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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Dec 102012
 

I just read an article on the site “Strategy + Business” called Building Cars by Design.  It caught my eye for two reasons.  First, the fact that a strategy site would deign to talk about engineering concepts was a pleasant surprise.  Second, the article discussed Design-to-Cost and Design-to-Value.

If we strip off the automotive context, the main premises of the article from a Product Cost Management point of view are as follows:

  • Design-to-Cost means designing a car to a specific absolute cost
  • Design-to-Cost is bad because it does not take into account “value”
  • Design-to-Value needs to be used instead of Design-to-Cost, i.e. the product company needs to think about what features that customers value and then deliver these.

I applaud the authors for opening up a discussion on these topics.  However, I feel this article is incomplete and does not tell the whole story about these concepts.  It also doesn’t really say how to do any of these things or point the reader to somewhere he can further learn how.  Here’s my specific suggestions for improvement.

  • Define Design-to-Cost properly, please – Maybe this is just a bit of nomenclature nit-picking, but I have never thought Design-to-Cost means designing a product to a specific cost.   That is what “Targeting Costing” advocates.  Design-to-Cost is about considering cost as a design parameter in your product development activities.  I.E. the design engineer balances cost with other goals (performance, quality, etc.) with the goal of delivering any group of features at the lowest cost possible.
  • Define How to Calculate “Value” to the Customer – The authors say [paraphrasing] that a company should *just* find out what the customers value and then design a product that delivers those things.  I am sure most companies do want to do this, but they don’t know HOW.  I realize that how to calculate value is too complex for the article, but the authors don’t even provide a resource for the reader to learn more.  For example, I studied under Dr. Harry Cook and I am a friend and business colleague of Dr. Luke Wissmann.  At very least, the authors could have pointed the reader to a book on the subject, such as the one Wissmann and Cook wrote:  Value Driven Product Planning and Systems Engineering.
  • What if the Customer Can’t Afford the Value? – It’s difficult to know what the authors mean (even theoretically) by design-to-value.  Regardless, the authors seem to assume that the customer can always afford this value, but I don’t believe this is true, especially in the a second or third world context, which is the focus of the article.

Regarding the last point, I will do my best to illustrate the problem.  Take a look at the figure below in which I graph the value the customer gets from the product versus the price the customer pays for the product.  Presumably, the authors in the article are saying that customers would be willing to pay up to the point that the slope of the value/price decreases substantially (the curve flattens).  But, that assumes the customer has the money to spend – kind of a Field of Dreams Strategy, i.e. “If you build in value, they will pay.”

Product Value versus features and cost Hiller Associates

Click on picture to ENLARGE!

But, what if the customer truly does value a set of features, but he just doesn’t have the funds to purchase all of the value?  In this case, we have to concede that there is a Minimum Viable Product (MVP) needed for the customer to purchase. This term, MVP, is most often used in software development and start-ups.  It is the minimum set of features and functionality that a product must have to have ANY value to the customer.    If you can’t master design-to-cost in your product so that it both includes the MVP features the customer needs  and allows you make adequate profit under the price ceiling of your customer, the product will not be successful.

If the customer has less funds than the MVP to deliver in your product, they can’t afford it.  Similarly, even if the customer has more funds than the MVP requires, but less than when the value/cost curve flattens, you cannot employ a blind strategy of maximizing value to the flattening point of the curve and price near it.  You are still going to have to set your price below your customer’s funds to succeed.

So, are the authors of the article talking about design-to-value to the point that the value/price flattens or to the point where the price ceiling of the customer intersects the curve?

Anyone? Anyone?  Bueller? Bueller? Bueller?

 

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Nov 052012
 

 

Last week, Hiller Associates published an article in Tech-Clarity with the title:

PRODUCT COST MANAGEMENT AS A LINK BETWEEN ENTERPRISE SYSTEMS

Here’s an outline of the article:

  • Siemens PLM recently bought Perfect Costing Solutions from Tsetinis & Partner.  What does this mean?
  • To answer this, let’s first ask, what IS Product Cost Management and what does PCM software really “do”?
  • Now that we know what PCM software really does, who would value this in the Enterprise Software world?
  • There are look’s of possible categories of enterprise software that could value PCM software, but the most likely are PLM and ERP.
  • Product Cost Management software  is really a bridge linking the engineering language of physical things to the rest of the organization (purchasing, supply chain, finance, manufacturing, etc.) who primary speak the financial language of dollars.
  • If independent PCM software companies are not bought by a large PLM or ERP player, what are the other possible options for their future?

