Process » Hiller Associates Product Cost Management

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Aug 252020

Hello operational improvement fans!

Apparently Eric hiller is cheating on us these days with his own personal website (www.eric-hiller.com). But, we are still happy to pass on his work to you. He just wrote a new piece for medium.com called:

Eric Hiller Provides Operational and Process Improvement Tips

This article is targeted toward executives and high level consultants that are trying to affect a process transformation in their organizations.

Certainly there are 1001 ways to fail in a process transformation in the organization, but in this article Eric’s only going to focus on the top ten (well, 11). On the other hand, if you get these 11 right, you probably will avoid 90% of the pitfalls!

Dr. Strangepart: How I Learned to Stop Worrying and Love the BOM

Product Lifecycle Management, Uncategorized 37 Responses »

Jan 232014

Yesterday, we began a series of articles at one of our media partners, www.ENGINEERING.com. Instead, of focusing on Product Cost Management, we are focusing on another maddeningly difficult problem with critical implications to the Firm: structuring the Bill of Material to promote ease of use… and re-use. We will reprint the article below, and you can view the original here:

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A few months ago, unleaded client and asked me an interesting question. That question was how does one reconcil the tension between specific parts or hardware vs. the functional use in the product of those parts. This client was from a major fortune 500 company with a bill of material (BOM) containing thousands of parts on each product. I was a bit taken aback, at first, by this question. Although it is a very difficult question and subject, I assumed that most major companies were old hands at dealing with this tension. I was wrong.

This reminded me that something that might seem old hat or common sense to one person, might be very interesting to another. For example, when I graduated from the university and went to work for Ford Motor Company, I was taught that the Ford part numbering system. Ford uses a system for parts that is an intelligent part numbering system, in which the part number makes it obvious which product programs , functional type of hardware, and what version of the part is being described

Hiller Associates - Intelligent Part Numbers

CLICK to ENLARGE!

This system of numbering parts has been around for goodness knows how long. It is no great secret in the auto industry. I’m sure every person at Chrysler, GM, the foreign auto companies know the Ford system of numbering parts. In fact, apparently , eBay even teaches us about the Ford part numbering system. It’s very straightforward and makes complete sense. As a young engineer, fresh out of school, who didn’t know any better, I assumed that every company had a similar intelligent part numbering system. However, when I gained a little bit more experience and maturity, I realized that Ford’s ingenious but simple system was not so common sense at all throughout industry. In fact, most companies I have met in manufacturing have nothing more than a sequential part numbering system that tells nothing about the part for which you were looking.

The point here is not for me to glorify the Ford part numbering system. I’m sure there are companies with even better and more intelligent part numbering systems out there. In fact, we don’t even have to go back into the horrors of the group technology fad in the late eighties or early nineties to know that! No, my point is that relatively simple and logical ways of classifying (but not over classifying things!) on the BOM can really help us in our management of engineering parts and the product.

Therefore, in the next few weeks, I plan to post a series of articles that talk about these ways that we can view the bill of material and help ourselves and our company. I look forward to hearing what other experts in the product life cycle management will have to say in comments.

Crossing Over from Classical Product Cost Management to being a PCM Rock Star

Product Cost Culture, Product Cost Management, Uncategorized 6 Responses »

Jun 172013

We spend a lot of time thinking about how organizations can improve Product Cost Management. After all, it’s our job at Hiller Associates, but we’re also very passionate about it. We’ve often wondered, why is it that there are so many people in Product Cost Management who are very intelligent and hardworking individuals, and yet the field, in most organizations, does not advance.

Why is this?

We don’t think it’s due to lack of effort.
We don’t think it’s due to lack of intelligence.
It may be due, in part, because the tools in the area are not that great, at least until recently. However, we don’t think that’s the cause either.

We have concluded that one of the biggest problems is that most Product Cost Management Experts are independent acoustic live performers.

Sing me a song!

What do we mean by that ? Well, if you go into the average product company and meet the Product Cost Management organization, it usually consists of a very small group of experts. They typically are sequestered in some back office. They appear to be a covert operation of some large organization, such as purchasing. When you meet them, they are almost always hardworking people , who looked frazzled, but still have their noses to the grindstone. They are busily trying to avoid product cost before launch and wringing cost out after the start of operations.

