The Dark Side of Target Costing – “Help! Everything around me is breaking!”

I believe that ‘Target costing’ is arguably one of the single greatest contributors to the poor quality of products in the marketplace today. Product innovators would like to maintain the mantra that beautifully-designed products needn’t cost more to manufacture. I argue that, in many cases, this is true, but at the same time, I also believe that a product doesn’t have much to offer in the beauty department if it consistently fails to survive the rigors of use for which it was supposedly designed–whether that’s within the few months or years of service. So what is Target Costing?

Target Costing is defined as a cost management tool for reducing the overall cost of a product over its entire life-cycle with the help of production, engineering, research and design. A target cost is the maximum cost that can be incurred on a product while still meeting the required profit margin at a particular selling price.

It’s all about reducing COST. This all-too-often involves the use of cheaper components and materials, including those that are less robust, less reliable, and more likely to fail during normal use. These are examples of “Target Costing,” which translate into shoddy products with a short working life span. You may ask, “Why is this so important?” Well, when in search of cost savings, you’d surely want to avoid the kind of mistake the following company made.

Back in the mid 1990s, a manufacturer of small kitchen electrical appliances was considering its options for reducing costs. They contracted with a supplier in the Far East to produce circuit boards for an electric grill designed for the U.S. household market.

The initial run of circuit boards met all the quality criteria and operated according to specification. However, without notifying its customer, the circuit board supplier as a means of reducing its own production cost, began using less silver and more copper in the circuit board among other cost saving initiatives. The lesser-quality circuit boards began to fail prematurely. Consumers started returning the defective electric grill to the stores, and the stores in turn returned them to the manufacturer, and ceased carrying any of the manufacturer’s products. Without the possibility of selling any additional new product, the manufacturer couldn’t absorb the cost of all the returns, and soon went out of business.

Bearing this in mind, and assuming that you really care about the reputation of your company, what do you think this means to your end-user customers?

Speaking of feeling ripped off!

A few years ago at a Target Costing presentation hosted by the American Society of Mechanical Engineers (ASME), the speaker offered some basic principles of Target Costing–cutting materials cost, decreasing the product life etc. An audience member neatly summed up the ludicrousness of this whole approach with the remark: “You mean Target Costing is the reason my windows in my $1M home were replaced within 3 years.”

Yes, it happens to all of us. The list of failed products is extensive, especially in the area of consumer electronics, examples of which we can probably all identify with. According to an analysis conducted by Accenture, the customer return rate for consumer electronics in the United States averaged 11 to 12 percent. It cost the U.S. electronics industry $13.8 billion to re-box, restock and resell the returned items. Based on my personal experience, these are some of the products that I’ve purchased over the last three years that failed within 3-12 months:

• Vacuum cleaners (2 times)

• Stereo systems and components (CD player, DVD player)Headphone(s)

• Desktop computer

• Printers (2 times)

• Phone systems (3 times)

• Beautifully designed Target brand lamps (2 times) and trash cans (2 times)

• Fax Machine

Now ask yourself what sense it makes to pay up to $500 for a premium vacuum cleaner, when you can purchase a 15-year old Oreck from a garage sale that costs only $20, but still works better than the three shiny brand new bag-less wonders purchased over the last three years.

Like you, I’m willing to pay extra for a product that’s designed and manufactured for a longer life, but not five or ten times the price. For instance, how much do you need to pay for a one-piece iPod docking station to help you get more out of your music collection at home?

Have you noticed all the awful reviews for music player docking stations sold through the big online retailers? Yes, to get something well-made, reliable and capable of doing what you ask of it, you’ve got to spend a bundle more than the $50 or $100 check that Aunt Agnes sent you for your birthday (to avoid total disappointment, Aunt Agnes might try looking at a check in the $500-1,000 range). But then you’d ask yourself: “But I could get an entire hifi system for that price!” Here’s a perfect example where new product developers could fulfill unmet consumer needs, in this case, by offering a reliable, high quality docking station priced 25-35% above those low quality competitor products.

So what is a product developer to do?

Start with your innovation/product strategy, and discuss the ramifications of Target Costing. Find out if it’s alienating your customers, or if there’s any ‘white space’ for high-performing innovative products (white space is that undiscovered domain of opportunity for new products and new markets).

To identify white space, try using the strategic tool, Perceptual Mapping. It is based on consumer perceptions about your products and brand, relative to your competitors. This is crucial for staking out a valuable place that can provide long-term competitive advantage for your company and its products.

Investigate online magazines and product reviews. Online retail sellers, such as Amazon, encourage customers to provide feedback (customers are evidently far from shy when sharing their faulty product experiences). Based on these reviews, where do you and your competitors fall short on performance, and where can you improve relative to your competitors?

So, when developing your product requirements document, don’t merely list target cost, but also consider things like reliability, and the mean time before failure (MTBF). Be sure to test your supplier components on an on-going basis, and to be aware of their motivations to reduce costs.

Spend time reviewing your warranty records and talk to your Quality Department and Customer Service Representatives. Analyze the type and number of complaints. Require your new product development team to spend a period of time answering the telephone help lines or processing returned goods.

Try to be different in the marketplace. Develop a value proposition for making products that last longer. Pursue and embrace your potential to gain and retain customers through good product development practices.

Endnotes

[1] Robin Cooper and Regine Slagmulder, Target Costing and Value Engineering (New York, NY: Productivity Press, 1997)

[1] Sohrab Vossoughi, “Consumer Electronics: Innovate or Die,” BusinessWeek Online (January 1, 2009): p5-5, 1p.

[1] For more on Perceptual Mapping, see Staking Out Valuable Positions,   Strategy 2 Market, Inc. (February 2007)

http://www.strategy2market.com/downloads/perceptual_mapping.html

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