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New product development costing
Developing a product costing model and
performance measuring system for a new product
Carles Debart
Product Costing and Financial Management
DM944, University of Strathclyde, Glasgow, UK
MSc Global Innovation Management
1
Content
1. Introduction ...........................................................................................................................2
1.1 Background ......................................................................................................................2
1.2 New product description .................................................................................................2
1.3 Discussion of the appropriate costing model..................................................................3
2. Product costing model...........................................................................................................4
2.1 Bill of Materials................................................................................................................4
2.2 Lifecycle costs ..................................................................................................................6
2.3 Building the model...........................................................................................................7
2.4 Sales scenarios .................................................................................................................9
2.5 Driving improvements through target costing principles..............................................11
3. Performance management systems....................................................................................15
3.1 Introduction to performance measurement systems ...................................................15
3.2 New product development performance......................................................................15
3.3. Role of supply chain performance in new product development................................16
3.4 Performance management models for NPD within supply chain .................................16
4. References ...........................................................................................................................18
2
1. Introduction
The purpose of this report is to build a product costing model for a new product development in the
context of a large multinational company. The key points to be addressed are to model the cost
elements of the product family, develop a costing model for various sales volume scenarios and
identify room of improvement using the model. Moreover, in order to manage the new product
development, a performance management system needs to be implemented and discussion about
existing methods and their suitability for the supply chain is sought.
In order to build the case study, all the references to Ikea have been taken to establish a starting
point and for educational purposes only.
1.1 Background
Ikea is a Dutch multinational company with origin in Sweden, famous worldwide because of his
approach of ready-to-assemble furniture, appliances and home accessories. Ikea is known for
focusing on cost control, operational excellence and continuous product development. This
approach has allowed them to continuously reduce their prices (between 2 or 3% per year) and
expanding successfully all over the world.
Ikea has been criticized for being the third-largest consumer of wood in the world, after The Home
Depot and Lowe’s. To clean their image, the commandment has decided to launch an
unprecedented family of eco-friendly products that will reinforce their alignment with the vision of
being a more of environmental friendly company.
1.2 New product description
Ikea’s marketing department has identified three possible options for this unprecedented product
family: bicycles, greenhouses, windmills. After some market research and a carefully selection
criteria (see figure 1), bicycles were chosen as the best way to accomplish the above mentioned
goal. However, although this product will be used as marketing strategy and lies away from core
competencies of the business (furniture), it needs to be designed and development in such a way
that won’t damage Ikea’s finances. This is of a great importance especially when we take into
account how competitive is the bicycle industry. For this reason, a new product costing model needs
to be deployed to guarantee that the entire project will be profitable.
The project will have a lifetime of 3 years, and after that time it will be reviewed for possible
extension. The new product will be a hybrid unisex bicycle (suitable for city and off-road) called
Bikea, with special focus on design, usability and low maintenance. Ikea will make use of their team
of talented designers to create a model that will make an impact on the market, while maintaining a
low cost. The biggest technological challenge is to build the frame, activity that will be externalised
to a manufacturer in Taiwan in order to limit the initial investment and possible risk. The rest of the
components will be taken from several different suppliers located in China. The assembly, quality
3
control, packaging and delivering will be done in a refurbished warehouse near Ikea’s headquarters
in Netherlands.
Figure 1: Evaluation criteria for the new product development
1.3 Discussion of the appropriate costing model
Despite being the traditional costing the most used costing model in the past, especially in the
manufacturing industry whose activities consists of a series of common or repetitive tasks, over the
last 20 years has gained a lot of detractors. Their main argument relies on the fact that it is not
sufficiently accurate for new manufacturing environment. The high adoption of automation, the
lower workforce required and the market globalisation puts standard costing into a tight spot. It is
agreed by researchers that standard costing is a model suitable for cost control but not for cost
reduction, which is a key point in the current manufacturing environment.
New methodologies appeared to improve the accuracy of traditional costing methods. Activity-
Based Costing (ABC) is one of the most widely adopted costing methods for manufacturing industry
nowadays. The aim of ABC is to calculate costs and performance of each activity involved to
manufacture a product. According to Turney (1996), a cost for each activity is set according to the
use of the companies’ resources and then, each product is allocated a cost regarding those activities
involved in its manufacture. However, ABC shows some pitfalls. ABC method can be resource
consuming method to deploy, and as it is argued by Gunasekaran (1999), it requires a deep
Evaluation Criteria Weighting Windmill Bicycle Greenhouse Notes
Rate between 1 - 10 5% 3 10 10
Rate between 1 - 10 10% 7 8 9
Rate between 1 - 10 15% 8 6 5
Rate between 1 - 10 10% 4 10 4
Rate between 1 - 10 15% 8 7 7
Rate between 1 - 10 5% 3 8 7
Rate between 1 - 10 5% 8 8 8
Rate between 1 - 10 5% 4 5 6
Rate between 1 - 10 20% 6 10 7
Rate between 1 - 10 5% 9 9 10
Rate between 1 - 10 5% 8 6 10
Totals 100% 6,45 8,05 7,05
Competitive Evaluation - Is the product similar to other products on the market? If so, have we identified our products competitive advantage?
Value - Can the product deliver value to the end user? Are customers willing to pay for the product?
Strategic Alignment - Does the product fall in line with our strategic objectives? Can we use existing infrastructure to produce the new product?
Demand - Is there a need for the product on the market? Does it follow market or industry trends?
Financial Feasibility - Can we afford the cost of development? , is the likelihood of a positive financial return high?
Launch - Will the product be easy to launch? Are the financial resources in place to allow for a successful product launch?
Usability - Is the product user friendly? Can it be widely used?
Implications - will the launch of the new product have any positive implications on existing product lines?
Innovation - Is the product new to the market? Is there anything else on the market that is similar?
Market Growth - Is there growth in the market? Is there room in the market for this product?
Barriers to Entry - Have barriers been considered (legal or otherwise)?
4
knowledge of organization’s processes and activities and it implies a high level of critical decision
making when activities and costs need to be mapped into the model.
Moreover, ABC needs to be deployed very carefully in order to select each cost driver that will lead
into correct cost estimations (Baykasoglu and Kaplanoglu, 2008). However, when it is applied
correctly, gives clear ideas on how activities and departments perform across the entire
organization, delivers better control tools for overheads costs and facilitates the identification of
cost reduction initiatives.
However, both traditional costing and ABC methodologies (and other similar approaches) have to
main flaws. The first one is that the product price will be based on its cost, which is a problem
because we cannot guarantee that the costumer will be willing to pay for that. It can happen that
our product includes functionalities that are irrelevant to the customer’s point of view and that will
raise the price with no reason. This problem is addresses by target costing methodologies. The
second flaw is that costs are allocated as current costs, but there are certainly other costs in new
product development without which is not possible to launch a new product to the market (like R&D
costs). Moreover, other costs incurred in the product’s life must be taken into account, like those
related to after-sales services or disposal costs. This is particularly addressed in lifecycle costing.
Ikea value proposition is to give good quality products at unbeatable prices, thus target costing is
certainly the best costing model for this purpose. However, as the bicycle project is not strategically
aligned with the current product lines, high investments have to be made in R&D, facilities and after-
sales services such as warranty management and repairing services. To input all this costs in a
manageable way, the lifecycle costing method is highly advisable. In conclusion, a hybrid costing
method will be deployed for bicycle project at Ikea, mixing the lifecycle costing with a target costing
approach.
2. Product costing model
In this section, the hybrid lifecycle target costing method will be depicted step by step, identifying
and arguing the inputs and parameters to justify its utility.
2.1 Bill of Materials
When we want to make profit from a product it is mandatory to take into account that the total
revenue will exceed the total costs incurred in the project, even if those costs are incurred before,
along or after the product is produced. In essence, all costs should be taken into account when
drawing the profitability model. Moreover, costs are linked. For example, more attention to design
can reduce manufacturing costs in the future. In the same way, more training can lead into
improvements on employee’s efficiency and thus, labour reduction.
The most straightforward cost of all is the bill of materials (BOM), where all the component’s cost of
the Bikea are detailed (Figure 2):
5
Bikea
Component Comments Unitary cost (€) % of cost
chain Steel 1,1 0,59%
Bar stem Aluminium 2,5 1,35%
Seat post Aluminium rims, steel hubs 2,6 1,41%
Pedals Plastic 2,7 1,46%
Lights LED 2,8 1,51%
Shifters Plastic 3,6 1,95%
Saddle Plastic/foam 3,7 2,00%
Fender Plastic 3,7 2,00%
Handle bar Aluminium 3,9 2,11%
Kickstand Steel 4,1 2,22%
Brakes Steel 4,4 2,38%
Headset Steel 5,3 2,87%
Carrier Leather 6,2 3,35%
Tires OEM Taiwan aluminium 6,3 3,41%
Bottom bracket Sealed cartridge 6,4 3,46%
Fork Steel 12,1 6,54%
Drive train Steel 26,2 14,17%
Wheels Aluminium rims, steel hubs 37,9 20,50%
Frame OEM Taiwan aluminium 49,4 26,72%
Total 184,9€ 100%
Figure 2: Bill of materials for Bikea
The next charts shows in a more visual way which are the costs that have more impact in the final
cost in the bill of materials (figure 3). Those are the frame, the wheels, drive train and the fork:
Figure 3: Visual inspection of % of each component in the total cost
6
2.2 Lifecycle costs
The next step is to identify all of the costs associated with the product life-cycle of the Bikea project:
1. R&D: Bikea project will consume HR resources from Ikea workforce. Designers will work on the
innovative frame design over the first half year. Once a successful design is achieved and approved
by marketing department, it will be sent to the Taiwan manufacturer to start production. In the
second half of the first year, some designers will remain involved part time to verify and improve the
manufacturability of the design, if it is needed. As the project has a lifecycle of 3 years, no other
models are planned for years 2 or 3, however some other costs will be allocated in those years to
improve existing models (10.000 € per year). The whole project’s R&D is estimated in € 2 Million,
which is fixed a cost.