Traditional PCM experts are like solo classical musicians. They improvise solo (excel spreadsheets) or play an expensive instrument (an expert tool). They play for command performances before the nobles. In this case, the noble is whatever manager is in the most desperate trouble at the time. The PCM guys are always overworked, but their solution to this is to work harder. Just like a classical live musician, they can only be at one place at one time. Their performances are beautiful to listen to, but there is no recording, nor is there a broadcast, so that others in the world can hear the wonderful music they make. They really are a solo act.

We show this on the diagram below by showing the simple sine wave representing the music they sing. Pound for pound, person for person, no one can save more cost than these soloists, singing their song live and alone. However, as with any organizations that relies on people to scale, it can all only scale so large, and it can only scale so fast . That is why professional services companies are typically very small. The growth of the company is limited by the expert resources they can find. Think of this versus a product company, where once the product is designed, it can be replicated very quickly through the magic of manufacturing.

Product Cost Management Rock Star Hiller Associates

CLICK TO ENLARGE!

Time to Crossover to Being a Rock Star

It’s time for product cost management groups to stop being solo live classical musicians and crossover, as they say in the music biz, to be rock stars. On the diagram to the right, look at the traditional path vs. a maximum performance path. It’s time for PCM experts to spend less time playing alone and move to being Rock Stars (and maybe the director of the band). In this arrangement, the musician continues to do a lot of what he does today. He composes and produces the music. The music itself is the technical expertise needed for product cost management, but the expert should be sharing it with the entire organization, not just a few people in solo performances. This requires that he have a *vision* for Product Cost Management. This is not a vision for how to cost model the next part or assembly, but where the organization is today and where he wants it to get to in the future.

This Amp Goes to 11

The key to success is to amplify the music made by the Product Cost Management expert. To do this, you need to find the right management champion. Management is an amplifier, because their job is to receive the good ideas that their people bring them and then boost the signal on the idea to the rest of the organization. Management also parses the signal to the right speakers in the organization that can most beautifully and powerfully and produce that signal. Think about a modern 5.1 or 7.1 home theater system, where the amp or receiver parses the signal and sends the right frequencies to the right speakers.

And, if you’re going to be a Product Cost Management rock star, you want the biggest and highest quality amp you can get. You would be pitching your vision at the VP or C-level. Remember the movie Spinal Tap? You want the amp that goes to 11!

The Recording Industry

Every rock star is going to both tour and record. The management amplifier lets you to play to stadiums full of people. But you also need to record it, so that your fans can hear it over and over. To generate maximum profit for the organization, the fans (engineering, purchasing, manufacturing, etc.) needs to be able to execute on your PCM vision. Many times that music will need to play when you can’t be there. You record by (1) changing the culture and (2) designing a PCM process that the organization can follow.

Money for Nothing and Your Savings for Free

The rewards to the organization when the PCM team moves from live classical performers to rock stars are very enticing. Although the results of the individual product cost manager experts will certainly be smaller, the rest of the organization now is producing results as well. Together, they will produce many more cost savings and far more the cost avoidance than the Product Cost Management expert could do alone.

The Path to Stardom

We realize that moving to the rock star model will initially be uncomfortable for some people who are experts. It’s hard for experts to let go of control, especially on a complex set of activities like Product Cost Management. There will be mistakes by the organization. There will need to be teaching. The system may be chaotic at first. That’s OK. This is the only way to get to a better state. It also means that the individual product cost expert will have to spend LESS time actually producing results on his own. His time needs to be used developing vision, casting vision, teaching, strategizing, and leading the organization. He doesn’t have to compose that vision and record it alone. His executive sponsor can help get him some great song writers and producers, both internal to the organization and through external consulting partners. And the executive champion will also fund these resources.

Therefore, it is critical to find the right management sponsor who understands the benefits of moving from a solo live performance model to the recorded rock star model. The management sponsor needs to have the authority to reduce the individual PCM demands on the expert. The expert must produce less individually so the organization can produce more as a whole.

