of the project itself.  In manufacturing, we are undertaking the project in order that we make many copies of a product in the future (when production begins).  In manufacturing, we call the project, “Product Development,” including sourcing, testing, design, manufacturing planning, etc.   In manufacturing, which is our primary focus on this blog, there is a fundamental difference in Product vs. Project cost management that goes all the way to the income statement itself.

Income Statement and Product Cost Hiller Associates

CLICK TO ENLARGE!

See the figure to above to understand the focus of Product vs. Project Cost Management on an example income statement for a manufacturing company.  The question then probably arises in everyone’s minds:  Do we need both and which one is more important?  That’s beyond this article, but maybe we can talk about it further in the future, if there is interest.  We’ve left you some clues to answer those questions yourself in the figure above.

In the meantime, somebody call the Project Cost Management guys and tell them they are infringing our acronym!  Everyone knows that the *real* PCM stands for PRODUCT Cost Management!

 

 

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Feb 042013
 

People complain about the profitability of products, especially early in production, but how often do products actually miss their profitability at launch?

According to the latest research by Hiller Associates, most companies miss product cost targets.  We asked almost forty  people from a variety of corporate functions “How often do you meet or beat product cost targets at launch?”   The results follow the familiar 80/20 rule of many business phenomena.  On 17% of respondents said that their companies meet cost targets Often or Very Often.

Product Cost Results goals at launch Hiller Associates

CLICK TO ENLARGE

That is not an impressive showing.  We would not accept 17% as a pass completion percentage from a NFL quarterback.  That’s not even a good batting average in baseball.  So why do we put up with this in our companies?  It’s also interesting that almost the same percentage of respondents (15%) don’t know enough about product profitability to even guess how well their companies are doing.

Companies are understandably careful with releasing actual product profit numbers.  Still, it would be great to have a more in-depth academic study done, in which actual financials were analyzed to answer the same question.

Percent meeting product cost summary Hiller AssociatesHow often does your company meet its product cost targets?  Does anyone know in your company know? These are questions you cannot afford not to ask. Is your firm the 17%… or the 83%.  If you are in the 83%, consider starting or improving your efforts in Product Cost Management.

 

 

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Jan 022013
 

I was just reading a really interesting article by Matthew Littlefield called Cost of Quality Definition.  I applaud the article for several reasons.  It is straightforward, clear, and short.  I especially like that Matthew acknowledged that Cost of Quality is not only in negative things that are avoided (warranties, recalls, scrap, etc.), but also that there are costs to prevent these negative consequences (cost of appraisal and prevention).

This sounds like a trivial thing, but I remember living through the 1990’s where some academics and practitioners had a cultic obsession with quality.  They would hammer you with the idea of cost of ‘poor’ quality.   As a university student and engineer I would say, “Well, yes, but obviously you pay something to ensure good quality and avoid recalls, customer satisfaction loss, etc., right?  I mean, there is a level of quality that is not worth while attaining, because the customer does not value it and will not pay for it.”  The quality obsessed would look at me like I had just uttered vile heresy and inform me that having good quality NEVER cost the organization anything – only poor quality did.  Mr. Littlefield’s definition makes a lot more sense.

What does not make sense is Mr. Littlefield’s engaging, but definitionless graph in the article.  The axes are not labeled, either with specific financial units, or with general conceptual terms.  Furthermore, in the paragraphs before and after, his discussion is about the trade-off needed to find the minimum between Cost of Good Quality and Cost of Poor Quality… but the graph has three axes?    Maybe on axis Total Cost and the others are Cost of Good Quality and Cost of Poor Quality?

Can  someone explain?

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Dec 182012
 

 

Hiller Associates has teamed up with CIMdata , a global leader in Product Lifecycle Management consulting and PLM industry analyst coverage to bring you the first annual Product Cost Management Survey.

It takes less than 10 minutes and you will be rewarded by receiving a free copy of the results and report of the learnings that we gain about product cost.

 

 

Product Cost Management Survey

 

 

 

http://www.esurveyspro.com/Survey.aspx?id=03984de4-e017-455d-914b-507bb529c308

 

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Jun 252012
 

Today we have the third in our series of insights from the article “Putting it All Together at Harley-Davidson.”

At the end of the article, Pete Schmitz strikes a chord in my heart when talking about supplier selection:

 

 

[Schmitz] Don’t pave a cowpath! We believe in never automating a bad process – first, fix the process, do a solid supplier selection, then automate it. The tools are only so good – at the core it is the philosophy.

