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.
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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?
So, 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.
44 Responses to “A Product Cost Management Post to Upset Everyone!”
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George Spiller SAYS:
Eric, you have correctly identified that the corporate world operates in silos. Product Cost is just one of those silo. The lean start up revolution has correctly identified that product cost is a subset of the issue. The real issue is providing the the customer with the product or service that is a value at the offered price. Worrying about product cost inside the product cost silo results in irrational actions like eliminating gum strips from imported tires. Companies who have adopted lean start-up thinking are succeeding in the marketplace because they have the entire team focused on providing customer value
George,
If lean is the sun around which you personally orbit, then I am sure product cost is a subset to you. However, at the end of the day, my personal belief is that maximizing total profit is the end game. Most people seem to believe that maximizing value to the customer will result in maximizing profit for the firm. I am not sure if that is true or not, but I agree max total profit (free cash flow for the purists) is the goal.
Lean, Product Cost Management, etc. methods are all pieces of the solution for max total profit. My expertise is in PCM and I advocate it because it is one of those underexploited advantages that the firm needs to put far more attention toward.
I am not advocating that product cost be minimized without regard to other pieces of the equation that lead max total profit. Sorry if you somehow got that idea. Have I specifically said that somewhere?
George Spiller SAYS:
Most of us who have been in the game a long time have read the preamble to the latest letters of the month system. The fact that corporations operate in silos causes a whole lot of inefficiencies. I happen to be excited by “The Lean Start-up” by Eric Rice because has an actionable method to overcome the lack of profit focus not just an complaint about the disadvantages of the status quo
I am familiar with the book, but we are not talking about start-ups here. If have been the founder of 2 start-ups, so I am familiar with them. However, I have also worked at Ford Motor Company and John Deere. Rice’s “pivoting” will not solve the problems in product cost with which big companies struggle. In my opinion Rice’s book is solving a different problem.
Eric
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‘Saum’ Sharma SAYS:
Eric – Interesting article and analogy of the “Strider” when it comes to Product Cost Management division in a firm. You have rightly pointed the amalgamation of engineering, finance, purchasing and Manufacturing to create the PCM role.
During my tenure working as a Project Lead for strategic sourcing, we considered all the above elements, and also included “Should Cost” calculation for a part. In addition to this, I always asked the engineering and the potential suppliers to think about the “Supply Chain/Logistics” implication of design and ultimately the overall cost of the supply chain. Reverse logistics is also another paradigm that can be considered for PCM.
Hi Saum,
Yes, Supply Chain could also be one of the territories that surround the no-man’s-land that is Product Cost Management.
Certainly, logistics is another piece of Cost of Goods Sold, and therefore, product cost. Do you have average % number range for logistics versus total product cost? Is logistics typically 1-5% of the total product cost*?
Eric
* By “total product cost” I mean (Raw material + Purchased materials + Labor + Direct OH + Period OH + Expendable Tooling + Amortized Capital Tooling + Logistics + any other special charges)
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Duane Grove SAYS:
My experience reinforces your key points and I believe in most organizations, these assertions hold true. One way to align PCM though with functional elements is a clearly delineated strategy that values PCM in the place that is of appropriate value to the company. If PCM for example is the #2 imperative strategically, then every function should be aligned accordingly. Without a clear strategic set of priorities, each function is left to make its own judgement.
Thank you for your interest Duane. Maybe you could share an anecdote or story about how you have encountered this problem in your career?
Duane Grove SAYS: One example a few years ago was focused on Supply Chain. In this organization, the supply chain team had been considered a cost center since its inception. They lacked any sense of strategy and the rest of the organization viewed them as a necessary hindrance to progress. The company’s overall strategy was focused on speed and improved profitability. We translated that strategy into actionable changes the supply chain team could use that enabled them to contribute. In addition, we changed the language within the SC team and in communication with other functions around the imperative that SC was a source of competitive advantage and a profit-generating function. Things of course didn’t change overnight, but slowly and visibly, the shift occurred. The further affect was that other functions started to move in similar directions. In this case, the SC team acted as both catalyst and tipping point. We starting with supply chain in this instance because greater than 60% of production costs were tied up in suppliers. This of course won’t always be the case, so my approach is to identify the greatest cost drivers then craft an approach that seeks to maximize impact in the shortest reasonable time.
Hope that helps illuminate my thoughts.
Great story, thank you, Duane.