Product Cost Management – Behind the Music…

Sadly, looking back at my time as a CEO and then the Chief Product Officer at a company that made Product Cost Management software , and in my current roll as a strategic consultant, I have never seen this rock star transition be driven by the musician (the Product Cost Management expert). Every time I’ve seen organization move the needle on Product Cost Management, the impetus for that change was an executive sponsor who had a vision for a better world. The executive sponsor (typically in engineering, purchasing, or a product owner) was poking his nose into the world of product cost, sometimes knowing very little about it. Paradoxically and sadly, often the existing Product Cost Management organization, instead of being grateful for the help and wanting to get made into a rock star, was resistant or even resentful of the help. That’s too bad, because rock stars make a lot more money than classical musicians, and often have far better job security. (People are going to pay to see Aerosmith until they die.)

So, my advice to you is that if you want to become critical to your management, be noticed in the organization, see your organization produce far better results, and get rewarded for doing it, it’s time to stop playing acoustic solos live.

It’s time for you to become a rock star.

A Product Cost Management Post to Upset Everyone!

Product Cost Culture, Product Cost in Industry, Product Cost Management 44 Responses »

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?

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.

Today’s Product Cost Killing Tip — Control the Evil Robot Overtolerancer!

Product Cost Killing Tip, Software Tools (for PCM, ERP, PLM, etc.) 2 Responses »

Feb 112013

There were a lot of comments last week to the article we posted with the title: Only 17% Percent of Companies Meet Product Cost Target

Many people complained about the dearth of knowledge of the design engineer in Design for Manufacturability. In the discussion, we also started to propose some solutions to overcome this problem. However, one comment that sparked my interest was a comment about WHY design engineers often overtolerance parts that went beyond “they don’t know any better.” The comment paraphrased was:

A big problem we have is that we are making parts directly from the CAD model. A lot of Catia based models have a general tolerance of +- .005 [in.] on the entire part .including fillet radii and edge breaks. …these features have to be penciled off with a ball end mill instead of using a standard tool with a radius on it can kill profit on a job when you miss it when quoting.

That is a fascinating observation. There is no doubt that the Product Lifecycle Management companies will be pleased as punch that people are finally taking their drum beating on “model is master” seriously. FYI – I agree that the model should be master and that drawings should be generated from the 3d master data. However, this improvement to PLM adherence highlights what happens when new technology (a tool) is foisted upon a problem without without understanding the current processes and outcomes that the incumbent tool is satisfying. In this case, the old tool is paper drawings. With the incumbent tool, there was a title standard block that for companies, and that title block would give helpful bounding constraints such as:

Unless otherwise specified:

All dimensions +/- o.o1 inches

All radius and fillets +/1 0.02 inches

Etc.

That helpful and protective title block may not be there with a 3d, model onl,y strategy. All the evangelism on “tolerance by exception” goes right out the window what the CAD system now has default values that are overtoleranced by definition. The CAD system itself becomes… The Evil Robot Overtolerancer.

The good news is that the Evil Robots can be controlled, and you don’t even need anyone named Yoshimi to help you do it. However, it will require some thought, before you change the default tolerances in your CAD system. Some considerations to think about are:

What were the default tolerances in the title block on your drawings when the drawing was master?
Can these tolerances be reduced?
How surgically will your CAD system allow you to set default tolerances?
Do you need different tolerence ‘templates’ depending on the primary manufacturing process. E.G. tolerance defaults may be very different for a casting that is machined than for a piece of sheet metal.
How will you make your design engineers aware of these new default tolerances?

Whatever decision you make, make sure all the right people are at the table to make it together, including design engineering, the drafting team (if separate from design), purchasing, and manufacturing (including suppliers, if parts are made externally). If done thoughtfully and correctly, the setting of default tolerance will bring the Evil Robot Overtolerancer under control. If these changes are made in a vacuum or carelessly, you may find that you have made the Evil Robot 10x more powerful as an agent of chaos and profit destruction.

You want to be dealing with the friendly Autobots, not the Decepticons, right?

That’s today’s Product Cost Killing Tip!

If you have Product Cost Killing tips that you would like to share, please send them to answerstoquestions@hillerassociates.com.

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.

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!