Buying the shake weight as the solution to your bad product cost eating habits

Jan 292013

Hiller Associates recently was the keynote speaker at aPriori’s first customer conference. It was a great opportunity to both teach and learn from experts that came from a wide range of industries and geographies.

Hiller Associates’ President, Eric Hiller, discussed several topics, of which we’ll mention two here. The entire presentation can downloaded for FREE. Just click on the slide below and get the presentation: Best_Practices_for_Starting Your Procuct Cost Management Journey or Improvement.

Variance in Cost Numbers

One of the main themes discussed was the possibility of getting an “accurate” cost, meaning how possible is it to get a cost that is within a certain percentage of a fixed point of reference, such as a supplier quote. There are several ways to look at this problem that we may discuss in subsequent weeks on this blog.

Eric Hiller at aPriori STARS 1 2012 product cost Hiller Associates

Eric Hiller presenting the keynote speech at the aPriori Customer Conference

However, in summary, the presentation asked the question: what cost variance is inherent in your system already? For example, if your 3 quotes from supplier have a range of 30% from highest to lowest, then is it realistic to expect the cost that you calculate in a product cost management software to be closer than 30% away from a random quote?

It was refreshing to see how open the audience was to these concepts. The reactions to the variance concept went from wide-eyed amazement from people who were new to the cost management field, to thoughtful reflection from the veterans. In fact, the veterans reacted like men who had been reminded of a truth that they knew all along. Often, such common truths are forgotten due to immersion in the day-to-day challenges of keeping a company profitable. We call this concept having a “blinding flash of the obvious” – a BFO. Everyone in the room had that BFO, and no one wanted to argue about it. Instead, there were many comments throughout the conference that further explored this concept.

Culture is the biggest loser

Another theme of the presentation was driven by the latest research in Product Cost Management done by Hiller Associates. Those who follow us regularly know that we segment problems in our consulting work into four root causes: Culture, Process, Roles/People, and Tools.

Our latest research shows that cultural problems are the clear bottleneck in most firms’ Product Cost Management journeys. The respondents overwhelmingly agreed. When Eric ask the attendees which area was their firm’s biggest PCM bottleneck, the conference participants voted as follows, based on a rough estimate of hands in the air:

Best Practices for Product Cost Management Hiller Associates

CLICK TO GET FULL PRESENTATION

Culture 60-70%
Process 20-30%
People/Roles 0-5%
Tools 5-10%

That’s fairly shocking at a conference whose organizers are a Product Cost Management TOOL vendor. [Next time HA will have to set our honorarium higher for taking the pressure off of any problems with the vendor’s product!] Joking aside, culture is obviously the biggest problem and it is not an easy thing to change. In fact, companies often buy a PCM software tool hoping that it will somehow magically fix their bigger cultural problems.

It reminds one of obesity problems. Many companies have a culture of binging on product cost during design. In purchasing & manufacturing they continue with cost obesity denial — not know what the cost calorie count is until the parts arrive at the door with an invoice. However, instead of changing their cost eating and exercising habits, they look for a magical cure in the form of a software tool. Let’s call this “the shake-weight approach” to product cost management.

We’re not disparaging the shake-weight, or any other home exercise equipment. Certainly, all home exercise equipment can help you lose weight, just as we are sure that all of the PCM Tools can help one reduce cost. But, you have to use these tools regularly and properly. PCM software tools are too much like home exercise equipment. People buy them thinking that the tool will magically solve cost obesity. They use the tool twice and then it sits in the corner unloved, unused, and unmaintained… and, yet, people wonder why they are still product cost obese! It’s not the tool that the problem, it’s your culture. Much like changing your eating lifestyle, changing the PCM culture is really hard and tricky to do. That’s why cultural issues are often at the forefront of most of the engagements that we do with clients at Hiller Associates.

However, it was refreshing to see that the attendees at aPriori’s conference did seem to understand this problem, or at least were very open to the idea. So, maybe we are making progress on this point. Or, maybe HA needs a TV show “The Biggest Cost Loser” in which Hiller Associates works with companies to increase product profit with weekly product cost “weigh-ins.” What TV viewer wouldn’t watch that kind of riveting drama…

Now, get out there and do some product cost push-ups!

If you would like to see the entire presentation from the conference, just click on the slide image above and get the presentation: “Best Practices for Starting Your Product Cost Management Journey or Improvement.”

