Page 263 - DMGT202_COST_AND_MANAGEMENT_ACCOUNTING

Cost and Management Accounting

Notes It is very important to separate the optional features from the basic ones, because if you make
an optional feature – that only some customers want – part of the basic product, you will either
force all customers in that segment to pay for it, or you will be giving it away. It is also important
to establish – and achieve – the target cost for the basic product, because that is where most
of the sales or revenues will be and so that is where you have to capture market share while
remaining profitable. Finally, we contend that a Market-Feature Table should play as great a role

in determining the architecture of a product as do physical and engineering considerations.
14.2.4 First, Price

Once you have established the high-level product requirements, the next step is to establish the
market price for the time at which the product is going to be sold. We have found that Experience
Curves (sometimes called Learning Curves) are very helpful. In this approach, the historical market
price of the product is plotted as a function, not of calendar time, but of the industry’s cumulative
sales of the product. On a log-log plot, the result is usually a straight line that is a very reliable
predictor of prices for some time into the future. Note that often you should not always use the
quantities of the product as the “sales”, but some key parameter that represents the functionality
that the customer is really buying and which is really driving the industry’s experience. For
example, in the famous “Moore Curve” showing the decrease in price of semiconductor memory,
the price per bit of memory is plotted against the cumulative bits that have been sold. (It is not a
plot of price per memory chip vs. the cumulative number of chips – the customers are really buying
memory bits, not packaged ICs.) If the product were cellular telephone network equipment, you
would plot the price of the equipment divided by the number of subscribers that it can serve vs.
the cumulative number of cell-phone subscribers in the world.
There are other ways to help triangulate on likely prices. Conjoint Analysis is quite quantitative,

and it gives insights about customers’ willingness to pay for various specific features and
capabilities. Other methods include gleaning information from bids and proposals, competitor’s
prices, reverse engineering, comparable technologies or products that do similar things, analyst’s
reports, and so on.

14.2.5 Then, Cost

When you have determined the price for the time when the product will be sold, you can set

the target cost. It is important to first decide how much of the company’s cost elements to
include. Traditionally, people have looked only at cost of goods sold (COGS), the cost of the raw
materials and purchased subsystems that go into a product plus the “conversion costs” (labor
and manufacturing overheads). In that case, you only need to know the healthy gross margin
rate required by the company in order to calculate the target cost ( = Price * [100% - G.M.%]).
However, we have found it better to try to capture as much of the company’s costs as possible
(e.g.: engineering, installation, transportation, tariffs & duties, R&D, marketing & sales, taxes,
etc.) If you use the company’s required net margin then you can establish a full-stream target

cost. The benefit is that, as ways to reach the target cost are explored, it is possible that design

and other choices can significantly reduce costs that lie beyond the area of COGS. It goes without
saying that Activity-Based Costing (ABC), if the company uses it, makes this cost decomposition
more meaningful and effective.
Once you have set the overall target cost, the next step is to set cost targets for each of the
components, subsystems and elements that go into making up the set of full-stream costs that
are being included. We have found that Value Engineering is a valuable tool to assist in this step.
Space does not permit a detailed explanation here. But the basic concept is to create a matrix that
relates different product features to the various elements that make up the product. The cells of

the matrix are filled with the extent (percent) to which each of the elements contributes to each
feature. Then, knowing the relative importance (to the customers) of each feature, and applying
some matrix multiplication it is possible to get a suggestion of the cost target for each product

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