May 202013
 

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

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

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

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

 

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May 062013
 

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

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

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

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

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

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

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

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

Engineering

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

Product Cost Abilities by Functional Group

CLICK TO ENLARGE

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

Finance

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

Purchasing

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

Manufacturing

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

What to do?

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

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

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

 

 

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Apr 292013
 

If you are a Product Cost Management person with an inner nerd like us, then you probably love and the Lord of the Rings trilogy by JRR Tolkien. One of the iconic characters in the book is the king in exile, wondering the wilds as a Robin Hoodesque type of character, a man named Aragorn.  One of the things that makes this character so compelling is the fact that he, and his brothers-in-arms, the Dunedain Rangers, secretly wander the wilds protecting those who are blissfully unaware of the evil all around them.  

Why do we love Aragorn, who goes by the nom de guerre “Strider” so much? It’s because Aragorn is unpretentious, self-sufficient, self-sacrificing, and yet dangerous and mysterious at the same time. Aragorn gets things done, even when those around him don’t realize it.  And when those around him do get to know him, they are astounded at just how powerful, efficient, and clever he is.

Yes, Strider is a misunderstood man, as Mr. Butterbur, the bartender at the Prancing Pony, the inn at Bree says,

He’s one of them rangers. Dangerous folk they are — wandering the wilds. What his right name is I’ve never heard, but around here, he’s known as Strider.

Strider and the rest of the Rangers don’t really have a home, and so it is also with Product Cost Management in most organizations. It’s very rare to find Product Cost Management a department that is not a part of a larger organization. And, it is always seems to be the red-headed stepchild of that organization.  No one really knows exactly who these guys are or what they do, except that “I think they know a lot about cost and manufacturing stuff.”  Product Cost Management never seems to fit in with the organization in which it has been placed, and everyone is always wondering if it really belongs in another organization.

So where does product cost management belong in the organization? That’s a difficult question because Product Cost Management relies so heavily on information from four different organizations. In order to do their work of profit maximization, expert in PCM deep domain knowledge of the following:

  • What is the geometry a part, a subsystem, a product, and how does the geometric features, tolerance, and materials of these physical items relate to their costs?
  • What is the costing structure of the organization, what are its overhead rates, what are its labor rates?
  • What suppliers does the organization have and what are the cost structures of these organizations? What are their manufacturing capabilities?
  • What is the organization’s internal manufacturing capabilities?

Where Product Cost Management lives in the company Hiller Associates

These are very broad pieces of information that are flung across the organization. If we look at the figure above, we see that these pieces of information are hidden in the four main functions of a manufacturing company: engineering, finance, purchasing, and manufacturing. Product cost management, like the Rangers in JRR Tolkien’s trilogy, seems to live in the no man’s land or wilderness between these organizations, where few people from any of the four organizations are comfortable operating.

Why are most people so uncomfortable operating in this nexus? Well, that’s a subject for our next post.

 

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Apr 222013
 

 

Good Morning PCM world,

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

 

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

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

PRODUCT vs. PROJECT

We have defined Product Cost Management before here as:

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

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

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

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

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

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

Income Statement and Product Cost Hiller Associates

CLICK TO ENLARGE!

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

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

 

 

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Apr 172013
 

 

Hello Internet and Product Cost Management industry! We’ve had strong interest in our latest article on the 2012 revenues of the Product Cost Management market. There have been several good questions that have made us want to clarify some of the assumptions in the analysis, so that people are clear on what is and is NOT included in the estimate.

 

Most importantly, this is an estimate of the REVENUE of the group of included vendors today in 2012. This does NOT represent the Total Addressable Market for Product Cost Management software.