I believe this is a brilliant observation.  Too often, companies that want to get involved in Product Cost Management kick start their PCM efforts after a particularly painful event where they missed a profit or product cost target on a specific product.  Often, their first impulse is, “What tool can help me solve this problem?”   That is just human nature, especially in our modern technological society, to look for an instant, easy, off-the-shelf solution to all the things that bring us woe.  Isn’t there an app for that?  For most complex problems in life, there is not an app for it, and if there is, that app does not work in isolation.  To make a tool work well, we have to assume that three other elements are considered:

  1. Culture
  2. Process
  3. Roles

We talked about these three elements and the fourth (Tools) in our discussion on the PCM World Map before.  I would argue that you need to start with Process.  Depending on the maturity of your Product Cost Management culture, you may be able to handle a more or less complicated set of PCM processes.  However, Pete Schmitz at least takes the focus from Tools up to the Process, which is major progress.

His analogy is interesting.  If you have a traffic problem, and the road connecting two places in a winding narrow cowpath, the solution is not to pave the winding road.  Cars move faster than cows and are wider.    Cows make cowpaths seeking the path of least resistance and not being able to remove inherent natural roadblocks and bottlenecks.  But, if you need to move thousands of cars per hour, you would look at the two places and see where the straightest path would be.  Within reason and technical ability, you will invest in removing the natural roadblocks first and then lay down a solid foundation, before paving a wide road.

Think of Product Cost Management like this too.  Buying the software tools to supercharge your process is the last step in your journey.  Consider the diagram to the right.

Fix the process in Product Cost Management Hiller Associates

Don’t Pave the Cowpath –> Simply and Supercharge!

Most people want to buy tools to speed up an existing PCM process.  However, there are usually many inherent problems, including:

  • There is NO Product Cost Management process to begin with
  • The old PCM process assumes a certain level of tools and roles/team attention
  • The old PCM process developed in an emergent way, i.e. no one ever design it; it just happened.
  • The old PCM process assumes a much lower priority on profit and product cost and the company wants in the future.
Assuming your firm is already clear on your PCM goals, the firm first should lay out the PCM process that will accomplish those goals, which are specific to its corporate culture.

As shown on the diagram, when you focus exclusively on the new tool, the firm will simply move from the existing process on the left to the the upper right diagram.  Here, the firm keeps the old byzantine cowpath process that was constructed with more primitive (or no) PCM tools in mind.  At best, the firm is just slightly speeding up the wrong process with new tools.  However, often the firm will realize no benefit from the new PCM tools, and they may even slow the process down further!

Compare this to the diagram at the bottom right.  Here, the process has been re-designed and value streamed with the the availability of newer tools in mind.  The firm has removed old process steps that are no longer value added.  In the bottom right process, the same PCM tools can much better supercharge a clean straight process.

Don’t pave the cowpath; plan the Product Cost Management autobahn.

 

Eric

Note: there is no PCM Tool today that can handle all of the many varied use cases most firms have for Product Cost Management.    You may likely need more than one of them and some of your own internal tools.  This is no reason for despair, though.  By realizing this and picking the PCM toolset that seamlessly threads into your PCM process, this is your opportunity to out distance your competition.

 

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Jun 182012
 

To continue my thoughts from last week’s blog regarding the article  “Putting it All Together at Harley-Davidson“, I’ve put together some additional insights below.

Keep Your Product Cost Management Promises and Don’t Force Others into Promises They Can’t Keep

I am reminded of a story about, Saint Augustine of Hippo, a brilliant theologian, who meets a young boy along the Mediterranean sea sea shore  one day.  As the story goes, Augustine had gone for a walk to clear his prodigious brain, trying to fathom the Christian mystery of the Trinity.  He sees a little boy running back and forth between the sea and a hole that the boy dug on the beach.  The boy uses a little bucket to transfer water from the sea to the hole.  Augustine asks the little boy what he is doing, and the boy replies that he is draining the ocean.  Augustine laughs at him and tells him that his goal is ludicrous, and he’ll never do it.    At this, the little boy replies to the great Doctor of the Church, “I’ll accomplish MY goal before you get to yours!”

Spiritual implications aside, the secular point is that there are goals that cannot be achieved.  In the article, Schmitz talks about his time at Honda:

“Plus, at Honda we learned to never miss a target, to never make a commitment that we couldn’t keep.”

That is a subtle, but important point.  I don’t believe the bigger problem is people not keeping realistic commitments, but forcing the team for sign up to unrealistic commitments.  The culture of US business has morphed to a state where everyone must accept “stretch” goals, some of which are ridiculous.  In addition, eager managers make assumptions about the execution of projects.  Getting a project authorized is the equivalent to assuming that that the Boston Red Sox will hit 3 home runs per inning for a whole game.  Managers who accept such ludicrous targets are “inspiring leaders with a ‘can-do’ attitude;”  while those who cry foul on silly expectations are “negative” and “not team players.”   The article on Harley seems to say that Honda has at least partially overcome this problem and is a bit more realistic in goal setting and acceptance.