This is no time to think about profit! We’re doing badly enough already.

Product Cost Culture, Product Cost Management No Responses »

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.

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.

The 6 Reasons Why People and Organizations Withhold Data (Habeas Corpus Data, Part 2)

Product Cost Culture, Product Cost Management 1 Response »

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?

Make 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.

Habeas Corpus Data (Part 1)

Product Cost Culture, Product Cost Management 2 Responses »

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.

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.

The Voice of Should-Cost (Voices Series, Part 3)

PCM Technique / Cost Models, Product Cost Culture, Purchasing / Sourcing, Uncategorized 4 Responses »

Jul 092012

It’s been a couple of weeks, since we discussed the Voices series, so if this post is interesting to you, you may want to go back and read the first two:

In these first two articles we introduced several of the voices that are always present in the Product Cost Management conversation, including:

The Voice of Hopefulness – the Pollyanna voice that assumes product cost will just work itself out in the end. It is a voice of justification to ignore Product Cost Management, because the team is just too busy at XYZ point in the development process to seriously consider product cost. Hope is NOT a strategy.
The Voice of Resignation – the nihilist voice that assumes that you have to accept high prices because the three suppliers that purchasing quoted gave you pricing far higher than what seems reasonable
The Voice of Bullying – the seemingly unreasonable scream of the customer telling you what your product should cost — not based on reality, but based on the customer’s own financial targets.

However, there is another voice in the conversation that can bring some reason to the cacophony. It is a voices of reason — the Voice of Should-cost.

Buck-up Cowboy. The Voice of Should-cost Can Help

Should-cost is just what it sounds like, using one or more techniques to provide an independent estimate of what the cost of a part or product “should” be. The question is, what does “should” really mean? For many, the definition depends on the type of cost being calculated, as well as personal should-cost calculation preferences. I will provide my own definition here, mostly targeted at providing a should-cost for a discretely manufactured part.

Should-Cost – The process of providing an independent estimate of cost for a part, assembly, component, etc. The should-cost is based on a specific design, that is made with a specific manufacturing process, and at a supplier with a specific financial structure. Or, the should-cost is calculated assuming a fictitious supplier in a given region of the world that uses the best manufacturing technology, efficiency operating at maximum sustainable capacity.

I realize that this is a broad definition, but as I said, it depends what you want to estimate. For instance, do you know the supplier’s exact manufacturing routing, overhead and labor rates, machine types, etc.? In this case, do you want to estimate what it “should” cost to manufacture the part under these conditions? OR… do you want to know what the cost “should” be for a new supplier who is well-suited to manufacture your design and has a healthy but not overheated order book? Although you could make many other assumptions, the point is: KNOW YOUR ASSUMPTIONS. You will note that I said nothing about margin. Some people call this a “Should-Price,” while others call it a “Should-Cost” referring to what they will pay vs. what the part costs the supplier to make. The only difference is that you will also make an assumption for a “reasonable” margin for a Should-Price.

The important point is that the team relying on the should-cost information must define the scenario for which they want a should-cost estimate. There is nothing wrong with wanting an answer for all these scenarios. In fact, it’s preferable. Run the calculation / estimate more than once.

Should-cost, Should Be a Choir, not a Solo Act

Manufacturing cost is a very tricky thing to calculate. I often say that the true cost of the economic resources to make a part or product is a number known but to God. Put statistically, you can’t know the true meaning or standard deviation of a population, you can only estimate it from the samples that you take. People take two common approaches to should-cost.

The Pop Star Solo Act

The popular solution that too many people pursue is the solution pictured at the right.

There’s no easy button to should-cost

They want the easy button — the single source of truth. They want the plasticized overproduced solo pop star version of should cost, i.e. the easy button tool. There’s nothing wrong with this and there are some really good should-cost solutions available, but none of them are infallible. In addition, it is not appropriate to put the same should-cost effort into each part or assembly in a problem. One should focus where the money is. However, too many people, especially cost management experts, become sycophants of one particular tool to the exclusion of others.

Single estimates in Product Cost Hiller Associates

The Lonely World of a Solo Should-cost Voice

Looking at the diagram to the left, you can see what the landscape looks like when you make your comparisons to one point in cost space. It is an uncertain, scary world when you only have one point of reference. In this case, all one can do is try to force a supplier to match the should-cost output of your favorite tool.