Here’s a teaser diagram from the article, just because who doesn’t like maps?

Product Cost Management Bridge from PLM to ERP Hiller Associates

Click to Enlarge! The position of PCM Software in the Enterprise World

 

My thanks to Jim Brown and Tech-Clarity for the publishing platform to discuss this subject – Eric Arno Hiller

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Sep 112012
 

Today is a day of solemn remembrance for Americans and many around the world who remember the 9-11 attack on the the United States of America.  However, there is at least one person who likely quite happy today for a very different reason: Andreas Tsetinis. Siemens Acquisition of  Tsetinis Perfect Cost Hiller Associates   Andreas is the Founder and CEO of Perfect Costing Solutions who makes Tsetinis Perfect Pro-Calc and Perfect Calcard.  In the biggest Product Cost Management (PCM) news of the day, Siemens PLM (specifically the Industry Automation Division) has announced the acquisition of Perfect Costing Solutions.

What is Tsetinis and What are Its Products?

For those of you who are not familiar with Tsetinis & Partner (parent of Perfect Costing Solutions), it is an integrated product cost company of software tools and consulting services. Siemens Acquisition of  Tsetinis Perfect Cost Hiller Associates Many people consider the software tool side of the Tsetinis business, Perfect Costing Solutions, the recognized market leader in Europe for the PCM.  In the last couple of years, the product Perfect Pro-Calc has also been making inroads in the US.  Perfect Costing Solutions makes two software products:

  1. Perfect Pro-Calc – This is a cost estimation tool used primarily by costing experts.  It is fed by manual input that allows predictions of cost for mechanical and some electrical parts.  Perfect Pro-Calc also includes that ability to roll up costs in a hierarchical BOM structure that the user defines.
  2. Perfect CalCard – This is a software focused on capital tooling (injection molding, casting, and stamping) cost estimation by tooling experts.  It has the capability of accepting 3d solid CAD models as input to the costing process, although, I am personally not aware how advanced this ability is.
Per the Perfect Costing Solutions website, “today over 240 companies in the automotive sector and other industries successfully use our products.”  Perfect Costing Solutions has 50 employees according to the Siemens press release.

What does this mean for Product Cost Management?

Product Cost dominos Hiller Associates

The last year, starting from September of 2011, has been a very eventful year in Product Cost Management.  First, Solidworks unveiled its first foray into the PCM world:  Solidworks Cost — the first tool, besides aPriori, that can cost parts directly from geometry.  Then PTC announced Windchill Cost.  Windchill is not a cost generation tool, but is a cost management / roll-up tool that builds off of Windchill.  It allows customers roll-up costs generated by other softwares or methods and track and analyze these costs.  Now we have the very first Product Cost Management acquisition (Perfect Costing Systems, Gmbh) by a major Product Lifecycle Management player (Siemens).  This begs many questions, among them:

  • Will the PLM companies begin to dominate the PCM space and crowd out the pure plays?
  • Will Siemens attempt to build CAD Feature Based Costing abilities into Perfect Pro-Calc?
  • What does this mean to PCM software companies; will other players acquire specialized PCM software companies?

I am going to see if I can get an answer to these questions.  In an eerie coincidence, just this week, Jim Brown of Tech Clarity and I were just discussing me writing an article about where Product Cost Management might settle out in the enterprise software landscape.  It sounds like it’s time for me to write that article…

What does the rest of the PCM world think about the Siemens acquisition of Perfect Costing Systems.  Please let us all know by commenting!

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Sep 052012
 

Yes, you read the title correctly.  It may sound like an oxymoron, but some form of this statement is uttered every day in the world of Product Cost Management (PCM).  Usually, a company, will say, “I don’t have time for profit.” right before it notifies the PCM software vendor that it cannot buy the vendor’s tool at the current time.   Sometimes, the statement is spoken to a PCM consultant who is proposing an engagement to boost the profit of the company.