2. Facilities expenses: Ikea has decided not to build new facilities for this project but reusing an
underused warehouse. The budget will be mainly used for the setup of this old warehouse to a
convenient place to assemble bicycles. The cost is fixed and is committed in the first year rising
600.000€, but will be paid in three instalments over the 3 years. Moreover there will be an
associated a yearly cost for depreciation of the whole place of 10%.
3. Production: All the cost incurred during the manufacture process of Bikea are taken into account
in this section. As Bikea manufacture process is mainly assembly of the components into the frame,
the associated costs are:
- Component: costs for each Bikea extracted from the bill of materials (variable cost).
- Labour cost: Ikea will make use of his workforce to adapt the number of employees to the
production conditions in order to maximize efficiency. In that way, labour cost (assembly of the
bicycles) can be considered as a variable cost. It is estimated that the gross man hour cost will be
20€ and one bicycle assembly will take 1 hour.
- Maintenance: These costs have to be taken into account as expenses for the correct development
of manufacture process. Maintenance has a fixed and variable nature: fixed because some cost are
incurred even if no Bikea is produced (maintenance of the building and facilities) and variable
associated to the wear of tools during the assembly process. Those proportions have been defined
as follows: fixed cost of 150,000€ over the three years plus 1€ of cost per Bikea produced.
- Utilities: these costs follow a similar cost pattern as maintenance, with fixed and variable costs:
250,000€ per year of fixed cost (€ 0.75 Million over the three years) plus 3€ per each Bikea
produced.
- Insurance: this cost is related to the insurance cost of the warehouse where the assembly will be
carried out. It is a fixed cost of 75,000 € over the three years.
4. Marketing: Although is seems it has a fixed cost nature (we may think that it is independent of the
number of Bikea sold), marketing activities go beyond promotion and advertisement. One of the
7
main tasks for this department is assure accessibility of products (how products are easily reached
by the costumers) and this is certainly dependable on the number of Bikea being produced and
showed in the stores. Taking everything into account, a fixed cost for this department is budgeted as
follows: € 3 Million the first year, € 2 Million for the second year, and €1 Million for the last year.
This budget distribution meets the demand of acquiring awareness of the product as soon as
possible. Regarding the variable cost of accessibility, it has been allocated 5€ per Bikea.
5. Distribution: Again, a semi-variable cost with a fixed component of 250,000 € per year plus an
average variable cost of distribution of 10€ per bicycle
6. Customer service: The cost of having a small space in each of Ikea stores dedicated to after-sale
service and repairing is € 0.35 Million per year. Moreover, Ikea is very committed with client
satisfaction and offers free of charge adjustment of any Bikea after one months of use. It has been
calculated to have a variable cost of 7€ per unit sold in terms of labour.
7. Additional overheads: Bikea project will make use of some Ikea resources, as it will be a part of
the existing product line. Those costs are mainly administration, software licences, patents
registration. Some budget is reserved as well for lawsuits if patents are found to be broken by the
competency. These costs are fixed and are forecasted to rise up to 225,000€ during the whole life-
cycle.
8. End of the life-cycle: If Ikea management decide to quit the project after the 3 initial years, the
costs involved in shutting down the warehouse and other related cost (waste management.) are
estimated in 250,000€ and represent a fixed cost for the final year.
2.3 Building the model
Once we have identified and analysed all the associated cost for the life-cycle of the Bikea project,
we can implement an structured table mapping all of those cost allocated across time (for fixed
costs) or allocated to product (for variable costs). We can draw some interesting conclusion from
cost table. Firstly, the variable cost associated to one Bikea has increased nearly 50€ from the initial
number drawn from the Bill of materials. That give us an idea on how important and what is the
impact of giving an efficient customer service. Lifecycle costing method allows us to identify all of
these costs that may have been unnoticed with other simpler costing methods.
Secondly, we can understand how expenses are committed during the whole duration of the project.
For example, the costs for the first year is nearly double that the other two years together. That is
interesting from a cash flow point of view because allows to envision how deep is the “first year
hole” in the project finances. However, product costing decisions such as selling price and margins
have to be forecasted taking into account the whole lifecycle of the project instead of one particular
year’s results or forecast.
8
Figure 4: Fixed and variable costs distributed through the lifecycle of the project
Fixed cost (€) Variable cost (€)
1st year 2nd year 3rd year lifecycle per unit
R&D
Design 2.000.000 0 0 2.000.000 -
Improvements 0 10.000 10.000 20.000 -
Total R&D 2.000.000 10.000 10.000 2.020.000 -
Facilities expenses
Fitting-out 200.000 200.000 200.000 600.000 -
Depreciation 20.000 20.000 20.000 60.000 -
Total facilites expenses 220.000 220.000 220.000 660.000 -
Production
BOM - - - - 184,9
Labour cost - - - - 20,0
Maintenance 50.000 50.000 50.000 150.000 1,0
Utilities 250.000 250.000 250.000 750.000 3,0
Insurance 25.000 25.000 25.000 75.000 -
Total production costs 325.000 325.000 325.000 975.000 208,9
Marketing
Awareness 3.000.000 2.000.000 1.000.000 6.000.000 -
Accessibility - - - - 5,0
Total marketing costs 3.000.000 2.000.000 1.000.000 6.000.000 5,0
Distribution
Logistic management 250.000 250.000 250.000 750.000 -
Average shipping - - - - 10,0
Total distribution costs 250.000 250.000 250.000 750.000 10,0
Customer service
Reparing workshop 350.000 350.000 350.000 1.050.000 -
Free 1st month adjustment - - - - 7,0
Total customer service costs 350.000 350.000 350.000 1.050.000 7,0
Additional overheads
Administration 65.000 65.000 65.000 195.000 -
Patents 12.000 - - 12.000 -
Lawsuits - 4.000 8.000 12.000 -
Software licenses 2.000 2.000 2.000 6.000 -
Total overhead cost 79.000 71.000 75.000 225.000 -
End of life-cycle project
Decommissioning - - 200.000 200.000 -
Waste management - - 50.000 50.000 -
Total EOC costs - - 250.000 250.000 -
Total accumulated costs 6.224.000 3.226.000 2.230.000 11.680.000 230,9
9
2.4 Sales scenarios
To assess the profitability of the Bikea project, the marketing department has carried out a deep
market research. As a result of this three different sales scenarios have been identified: worse case,
best case, and average case. These sales forecast are shown in the next figure:
Figure 5: Sales scenarios forecasted by the marketing department
The costing department together with the marketing department have agreed on the minimum
profitability margins that any product line of Ikea has to meet: 30%. The next step is to calculate, for
each of the forecasted scenarios, which will be the total cost of one Bikea, which are the
percentages of each cost attributable to one sold Bikea and whether the target margins are met. The
market department, after comparing the competence, evaluating the targeted segment, assessing
the features included in the product and aligning it with the price strategy of the company has
decided to launch the Bikea for 419€. With that price and the costing table for each sales scenario
(see Figure 7) we can assess the total profits and margins for one unit of Bikea.
Figure 6: Profits and margins per unit sold for each scenario based on Figure 7 detailed cost
1st year 2nd year 3rd year
Total
lifecycle
Scenarios
Best 50.000 75.000 45.000 170.000
Average 35.000 55.000 30.000 120.000
Worst 20.000 25.000 15.000 60.000
0
20.000
40.000
60.000
80.000
100.000
120.000
140.000
160.000
180.000
Unitssold
Forecasted sales scenarios
Cost allocation per unit, turnover and margins (€)
Best Average Worse
Selling price 419,00 419,00 419,00
Expenses
R&D 11,88 16,83 33,67
Facilities 3,88 5,50 11,00
Marketing 40,29 55,00 105,00
Distribution 14,41 16,25 22,50
Customer service 13,18 15,75 24,50
Additional overheads 1,32 1,88 3,75
End of lifeclye 1,47 2,08 4,17
Production costs 214,64 217,03 225,15
Profit total 117,92 88,68 -10,73
Profit margin 28,14% 21,17% -4,77%
10
Figure 7: Detailed cost per unit.