Reality Cannot Be Fooled Repeatedly for Very Long

There are “stretch” goals, and then there are miracles.  For example, consider the picture below.  Boiling the ocean in Product Cost Management Hiller AssociatesThis leads us to ask, how do you know if your goal is too aggressive in Product Cost Management?   I don’t have an exact answer, but I would suggest that people think of goal setting like tolerance stack up.   Managers should remember back to the days when they were engineers.  If a design is so delicate that all parts must have extremely tight tolerances and must be heated/cooled to assemble, would you say this is a design that will ever work in the real world of production?  No.  Alright, so when you are setting your product cost targets, reduction targets, or any other target, consider what intermediate goals must be reached to accomplish the overall target.   It is a lot easier to assess the chance of accomplishing the more narrow intermediate goals than the big longer term goal.  If you need flawless execution on each intermediate goal to achieve the overall goal, you may want to consider whether or not you are boiling the ocean.

Part 3 in this series is coming soon.

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Jun 112012
 

I just read the article “Putting it All Together at Harley-Davidson” in the July 2012 [July??] Blue Heron Journal.   The article is a profile on Pete Schmitz, a Honda veteran in Product Cost Management, who now works at Harley-Davidson.    According to the article,:

“[Schmitz] combines procurement, design, manufacturing and cost expertise in a unique job function. Reporting up ultimately to Harley’s CFO, Schmitz describes his ten year Finance Product Cost Manager position as ‘the cat bird’s seat…we are the neutral third party in product development – getting the whole organization to work together.”

That perked up my ears right away.  As many of our readers may know, Harley Davidson is a classic case study in the positive effects of successful Product Cost Management.  It was an exciting article to me for several reasons.  I would like to explore them in the next few days in some shorter posts.  The first insight that I gained from the article is the following:

Finance Must be Involved with Purchasing and Engineering

According to the article, Harley is at the mature stage of Product Cost Management making their efforts truly cross-functional.  Specifically, the finance (maybe accounting too?) people are involved directly with the engineering and purchasing groups.  That is impressive.  If you are familiar with Product Cost Management efforts, you know how difficult it can be just to get engineering and purchasing to work together.  However, getting finance and accounting meaningfully involved is even harder in my experience.  That is unfortunate, because often finance and accounting have so much of the existing data that the cost management team needs to make valid cost models, do spend analytics, etc.

I am not sure why finance and accounting often shy away from participating in PCM efforts.  My own experience is that the finance and accounting people are uncomfortable with the very physical world that includes the Bill of Material (BOM) and purchasing commodities.  Moreover, the PCM team often needs to recalculate overhead and other financial rates to be RELEVANT for cost management analyses.  This recalculation is is very different from the RELIABILITY focused, acceptable financial accounting viewpoint with which the accounting team is comfortable.  That is just a general guess from my experience over the years, but maybe a reader can provide more insight.  Regardless, I would urge more finance and accounting folks to step out of their comfort zone in the financial world to participate in the physical world with engineering, purchasing, and manufacturing.

Translating from the Physical World to the Financial

At the end of the day, isn’t translating the physical into the financial what Product Cost Management is about?   I actually wrote one of my first blog posts in 2007 about this concept for Jason Busch at SpendMatters.Translating Features to Cost in Product Cost Management Hiller Associates  The article is called What’s The Language of Your Business?   It’s very helpful to ensuring a good translation when experts in all languages are present during the translation work.  Ergo, both the people that speak physical (features, functions, BOM, machines, and supplier) and people who speak financial (dollars, overhead rates, internal rate of return, net present value) need to be around the table to make sure nothing is lost in translation.

See you again soon with part 2.

 

 

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May 292012
 

One thing that is interesting about Product Cost Management is that people have different thoughts as to what is included in the product cost.  Is the product cost the raw material, labor, and direct  labor?  What about the capital tooling?  What about logistics and shipping?  Oh, and what about warranty cost or end of life disposal fees for which your firm is responsible?

The short answer is E. All of the above.

In a product and manufacturing firm, everything on the income statement is included in the product cost.  However, the income statement does not easily present a direct association between a particular cost with a certain product.  Hence, accounting came up the concept of “indirect,” “period,” or “burden” costs.  This is accounting speak for, “We’re not really sure how to reliably split this bucket of cost and assign it to an individual product.”  Later, academics and consultants made a lot of money, and caused great pain and suffering, with Activity Based Costing.   This method was invented to try to reasonably amortize indirect costs in a logical way, so that people could call them direct costs.  ABC was a good idea, but in most companies, it was badly implemented in an impractical way that made everyone lose interest in it.