The Andrews Sisters, Competitive Trio Quoting

The other very popular approach comes from the purchasing department: three competitive quotes. If the auto-tuned single pop star should-cost is too uncertain, purchasing will listen to a trio instead. Why three quotes?

Supplier quotes in Product Cost Hiller Associates

The Trio of Should-cost Quoting

No one seems to know, but in EVERY purchasing department with which I have ever worked, three shall be the number of the quoting, and the number of the quoting shall be three. [If you are an engineer, you know my allusion. If not, watch the video to the left!] The trio of quotes in the diagram to the right do help clarify the picture a little better, but there is still too much uncertainty and what I call “commercial noise” to really believe that the quotes alone bound what the should-cost plus a reasonable margin is in reality.

An Ensemble of Should-Cost Estimates

Returning to our statistics example, one of the first things you learn in statistics is that it takes about 33 samples to characterize a bell curve distribution. At 33 samples, you can start to approximate the true mean and standard deviation of the actual population. I am not saying that one needs 33 estimates of should-cost to triangulate on the true cost, but you should get as many as you can within a reasonable time frame. Have a look at the diagram at the right to see this illustrated. Instead of the single pop star approach or the Andrews Sisters trio of quotes, hopefully what you get is a well-tuned small chorus of voices who start to drown out the Voices of Resignation, Hope, and Bullying. The chorus of should-cost estimates start to bound the “true” should-cost of the part or product and can give the team a lot more confidence.

Triangulating on Product Cost Hiller Associates

Chorus of Should Cost [CLICK TO ENLARGE!]

Sometimes the team does not have time to assemble all the voices of should-cost. Not all parts or products are worth assembling the full choir. More often than not, the organization is either unaware of the should-cost voices at its disposal, or are just too lazy to assemble them.

Don’t let your organization be lazy or sloppy with respect to should-cost, and remember that the best music is made when groups of instruments and voices work together, not when one person sings in isolation.

p.s. Bonus PCM points if you can guess what a cappella group is pictured in the thumb nail to the post

Don’t Pave the Cowpath; Plan the Autobahn (Part 3 of Pete Schmitz at Harley-Davidson)

Product Cost Culture, Product Cost in Industry, Product Cost Management, Purchasing / Sourcing No Responses »

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:

Culture
Process
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.

What’s in a Product Cost Part 1 — Grand Theft Auto [Capital]

Product Cost Culture, Product Cost in Industry, Product Cost Management 2 Responses »

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:

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.
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.
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.

Do you hear the voices? (Voices Series, Part 1)

Product Cost Culture, Product Cost in Industry, Product Cost Management 4 Responses »

May 142012

Lately, it’s become popular to talk about “voices” in business, e.g. the “Voice of the Customer.” With all the voices, it is difficult not to wonder if one is listening in on a business meeting, or a group of choral composers arguing over the score’s balance, psychologists trying to diagnose a patient, or a kitschy show with karaoke singers trying to go pro. I believe that the “voice” nomenclature is the new new way to say “stakeholders,” a term that was the new way to describe the groups of people and forces of the universe that prioritize your product decisions and limit its possibilities.

All frivolity aside, the Voices framework is not a bad one. Instead of arguing over what we call the rose, I’d like to focus on WHO and WHAT those voices are with respect to Product Cost Management. Click on the diagram to the right. In this graphic, I show three categories across the product development cycle:

Voices in Product Cost Management Hiller Associates

Click to Enlarge! Voices in Product Cost Management

What are the ‘Voices’ in the discussion of product cost and profit
What are the target costs or cost statuses that the voices dictate or influence
What are the ways that people can estimate the cost target or cost

The First Voices in the Discussion Had Better Be Balanced

The first two voices are the Voice of the Customer and the Voice of the Business. The Voice of the Customer is supposed to tell you what consumers will pay for a certain bucket of product features and attributes based on perceived customer value. Understanding the weird customer dialects isn’t so easy because customers won’t give you an exact number for the price they expect, such as $44.85. If customers do give you an exact number, the number should still be considered fuzzy because customers have a hard time conceiving the value of your intended offer. It is traditionally marketing’s job to read these tea leaves in order to decipher the Voice of the Customer.