From both tables above, we can draw the conclusion that the product costing has not met the
requirements established by the marketing department regarding sales and profit margins. In any of
the three scenarios the targeted 30% of profit margin is met and moreover, in the case of the worst
scenario losses are expected. Marketing department is very confident with their forecasts and
hence, has required the costing department to reduce expenses in order to meet a minimum profit
margin of 30% for the average case and no losses in the worst case.
Fixed cost Variable cost (€) Cost per unit for each scenario (€)
lifecycle per unit Best Average Worse
R&D
Design 2.000.000 - 11,76 16,67 33,33
Improvements 20.000 - 0,12 0,17 0,33
Total R&D 2.020.000 - 11,88 16,83 33,67
Facilities expenses
Fitting-out 600.000 - 3,53 5,00 10,00
Depreciation 60.000 - 0,35 0,50 1,00
Total facilites expenses 660.000 - 3,88 5,50 11,00
Production
BOM - 184,9 184,90 184,90 184,90
Labour cost - 20,0 20,00 20,00 20,00
Maintenance 150.000 1,0 1,88 2,25 3,50
Utilities 750.000 3,0 7,41 9,25 15,50
Insurance 75.000 - 0,44 0,63 1,25
Total production costs 975.000 208,9 214,64 217,03 225,15
Marketing
Awareness 6.000.000 - 35,29 50,00 100,00
Accessibility - 5,0 5,00 5,00 5,00
Total marketing costs 6.000.000 5,0 40,29 55,00 105,00
Distribution
Logistic management 750.000 - 4,41 6,25 12,50
Average shipping - 10,0 10,00 10,00 10,00
Total distribution costs 750.000 10,0 14,41 16,25 22,50
Customer service
Reparing workshop 1.050.000 - 6,18 8,75 17,50
Free 1st month adjustment - 7,0 7,00 7,00 7,00
Total customer service costs 1.050.000 7,0 13,18 15,75 24,50
Additional overheads
Administration 195.000 - 1,15 1,63 3,25
Patents 12.000 - 0,07 0,10 0,20
Lawsuits 12.000 - 0,07 0,10 0,20
Software licenses 6.000 - 0,04 0,05 0,10
Total overhead cost 225.000 - 1,32 1,88 3,75
End of life-cycle project
Decommissioning 200.000 - 1,18 1,67 3,33
Waste management 50.000 - 0,29 0,42 0,83
Total EOC costs 250.000 - 1,47 2,08 4,17
Total accumulated costs 11.680.000 230,9 301,08 330,32 429,7
Attributable to fixed costs 70,18 99,42 198,83
Attributable to variable costs 230,90 230,90 230,90
11
2.5 Driving improvements through target costing principles
The restrictions imposed by the marketing department on the price of Bikea are driven by the need
of an answer to the following questions:
1. What is/are the segments that we want to target with our product?
2. What characteristics are the customers want in the product?
3. What is the price the customers would pay for the product?
4. What is the competence regarding our product?
5. What is the cost of advertising the product?
The conclusion drawn to the answers of these questions is that often engineers, management and
accountants work in a forward way, calculating the costs, adding a mark-up and finally, establishing a
selling price. Target costing approach is right the opposite: establishing a price that customers will be
willing to pay and then work backwards to find out the cost (features included in the product) taking
into account the profit margins. The target costing model is clearly self-explains in the following
figure:
Figure 8: Summarized flow of target costing principles. Source: MIT Sloan Management Review
Target costing is not mutually exclusive with any other costing method, nor is with the lifecycle
costing method developed for the Bikea Project, and In fact they are both often presented together
in hybrid forms. The next steps based in target costing principles have been identified and will allow
the costing department to meet the requirements set by marketing:
1. R&D: Although one may think that the expense on R&D is high and would be room for
improvement, the costing department agrees that is a key point of the whole development of Bikea
project cut down should be made. Moreover, some TQM improvements will be implemented to
achieve a lower manufacturability cost and lower rate of failure, which will lead into customer
12
service cost reduction. Hence, there will be allocated 30000€ per year in TQM activities, which
implies a growth of 4,5% in the whole R&D budget.
2. Facilities expenses: The marketing department in has put emphasis in the most likely scenario
(average) which is nearly 30% less than the best case scenario. In that way facilities will be optimized
for the production of this this forecast. This leads into savings of 30% (198000€).
3. Production: Thanks to the use of QFD methodologies, some features initially included in the bike
won’t be any longer included in the improved version, as they don’t add value to the customers:
carrier, kickstand and fender are removed (saving 14€ per unit). Wheels are downgraded (saving 5€
per unit) and thanks to TQM the same quality frame can be produced for 3€ less. In total, BOM
materials has been reduced from 184,9€ to 162,9€.
Through the improved design in manufacturability, assembling time will be reduced. Labour cost per
unit will decrease to 15€.
As the facilities have been scaled down, maintenance is less costly now (30% less) achieving a total
savings of 45000€ in the whole lifecycle. In the same way we save 30% in utilities and insurance.
4. Marketing: No cost reduction is considered.
5. Distribution: Designers have found a way to ship batches of 5 bicycles for container; hence the
cost per unit has decreased in 50%. Logistic management will be integrated in Ikea’s normal product
lines, which implies savings of 150000€.
6. Customer service: Average free 1st
month adjustment will be reduced in 2€ as the design has been
improved and the fixed cost associated to repairing booths in Ikea’s shop will be reduced in a 30%.
7. Additional overheads: Administration overheads will be again integrated in Ikea’s administration
departments, saving up to 50% of the total cost.
8. End of life-cycle project: The end of life-cycle project will be externalised to a specialized company
that will allow saving 50% of the decommissioning and waste management cost.
As a summary of improvements driven by target costing can be summarized as follows:
-The total fixed costs for entire lifecycle of the project have been reduced from to € 11.68 Million to
€ 10.83 Million (- 9,2%)
-The variable cost has been cut down from the initial 230,9€ to 196,9 € ( -8.5%)
The next tables (Figure 9) show the detailed new costing and the allocation of each cost (variable
and fixed) to each unit according to sales forecast scenarios, as well as (Figure 10) total profits and
margins for the improved costing model:
13
Fixed cost (€) Var cost (€) Cost per unit for each scenario (€)
1st year 2nd year 3rd year lifecycle per unit Best Average Worse
R&D
Design 2.000.000 0 0 2.000.000 - 11,76 16,67 33,33
Improvements 30.000 40.000 40.000 110.000 - 0,65 0,92 1,83
Total R&D 2.030.000 40.000 40.000 2.110.000 - 12,41 17,58 35,17
Facilities expenses
Fitting-out 140.000 140.000 140.000 420.000 - 2,47 3,50 7,00
Depreciation 14.000 14.000 14.000 42.000 - 0,25 0,35 0,70
Total facilites expenses 154.000 154.000 154.000 462.000 - 2,72 3,85 7,70
Production
BOM - - - - 162,9 162,90 162,90 162,90
Labour cost - - - - 15,0 15,00 15,00 15,00
Maintenance 35.000 35.000 35.000 105.000 1,0 1,62 1,88 2,75
Utilities 175.000 175.000 175.000 525.000 3,0 6,09 7,38 11,75
Insurance 17.500 17.500 17.500 52.500 - 0,31 0,44 0,88
Total production costs 227.500 227.500 227.500 682.500 181,9 185,91 187,59 193,28
Marketing
Awareness 3.000.000 2.000.000 1.000.000 6.000.000 - 35,29 50,00 100,00
Accessibility - - - - 5,0 5,00 5,00 5,00
Total marketing costs 3.000.000 2.000.000 1.000.000 6.000.000 5,0 40,29 55,00 105,00
Distribution
Logistic management 200.000 200.000 200.000 600.000 - 3,53 5,00 10,00
Average shipping - - - - 5,0 5,00 5,00 5,00
Total distribution costs 200.000 200.000 200.000 600.000 5,0 8,53 10,00 15,00
Customer service
Reparing workshop 245.000 245.000 245.000 735.000 - 4,32 6,13 12,25
Free 1st month adjustment - - - - 5,0 5,00 5,00 5,00
Total customer service costs 245.000 245.000 245.000 735.000 5,0 9,32 11,13 17,25
Additional overheads
Administration 32.500 32.500 32.500 97.500 - 0,57 0,81 1,63
Patents 6.000 - - 6.000 - 0,04 0,05 0,10
Lawsuits - 2.000 4.000 6.000 - 0,04 0,05 0,10
Software licenses 1.000 1.000 1.000 3.000 - 0,02 0,03 0,05
Total overhead cost 39.500 35.500 37.500 112.500 - 0,66 0,94 1,88
End of life-cycle project
Decommissioning - - 100.000 100.000 - 0,59 0,83 1,67
Waste management - - 25.000 25.000 - 0,15 0,21 0,42
Total EOC costs - - 125.000 125.000 - 0,74 1,04 2,08
Total accumulated costs 5.896.000 2.902.000 1.904.000 10.827.000 196,9 260,59 287,13 377,4
Attribut. to fixed costs 63,69 90,23 180,45
Attribut. to variable costs 196,90 196,90 196,90
Figure 9: Improved costing model and detailed cost per unit in each scenario.