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timmi burke SAYS:
I totally AGREE.
Unfortunately there is a huge gap between the user/departments, buyer and safety. The cost management should be viewed in multiple areas, based on effectiveness, actual cost and safety.
1) Safety first based on the application area (will it harm the surface), the employee’s safety and the cost. These facts determines rather or not there is a true cost savings or an increases by incident (machine failure, surface damage to parts or compromising employee safety).
2) Product quality determines actual cost. For example, a concentrated product with a ratio of 1:128 at $50 per gallon is a greater value than a ready to use product at $25 per gallon.
WHY: the product at $55 per gallon providing a ratio of 1:128 provides the end user 7,040 gallons (ie 128 ounces per gallon X 55 gallons of concentrated product = 7,040 gallons.
3) If the buying department receives the incorrect product requested by the user and buys, then budgets are wasted on an unneeded product, even if the buying cost was low.
4) Then there is another area to evaluate actual cost!! PRODUCTION DOWN TIME can cost $1,000’s, sometimes millions. Using a cheaper product can cost BIG MONEY!! For example:
Grease – There are so many greases out there it can be mind boggling to buyers trying to determine the value. When it come to production in manufacturing, bearings can cost $1000 to upwards of $20,000 per bearing depending on the type and size. Using a grease based on price alone can cost the manufacturer in multiple ways. Low cost grease with lower volumes of tackifiers result in damage and bearing failure. By not understanding this important tack knowledge, basing the purchase on cost alone can cost far more in the long run. WHY: Tackifiers are additives that confer a tack, or stringiness, to a substance and are typically used to provide adherence in fluid lubricants and stringiness in grease. Thickeners give additional body to greases reducing pound out and metal to metal contact which damages bearings, leading to break down and lost production. Both tackifiers and thickeners also provide drip resistance and reduces the amount needed to reapply.
By having the input from engineering, quality control, production and purchasing is KEY to cost savings across the board.
I hope my experience and insight is helpful to all in evaluating cost vs quality.
Timmi Burke
PRO CHEM INC
Thank you for your comment, Timmi. It is a good example of how there are simple things, even at the most operational of levels that can be done to intelligently maximize profit through product cost. Sadly, our experience has been that the organization is often better at the operational PCM than it is at the strategic level.
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DENNIS P HOBBS SAYS:
Manufacturers are very parochial when thinking Lean is about manufacturing only. Days are spent debating the nuances of the numerators and denominators of performance measurement, what measurement means, and how the quotient of a measurement calculation should enhance improvement efforts.
What is the real goal of a lean operating system? Is it to make the manufacturing operation the best in the industry? Is it to have beautifully displayed dashboards to show customers on a plant tour? Is it simply to provide “executive eyewash” for executive management so they can pretend to be managing corporate resources without having to actually go down to the shop floor to do it? Manufacturers are usually too close to the trees of day-to-day problems to see the forest.
It is not a singular goal to simply be the best manufacturing facility in the world. Rather, it is about being the best at leveraging the benefits of Lean by minimizing product cost, achieving the highest quality possible, and responding to customer demand with speed to market. Product cost is just one component and as with all Lean measurements, a truly lean company should be the best in their industry.
Achieving greater distance between your competitors on measurements such as price, delivery or quality will give your sales team the differentials necessary to increase sales revenue of your company at the expense of competitors who are unable to offer these same differentials. It’s easy. The best performance measurement for manufacturing is the increase of its company’s share of the marketplace in which it competes.
@Dennis — Well stated. I agree. Whether it is Lean, Product Cost Management, or any other technique, we always have to keep in mind what the end game / goal is. The methodology is not the end goal in and of itself. I am often struck by the slavish devotion some people have to such methodologies, as if the methodology is a new god or a religion to supplant real religion.
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Christopher Seifert SAYS
One of the biggest challenges with product costing is that most accounting systems are static, but product costs are dynamic. For example, most accounting systems treat the set-up time for a given product as if it is fixed and driven solely by the product. In reality, the set-up time for a given product is often impacted as much by the prior production run as it is the product itself. Most accounting systems (at least ones I’ve ever seen) don’t have the ability to account for this. I’d be curious to know how people have allocated costs like set-up time to individual products.
Chris,
This is a very powerful observation. You are absolutely correct. Costs do change over time. This is not only an accounting problem, but a manufacturing problem, as you say. But, one question would be, is this change below the level of being “material,” in accounting vernacular.