The second voice, the Voice of the Business, gives us the Product Target Price and Product (System) Level Cost Target. To illustrate, the CEO or Group VP comes in and says, “We need X total revenue and Y market share,” and the VP of Finance comes in and says “We need to have Z profit margin on the product.” Great! Right? Well, yes, but this is a TOP-DOWN cost target, or as the EE‘s in the room would say, an “open loop” control. Normal people refer to this as an “estimate” or a “guess” (a.k.a. a hope).

Trade-offs in Product Cost Management Hiller Associates

Click to Enlarge! Product Fiscal Planning Triangle

The hopeful nature of the top-down product cost target is why the next voice in the discussion is so important: the Voice of Reason. What modern businesses don’t like to think about (or have been taught not to by consultants) is that there is a fairly rigid triangle (see the figure to the left) linking the price you must charge (or the customer will pay), the feature set (value) you will deliver in the product, and the product’s cost (margin). If you set two of the corners of the triangle, the third will move to compensate. I am not saying that people cannot do better on their product cost, but there are limits.

The key is to ALSO estimate what is theoretically possible for product cost in a BOTTOMS UP way — given REASONABLE assumptions.

The bottoms-up estimate moves you from an open loop control to a closed loop control (with feedback for adjustment), as the EE’s would say. If the top-down and the bottoms-up costs are too far apart, somebody needs to throw a flag. The first figure above shows the methods one can use to get an early bottoms-up product cost estimate. Another voice that is often not heard is the Voice of Intent. People often just assume a design alternative and immediately launch into full scale engineering. But the old DARPA study told us that 80% of cost is decided in the first 20% of decision making. So, the solution is pretty obvious.

Spend significant effort and time in the concept design stage seriously generating, considering, and costing a series of alternatives with your cross-functional team of design, manufacturing, purchasing, etc.

Spend the money needed on comparative teardowns of carryover systems you plan to cost reduce and systems with new features you plan to design versus similar systems of your competitors’ products. Spend time together in a workshop evaluating your design alternatives and estimating your costs (raw material, manufacturing, shipping, etc.). You do not need triple point precision — you only need a good enough estimate to allow you to compare one alternative to another. Then you should give a REVISED Product Cost Target to management and marketing. Very little cost has been spent up to this point, so if a program needs to be stopped or modified, now is the time!

Keep the Conversation Going

The next voice that should be in the product cost discussion is the Voice of Engineering. Often, the discussion on product cost just stops for months or years until suppliers send in the first quotes at the end of the detailed design phase. However, the conversation should continue. Where is the engineering team in their cost roll-ups? Have they discovered problems and barriers that will force costly changes, or have they found clever ways to beat the cost target?

Shrink the Triangle with Should-Cost and Spend Analytics

The Voice of Partners and the Market refers to the price your suppliers (or your internal plant) will charge you to produce your design. If you want to get the best prices, it is important to understand another triangle: the Purchased Cost Triangle (to the right). The corners of this triangle are the price the supplier or plant quotes, the final cost you negotiate with the supplier/plant, and your should-cost calculations. Here’s the secret: this triangle is much more flexible and stretchy than the product fiscal planning triangle above. Powered by the number and quality of your should-cost and spend analytics estimates, you want to drive all three vertexes together and converge. Product cost is a difficult and fuzzy world; it’s even fuzzier when you have no facts (or even well-reasoned estimates) to rely upon.

Triangulating in Product Cost Management Hiller Associates

Click to Enlarge! Purchased Cost Triangle

If you want your Negotiated Costs to reflect the actual costs of manufacturing plus a reasonable supplier margin, invest heavily in good Should Cost and Spend Analytics.

If that’s too hard or too expensive… well, it’s only your product’s profit anyway, right?

Time to Pay the Piper

For the most part, the final voices settle things. The Voice of Realization happens when you actually start to make the product and do the formal accounting to see what the product actually costs. Sadly, this is where most companies spend the lion share of their product cost management effort. This is not to say that there are not opportunities to reduce costs after launch. However, this is not where companies should be spending a lot of Product Cost Management effort. Cost is pretty much set at this point, and companies should be working on the NEXT product.

The last voice is the Voice of Regulation / Responsibility. In general, the Voice of Regulation should be known up front, in regards to disposal fees or other government penalties and taxes for which the company is responsible. On the other hand, the Voice of Responsibility is trickier. The company should take its warranty predictions very seriously. Most products, though, tend to have surprises, and they are typically not positive surprises. Sometimes, the Voice of Responsibility speaks with legal authority (e.g. contractual warranty), but it should also speak to the corporate conscience to do the right thing for the customer, even when the company is not legally bound.