14
Figure 10: New figures for profit and margins
The improvements introduced thanks to the costing model have enabled to meet marketing’s
requirements. In the worst case scenario the profit margin stands up to 21%, while in the average
scenario we reach 31%. Next figures show in a more visual way how are the costs finally allocated
per unit:
Figure 11: Profit and total cost allocation per unit for each sales scenario.
Cost allocation per unit, turnover and margins (€)
Best Average Worse
Selling price 419,00 419,00 419,00
Expenses
R&D 12,41 17,58 35,17
Facilities 2,72 3,85 7,70
Marketing 40,29 55,00 105,00
Distribution 8,53 10,00 15,00
Customer service 9,32 11,13 17,25
Additional overheads 0,66 0,94 1,88
End of lifeclye 0,74 1,04 2,08
Production costs 185,91 187,59 193,28
Profit total 158,41 131,88 41,65
Profit margin 37,81% 31,47% 21,55%
15
3. Performance management systems
3.1 Introduction to performance measurement systems
There have been several approaches to performance measurement in the past. Going back to 80s,
researchers agree that more integrated performance measurement systems were needed to match
with the tendency of globalisation that emerged from the aim of companies to be more competitive.
Hence, from that point we have been testimonies of the birth of many frameworks and models such
as the SMART and the performance measurement questionnaire (Bititci et. al 2005).
A more recent approach to performance measurement appeared with the birth of the balance
scorecard (1996) and the European business excellence model EFQM (1998). Both models give clues
in terms of what kind of measurements should be deployed and what conclusions should be
extracted from them. In 1998, the EPSRC established the concept of integrated performance
measurement systems, which was developed upon the balance scorecard and the EFQM models
(Bititci et. al 2005). Since then, other hybrid frameworks have used approaches from the above
mentioned models. Examples of this are the performance measurement systems and the
measurement workbooks.
Apart from the more generalist frameworks mentioned above, there have been other performance
measurement systems more focused in certain business areas and processes such as production and
planning, product development process, human resources or even for service management.
In conclusion, all the performance measurement systems, both the generalist and the more business
focused, should have in common a set of characteristics such as being balanced (regarding the
requirement of the stakeholders), being integrative (different measures need to be interlinked),
informing of the strategy (useful as an input for the strategy), deploying strategy (being able to
communicate business’ strategy), focusing on activities that deliver valuable (principle of the EFQM),
including competencies and stakeholder contribution (Bititci et. al 2005).
3.2 New product development performance
There is consensus among the researchers that product development is one of the most important
things in the future sustainability of any company, and especially those in the technological field.
New product development is becoming, as most of other business areas and processes within
companies, a more globalised activity where changes occur fast due to constantly changing
customer’s needs (Goffin and Mitchell 2005).
Product development is, as any other process in a business, able to measured and improved.
Although researchers have deeply analysed the product development process and contributed to
understand it, most of the companies are still reluctant to measure their product development
processes because the challenges that implies: complexity, uncertainty, intensive decision making,
short financial term vision, shorten time to market approaches, etc. This is the reason why
16
performance measurement within product development has been historically limited to cost and
time only, forgiving maybe the most important aspect, value of creation (Koller et al. 2005).
Other challenges that an effective performance management system for product development
should consider are for example: the different capabilities and activities that are required within the
organization in order to be successful, the alignment of business strategy with the product and with
customer needs, the alignment between the product development strategy and the business
strategy, competitive advantage (in the long term) and the rise of competitive environment among
customers and suppliers (Cedergren, S. 2008).
3.3. Role of supply chain performance in new product development
How can an effective performance supply chain help in the new product development? Take the
example of Inditex, the clothes fashion empire, where the perfectly fitted and extremely efficient
supply chain has been the true clue for its tremendous success. Although it doesn’t stands as high
technological new product development (as clothes cannot be considered) it is useful to illustrate
how the clothes development is boosted by its supply chain, able to supply the market with low cost
and high speed service. Another key point is its vertical integration and how coordinated are the
different departments associated to product development. As an example, it is interesting to note
that they can respond to a new market need within two weeks. Vertical integration plays an
important role as well, as stocks are just around 7% of the incomes. This integration strategy allows
the company to reduce costs and acquire some flexibility, reducing in that way the potential
negative impact of uncertainty during product development and the presences of specific actives
along the chain value.
Furthermore, Inditex takes the concept of supply chain to the extreme by establishing the role of
shops away from the “end of the chain” concept to a more “place to get user’s feedback” concept.
To do, shops are technologically equipped and staff trained to retrieve invaluable design information
that customer’s hint at during their visits. Inditex has certainly grown thanks to the competitive
advantages that its supply chain has brought, making it a clear example of an extended enterprise.
According to Childe (1998) an extended enterprise is a conceptual business unit or system that
consists of a purchasing company and suppliers who collaborate in such a way as to maximise the
returns to each partner. That means that the extended enterprise is a knowledge-based organization
that uses the distributed resources and capabilities through the supply chain in order to maximize
the competitive advantage and performance of the entire organization (Bititci et. al 2005), including
of course the product development processes.
3.4 Performance management models for NPD within supply chain
As it has been argued in the section before, supply chain management (and extended enterprise
methodologies that emanate from it), allow companies to take advantage from its network of
suppliers through upstream and downstream linkages that produce a value in the form a new
17
product or service to ultimately meet or exceed customer expectations. In practise, there are some
models that are specifically designed to manage performance of those extended enterprises. For
example, Gunasekeran et al. (2001) presents that the measures are arranged in three different levels
(strategic, tactical and operational) through the supply chain: plan and source performance,
production performance, deliver performance and client satisfaction. This model is in essence very
similar to the supply chain operations reference SCOR model and its six key activities (plan, source,
make, deliver, return and enables). Another model was introduced by Beamon (1999) and argues
that a framework for supply chain measurement should tackle at least one measure for each of the
following steps: resource measure, output measure and flexibility measure. In addition, Kochar and
Zhang (2002) proposed a model in which each company have its owns performance measurement
system that asses how coordinated and synchronised are companies between them in a given
network.
The essence of all these frameworks is to bring up to the surface the same measures proposed for
traditional single enterprise measuring systems (balance scorecard, EFQM, IPMS, performance
prism, smart pyradmid, etc) but suited to the supply chain. It is interesting to note how aligned is
the supply chain management goal’s with the new product development’s goals. The following list,
extracted from CIPS (2010) highlights the most prominent ones:
1. Reducing the non-value-adding activities through the supply chain (processing, inventory, waste)
2. Reducing cycle times to support innovation and fast new product development.
3. Enhancing quality through collaborative quality management, TQM initiatives, supplier motivation
and supplier commitment
4. Reducing total costs through better coordination and planning increased plant capacity utilisation,
waste reduction, less inspections and defects.
5. Optimising the balance of service levels and costs
6. Improving supply chain communication to boost all the above mentioned goals
As a conclusion, we provide a table linking those supply chain goals (according to their number) with
typical performance indicators associated to new product development (Slack et al. 2007)
18
4. References
Baykasoglu, A. and Kaplanoglu, V. (2008), “Application of activity-based costing to a land
transportation company: A case study”, Int. J. Production Economics, Vol. 116, pp. 308-324.
Beamon, M. (1999), “Measuring supply chain performance”, International Journal of Operations &
Production Management, Vol. 19 No. 3, pp. 275-92.
Bititci, U.S. et al., (2005). Measuring and managing performance in extended enterprises.
International Journal of Operations & Production Management, 25(4), pp.333–353.
Cedergren, S., (2008). Modeling Performance in Complex Product Development. Product
Development Organisational Performance Model.
Childe, S.J. (1998), “The extended enterprise: a concept for co-operation”, Production Planning and
Control, Vol. 9 No. 4, pp. 320-7.
Goffin, K. and R. Mitchell (2005). Innovation management: Strategy and implementation using the
Pentathlon framework. London: Palgrave MacMillan.
Guillen, Mauro F. "Archivo Edición Impresa." EL PAÍS. N.p., 11 July 2011. Web. 25 Apr. 2013.
<http://elpais.com/diario/2011/07/17/negocio/1310907804_850215.html>.
Gunasekaran, A., (1999), “A framework for the design and audit of an activity-based costing system”,
Managerial Auditing Journal, Vol. 14 Iss: 3pp. 118-127
Gunasekaran, A., Patel, C. and Tirtiroglu, E. (2001), “Performance measures and metrics in a supply
chain environment”, International Journal of Operations & Production Management, Vol. 21 No. 1/2,
pp. 71-87.
Kochhar, A. and Zhang, Y. (2002), “A framework for performance measurement in virtual
enterprises”, Proceedings of the 2nd International Workshop on Performance Measurement, 6-7
June, Hanover, pp. 2-11.
Koller, T., M. Goedhart, et al. (2005). Measuring and managing the value of companies. New Jersey:
John Wiley & Sons.