The customer typically does not convey the thought exactly as the title says.  It is usually more eloquent, such as:

Um, yes well, I’m sorry, but times are pretty bad here.  We just got our quarterly results and sales [or profits] are down.  Our management is having to really tighten their belts, so we have to put the implementation of your software [or your consulting engagement] on hold until times get better.  It’s a shame, because everyone really liked your software and thinks it would significantly benefit our bottom line, but we just can’t invest in anything right now.

Actually, I am a pretty naive guy, so maybe this is the customer’s way of politely telling the vendor that they are not interested in the vendor’s or consultant’s product or service (or that there are better options to increase profit).  Maybe the customer is trying not to hurt the sales guy’s feelings — similar to the girl that makes up legitimate excuses why she can’t go out with you every time you ask her out.  However, I actually believe most customers are very honest about these things, and they are telling the vendor the truth.

Manufacturing companies are really saying:  “This is no time to think about profit! We’re doing badly enough already.”

Paraprosdokians

There is actually a word for a statement such as the title of this post.  It’s called a a paraprosdokian — a statement that leads you to start drawing conclusions in one direction and then finishes in an unexpected (and often humorous) different direction.    Winston Churchill, Groucho Marx, and Henny Youngman were all masters of these grammatical zingers.

The difference here is that I don’t think the customers intend the paraprosdokian.

No time for profit right now

I have observed an interesting phenomena during my years in the Product Cost Management.  One would think that the companies in need of Product Cost Management are the ones that are facing a profit problem or a sales decline.  The idea is that the PCM improvements would generate greater profits to make up for sales volume loss.   However, these firms are regularly the ones that will delay buying a PCM tool or seriously engaging a PCM expert.

No time for Product Cost Hiller Associates

This phenomenon reminds me of a cartoon that one of my bosses once showed me (see figure to the right).

Conversely, the companies that are the fastest buyers of PM tools and consulting are those that are doing really well and want to keep on winning. These companies use PCM as a steroid to pump their profits, but in reality, it is the companies having a tough time that truly need the vaccine of Product Cost Management.

I find this an ironic Catch 22.

Damn the Torpedoes, Full Speed Ahead!

To firms who are facing difficult quarters with sales and profit, I would say, that most of your business brothers sympathize.  We have all been in your position before and may be in it with you right now.  However, now is NOT the time to accept less profit. Now is the time to make more profit, so you can trade-off profit vs. increase sales through market share.

I’m not sure my reasoning will convince all the firms out there that are delaying taking serious action to improve their PCM culture, process, human resources, and tool kits.   However, I do hope that the decision makers in some of the firms that read this article will think twice before summarily delaying the improvements on Product Cost Management.  If you and your fellow managers and executives have already agreed already agreed that PCM is needed, don’t be so quick to casually push off the PCM work until next quarter or next year.  The time for more profit and sales is now.

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Jul 232012
 

Last week we began talking about a common problem in many projects, including Product Cost Management: the withholding of needed data for analysis and modeling.  We also talked about the many reasons, some legitimate and some not, why people refuse to share data. Those reasons are summarized in the graph below.

Then I introduced one way of working through the data withholding problem.  I call this technique Habeas Corpus Data.

Excuses for no data in Product Cost Hiller Associates

Reasons people withhold data [CLICK TO ENLARGE}

It’s very simple and works like this:

  • Politely and ardently make your case to the data gatekeeper as to why they should share the data with you.
  • If you are rebuffed, ask your management or project champion to see if he can break the data roadblock.
  • If you are still ignored, simply nod politely and stop asking. Instead, go and make an assumption for what the data should be.
  • Present your findings (based on your assumptions for the withheld data) in the presence of the data prison warden (be it the individual or organization that is withholding).
  • Sit back and watch the chaotic scrambling of the data warden.

This is the typical flow of the Habeas Corpus Data process, but in reality, the result will be slightly different depending on the real reason that the person or organization is guarding the data. In our post today, we are going to go through each reason and talk about the result that Habeas Corpus Data has in each case.

1. Data truly requires confidentiality / conflict of interest

This is the best and, really, the only legitimate reason that data should ever be withheld. Fortunately, it’s also the rarest. Very little data really needs to be kept confidential, especially to another member of the same product program or a consultant who is under a Non-Disclosure Agreement (NDA) already.