The total addressable market is many times larger than the revenue of the included vendors that are estimated in 2012.  In fact, we plan to write follow-up articles that discuss the total addressable market, as well as the growth rate of the current vendors in reaching that total addressable market  Here’s some of the assumptions we made in the analysis:

  1. Only the Vendors noted are estimated – The uncertainties do not explicitly take into account other vendors. They reflect the fact that most of these are private companies whose numbers are not public and that vary from year to year. Obviously, it matters where one draws the line in the analysis.
  2. Focused on the estimation of manufactured products, not construction – there are many products in the market that focus on construction estimation, for example estimates for building an office building, an oil platform, a refinery, etc.  We consider this a wholly different market. In our own experience we have rarely if ever see the companies that specialize in construction estimation also compete for the same customers for which the companies listed in this Monday’s article compete.
  3. Not focused on job shops – there is also a separate market for software used by small “job shops.” These are small, mostly family owned businesses, that typically manufacture one type of part, for example sheet metal, machined castings, etc.  Some of the included vendors may sell to a few job shops, but there software is capable of being used by bigger enterprises.
  4. Generally Available Software – We only included vendors whose primary business involves selling a legitimate “generally available” software product (not a consulting business with internal tools)

Given these constraints, we believe this group represents over 90% of the revenue in the market today. If you know of other competitors who meet the criteria above and make over $2 million USD a year in revenue, let us know.

Keep the questions coming! We are glad there’s so much interest.

 

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Apr 152013
 

Hiller Associates received a question this week from a business school asking us what the revenue of the product cost management market is. That was a very interesting question, and one that we have thought about before. However, we’ve never actually sat down to think about the question formally. So rather than answer the person privately, we thought it might be helpful to everyone to discuss this in a public forum.

 

Product Cost Management Software Companies Hiller Associates

Companies included in the Revenue Aggregate

There’s good news and there is bad news with respect to the estimation of the size of the Product Cost Management market. The good news is that the market is fairly self contained, i.e. there are only a certain limited number of players in that software market. However, that’s where the good news ends. There are several challenges to estimating the market size:

  • Private companies -80% of the players in the product cost management software market are privately held companies, either venture funded, or privately held by a small group of founding owners and managers. Therefore, their revenue numbers are closely guarded information that is not publicly available. This includes the PCM company that our managing partner, Eric Hiller, founded and at which he was the CEO and then the Chief Product Officer for many years (aPriori).
  • Bundling – the second challenge comes with the fact that some of the larger players bundle product cost functionality into the price of another larger product. For example, Solidworks Cost is a bundled-free option that is included whenever someone buys their professional or premium level Solidworks CAD product.

There is is one other good piece of news, which is that Hiller Associates knows most of the players in the market and speaks with them regularly.  For some of them, we do know the revenue, and for others, we have a good idea. Obviously, we cannot share revenue numbers of an individual company, but this inside information will help us move the estimate from a wild guess to an educated guess.

Taking a look at the figure on the left, you will see the companies that we have included in the estimate. These are all the main players that we know of in the market. If there are others that we’ve missed, we’re very happy to learn about them and consider if we should add them to the market sizing.

2012 Revenues in the Product Cost Management Software Market

Those of you who follow this blog or have worked with Hiller Associates know that our philosophy is that point estimates are very dangerous and, often, not even that useful. Knowing the uncertainty around a cost number is just as important as having a point estimate of what that number is. We feel this holds true with any financial quantity. Therefore, we will provide a range of the size of this market.  Please see the figure on the right, which shows are estimate of the total revenue of the company’s above for 2012. When given the uncertainty factors that we have discussed above, we feel the total market has a large range. Total revenue could be as low as $60 million or as high as, perhaps, $115 million.

Current market revenue of Product Cost Management Hiller Associates

Click to Enlarge!

Other questions that people should ask are how much of this revenue comes from services and how much of this revenue comes from actual licensing of product. Some of the companies included are primarily product companies, and most of the services that they offer are tightly bound around the product. Such services would include training on the software, implementation, and customization. However, there are others in the group that also maintain general consulting businesses. For example, several of these companies offer classes about product cost or  subsets of product cost management, such as design for manufacturing & assembly (DFM/DFA).  These are general classes which only relate peripherally to their products.

Estimate Methodology

To do our estimate, our methodology was to estimate the revenue of each of the included companies individually. We also did an estimate of the service percentage of their revenue on an individual company basis. Then we added up the aggregate numbers. You will notice from the estimate figure to the right that when all the numbers for service and product revenue or aggregated, there is approximately a 60/40% split between product and service respectively. This ratio of product vs. service revenue seems approximately correct, per our experience in the market.