MIT Sloan Management Review. MIT Sloan Management Review RSS. N.p., n.d. Web. 25 Apr. 2013
[link] http://sloanreview.mit.edu/article/develop-profitable-new-products-with-target-costing/
Slack, N., Chambers, S. and Johnston, R. (2007). Operations Management, 5th edition, Pearson
Education.
Turney (1996), Activity Based Costing: The Performance Breakthrough (London: CLA).

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New product development costing. Carles Debart

  • 1. New product development costing Developing a product costing model and performance measuring system for a new product Carles Debart Product Costing and Financial Management DM944, University of Strathclyde, Glasgow, UK MSc Global Innovation Management
  • 2. 1 Content 1. Introduction ...........................................................................................................................2 1.1 Background ......................................................................................................................2 1.2 New product description .................................................................................................2 1.3 Discussion of the appropriate costing model..................................................................3 2. Product costing model...........................................................................................................4 2.1 Bill of Materials................................................................................................................4 2.2 Lifecycle costs ..................................................................................................................6 2.3 Building the model...........................................................................................................7 2.4 Sales scenarios .................................................................................................................9 2.5 Driving improvements through target costing principles..............................................11 3. Performance management systems....................................................................................15 3.1 Introduction to performance measurement systems ...................................................15 3.2 New product development performance......................................................................15 3.3. Role of supply chain performance in new product development................................16 3.4 Performance management models for NPD within supply chain .................................16 4. References ...........................................................................................................................18
  • 3. 2 1. Introduction The purpose of this report is to build a product costing model for a new product development in the context of a large multinational company. The key points to be addressed are to model the cost elements of the product family, develop a costing model for various sales volume scenarios and identify room of improvement using the model. Moreover, in order to manage the new product development, a performance management system needs to be implemented and discussion about existing methods and their suitability for the supply chain is sought. In order to build the case study, all the references to Ikea have been taken to establish a starting point and for educational purposes only. 1.1 Background Ikea is a Dutch multinational company with origin in Sweden, famous worldwide because of his approach of ready-to-assemble furniture, appliances and home accessories. Ikea is known for focusing on cost control, operational excellence and continuous product development. This approach has allowed them to continuously reduce their prices (between 2 or 3% per year) and expanding successfully all over the world. Ikea has been criticized for being the third-largest consumer of wood in the world, after The Home Depot and Lowe’s. To clean their image, the commandment has decided to launch an unprecedented family of eco-friendly products that will reinforce their alignment with the vision of being a more of environmental friendly company. 1.2 New product description Ikea’s marketing department has identified three possible options for this unprecedented product family: bicycles, greenhouses, windmills. After some market research and a carefully selection criteria (see figure 1), bicycles were chosen as the best way to accomplish the above mentioned goal. However, although this product will be used as marketing strategy and lies away from core competencies of the business (furniture), it needs to be designed and development in such a way that won’t damage Ikea’s finances. This is of a great importance especially when we take into account how competitive is the bicycle industry. For this reason, a new product costing model needs to be deployed to guarantee that the entire project will be profitable. The project will have a lifetime of 3 years, and after that time it will be reviewed for possible extension. The new product will be a hybrid unisex bicycle (suitable for city and off-road) called Bikea, with special focus on design, usability and low maintenance. Ikea will make use of their team of talented designers to create a model that will make an impact on the market, while maintaining a low cost. The biggest technological challenge is to build the frame, activity that will be externalised to a manufacturer in Taiwan in order to limit the initial investment and possible risk. The rest of the components will be taken from several different suppliers located in China. The assembly, quality
  • 4. 3 control, packaging and delivering will be done in a refurbished warehouse near Ikea’s headquarters in Netherlands. Figure 1: Evaluation criteria for the new product development 1.3 Discussion of the appropriate costing model Despite being the traditional costing the most used costing model in the past, especially in the manufacturing industry whose activities consists of a series of common or repetitive tasks, over the last 20 years has gained a lot of detractors. Their main argument relies on the fact that it is not sufficiently accurate for new manufacturing environment. The high adoption of automation, the lower workforce required and the market globalisation puts standard costing into a tight spot. It is agreed by researchers that standard costing is a model suitable for cost control but not for cost reduction, which is a key point in the current manufacturing environment. New methodologies appeared to improve the accuracy of traditional costing methods. Activity- Based Costing (ABC) is one of the most widely adopted costing methods for manufacturing industry nowadays. The aim of ABC is to calculate costs and performance of each activity involved to manufacture a product. According to Turney (1996), a cost for each activity is set according to the use of the companies’ resources and then, each product is allocated a cost regarding those activities involved in its manufacture. However, ABC shows some pitfalls. ABC method can be resource consuming method to deploy, and as it is argued by Gunasekaran (1999), it requires a deep Evaluation Criteria Weighting Windmill Bicycle Greenhouse Notes Rate between 1 - 10 5% 3 10 10 Rate between 1 - 10 10% 7 8 9 Rate between 1 - 10 15% 8 6 5 Rate between 1 - 10 10% 4 10 4 Rate between 1 - 10 15% 8 7 7 Rate between 1 - 10 5% 3 8 7 Rate between 1 - 10 5% 8 8 8 Rate between 1 - 10 5% 4 5 6 Rate between 1 - 10 20% 6 10 7 Rate between 1 - 10 5% 9 9 10 Rate between 1 - 10 5% 8 6 10 Totals 100% 6,45 8,05 7,05 Competitive Evaluation - Is the product similar to other products on the market? If so, have we identified our products competitive advantage? Value - Can the product deliver value to the end user? Are customers willing to pay for the product? Strategic Alignment - Does the product fall in line with our strategic objectives? Can we use existing infrastructure to produce the new product? Demand - Is there a need for the product on the market? Does it follow market or industry trends? Financial Feasibility - Can we afford the cost of development? , is the likelihood of a positive financial return high? Launch - Will the product be easy to launch? Are the financial resources in place to allow for a successful product launch? Usability - Is the product user friendly? Can it be widely used? Implications - will the launch of the new product have any positive implications on existing product lines? Innovation - Is the product new to the market? Is there anything else on the market that is similar? Market Growth - Is there growth in the market? Is there room in the market for this product? Barriers to Entry - Have barriers been considered (legal or otherwise)?
  • 5. 4 knowledge of organization’s processes and activities and it implies a high level of critical decision making when activities and costs need to be mapped into the model. Moreover, ABC needs to be deployed very carefully in order to select each cost driver that will lead into correct cost estimations (Baykasoglu and Kaplanoglu, 2008). However, when it is applied correctly, gives clear ideas on how activities and departments perform across the entire organization, delivers better control tools for overheads costs and facilitates the identification of cost reduction initiatives. However, both traditional costing and ABC methodologies (and other similar approaches) have to main flaws. The first one is that the product price will be based on its cost, which is a problem because we cannot guarantee that the costumer will be willing to pay for that. It can happen that our product includes functionalities that are irrelevant to the customer’s point of view and that will raise the price with no reason. This problem is addresses by target costing methodologies. The second flaw is that costs are allocated as current costs, but there are certainly other costs in new product development without which is not possible to launch a new product to the market (like R&D costs). Moreover, other costs incurred in the product’s life must be taken into account, like those related to after-sales services or disposal costs. This is particularly addressed in lifecycle costing. Ikea value proposition is to give good quality products at unbeatable prices, thus target costing is certainly the best costing model for this purpose. However, as the bicycle project is not strategically aligned with the current product lines, high investments have to be made in R&D, facilities and after- sales services such as warranty management and repairing services. To input all this costs in a manageable way, the lifecycle costing method is highly advisable. In conclusion, a hybrid costing method will be deployed for bicycle project at Ikea, mixing the lifecycle costing with a target costing approach. 2. Product costing model In this section, the hybrid lifecycle target costing method will be depicted step by step, identifying and arguing the inputs and parameters to justify its utility. 2.1 Bill of Materials When we want to make profit from a product it is mandatory to take into account that the total revenue will exceed the total costs incurred in the project, even if those costs are incurred before, along or after the product is produced. In essence, all costs should be taken into account when drawing the profitability model. Moreover, costs are linked. For example, more attention to design can reduce manufacturing costs in the future. In the same way, more training can lead into improvements on employee’s efficiency and thus, labour reduction. The most straightforward cost of all is the bill of materials (BOM), where all the component’s cost of the Bikea are detailed (Figure 2):