Perhaps others who are accountants and more used to dealing with ex post facto cost allocation can answer you on your product question.
I believe a bigger problem is the focus is the “allocation” of costs in general. Allocation is important to make the books balance, but to make the right engineering and purchasing decisions, allocation is not the best solution for predictive guidance.
Eric
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Christopher Seifert SAYS
It’s not so much that costs change over time (although they do) that creates the challenge. Where it becomes difficult is when they change based on the their interactions with other processes/products. Set-up time is the most obvious, but there are others. In some cases these aren’t material, but in some plants downtime can cost tens of thousands of dollars. Not allocating it correctly can lead to bad decisions.
To relate my own personal experience as an operations manager, I was often asked by sales to run small batches of product. The manufacturing process was a continuous process, and changeovers resulted in downtime and scrap for the first 15 minutes of the production run. The impact of the changeover also varied depending on the products run before and after the one they wanted to add to the schedule. When accounting would validate the profitability of the request sales made, they would use the historical average cost for that particular product, or a similar product if it was the first time we made it. Obviously, the historical average cost didn’t account for the variation in actual cost that was dependent on length of product run, product mix, etc. There was no way for SAP to account for this complexity. The only way to do so was through lengthy manual calculations.
Personally, I feel that too often we (myself included) want to believe that allocated costs aren’t “material” to a decision because they are “fixed”, “sunk”, or just too small to matter, when the issue is really that we know we don’t have a way to allocate them correctly. As a wise accountant once told me, “all costs are variable over the long term”.
@ Christopher
OK, that helps me understand what you are saying much better. I agree with you that allocation is the root of many evils. You have two extremes: the ABC fanatics who want to specially allocate to levels that are silly and immaterial and the peanut butter crew who smear everything. Obviously, there is likely an 80/20 thing that is appropriate. And in your example, you are not even talking about indirect costs, but direct set-up. That’s just lazy peanut butter accounting that you were experiencing.
I am surprised (but probably should not be) that SAP could not calculate this properly out-of-the-box.
I completely agree there is a perversity of consider costs as fixed or sunk. You may like this article: https://www.hillerassociates.com/whats-in-a-product-cost-part-1-grand-theft-auto-capital/
Indeed “all costs are variable over the long term”.
Eric
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Tom Bellinson SAYS
Christopher, that company sounds like a plastic injection molder to me. This is a classic case of having a system that doesn’t have the ability to align with the manufacturing process your are executing. Something like IQMS, which specializes in injection molding operations can keep track of the number of cavities being used, shot weight, regrind, etc. All these things must be factored into the cost, but if you can’t capture them, you’re left with fudging numbers that don’t really drive good decision making.
SAP does a great job of convincing companies that they can be all things to all companies, but in the end, they are usually everything to nobody.
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Alexander M. Swoboda SAYS:
You didn’t upset me – obviously there is need for a solution which combines the world of finance/controlling with the bill of material and bill of process – and I happen to know one.
The only part of your posting, I can’t support is that you talk down the value of continuous improvement after SOP. While I agree that the foundation needs to be laid during the product definition phase, it is fait to assume that experience and technological improvement will bring costs down over the live cycle.
@ Alex — Well, I must try harder next time!
Regarding ‘continuous improvement,’ I believe this is not a problem of category but degree. The problem in our opinion at Hiller Associates is that TOO much focus is post SOP regarding product cost. Today my experience has been most companies focus 90% of resources on Product Cost Management post launch. We would advocate the ratio should be reversed. Maybe not 90/10 pre-launch, but certainly the lion’s share. Obviously that leverage on product cost is so much larger early in the cycle.
You’ve inspired me for next weeks post, though, Alex.
Eric
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Scott Harder SAYS:
All of this is true. Its only offensive to the departments its criticizes and not the PCM personnel.
@ Scott — actually, I hope it is not offensive to the other departments but just honest. Although, sadly it is human nature, especially in our modern environment to be “offended” by the truth. 🙂
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Dr. Paul D. Giammalvo, CDT, CCE, MScPM, MRICS SAYS:
Eric, just took a quick look at your profile and given your experience, I cannot imagine how, as a successful entrepreneur, you can say that PRODUCT cost management lives in a “no man’s land”. As a provider of professional services (as well as new product development or manufacturing,) being able to calculate, track and control the costs of our professional services makes the difference between staying in business and going bankrupt.