Effect of Habeas Corpus Data: The data holder probably feels guilty already for having to withhold the data. If the data is legitimately confidential, he will likely give you an indication of how good your assumptions are saying something such as: “Well, I can’t tell you the exact values, but you’re not making a bad guess.” Or “Well, I can’t tell you the exact values, but I would reconsider your numbers, because they aren’t remotely close.”

The more important effect of Habeas Corpus Data happens when the person or organization is using “confidentiality” as an excuse for one of the other five reasons. This is the common result. In this case, the data warden will start complaining about your results, to which you will politely reply, “Oh, well I had to make an assumption, but if you have actual data that is better, I am happy to redo the analysis with quality assumptions.” This is basically checkmate for you. The data warden will either immediately produce the data, or mumble something vague about having to check with his manager about seeing if he can share the data. This is your permission to promptly follow up a day later to see if that “permission” has been received.

2. Legitimate concern that colleagues / partners understand the sensitivity

Sometimes data is not officially confidential in the sense that it cannot be technically shared with someone of your clearance, but the data warden is personally concerned that you do not understand the sensitivity of the data.

Effect of Habeas Corpus Data:  Habeas Corpus Data will almost always make the data warden reconsider his reservations. He may initiate a discussion with you directly or with your executive champion to re-emphasize the gravity of the data he will now share, but you will get your data.

3. Does not know the data asked for

Sometimes the person you ask does not have the data.

Effect of Habeas Corpus Data:  The question is, “should” he have the data?  If the answer is no or maybe, consider who else might have the data. However, if the data would normally reside in the bailiwick of the person or organization, the organization may welcome your assumptions as the first steps in researching the needed data and may ask you to work with them in refining your assumptions.

4. Too busy or lazy to assemble data

Effect of Habeas Corpus Data:   If the reason that the person or organization does not know the data is because they are busy with other things or the organization is simply negligent, Habeas Corpus Data will force them to prioritize digging out the data that they do have in their organization.  If they do not currently have the data they will typically prioritize the due diligence required to get it. Otherwise, they will be forced to accept your assumptions.

5. Job security / authority protection

Sadly, the two most common reasons people withhold data are the two most illegitimate reasons. First, many people see data and/or knowledge [which is valuable] as one of the biggest contributors to personal job security. This may seem strange to some younger readers, who have grown up in the world of the internet and social media.  In the internet world, sharing (not hoarding) ideas makes one popular and successful. On the other hand, consider the importance of “content” (the fancy internet word for data) ownership and rights. Many people do not want to share the data they have personally appropriated from the organization, believing they will be less important without the data.

Effect of Habeas Corpus Data:   Even if he personally still does not want to share data, if the audience with whom you share results includes the data warden’s colleagues, it is highly likely that one of them will force the Data Warden to relent. They will not want you using incorrect assumptions that produce incorrect results. If these results are used and lead to a bad decision, the executives will start investigating the analysis chain and discover that the Data Warden’s organization had data and were aware of the analysis, but refused to share.  Habeas Corpus Data typically makes the fear of being seen as a data hoarder greater than the fear of losing your job from sharing data.

6. Fear of exposure of mistakes

Everyone makes mistakes, but some people are more sensitive than others about having their errors exposed. Without the proper data, it is very difficult to prove that a decision was right or wrong in the past. Obviously, you are rarely explicitly looking for mistakes in Product Cost Management. However, with the right data, you may well uncover honest mistakes from the past, or simply new opportunities to re-source, re-route, or re-design a part or product. Many people are uncomfortable with someone finding out that their original decisions were not optimal and/or they just don’t want the hassle of having to deal with a certain part again.

Effect of Habeas Corpus Data:  The effect of Habeas Corpus Data in this case is similar to the effect it has on “5. Job security / authority protection.” Habeas Corpus Data typically makes the fear of being seen as a data hoarder greater than the fear of discovering a past mistake or opportunity discovered.

Is Habeas Corpus Data Too Harsh?