  • 6. 5 Bikea Component Comments Unitary cost (€) % of cost chain Steel 1,1 0,59% Bar stem Aluminium 2,5 1,35% Seat post Aluminium rims, steel hubs 2,6 1,41% Pedals Plastic 2,7 1,46% Lights LED 2,8 1,51% Shifters Plastic 3,6 1,95% Saddle Plastic/foam 3,7 2,00% Fender Plastic 3,7 2,00% Handle bar Aluminium 3,9 2,11% Kickstand Steel 4,1 2,22% Brakes Steel 4,4 2,38% Headset Steel 5,3 2,87% Carrier Leather 6,2 3,35% Tires OEM Taiwan aluminium 6,3 3,41% Bottom bracket Sealed cartridge 6,4 3,46% Fork Steel 12,1 6,54% Drive train Steel 26,2 14,17% Wheels Aluminium rims, steel hubs 37,9 20,50% Frame OEM Taiwan aluminium 49,4 26,72% Total 184,9€ 100% Figure 2: Bill of materials for Bikea The next charts shows in a more visual way which are the costs that have more impact in the final cost in the bill of materials (figure 3). Those are the frame, the wheels, drive train and the fork: Figure 3: Visual inspection of % of each component in the total cost
  • 7. 6 2.2 Lifecycle costs The next step is to identify all of the costs associated with the product life-cycle of the Bikea project: 1. R&D: Bikea project will consume HR resources from Ikea workforce. Designers will work on the innovative frame design over the first half year. Once a successful design is achieved and approved by marketing department, it will be sent to the Taiwan manufacturer to start production. In the second half of the first year, some designers will remain involved part time to verify and improve the manufacturability of the design, if it is needed. As the project has a lifecycle of 3 years, no other models are planned for years 2 or 3, however some other costs will be allocated in those years to improve existing models (10.000 € per year). The whole project’s R&D is estimated in € 2 Million, which is fixed a cost. 2. Facilities expenses: Ikea has decided not to build new facilities for this project but reusing an underused warehouse. The budget will be mainly used for the setup of this old warehouse to a convenient place to assemble bicycles. The cost is fixed and is committed in the first year rising 600.000€, but will be paid in three instalments over the 3 years. Moreover there will be an associated a yearly cost for depreciation of the whole place of 10%. 3. Production: All the cost incurred during the manufacture process of Bikea are taken into account in this section. As Bikea manufacture process is mainly assembly of the components into the frame, the associated costs are: - Component: costs for each Bikea extracted from the bill of materials (variable cost). - Labour cost: Ikea will make use of his workforce to adapt the number of employees to the production conditions in order to maximize efficiency. In that way, labour cost (assembly of the bicycles) can be considered as a variable cost. It is estimated that the gross man hour cost will be 20€ and one bicycle assembly will take 1 hour. - Maintenance: These costs have to be taken into account as expenses for the correct development of manufacture process. Maintenance has a fixed and variable nature: fixed because some cost are incurred even if no Bikea is produced (maintenance of the building and facilities) and variable associated to the wear of tools during the assembly process. Those proportions have been defined as follows: fixed cost of 150,000€ over the three years plus 1€ of cost per Bikea produced. - Utilities: these costs follow a similar cost pattern as maintenance, with fixed and variable costs: 250,000€ per year of fixed cost (€ 0.75 Million over the three years) plus 3€ per each Bikea produced. - Insurance: this cost is related to the insurance cost of the warehouse where the assembly will be carried out. It is a fixed cost of 75,000 € over the three years. 4. Marketing: Although is seems it has a fixed cost nature (we may think that it is independent of the number of Bikea sold), marketing activities go beyond promotion and advertisement. One of the
  • 8. 7 main tasks for this department is assure accessibility of products (how products are easily reached by the costumers) and this is certainly dependable on the number of Bikea being produced and showed in the stores. Taking everything into account, a fixed cost for this department is budgeted as follows: € 3 Million the first year, € 2 Million for the second year, and €1 Million for the last year. This budget distribution meets the demand of acquiring awareness of the product as soon as possible. Regarding the variable cost of accessibility, it has been allocated 5€ per Bikea. 5. Distribution: Again, a semi-variable cost with a fixed component of 250,000 € per year plus an average variable cost of distribution of 10€ per bicycle 6. Customer service: The cost of having a small space in each of Ikea stores dedicated to after-sale service and repairing is € 0.35 Million per year. Moreover, Ikea is very committed with client satisfaction and offers free of charge adjustment of any Bikea after one months of use. It has been calculated to have a variable cost of 7€ per unit sold in terms of labour. 7. Additional overheads: Bikea project will make use of some Ikea resources, as it will be a part of the existing product line. Those costs are mainly administration, software licences, patents registration. Some budget is reserved as well for lawsuits if patents are found to be broken by the competency. These costs are fixed and are forecasted to rise up to 225,000€ during the whole life- cycle. 8. End of the life-cycle: If Ikea management decide to quit the project after the 3 initial years, the costs involved in shutting down the warehouse and other related cost (waste management.) are estimated in 250,000€ and represent a fixed cost for the final year. 2.3 Building the model Once we have identified and analysed all the associated cost for the life-cycle of the Bikea project, we can implement an structured table mapping all of those cost allocated across time (for fixed costs) or allocated to product (for variable costs). We can draw some interesting conclusion from cost table. Firstly, the variable cost associated to one Bikea has increased nearly 50€ from the initial number drawn from the Bill of materials. That give us an idea on how important and what is the impact of giving an efficient customer service. Lifecycle costing method allows us to identify all of these costs that may have been unnoticed with other simpler costing methods. Secondly, we can understand how expenses are committed during the whole duration of the project. For example, the costs for the first year is nearly double that the other two years together. That is interesting from a cash flow point of view because allows to envision how deep is the “first year hole” in the project finances. However, product costing decisions such as selling price and margins have to be forecasted taking into account the whole lifecycle of the project instead of one particular year’s results or forecast.
  • 9. 8 Figure 4: Fixed and variable costs distributed through the lifecycle of the project Fixed cost (€) Variable cost (€) 1st year 2nd year 3rd year lifecycle per unit R&D Design 2.000.000 0 0 2.000.000 - Improvements 0 10.000 10.000 20.000 - Total R&D 2.000.000 10.000 10.000 2.020.000 - Facilities expenses Fitting-out 200.000 200.000 200.000 600.000 - Depreciation 20.000 20.000 20.000 60.000 - Total facilites expenses 220.000 220.000 220.000 660.000 - Production BOM - - - - 184,9 Labour cost - - - - 20,0 Maintenance 50.000 50.000 50.000 150.000 1,0 Utilities 250.000 250.000 250.000 750.000 3,0 Insurance 25.000 25.000 25.000 75.000 - Total production costs 325.000 325.000 325.000 975.000 208,9 Marketing Awareness 3.000.000 2.000.000 1.000.000 6.000.000 - Accessibility - - - - 5,0 Total marketing costs 3.000.000 2.000.000 1.000.000 6.000.000 5,0 Distribution Logistic management 250.000 250.000 250.000 750.000 - Average shipping - - - - 10,0 Total distribution costs 250.000 250.000 250.000 750.000 10,0 Customer service Reparing workshop 350.000 350.000 350.000 1.050.000 - Free 1st month adjustment - - - - 7,0 Total customer service costs 350.000 350.000 350.000 1.050.000 7,0 Additional overheads Administration 65.000 65.000 65.000 195.000 - Patents 12.000 - - 12.000 - Lawsuits - 4.000 8.000 12.000 - Software licenses 2.000 2.000 2.000 6.000 - Total overhead cost 79.000 71.000 75.000 225.000 - End of life-cycle project Decommissioning - - 200.000 200.000 - Waste management - - 50.000 50.000 - Total EOC costs - - 250.000 250.000 - Total accumulated costs 6.224.000 3.226.000 2.230.000 11.680.000 230,9