So, what IS in Product Cost?  That’s a tricky question that we may be talking about for a long time.  However, I would like to address one particular cost that is a perennial burr in my bell bottoms.

Grand Theft Auto — Yes Virginia, Capital is a Real Cost

Imagine you were selling your car and put a “For Sale” sign on it in the parking lot of your company.  Over lunch one day, one of the engineers in your firm walks up to your desk and says he’d like to buy your car.  You might say, “Great!  I’ll make you a deal. It’s $5,000.”   But the engineer looks at you in a confused manner and said, “Oh no, you see, I’m only responsible for the ‘variable’ costs of the car such as gas, insurance, those little pine tree air fresheners, etc.  The capital cost of the car is not my problem.  It comes out of ‘another budget,’ for which I am not responsible.  Can I have the keys now?”  You would not give him your car and might actually ask his supervisor to have the guy checked out for behaving in such an irrational way.

That’s a bizarre story, and no engineer that I know would say something like that… unless they are talking about Product Cost.  I wish I had a dollar for every time an engineer or his manager told me that capital tooling “didn’t matter because that comes out of a different budget.”  Capital Investment and Capital Tooling are real things that cost real money.  However, most organizations treat them as if they are totally different than the variable product costs (e.g. raw material, labor, direct overhead, etc.).    No, capital is not different, in the sense that the design team’s decisions will determine how much capital is needed, just as their decisions affect variable costs.  However, at best, engineering teams will only consider capital as completely separate from the “Piece Part Price.”  Many engineering departments do not consider capital in any serious manner at all.

This leads to perverse decision making.  Why?  Typically, investment in capital will reduce the variable cost of a part, and there are often multiple ways to make a part.  For example, let’s say that you are Joey Bag O’Donuts design engineer, who has been given challenging cost targets for Piece Part Cost.  You design a part and your purchasing guy comes back with quotes from 3 suppliers:

Supplier  Piece Part Cost Capital Tooling Cost
Louie’s Laser Library $15.10 $1,000
Pete’s Press Emporium $12.50 $15,000
Chuck’s Casting Shack $10.50* $13,000
Capital breakeven in Product Cost Management Hiller Associates

Click to Enlarge!

* Redesign will be required to use Chuck as a supplier

Of course, capital is “considered” by Joey’s engineering team, but it’s hard to comprehend because it is considered separately from variable costs.  Joey would likely choose Pete as a supplier because Pete is cheaper on Piece Part Cost.  Joey won’t have to redesign as he would if Chuck was Joey’s supplier.  Joey’s Cost Target is based on Piece Part Cost.  Sure, his supervisor tells him to “watch the capital,” but the capital budget is this big amorphous pot of money that everyone shares, so Joey is not personally penalized for using it.

However, using a bit of eighth-grade math, we can graph the real cost to the company, including the capital amortized over the life the tool.  We see that the right decision for maximum product profit depends on the volume of products we will sell before more capital needs to be spent to refurbish or replace the tool.

Capital is Different… It’s MORE Important Than Piece Part Cost

The attitue of most product development teams towards capital shows that they implicitly believe capital is LESS important than the Piece Part Cost.  However, I would argue that the opposite is true for at least 3 reasons:

  1. Time Value of Money — You have to buy capital up front, spending the dollars earlier.  Using sophomore math and a proper cost of capital for the organization, you can calculate how much more expensive capital is than variable costs.
  2. Risk of Change — Capital Tooling is often called “hard tooling” because it is made for a specific part.  Often out of hardened steels that are expensive to manufacture and machine. But, the tooling is ‘hard’ in another way:  it’s hard to change.  Let’s say that Joey’s part failed in the field and needed to be modified.  It’s likely that the tooling will need to be to be modified, and tooling modifications are expensive.  So, how do we account for the risk of changes in calculations of tooling cost?  I will have to look into that, or perhaps, one of our readers can suggest a method.  One  method would be to ask the following questions:  What percentage of parts are modified after tooling is created and what is the average cost of tool modification as a percentage of the original tooling cost?  Using these two numbers, we could create a reasonable risk multiplier for capital.
  3. Return on Assets — Since the 1980’s, Wall Street has been obsessed with “asset light” companies.  Some of this is just Wall Street codifying reasons 1 & 2 in the stock price.  However, a lot of this has to do with leveraged buyouts and other financial “engineering” voodoo.  Regardless of whether assets light strategy really adds or subtracts value from the firm, Wall Street thinks it does.

These are just three reasons why capital is an expensive cost that should be considered as part of product cost and considered together with piece part cost.  There may be others, too, but at the end of the day remember:

Cars are not free and neither is the capital tooling for your product.

This advice may help keep you out of jail and/or the world of unprofitable products.

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