Software vs Services in Product Cost Management Hiller AssociatesIt’s important to understand, that this estimate is four the actual revenue of these companies in 2012. It does not reflect the total addressable market for product cost management software, which we believe is woefully on realize that this moment. This is the first our discussions about revenue in the product cost management software market.

NEXT TIME: Growth Rate in the Product Cost Management Software Market

 

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Mar 182013
 

There are universalities that seem to cross people and cultures, such as, it’s polite to say “please” and “thank you.” These universalities also occur numerically. For example, designs that follow the Golden Ratiopop up all over the world. Many other aspects of one group versus another may vary, but there are these universal touchstones that pervade the world. The same is true with companies. Granted, one might argue that one company simply is imitating another company and that is why they share a simple practice or the important of a certain number. We believe that this is, indeed, true in most cases. Still, there are a couple of numbers in companies that seem to arise independently in all companies. We are going to talk about some of those universal and independent numbers today with respect to Product Cost Management.

The great universal number in PCM is “10%.” I have met hundreds of companies over the years, both in consulting and when I was the Founder, CEO, and then Chief Product Officer of one of the product cost management software companies. Invariably, a meeting with a company will occur, in which one of the customers will utter the “a” word: accuracy. The dialogue proceeds similar to the following:

CUSTOMER: So, how accurate is your software?
PCM TOOL COMPANY: What do you mean by “accurate?”
CUSTOMER: Uhh, um, well, ya know. How ‘good’ is the number from your software?
PCM TOOL COMPANY: Do you mean do we have miscalculations?
CUSTOMER: No, no, I mean how accurate is your software to the ‘real’ cost?
PCM TOOL COMPANY: What do you consider the real cost?
CUSTOMER: Uhh, um, well, I guess the quotes that I get from my purchasing department from our suppliers.
PCM TOOL COMPANY: Oh, I don’t know, because it depends on how close the quote is to the true cost of manufacturing the part plus reasonable margin.  Are you confident your quotes are correct proxies for the true cost of manufacturing.
CUSTOMER: Hhmmmmmmm… yeah, I think think so
PCM TOOL COMPANY: OK, how close do you expect the costs from our PCM software to be to your quote [or internal factory cost or whatever source the customer believes is truth]?
CUSTOMER: Oh, you know, I think as long as you are +/-10% of the quote, that would be alright.

 

Ding! Ding! Ding! – no more calls, we have a winner! The customer has uttered the universal expectation for all costs produced by a product cost management tool, with respect to the “source of true cost”: +/-10%

The universal expectation of customers of Product Cost Management software is that the PCM tool is accurate to within +/-10% of whatever forecast the customer considers the “true cost.”

This expectation is so common that you would think that every customer in the world had gone to the same university and had been taught the same expectation. Of course, that is not the case, but it is a ubiquitous expectation. How did this universal convergence of expectations come to be? We will probably never know; it’s one of the great mysteries of universe, such as, why do drivers is Boston slow down to 4 mph at the lightest sign of snow or rain?

The more important question is: Is the expectation that the cost from a PCM tool should be +/-10% of a quote realistic? To answer this question, we first have to ask:  How truthful is “the truth?” The truth in this case is supposedly the quote from the purchasing department. The reader may already be objecting (or should be), because there is not just one quote, but multiple quotes. How many quotes does a company get? Well, that depends, but we all know how many quotes a typical company gets: THREE!

The universal number of quotes that purchasing gets is 3, and they believe the “true cost” is within +/-10% of whichever of these 3 quotes they select as truth. 

Three shall be the number of the quoting and the number of the quoting shall be three. Four that shalt not quote; neither shalt they quote two, excepting thou proceedest to three.

Variance Within Supplier Quotes

Do all the  quotes have the same price for the quoted part or assembly? No, of course not. If they were the same, purchasing would only get one quote. So what is the range among these quotes? That is a fascinating question, one that I am currently investigating. So far, my research indicated that the typical range among a set of three quotes is 20-40%. That seems about right from my personal experience.