  • 10. 9 2.4 Sales scenarios To assess the profitability of the Bikea project, the marketing department has carried out a deep market research. As a result of this three different sales scenarios have been identified: worse case, best case, and average case. These sales forecast are shown in the next figure: Figure 5: Sales scenarios forecasted by the marketing department The costing department together with the marketing department have agreed on the minimum profitability margins that any product line of Ikea has to meet: 30%. The next step is to calculate, for each of the forecasted scenarios, which will be the total cost of one Bikea, which are the percentages of each cost attributable to one sold Bikea and whether the target margins are met. The market department, after comparing the competence, evaluating the targeted segment, assessing the features included in the product and aligning it with the price strategy of the company has decided to launch the Bikea for 419€. With that price and the costing table for each sales scenario (see Figure 7) we can assess the total profits and margins for one unit of Bikea. Figure 6: Profits and margins per unit sold for each scenario based on Figure 7 detailed cost 1st year 2nd year 3rd year Total lifecycle Scenarios Best 50.000 75.000 45.000 170.000 Average 35.000 55.000 30.000 120.000 Worst 20.000 25.000 15.000 60.000 0 20.000 40.000 60.000 80.000 100.000 120.000 140.000 160.000 180.000 Unitssold Forecasted sales scenarios Cost allocation per unit, turnover and margins (€) Best Average Worse Selling price 419,00 419,00 419,00 Expenses R&D 11,88 16,83 33,67 Facilities 3,88 5,50 11,00 Marketing 40,29 55,00 105,00 Distribution 14,41 16,25 22,50 Customer service 13,18 15,75 24,50 Additional overheads 1,32 1,88 3,75 End of lifeclye 1,47 2,08 4,17 Production costs 214,64 217,03 225,15 Profit total 117,92 88,68 -10,73 Profit margin 28,14% 21,17% -4,77%
  • 11. 10 Figure 7: Detailed cost per unit. From both tables above, we can draw the conclusion that the product costing has not met the requirements established by the marketing department regarding sales and profit margins. In any of the three scenarios the targeted 30% of profit margin is met and moreover, in the case of the worst scenario losses are expected. Marketing department is very confident with their forecasts and hence, has required the costing department to reduce expenses in order to meet a minimum profit margin of 30% for the average case and no losses in the worst case. Fixed cost Variable cost (€) Cost per unit for each scenario (€) lifecycle per unit Best Average Worse R&D Design 2.000.000 - 11,76 16,67 33,33 Improvements 20.000 - 0,12 0,17 0,33 Total R&D 2.020.000 - 11,88 16,83 33,67 Facilities expenses Fitting-out 600.000 - 3,53 5,00 10,00 Depreciation 60.000 - 0,35 0,50 1,00 Total facilites expenses 660.000 - 3,88 5,50 11,00 Production BOM - 184,9 184,90 184,90 184,90 Labour cost - 20,0 20,00 20,00 20,00 Maintenance 150.000 1,0 1,88 2,25 3,50 Utilities 750.000 3,0 7,41 9,25 15,50 Insurance 75.000 - 0,44 0,63 1,25 Total production costs 975.000 208,9 214,64 217,03 225,15 Marketing Awareness 6.000.000 - 35,29 50,00 100,00 Accessibility - 5,0 5,00 5,00 5,00 Total marketing costs 6.000.000 5,0 40,29 55,00 105,00 Distribution Logistic management 750.000 - 4,41 6,25 12,50 Average shipping - 10,0 10,00 10,00 10,00 Total distribution costs 750.000 10,0 14,41 16,25 22,50 Customer service Reparing workshop 1.050.000 - 6,18 8,75 17,50 Free 1st month adjustment - 7,0 7,00 7,00 7,00 Total customer service costs 1.050.000 7,0 13,18 15,75 24,50 Additional overheads Administration 195.000 - 1,15 1,63 3,25 Patents 12.000 - 0,07 0,10 0,20 Lawsuits 12.000 - 0,07 0,10 0,20 Software licenses 6.000 - 0,04 0,05 0,10 Total overhead cost 225.000 - 1,32 1,88 3,75 End of life-cycle project Decommissioning 200.000 - 1,18 1,67 3,33 Waste management 50.000 - 0,29 0,42 0,83 Total EOC costs 250.000 - 1,47 2,08 4,17 Total accumulated costs 11.680.000 230,9 301,08 330,32 429,7 Attributable to fixed costs 70,18 99,42 198,83 Attributable to variable costs 230,90 230,90 230,90
  • 12. 11 2.5 Driving improvements through target costing principles The restrictions imposed by the marketing department on the price of Bikea are driven by the need of an answer to the following questions: 1. What is/are the segments that we want to target with our product? 2. What characteristics are the customers want in the product? 3. What is the price the customers would pay for the product? 4. What is the competence regarding our product? 5. What is the cost of advertising the product? The conclusion drawn to the answers of these questions is that often engineers, management and accountants work in a forward way, calculating the costs, adding a mark-up and finally, establishing a selling price. Target costing approach is right the opposite: establishing a price that customers will be willing to pay and then work backwards to find out the cost (features included in the product) taking into account the profit margins. The target costing model is clearly self-explains in the following figure: Figure 8: Summarized flow of target costing principles. Source: MIT Sloan Management Review Target costing is not mutually exclusive with any other costing method, nor is with the lifecycle costing method developed for the Bikea Project, and In fact they are both often presented together in hybrid forms. The next steps based in target costing principles have been identified and will allow the costing department to meet the requirements set by marketing: 1. R&D: Although one may think that the expense on R&D is high and would be room for improvement, the costing department agrees that is a key point of the whole development of Bikea project cut down should be made. Moreover, some TQM improvements will be implemented to achieve a lower manufacturability cost and lower rate of failure, which will lead into customer
  • 13. 12 service cost reduction. Hence, there will be allocated 30000€ per year in TQM activities, which implies a growth of 4,5% in the whole R&D budget. 2. Facilities expenses: The marketing department in has put emphasis in the most likely scenario (average) which is nearly 30% less than the best case scenario. In that way facilities will be optimized for the production of this this forecast. This leads into savings of 30% (198000€). 3. Production: Thanks to the use of QFD methodologies, some features initially included in the bike won’t be any longer included in the improved version, as they don’t add value to the customers: carrier, kickstand and fender are removed (saving 14€ per unit). Wheels are downgraded (saving 5€ per unit) and thanks to TQM the same quality frame can be produced for 3€ less. In total, BOM materials has been reduced from 184,9€ to 162,9€. Through the improved design in manufacturability, assembling time will be reduced. Labour cost per unit will decrease to 15€. As the facilities have been scaled down, maintenance is less costly now (30% less) achieving a total savings of 45000€ in the whole lifecycle. In the same way we save 30% in utilities and insurance. 4. Marketing: No cost reduction is considered. 5. Distribution: Designers have found a way to ship batches of 5 bicycles for container; hence the cost per unit has decreased in 50%. Logistic management will be integrated in Ikea’s normal product lines, which implies savings of 150000€. 6. Customer service: Average free 1st month adjustment will be reduced in 2€ as the design has been improved and the fixed cost associated to repairing booths in Ikea’s shop will be reduced in a 30%. 7. Additional overheads: Administration overheads will be again integrated in Ikea’s administration departments, saving up to 50% of the total cost. 8. End of life-cycle project: The end of life-cycle project will be externalised to a specialized company that will allow saving 50% of the decommissioning and waste management cost. As a summary of improvements driven by target costing can be summarized as follows: -The total fixed costs for entire lifecycle of the project have been reduced from to € 11.68 Million to € 10.83 Million (- 9,2%) -The variable cost has been cut down from the initial 230,9€ to 196,9 € ( -8.5%) The next tables (Figure 9) show the detailed new costing and the allocation of each cost (variable and fixed) to each unit according to sales forecast scenarios, as well as (Figure 10) total profits and margins for the improved costing model:
  • 14. 13 Fixed cost (€) Var cost (€) Cost per unit for each scenario (€) 1st year 2nd year 3rd year lifecycle per unit Best Average Worse R&D Design 2.000.000 0 0 2.000.000 - 11,76 16,67 33,33 Improvements 30.000 40.000 40.000 110.000 - 0,65 0,92 1,83 Total R&D 2.030.000 40.000 40.000 2.110.000 - 12,41 17,58 35,17 Facilities expenses Fitting-out 140.000 140.000 140.000 420.000 - 2,47 3,50 7,00 Depreciation 14.000 14.000 14.000 42.000 - 0,25 0,35 0,70 Total facilites expenses 154.000 154.000 154.000 462.000 - 2,72 3,85 7,70 Production BOM - - - - 162,9 162,90 162,90 162,90 Labour cost - - - - 15,0 15,00 15,00 15,00 Maintenance 35.000 35.000 35.000 105.000 1,0 1,62 1,88 2,75 Utilities 175.000 175.000 175.000 525.000 3,0 6,09 7,38 11,75 Insurance 17.500 17.500 17.500 52.500 - 0,31 0,44 0,88 Total production costs 227.500 227.500 227.500 682.500 181,9 185,91 187,59 193,28 Marketing Awareness 3.000.000 2.000.000 1.000.000 6.000.000 - 35,29 50,00 100,00 Accessibility - - - - 5,0 5,00 5,00 5,00 Total marketing costs 3.000.000 2.000.000 1.000.000 6.000.000 5,0 40,29 55,00 105,00 Distribution Logistic management 200.000 200.000 200.000 600.000 - 3,53 5,00 10,00 Average shipping - - - - 5,0 5,00 5,00 5,00 Total distribution costs 200.000 200.000 200.000 600.000 5,0 8,53 10,00 15,00 Customer service Reparing workshop 245.000 245.000 245.000 735.000 - 4,32 6,13 12,25 Free 1st month adjustment - - - - 5,0 5,00 5,00 5,00 Total customer service costs 245.000 245.000 245.000 735.000 5,0 9,32 11,13 17,25 Additional overheads Administration 32.500 32.500 32.500 97.500 - 0,57 0,81 1,63 Patents 6.000 - - 6.000 - 0,04 0,05 0,10 Lawsuits - 2.000 4.000 6.000 - 0,04 0,05 0,10 Software licenses 1.000 1.000 1.000 3.000 - 0,02 0,03 0,05 Total overhead cost 39.500 35.500 37.500 112.500 - 0,66 0,94 1,88 End of life-cycle project Decommissioning - - 100.000 100.000 - 0,59 0,83 1,67 Waste management - - 25.000 25.000 - 0,15 0,21 0,42 Total EOC costs - - 125.000 125.000 - 0,74 1,04 2,08 Total accumulated costs 5.896.000 2.902.000 1.904.000 10.827.000 196,9 260,59 287,13 377,4 Attribut. to fixed costs 63,69 90,23 180,45 Attribut. to variable costs 196,90 196,90 196,90 Figure 9: Improved costing model and detailed cost per unit in each scenario.