Next week….

This week we talked about how things SHOULD work. However, the framework and solutions presented are not how many companies DO work. Next week, we’ll talk the ad hoc and emergent system by which most companies operate, and what problems this causes.

Five Questions to Ask Before You Run off to Re-quote

Product Cost Culture, Product Cost Management, Purchasing / Sourcing No Responses »

Apr 232012

Today, I’d like to talk about when it is prudent to poke the tiger, so to speak. During a client visit a few weeks ago, I learned of two situations the company had experienced involving re-quoting parts with the supplier. Although the situations were similar, they resulted in two exactly opposite outcomes – one happy, one sad. The happy situation went like this:

We had the big casting on a housing of our product. One day we were talking in passing about how this casting cost us $500. One of our machinists overheard us and his eyes popped open. He exclaimed, ‘$500! That is only about a $100 casting!’ So, we made a very gentle inquiry of the supplier about this casting’s cost, and before we even mentioned shopping the part, they had dropped the part price to $150. On one hand, we were happy, but on the other, we wondered, were these guys cheating us? How many other parts like this were in our bills of materials?

Later that day, I found out about the sad re-quoting situation:

We were trying to find savings on a bucket of parts and thought we had an interesting design change that could lower cost. Our supplier was happy to recalculate based on the design change as time had played a role in the price of parts. He said, “I think that there will be a $14 per part savings for the design change, but this part was quoted five years ago and the material cost and our costs are now higher. The increase is over $20 on old design and $15 on the new design. I’m sorry for this, but we have to ask for a price increase, because we are upside down on this part.”

These situations highlight a lot of latent problems, forcing me to ask:

How did a $150 part get through quoting at $500?
Why was material cost not indexed on these parts, so that the OEM and the supplier were protected and unsurprised by raw material price changes?
Is the spend reviewed on a regular basis by a spend analytics tool that looks for outliers (positive and negative)?
Etc. etc.

These answers to these questions are beyond the time that we have today. What this company needed in both situations was a good, speedy, should-cost process and a tool to support their quoting, re-quoting, and re-design processes. However, there are a few things that this company could have asked immediately (without a should-cost tool)? The following five questions are a powerful and fast filter to determine were a company should look deeper into re-quoting or not.

What is the change in raw material price from the time the part was quoted – You know when the part was last quoted, its composition, and mass. It’s even better if you know the portion of the Piece Part Cost that comes from raw material, but you don’t really need it. There are paid sites such as American Metals Market, MetalMiner, London Metal Exchange, and Plastics News that calculate materials pricing. You can also access free data from the US government at the Bureau of Labor Statistics. Look up the price of the materials on the date you last quoted and today. Take the part mass and calculate what the difference would be. Then you will be able to avoid poking the tiger of asking for a re-quote when the cost of the raw material has risen significantly (as we see in the second situation above).
Was the part quoted in a bundle or individually? Parts that are quoted in packages and bundles typically have less precise pricing from the supplier than individual parts. The supplier will want to make money on the bundle and may not put in that much effort to see that they are making appropriate profit (not too high or low) on an individual part. There may be more opportunity on a bundled part than on an individually quoted part. But, beware, you risk ‘cherry picking’ the part with the supplier and damaging your relationship with them. Also, you should check whether your contract on a bundled part even allows you to re-quote an individual part, or only the entire bundle.
What is your buyers relationship with the supplier? – Although business is business, people still buy from people and make decisions in a way that is not always wholly rational, i.e. goodwill and bad will matter. If you are dealing with a supplier whose relationship is rocky with your company, make sure that the amount of money you think you will save on your part is worth potentially souring the relationship. Conversely, your part may become a battlefield where the buyer and the supplier fight out an existing cold war that has been brewing between them. Your part may get punished for reasons that have nothing to do with the situation at hand.
Click to Enlarge: Cost per Mass Analysis
Do a simple cost/mass spend analysis on Piece Part Cost of that commodity – Pricing and cost are not precise sciences, but they do follow general trends. You don’t have to do a full and fancy spend analysis, but you can do a back of the envelop spend analysis that will point out the big opportunities and risks. All you have to do is ask for the costs and masses of 30 -50 parts of same type of commodity that you are interested in re-quoting (e.g. castings, forgings, sheet metal, etc.). You should be able to export this info from your company’s ERP, MRP, SRM, etc. system. Just graph the cost versus mass and graphically consider if there “looks” like there might be an opportunity. This simple method would have prevented the first situation described above.
Do a simple cost/mass spend analysis on the non-raw material costs portion of Piece Part Costs of that commodity– This method is a little more fancy but can highlight outliers a little more accurately. Remember that you already have a raw material cost approximation from the first question. Just calculate the Non_raw Material_Cost = Piece_part_cost – (CostCurrent_Raw_material_price * Part_Mass). Graph the Non_raw Material_Cost versus part mass (like we did in 4). Once again, look to see if your part of interest is or is not an outlier.
Click to Enlarge: Non-Material Cost per Mass Analysis