But, is the “true” price (cost + reasonable margin) contained within the range of the 3 quotes? Not necessarily. If we assume that quotes are normally distributed (another assumption that I am researching), the range would be much bigger in reality. For example, if we had three quotes evenly distributed with the middle being $100 and these quotes had a 30% range, the high quote would be $115 (+15%) and the low, $85 (-15%). This gives us a standard deviation that, conveniently, is $15. At two standard deviations (~95% confidence or “engineering” confidence), we predict that the “true cost” of the part is between a predicted  high quote of $130 and a low of $70. This is a range of 60% (+/-30%). You can see this on Figure 1.

OK, but what about if we  just source a single supplier. Well, there will be variance in this supplier, as well. This variance breaks down into two types: physical noise and commercial noise.

  • Physical noise — the difference in cost that could occur due to physical reasons, such as choosing a different machine (i.e. different overheads) a different routing (sequence of the machines), or even simple human variation from part to part or day to day.
  • Commercial noise – differences in pricing driven by the market, emotions, and transient conditions.
Variance in the Cost Forecast from Quotes Hiller Associates

Figure 1 – Variance in the Cost Forecast from Quotes (click to enlarge)

Physical noise can easily account for a range of 20% (+/-10%) in the quote that a supplier might provide to an OEM. However, physical noise can be quantified and discovered. A supplier can share what routing or machine they are using. The problem is that Commercial noise is very difficult to quantify. How do you quantify when the supplier believes you hurt him in the last negotiation and now he is going to repay you for it, or that he needs your company as a new strategic customer and will underbid to get initial business? Worse yet, Commercial Noise is often LARGER than Physical Noise in the quote! How big is Commercial noise? That is difficult to say, because we can’t measure it very well, but from our discussions with purchasing groups, at minimum, Commercial Noise adds at least another +/-10% .

Physical Noise  Commercial Noise
Comes from selection of different machines, routings. Comes from market conditions, emotions, and transient conditions
Quantifiable in general by understanding the selections. Very difficult quantifiable
+/-10% of the “factory average” +/-20%+ on top of Physical Noise

 

Supplier quotes are just one forecast of true cost. There are other forecasts the organization has.

Cost Estimation Experts

What about those people in the organization with the most manufacturing and product cost knowledge? What is the noise in their estimates compared to a source of alleged truth, such as a quote. We are not sure, but we have asked another question about variance to these experts. When asked the question, “How close are you as a cost estimator to the estimates of other cost estimators in your company, people most often reply, “Probably +/-10-20% depending on the complexity of the part cost estimate or assembly.” So, we might say that the cost estimators have at least a 30% range of quotes themselves.

Historical Costs in ERP

What about the historical costs in ERP? How “accurate” are they? There’s actually at least two problems with data in corporate databases. First, sometimes it is just plain wrong from the beginning of its life in the database. However, even if it is correct initially, it gets out of date very quickly. Material cost, labor rates, efficiency, etc. change. Go ask you purchasing buyer how close a re-quote of a current part that has been in the database for three or four years will be to the original quote. To give you an idea of the magnitude of this problem, consider these findings:

The Accuracy (i.e. variance to quote) of a Product Cost Management Software

Variance in Different Forecasts for Product Cost (click to enlarge)

Variance in Different Forecasts for Product Cost (click to enlarge)

So, after all of the discussion of the variance within other cost forecasts, how “accurate” are the forecasts from a product cost management software? Well, if the internal variance among expert cost estimators independently estimating is 30%, the BEST the PCM tool could do would be +/-15%… IF it is controlled by experts. What happens when non-experts use this software? How much does the range increase? Who knows? Obviously, the more automatic and intelligent the PCM Tool, the less the added variance would theoretically be. But, is this added variance +/-5%, +/-10%, +/-20%?  That is hard to say.

The Reality of Accuracy and Variance in Product Cost Forecasts

Regardless of the answer to the above question, the bigger questions are:

  1. What is your EXPECTATION of how “accurate” your PCM Tool’s cost forecast is to the quote forecast?
  2. Is your expectation reasonable and realistic?

We know the answer to question 1:   Be +/-10% of a my selected quote.

To answer the second question, let’s quickly review what we know:

Source of the Cost Forecast Common Variance Inherent in the Forecast
Range among 3 quotes +/-15%
95% confident interval (engineering confidence in quotes) +/- (15%+15%)
Physical noise within one single supplier +/-10%
Physical noise plus Commercial noise within one single supplier +/- (10%+20%)
Internal range among cost experts +/-30%
Best Case PCM Tool used by experts +/-30%
Non-cost expert using PCM tool +/- (30%+ 5%?)
Common [Universal] expectation of PCM Tool Cost Forecast +/-10%

 

Hhhmmmmmmm… Houston, I think we have a problem.