Pick up any decent book on Operations Management and you will find all kinds of formulae, methodology, procedures, tools and techniques which shows us how to calculate, manage and control costs, and that is or should be the Operations or Asset Manager’s job. (NOT the project manager’s job)
Bottom line- It is MANAGEMENTS role and responsibility to coordinate all the “stakeholder” and “contributors” to the product pricing challenge.
BR,
Dr. PDG, Jakarta, Indonesia
Dr. Giammalvo,
Perhaps, things are different in Indonesia. However, our experience in the US had been that companies, as a rule, really struggle with Product Cost Management. Perhaps, you have a different definition, though. You reference Operations textbooks. I am not talking about focusing efforts AFTER the product is in production and already over cost. I am talking about focusing efforts BEFORE launch, when the product is still in development.
We do agree that it is management’s job to ensure that PCM activities happen and the various functions, such as engineering and purchasing participate.
Eric
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Ron Giuntini SAYS:
From my many years of experience in product costing, I have embraced the concept of target pricing (the price that the marketplace will consider of value) minus desired profit, with the remainder being product cost-not-to-exceed. I believe that this approach energizes each of the functions within an organization to work together.
Let me give you an example. Marketing is primarily focused on the revenue side and their ensuing incentives/commissions. Now, what if you gave the marketing/sales group a higher commission, if they were to find ways to cut costs, such as changing packaging, changing channels of distribution, eliminating some product capabilities during the design stage; you are in effect giving them a share of the incremental profits generated by them. So if actual costs came to 85% of costs-not-to-exceed as a result of their efforts, the marketing/sales force would get an extra 3% commission.
I have done such things and it is amazing how many people truly get involved in costing. You could do similar things with design engineers by providing extra funding for “pet projects”
I must admit that the financial accountants cannot often be motivated to reduce product costs because in most cases they are clueless on how product costs are developed; their world is a rear mirror one.
Anyway there are many other ways to engage an organization in product costing, but you MUST think about the self-interests of the members of the organization. Just giving people a tiny piece of the financial pie can go a long way. If you spend a lot of time on the price side, product costing is often much more simple to develop.
Also note that you shouldn’t employ the same amount of resources for the product costing of all products. Products that are immaterial to the organization’s overall financial health can often be break even or be losers, but who cares in the big picture.
The worst results in employing a product cost technique is one in which “this is my cost, and this is the profit that I want to make, so this is my price I have to charge” approach….only an organization bent on its destruction would embrace such an approach…of course that is my opinion!!
Obviously the above discussion is not relevant to a made-to-order business model
Ron,
Thank you for the thoughtful response. Perhaps, you can talk about target costing. The difficulty that I have always found is that target costing seems like a “hope,” not a realistic goal, when all people do is set a top-down target. I believe that is what you are saying in your last paragraph. Just because Marketing says “We want price X.” and finance says “We want profit Y.” so what? How do we know this is possible?
Perhaps, you can expand further?
I have been of the same opinion as you about incentives for years. There is no doubt. People are motivated by correction and reward. If people (including suppliers) are rewarded personally and corporately with a piece of the savings they deliver, I think that good things happen.
Eric
RON SAYS:
Eric:
the key issue is all about leadership and their energizing an organization to focus on profitability and thus costs. So by using a target cost approach, a leader MUST indicate to its organization that he/she is actually looking at cost data details and will bring the accountable person to the carpet to be “flogged” when variances are unfavorable. Let me tell you that when an organization gets that message, they will always provide a mea culpa regarding unfavorable variances before the leader summons them into their office to be “flogged.” The above tale is one that I actually implemented as a business unit head…and it worked very well for my entire 9-year tenure as a business unit head; we always exceeded our overall targeted profits, and thus met our targeted costs
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Saumitra ‘Saum’ Sharma SAYS:
Eric – To my point on considering supply chain cost (forward and reverse) – is an essential element to get a true ‘Holistic’ picture of Total Costing of a product. As you mentioned in your comment above – the logistics cost would include details such as what is your – Inventory Holding Cost per unit (~15% to 20%), Warehousing cost per unit (~5% to 7%), Packaging cost (depends on end customer location and goods at hand) and anticipated defect/rework cost (depends on mode of transportation). All these costs can be effectively tackled through sound collaboration between all the divisions – Engineering/Design, Procurement, Supply Chain….