The great thing about suggestion 4 and 5 is that once you have done the mini-analysis for a commodity, other parts in the that commodity can be compared quickly.

To re-quote or not to re-quote – that is the question. Hopefully, the five considerations explain here today will help you answer that question a little more confidently.

As an aside… I was having trouble when researching this subject beyond my knowledge on the web. I.E. I could not find other articles on things to consider before asking for a re-quote. Does anyone know of articles that are relevant on the net, or is this only covered in books, or the tribal knowledge of gray haired purchasing agents?

World Map of Product Cost Management

Product Cost Management 41 Responses »

Apr 102012

On the last blog post (Product Cost Management – What is it?), I talked the different ways that my colleagues and I have seen the meaning of Product Cost Management take shape over our careers and PCM’s development. I offered what I believe is a good operating definition of PCM:

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.

This definition can certainly be fleshed out further. I was at a conference a few weeks ago and heard a great presentation on social media by Overdrive Interactive. Part of the presentation was showing their map of the social media sphere that has become viral on the internet and the de facto standard many people use to orient themselves to the social web. I really liked that idea, and I’m a big believer in 1-page maps that give the reader an overview of a complex subject, as well as a starting point to dig for deeper detail.

What does Product Cost Management look like from a graphical viewpoint? I believe that it looks like the attached map (click on the diagram to enlarge the map or DOWNLOAD IT IN .PDF FORMAT.

Like any other major discipline that product companies follow, PCM contains four main areas:

Culture, Goals, and Incentives
Processes (tied to the product life cycle)
Team Structure and Participants (tied to the product life cycle)
Tools/Software that can help
CLICK TO ENLARGE!

Culture, Goals, Incentives – before attempting to put in place any process, people, or tools, the organization first has to ask the tough strategic questions. Where is our organization today in the PCM journey? To where does we hope to get and by when? And the big question: What is the priority of PCM and how much investment (honestly) will we make to close the gap from between today’s state to our goal? Once the company answers these questions, it can talk about the strategic structures that drive behavior (roles, incentives, and leadership support).

The next two continents on the PCM world map (PCM Processes, and PCM Tools/Software) follow the product lifecycle, and need to integrate with the company’s product development process. Different processes and different participants are appropriate at different points in the cycle.

Finally, we have the PCM Tools available to take on the journey. They fall into different buckets as follows: (a) homegrown tools (including Excel), (b) general platforms (e.g. PLM, ERP) that may be customized, and (c) specialty Best-In-Class (BIC) tools that focus on PCM processes. In the PCM World Map, many of the major BIC software systems are shown in a 2×2 diagram. We’ll discuss the 2×2 in more detail in a future post, but I don’t want readers to think there is a “magic [best] quadrant” in this 2×2. It is simply a descriptive conceptual diagram

One important thing for people who are navigating the map to realize is that Culture, Process, Team, and Tools are all interconnected and influence one another (see the top right in the header of the map). For example, if you are at the beginning of the PCM journey, it is likely that your company is not ready for all the processes shown. It also may only use one or two of the tools. The company may not have reached a capability level to benefit from some processes, people, or teams. Despite the inter-connectivity of the system, the best place to start when beginning the PCM journey is with the Culture (see blue arrows on the left of the map).

Like all high level maps, there are cities and even countries shown on it that have more detailed maps of their own. However, most companies would do well to focus on understanding the geography at the world level first, before hoping on a plane to a specific city. We can worry about street maps once we decide which cities we are going to visit!