It just doesn’t seem that +/-10% is a reasonable expectation.

Bringing Sanity Back to Product Cost Management Expectations

What can you do in your company to help reset these unrealistic expectations? There are three things.

  1. First make your colleagues (engineering, purchasing, etc.) aware of the reality of the cost forecasting world. Don’t let them develop uninformed and unrealistic expectations.
  2. Don’t focus exclusively on the end cost, but on the physical and immutable concepts that cost is supposed to quantify: mass, time, tooling.
  3. Start to quantify the internal variance in your own firm’s cost forecasts. Your firm’s internal cost ranges in quotes, internal estimates, etc. may be lower or higher than the numbers presented here. However, you won’t know until you start to investigate this.

Is this a painful realization?  Perhaps, but you are already living with the situation today.  It is not a new problem in the organization.  If you don’t acknowledge the potential problem, you run the risk of misleading yourself.  If you acknowledge the potential problem, you may be able to solve it, or at least make it better.

 

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Feb 212013
 

Last week we talked about the struggle in corporate strategy between Core Competency structures and Lean manufacturing. Whereas Core Competency thinking naturally leads to more outsourcing and extended supply chains, Lean manufacturing would advocate for a geographically tight supply chain, often with more vertical integration.

So, what does this have to do with Product Cost Management. The answer is “knowledge.”

The Lack of Manufacturing Knowledge In Design

One of the biggest complaints that I get from my clients is that their teams have lost or are rapidly losing product cost knowledge in the last 10 years. This is especially acute with design engineering teams, but also effects other parts of the organization, such as purchasing. Years ago, the engineering curriculum at universities became so overloaded that manufacturing began to be pushed to the side in the education of most engineers (excepting the specific “manufacturing” engineering major). In fact, at most top engineering schools today, there is only one high level survey course in manufacturing that is part of the required curriculum.

However, manufacturing and its evangelistic design missives (design-to-cost, design-for-manufacturability, design-for-assembly, etc.) were still learnable skills that the young engineers and others could pick up on the job, over time. This is because most product companies were not only in the business of final assembly, but also in the business of sub-assembly, as well as manufacturing components from raw materials. These companies employed large amounts of manufacturing engineers who were resources for the design and purchasing teams. Even for parts and subassemblies that were purchased, the suppliers were likely close by the design centers and had long standing relationships with the OEMs.

Designers and purchasing people could literally walk down to a manufacturing floor in an internal plant or drive a few minutes to a supplier. Conversely the manufacturing engineer would walk upstairs to question engineering about a design. This is nearly impossible when suppliers are often in different countries and the firm that designs does little manufacturing themselves

The Effect of Lack of Manufacturing Knowledge on PCM Tools

One of the ways that industry has tried to remedy this situation is with sophisticated Product Cost Management software. This software codifies a lot of the tribal knowledge that resided in the manufacturing engineers head. However, these tools assume that the tool users have (1) the will and (2) the skill set to properly use a PCM Software.

There is no doubt that the PCM and DFM/DFA tools today are far more advanced than they were, even ten years ago.  However, the value one derives from a tool is not a function of the tool’s capability alone.   There is a bottleneck problem of using a tool to its full potential.  We could say that the value the PCM tool actually gives to the organization equals:

Value of PCM Tool = (Will to use tool) * (Ability to use tool) * (Potential of the tool)
 

People often forget about the ability component, but this is true with any tool.  People buy expensive tools, e.g. golf clubs, hoping to improve their performance.   However, 90% of the time, they cannot even use the set clubs they have to their full potential.  Worse yet, often more expensive or sophisticated tools are more powerful and have the potential to give more value, but they are often less forgiving of errors.  If you don’t know how to use them, they will HURT your performance.