Saum,
That seem very high. Do you have an references to substantiate this? I looked on the web, but could not find good sites for it. For most mechanical parts, you have
Raw Material 60-80%
Labor 10-20%
Direct Overhead 20-30%
Expendable tooling 0-5%
Amortized Capital tooling 0-3%
These are % of the cost at the exit dock of the factory.
You are saying supply chain is an ADDITIONAL 15% for inventory and 5% for Warehouse… not to mention shipping? That seems very very high, but I maybe its right. I have no reference. Do you have a reference.
Eric
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Scott Harder says:
I agree with Eric, those are highly inflated cost margins on Warehousing and Holding costs.
Warehousing should be about 2% and capital lock-up on holding should be 6%-8% max.
If your costs are that high, then the inventory isn’t turning around fast enough and is being inflated simply by sitting.
By Scott Harder
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Saumitra ‘Saum’ Sharma SAYS:
Eric, Scott – I should have mentioned that the quantities are “Annual” estimates.
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Tom Bellinson SAYS
Eric, great post! Costing is so often an “after the fact” item that managers just shake their head about because they feel helpless to do anything about it. As an ERP software specialist, I know this will sound like a “to a hammer every problem is a nail” answer, but the fact is, product costs are generated along the entire core process value chain.
The trick to good costing is to capture those costs where they occur and give process stakeholders the tools they need to manage the costs they can manage. If purchasing can see component pricing trends and histories along with component quality issues, they can manage TCO, rather than just price.
If foremen/shop supervisors can see setup time performance for different operations/parts over time, people, shifts, etc., they can evaluate the best way to perform setup and get everyone doing it the best way.
Without data to feedback into the process for continuous improvement, efforts to manage product cost are doomed to be spotty at best. But most importantly, a good ERP system that captures all of the right cost data at its source will allow the people who care most – finance – to identify trouble spots and manage them with the tools they know how to use.
Thank you for your comment, Tom.
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Timothy P Tsai SAYS:
Eric, thanks for posting and it is a good topic where Product Cost Management is important but hard to archive cost accounting precisely.
However, the “physics” in the article is quite different from I understand:
1.) Manufacturing is born to manage cost or it cannot survive. They are not in the center. They are in high interest and also highly capable. Manufacturing is not managing by engineer or IE etc. They are managing by Operation which is composed of engineering, quality, production floor, IE etc. Even it is a EMS/OEM, it is still way to get engineering capability via tech transfer etc.
2.) Engineering is born to delivery product performance as his primary priority and so does each functional department on their own priority. It has management team as check and balance to optimize the goal and resolve conflicts.
3.) The best balance organization is applying matrix organization structure which is Project Management based architecture. It has born to balance performance, schedule, and cost depends on biz goal and objective. It has built in cost accounting as all PM operation does.
In many good organization, PM based matrix org is applying everywhere even it is not a PM driven org like some consultant firm.
Hi Timothy,
I’ll try to respond, but I am not sure what you mean exactly on some of the points.
1. “Manufacturing is born to manage cost or it cannot survive.” – I agree. I am just not sure what you are disagreeing with that I said?
2. “Engineering is born to delivery product performance as his primary priority… management. ”
a. I agree mostly with the first point, although I would argue engineering should be have value to the customer which I believe equals long term max profit to the firm. But value is a function, not only of performance, but quality, time-to-market, cost, etc.
b. I agree management “should” be a check and balance on Product Cost Management, but it often is not.
3. Matrix Orgs – I disagree. Matrix orgs sound wonderful but are miserable in practice. My observations is that P&L orgs work better. However, that really deserves an article with proof.
Eric
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Timothy P Tsai SAYS:
Hi Eric, Thanks for the verification. Here are more explanation might be missed:
For comment “1”, is directly to article you post. There is a graphic plot on “Interest in Product Cost vs.Ability to link the physics to finance” and it put the mfg in the middle. That does not make sense to me about mfg does not care about cost.
2.priority of function: every function in org has its primary priority. For example, performance-engineering; output, cycle time -production; quality system-quality; supply-procurement..etc. However each function will be challenged when his priority is conflicted with others (or other functions) under a common biz goal. For example, in a tight-budget R&D project, it delivery performance and cost also. In good production line, it is output and quality too, In some advanced DoD project, only Performance no natter what. Each company has different setup on check-and-balance mechanism on trade-off study in different scenario.