Habeas Corpus product cost data Cost Hiller AssociatesMake no mistake, Habeas Corpos Data is a powerful technique. However, readers should not view it, nor practice it with the attitude of being a “data extortionist.” Much like the martial art of Judo, Habeas Corpus Data is really the “gentle way” compared to your other alternatives, escalating the data withholding in a loud way to the executive ranks of a company.  As I discussed above, Habeas should not be used until you have personally made your case to the data gatekeeper and asked your immediate management or project champion to see if he can break the data roadblock.  Like Judo, Habeas Corpus Data will often allow you to control your data withholding opponent without harming them. It allows them to gracefully back down from their recalcitrant position in a way that will allow them to save face in front of your executives and theirs.

 

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Jul 192012
 

Data.

At the end of the day, the data and assumptions that we use in Product Cost Management, specifically in cost models, is as (or more) important than the equations and the approach to modeling itself.  The classic example in cost modeling is raw material rates ($/kg for steel, plastic, etc.). A close second and third in importance are the labor rate ($/man-hour) for work in a given manufacturing activity and direct overhead rates ($/machine-hour).

Good, trustable data can be very hard to find in a company, even when everyone in the company wants to help the cost modeling effort. However, a bigger problem is not the unavailability of data, but the unwillingness of people to share the needed data with you. If you have ever been involved in a Product Cost Management (PCM) effort, especially one involving cost modeling or implementing a PCM tool, you have certainly encountered this problem.  Certain people and whole organizations will be unwilling to share data with other organizations and/or with you personally as the PCM professional who is trying to help the firm.

So, what do you do when you run into this data stonewall? Today, I would like to share a very powerful but simple technique that I discovered years ago. Some may call this technique by another name, but I call it “Habeas Corpus Data.”

Why People Withhold Data

As a young researcher at University of Illinois, I was flabbergasted the first time that I was on an internship and someone became squirrely or delaying regarding data.  At a university, of course, the goal is to freely share and promote good data to advance the common good of learning and research.  However, in organizations this is not the case.  Over the next few years, I realized that withholding data was the norm, not the exception in many organizations.  The natural question one asks when told “no” is “why?”  I have been given a lot of excuses, ranging from the presumably plausible to the outright ludicrous.  However, they mostly break down into the six categories shown in the pie chart below.  Furthermore, in my experience they break down in the proportions shown.

Excuses for no data in Product Cost Hiller Associates

Reasons people withhold data [CLICK TO ENLARGE}

As you can see, the first three categories, are legitimate concerns that need to be addressed.  However, you will also note that this is a minor part of the pie.  The lion’s share of the reasons given are simply excuses that should not be tolerated.  The most frustrating thing is that no matter how illegitimate the real reason for withholding data is, the withholder will tell you a covering lie.

So, what do you do when you find the data door locked? Easy! You use Habeas Corpus Data to storm the castle.

Habeas Corpus Data

Many of the readers may remember Habeas Corpus from junior high civics class as the Latin phase meaning “you must present the person in court.”  This legal idea originated in 12th century England and means that you cannot hold someone in detention without first showing sufficient cause.  Or, as William Blackstone explained in 1305 “The King is at all times entitled to have an account, why the liberty of any of his subjects is restrained, wherever that restraint may be inflicted.”  [Maybe that means you are the King and the data are your subjects?… oh, if only Product Cost Management were so glorious!]

Just as the court demands a reason for imprisonment of a citizen, so too you demand a real reason why the data is being held hostage. But, how do you expose the data despot for the unlawful detainment?  Here’s the key to the prison cell:

Make and assumption and present the results from your work.

For example, if purchasing will not cough up a supplier’s labor and overhead rates for the cost model on which you are working, you assume a labor and overhead rate based on your past experience and expertise in PCM.  It does not even matter if your assumption is close to the real numbers.  When you present your results for the costs of the product or part, the warden of the data prison will very likely be present.  You should make sure of it, which will be easy, because he is likely be a key stakeholder in the product cost project.   As this point, you are effectively calling his hand, and he will have to lay down his cards and show the true reason why he is withholding data.

Why does Habeas Corpus Data have this effect on the warden of the data?  First, he will be shocked you were able to proceed with your work without his data.  More importantly, he will get very worried how your results (which are based on your assumptions, not his) will affect his job.  The exact effect that Habeas Corpus Data will have depends on which of the six reasons for withholding data is the real underlying reason the person should have admitted in the first place.

Stay tuned next week, and I will will let you know the specific effect Habeas Corpus Data has based on the true each reason for data withholding.

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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 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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