In the past, with a Lean (vertically integrated and geographically close) supply chain, people used primitive PCM tools (often only spreadsheets).  On a scale of 1 (worst) to 10 (best), on average what I hear from industry is that there capability to use the tool was higher, but the tool was limited and cumbersome.  The users, including design engineers, knew what decisions to make in the tool, but the tool was cumbersome.   Currently, we have more of the opposite problem.  The PCM tools are better and much easier to use, but most design engineers are somewhat baffled on how to make what seems like the simplest of manufacturing input decisions in the tools.  The “Will to use the Tool” is another problem altogether that is beyond our discussion today.  However, my experience, in general, would be represented by the following table:

Tool_effectiveness

These results will vary company to company, and even, from design team to design team within the company.  Regardless, I wonder if we are at a breakeven state from where we were in the past today in the value we get from PCM tools… or maybe, we have even lost ground.  The sad thing is  that the PCM tools today ARE more user friendly and requires less of an expert to use.  However, is the loss of manufacturing knowledge in design engineering is so bad that it has overwhelmed the PCM tooling ease-of-use-improvements?

What Can You Do to Help the Situation in Your Company?

Obviously, nothing is as good as the osmosis of manufacturing learning that occurs from a tightly coupled, geographically close, and vertically integrated supply chain.  However, the state of your firm’s supply chain is likely out of your control personally. There is some positive movement with the re-shoring and re-integration trends in industry, in general. However, there are steps you can take to improve the value your firm derives from PCM tools.

  • Send Engineers Back-to-School – do you offer (or better yet, mandate) classes in Product Cost Management, DFM/DFA, Target Costing, etc. for your design team? This should be part of the continuing education of the design engineer. I am not talking about training on the PCM tools themselves (although that is needed, too), but general classes on how different parts are made, the different buckets of cost, the design cost drivers for each manufacturing process, etc.
  • Design Cost Reviews – This is a very low tech way to create big wins. Design reviews in which design engineers review each other’s work and offer cost saving ideas should be a regular facet of your PCM process. Even better: include the engineer’s purchasing counterpart, company manufacturing experts, and a cost engineer to lead the review
  • Embed Experts – Does the design team have at least one advanced manufacturing engineer or cost engineering expert for no more than 20 design engineers? If not, you should consider funding such a resource. Their salary will easily be paid for by (a) the cost reductions they they help your team identify for products already in production, (b) the costs that help the team avoid in designs before production, and (c) the speed their efforts will add to time-to-market by helping the team avoid late changes and delays due to cost overruns.

In the past, vertical integrated, geographically close supply chains helped Product Cost Management in a passive way.  The pendulum may be swinging back to that structure.  However, even if it does, don’t rely on the “passive” Product Cost Management to help. Take the active measures described above and get more value out of your PCM Software investment.

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Feb 042013
 

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

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

Product Cost Results goals at launch Hiller Associates

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

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

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

 

 

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Jan 162013
 

It’s one of the most famous studies in the world of product development and probably the most famous study in the history of Product Cost Management.  It was done in the 1960’s (reportedly) by DARPA (The US Defense Advanced Research Projects Agency of the United States Government).  It’s so famous that it is typically referred to as “The DARPA Study.”  Some claim that the entire software category of Product Lifecycle Management has used the study for its primary justification for being.

But, if it is so famous… where is it?

I have searched for the study a couple times on the internet.  It is easy to find The DARPA Study of product cost referenced loosely, but I could not find the original study, or even a formal citation… and as we know, if you can’t find something after thirty minutes of searching on Google, it does not exist, right?

Fortunately, I was able to dust off my engineering masters thesis and find the following studies that corroborate DARPA’s alleged claim.

Cost Committed vs spent in Product Cost Management Hiller Associates

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DARPA’s claim what bold and powerful and if we paraphrased it, we would say:

“80% of a product’s cost is determined in the first 20% of activities in design and development”

I have even found a great webpage that lists FOUR PAGES of references to studies, corroborating DARPA’s results:

Design Phase Cost Rational

… but it does not have a reference to the original DARPA Study.

So, can anyone help?  Can someone send me:

  1. A link to “The DARPA Study” on the web? AND/OR
  2. A .pdf of the study? AND/OR
  3. At least the proper academic citation to the study?

Anyone, Anyone, Bueller, Bueller, Bueller…

Cost Committed vs. spent for product cost hiller associates

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