3. Matrix Orgs- I agree with you the Matrix orgs is difficult to implement. But going to the “Product Cost Management” topic, there are not much choices can do it since mfg is assignable cost to support the product life cycle itself is PM based management structure. I believe there are many companies is running one-of-a-kind org which can archive Product Cost Management very well but it will be difficult to be responsive to large customer based with dynamic demand,cross over multiple functions and even multiple-stages supplier chain.
Cross functions, cross companies collaboration itself is a big challenge, PM or not PM, Matrix Orgs or not Matrix Orgs, doesn’t matter.
@ Tim
1. My point is that manufacturing cares about the cost of making the design they are given, but whether that design is expensive or cheap does not matter as much as the relative goals mfg has for year over year cost reduction.
2. I agree with the point, but I am not sure what you are disagree with, regarding the original article.
3. Could you define “PM based management structure”? Also, what does the acronym “PM” mean?
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Scott Harder says:
ERIC: Although, sadly it is human nature, especially in our modern environment to be “offended” by the truth. 🙂
SCOTT: That’s because society and the workplace have strayed away from the truth for so long, the truth becomes offensive in of itself.
That’s my tangent, I’ll stick to the posting subject…
When PCM’s enter into a new environment that is not accustom dealing with PCM types. The best thing to do is deal with each of the one at a time and present the methods and details on how they would benefit the department personnel. For example, Purchasing needs cost reductions, so present the job requirements how they will support Purchasing processes to meet their targets. Teach them how you would interact during negotiations when they start becoming more technical or financial with the supply base. Be a part of the supplier sign-off when new parts are awarded and so on.
Basically, take your time to integrate within into the company departments. Let them see actual benefits versus just stating your job and what you’re going to do to add to their workload.
@ Scott – That is a good point to try to let people know that Product Cost Management will lighten there work load. That is tricky, though, because like all strategic initiatives, PCM will help in the long run, but in the short term requires new learning and more work.
One thing that can help is to have the people STOP doing the ineffective things / less effective things they do to manage cost today.
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Ron Giuntini says:
Interesting thread going on here regarding “product costs” Obviously there are huge differences between forecasting direct parts/labor product costs and that of indirect product costs. Every industry has different distributions of costs; some industries have specific costs that are financially material and for others it is a rounding error. An example is the energy resources employed in the mfg process; for chemical mfg companies, energy is a major direct cost, while for a discrete assembly company, energy is not even considered as a direct cost.
As Eric noted, there isn’t much on the web regarding product cost details, such as the % allocation of cost categories. Trust me I too have searched the web relentlessly over the years and have found little info…but that has not stopped me from gathering info. Besides my consulting projects, where I was able to gather much detailed cost data and scrubbed the data as generic for a specific industry, I also have read every 10K of every capital good OEM and their key suppliers to gleam additional cost info…not light reading, but there is lots of info in those SEC documents, but depending upon the segment reporting of the OEM, reported costs can be dramatically impacted.
Also note that managerial costing, GAAP reporting and tax reporting can be quite different for the same product. Issues of import duties, intercompany transfers, tax issues and so many other issues can “corrupt” product costing…all-in-all, the reason that product costing is so often inaccurate is that the number agreed upon is the creation of a committee in which each member has different objectives.
As to forward and reverse supply chain costs, I have collected data sets for discrete mfg and product support organizations. SCM costs are all over the place. There are big differences between supply chain costs for remanufacturing versus new product mfg, yet many OEMs combined those costs in the same ledger account.
In conclusion, it is my opinion that product costs have to be spoken to for a specific industry and for a specific process within that industry.
@Ron – True statements. There’s no doubt that people applying Financial (GAAP) or Tax accounting principles to managerial/cost accounting, are setting themselves up for failure. Similarly, the problem you bring up of confounding different costs in the same account number is also awful.
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Roman Siemens SAYS
It’s actually not that much about cost reduction or cost avoidance then about proper product development. It’s true, the mistake in the product design are the most expensive mistakes.
That’s why it so important during development phases to have close cooperation between sales department, actually design office and production. Sales people know best what the potential customers need. Production can tell about what design is best for cost efficient manufacturing. The designer finally brings all that together.
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Silvia Bitchkei-Campbell SAYS:
Like with almost all fields, an expert has to be multi-disciplinary. Being able to look at the bigger picture is almost a pre-requisite for successful evaluation to improve operations, or in this case product cost management. In short, diversity of talents is a must.