  • 15. 14 Figure 10: New figures for profit and margins The improvements introduced thanks to the costing model have enabled to meet marketing’s requirements. In the worst case scenario the profit margin stands up to 21%, while in the average scenario we reach 31%. Next figures show in a more visual way how are the costs finally allocated per unit: Figure 11: Profit and total cost allocation per unit for each sales scenario. Cost allocation per unit, turnover and margins (€) Best Average Worse Selling price 419,00 419,00 419,00 Expenses R&D 12,41 17,58 35,17 Facilities 2,72 3,85 7,70 Marketing 40,29 55,00 105,00 Distribution 8,53 10,00 15,00 Customer service 9,32 11,13 17,25 Additional overheads 0,66 0,94 1,88 End of lifeclye 0,74 1,04 2,08 Production costs 185,91 187,59 193,28 Profit total 158,41 131,88 41,65 Profit margin 37,81% 31,47% 21,55%
  • 16. 15 3. Performance management systems 3.1 Introduction to performance measurement systems There have been several approaches to performance measurement in the past. Going back to 80s, researchers agree that more integrated performance measurement systems were needed to match with the tendency of globalisation that emerged from the aim of companies to be more competitive. Hence, from that point we have been testimonies of the birth of many frameworks and models such as the SMART and the performance measurement questionnaire (Bititci et. al 2005). A more recent approach to performance measurement appeared with the birth of the balance scorecard (1996) and the European business excellence model EFQM (1998). Both models give clues in terms of what kind of measurements should be deployed and what conclusions should be extracted from them. In 1998, the EPSRC established the concept of integrated performance measurement systems, which was developed upon the balance scorecard and the EFQM models (Bititci et. al 2005). Since then, other hybrid frameworks have used approaches from the above mentioned models. Examples of this are the performance measurement systems and the measurement workbooks. Apart from the more generalist frameworks mentioned above, there have been other performance measurement systems more focused in certain business areas and processes such as production and planning, product development process, human resources or even for service management. In conclusion, all the performance measurement systems, both the generalist and the more business focused, should have in common a set of characteristics such as being balanced (regarding the requirement of the stakeholders), being integrative (different measures need to be interlinked), informing of the strategy (useful as an input for the strategy), deploying strategy (being able to communicate business’ strategy), focusing on activities that deliver valuable (principle of the EFQM), including competencies and stakeholder contribution (Bititci et. al 2005). 3.2 New product development performance There is consensus among the researchers that product development is one of the most important things in the future sustainability of any company, and especially those in the technological field. New product development is becoming, as most of other business areas and processes within companies, a more globalised activity where changes occur fast due to constantly changing customer’s needs (Goffin and Mitchell 2005). Product development is, as any other process in a business, able to measured and improved. Although researchers have deeply analysed the product development process and contributed to understand it, most of the companies are still reluctant to measure their product development processes because the challenges that implies: complexity, uncertainty, intensive decision making, short financial term vision, shorten time to market approaches, etc. This is the reason why
  • 17. 16 performance measurement within product development has been historically limited to cost and time only, forgiving maybe the most important aspect, value of creation (Koller et al. 2005). Other challenges that an effective performance management system for product development should consider are for example: the different capabilities and activities that are required within the organization in order to be successful, the alignment of business strategy with the product and with customer needs, the alignment between the product development strategy and the business strategy, competitive advantage (in the long term) and the rise of competitive environment among customers and suppliers (Cedergren, S. 2008). 3.3. Role of supply chain performance in new product development How can an effective performance supply chain help in the new product development? Take the example of Inditex, the clothes fashion empire, where the perfectly fitted and extremely efficient supply chain has been the true clue for its tremendous success. Although it doesn’t stands as high technological new product development (as clothes cannot be considered) it is useful to illustrate how the clothes development is boosted by its supply chain, able to supply the market with low cost and high speed service. Another key point is its vertical integration and how coordinated are the different departments associated to product development. As an example, it is interesting to note that they can respond to a new market need within two weeks. Vertical integration plays an important role as well, as stocks are just around 7% of the incomes. This integration strategy allows the company to reduce costs and acquire some flexibility, reducing in that way the potential negative impact of uncertainty during product development and the presences of specific actives along the chain value. Furthermore, Inditex takes the concept of supply chain to the extreme by establishing the role of shops away from the “end of the chain” concept to a more “place to get user’s feedback” concept. To do, shops are technologically equipped and staff trained to retrieve invaluable design information that customer’s hint at during their visits. Inditex has certainly grown thanks to the competitive advantages that its supply chain has brought, making it a clear example of an extended enterprise. According to Childe (1998) an extended enterprise is a conceptual business unit or system that consists of a purchasing company and suppliers who collaborate in such a way as to maximise the returns to each partner. That means that the extended enterprise is a knowledge-based organization that uses the distributed resources and capabilities through the supply chain in order to maximize the competitive advantage and performance of the entire organization (Bititci et. al 2005), including of course the product development processes. 3.4 Performance management models for NPD within supply chain As it has been argued in the section before, supply chain management (and extended enterprise methodologies that emanate from it), allow companies to take advantage from its network of suppliers through upstream and downstream linkages that produce a value in the form a new
  • 18. 17 product or service to ultimately meet or exceed customer expectations. In practise, there are some models that are specifically designed to manage performance of those extended enterprises. For example, Gunasekeran et al. (2001) presents that the measures are arranged in three different levels (strategic, tactical and operational) through the supply chain: plan and source performance, production performance, deliver performance and client satisfaction. This model is in essence very similar to the supply chain operations reference SCOR model and its six key activities (plan, source, make, deliver, return and enables). Another model was introduced by Beamon (1999) and argues that a framework for supply chain measurement should tackle at least one measure for each of the following steps: resource measure, output measure and flexibility measure. In addition, Kochar and Zhang (2002) proposed a model in which each company have its owns performance measurement system that asses how coordinated and synchronised are companies between them in a given network. The essence of all these frameworks is to bring up to the surface the same measures proposed for traditional single enterprise measuring systems (balance scorecard, EFQM, IPMS, performance prism, smart pyradmid, etc) but suited to the supply chain. It is interesting to note how aligned is the supply chain management goal’s with the new product development’s goals. The following list, extracted from CIPS (2010) highlights the most prominent ones: 1. Reducing the non-value-adding activities through the supply chain (processing, inventory, waste) 2. Reducing cycle times to support innovation and fast new product development. 3. Enhancing quality through collaborative quality management, TQM initiatives, supplier motivation and supplier commitment 4. Reducing total costs through better coordination and planning increased plant capacity utilisation, waste reduction, less inspections and defects. 5. Optimising the balance of service levels and costs 6. Improving supply chain communication to boost all the above mentioned goals As a conclusion, we provide a table linking those supply chain goals (according to their number) with typical performance indicators associated to new product development (Slack et al. 2007)
  • 19. 18 4. References Baykasoglu, A. and Kaplanoglu, V. (2008), “Application of activity-based costing to a land transportation company: A case study”, Int. J. Production Economics, Vol. 116, pp. 308-324. Beamon, M. (1999), “Measuring supply chain performance”, International Journal of Operations & Production Management, Vol. 19 No. 3, pp. 275-92. Bititci, U.S. et al., (2005). Measuring and managing performance in extended enterprises. International Journal of Operations & Production Management, 25(4), pp.333–353. Cedergren, S., (2008). Modeling Performance in Complex Product Development. Product Development Organisational Performance Model. Childe, S.J. (1998), “The extended enterprise: a concept for co-operation”, Production Planning and Control, Vol. 9 No. 4, pp. 320-7. Goffin, K. and R. Mitchell (2005). Innovation management: Strategy and implementation using the Pentathlon framework. London: Palgrave MacMillan. Guillen, Mauro F. "Archivo Edición Impresa." EL PAÍS. N.p., 11 July 2011. Web. 25 Apr. 2013. <http://elpais.com/diario/2011/07/17/negocio/1310907804_850215.html>. Gunasekaran, A., (1999), “A framework for the design and audit of an activity-based costing system”, Managerial Auditing Journal, Vol. 14 Iss: 3pp. 118-127 Gunasekaran, A., Patel, C. and Tirtiroglu, E. (2001), “Performance measures and metrics in a supply chain environment”, International Journal of Operations & Production Management, Vol. 21 No. 1/2, pp. 71-87. Kochhar, A. and Zhang, Y. (2002), “A framework for performance measurement in virtual enterprises”, Proceedings of the 2nd International Workshop on Performance Measurement, 6-7 June, Hanover, pp. 2-11. Koller, T., M. Goedhart, et al. (2005). Measuring and managing the value of companies. New Jersey: John Wiley & Sons. MIT Sloan Management Review. MIT Sloan Management Review RSS. N.p., n.d. Web. 25 Apr. 2013 [link] http://sloanreview.mit.edu/article/develop-profitable-new-products-with-target-costing/ Slack, N., Chambers, S. and Johnston, R. (2007). Operations Management, 5th edition, Pearson Education. Turney (1996), Activity Based Costing: The Performance Breakthrough (London: CLA).