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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.
 Robin Cooper and Regine Slagmulder, Target Costing and Value Engineering (New York, NY: Productivity Press, 1997)
 Sohrab Vossoughi, “Consumer Electronics: Innovate or Die,” BusinessWeek Online (January 1, 2009): p5-5, 1p.
 For more on Perceptual Mapping, see Staking Out Valuable Positions, Strategy 2 Market, Inc. (February 2007)
Product Management responsibilities are immense. Responsibilities include, but are not limited to life cycle management, P&L oversight, market research, segmentation, competitive analysis, pricing, launch strategies, marketing plans and sales force motivation.
Recently, I had an interesting conversation with a Senior Product Manager. We discussed the changing roles and responsibilities within his position. He no longer oversees the administrative duties of his role, such as life cycle management. He has delegated this responsibility to a more junior person within his firm. He is now primarily responsible for the strategic direction of new product development (NPD) within his product category. We have also seen this trend with some of our other clients.
So what strategic NPD activities are Product Managers responsible for within the new product development process? The most important activity is the development of a product strategy. Having a product strategy is a crucial need for your product category, but the process of creating a product strategy can create great a great deal of confusion. A product strategy lays out the role and goals of new product development, the kinds of products to be focused on, the resources to be allocated to new product development and a high-level plan for development.
Notice that by focusing on certain types of products, the company chooses to ignore others, and this can be a cause of distress because people perceive this focus as throwing away potentially good opportunities. But, this focus allows the company to avoid wasting resources on scattershot opportunities and to direct all its resources toward the opportunities that really matter: the opportunities that best utilize the assets and capabilities of the company.
Four Elements of Product Strategy
The first element of the strategy is the end result – what is the company trying to achieve by developing new products? Some companies develop new products because they are looking for new sources of revenue, others do it because they are trying to grow their customer base, and others do it because they are trying to hold on to their current customer base. Be clear about the role of new product development. Then set a measurable goal such as percentage of revenue from new products, percentage increase in the size of the customer base, percentage of customers making repeat purchases. We all know that what gets measured is what gets done.
The second element of the product strategy identifies where you will focus your new product efforts: what kinds of products, what customers and markets, and what technologies. This decision requires a thorough understanding of your markets, your customers, your competitors, your own company, your environment, technologies in use and on the horizon, and more. Spend the time and effort to understand all these dimensions and determine where to focus your new product development efforts. This decision provides the direction for all your new product development efforts to follow.
The third element is resources. How much money and how many employees are going to be devoted to your product category? This is an important decision and should reflect the importance of each of the areas you want to focus on. Some companies set the total budget by matching competitors on R&D as a percentage of sales; some do more of a bottom-up budgeting approach.
The fourth element includes planning your product introductions and technology acquisitions. Based on your research, you know what kinds of products to pursue and have some idea of the technologies required. Laying out a plan on a timeline, using tools such as product and technology roadmaps, helps to communicate the plan and get the organization focused.
As a Product Manager, with strategic NPD responsibilities, the development of a product strategy is by far the most important activity you can undertake for your product category. Of course, there are other early staged new product development activities that product managers are responsible for, but we’ll leave that for a future article.
Cycle time reduction is usually reserved for the engineering/manufacturing phases of the new product development process. This is not surprising since it’s fairly easy to measure the time to make an engineering change or create a CAD drawing. But how do you reduce cycle time within the more subjective activities of the early phases of new product development a.k.a. Fuzzy Front End (FFE)?
Three Critical Considerations: Unfortunately, there is no single easy solution to reducing the cycle time of the FFE. Three of the most critical challenges typically encountered in reducing FEE cycle times include:
1. Lack of strategic focus
2. Absence of a sustainable new product development front-end process
3. A lack of capabilities and infrastructure to support a front-end process
If you don’t have a strategic focus, get one. You need to understand where you’re going to compete, who you’re going to serve and what technology is going to get you there. If you do have a strategic focus, communicate it. Start communicating your strategic focus to the members of your team. If your strategic focus is not evident to your team, you’re just going to be spinning your wheels with a lot of off-strategy ideas. Off-strategy ideas equate to wasted time.
The Importance of a Front End Process
We have witnessed many companies rushing their products to market without investing time to understand either the market or the customer. Perhaps the sales person makes a few customer calls, but that’s about all. Sure enough, that cuts down on the cycle time in the FFE, but equally surely, it spells disaster. Remember Robert Cooper’s research, where poorly-defined early-phased FFE activities equated to a 26% success rate, whereas sharp and early definition produced a success rate of 85%. So we certainly do not recommend skipping these important FFE activities for the sake of reducing your cycle time.
Infrastructure Is Essential
Essential FFE capabilities include a marketing research team that performs on-going research to gain an understanding of unmet customer needs, attitudes, perceptions, market size, trends etc. The team is responsible for constantly feeding a pipeline of opportunities, so that marketing research efforts are independent of any single project. This offers considerable advantages over the alternative approach, which involves setting up ad hoc research capabilities and additional time-consuming data collection for each new product that is released to market.
Perhaps you already have a marketing research team, but everything still seems to move at snail’s pace. This is a familiar problem. It usually lies with too many off-strategy ideas, and either a lack of strategic focus, or a failure to communicate the strategic focus to the marketing research team.
If you’re genuinely serious about releasing successful new products and reducing cycle time in the FFE, do your due diligence, and ensure that you have an excellent understanding of your customers and market. Assess whether your organization has a sustainable new product development process—one with the right market research capabilities. Last but not least, ensure that you have a strategic focus, thereby reducing all those off-strategy ideas.
The secret is that by ensuring a more robust and focused up-front product development process you will achieve the desirable side-effects of reduced cycle times and successful new products.
So often, when developing new products, new product developers get caught up in the beauty of the solution. We believe the product is perfect and people will clamor to buy it. Like Ray Kinsella in Field of Dreams we believe “If you build it, they will come.”
But, so often dreams are dashed and the product never catches on. We blame marketing and sales, we blame the customer who didn’t see the value of the product, and we are dumbfounded that even though we designed the best solution to a problem, no one wanted it.
Maybe we need to think about the theories of diffusion and adoption. There are things we can do, as product developers, to improve the chance that our new product will catch on and be a success. Everett M. Rogers, author of “Diffusion of Innovations” and grandfather of diffusion theory offers many insights into how innovations are adopted and how characteristics of innovations can help or hinder adoption.
Diffusion is defined by Everett Rogers as the process by which an innovation is communicated through certain channels over time among the members of a social system. Some people take longer than others to try out and adopt a new innovation. The first ones to adopt an innovation are called Innovators. They tend to be avid consumers of mass media, from which they learn about new innovations they are eager to try out. They also tend to be big networkers, sharing information about innovations across far-flung social networks. Since innovators tend to be a little “out there” they don’t function as opinion leaders, but their value is in getting the word out to different far-flung social networks. They make up about 2.5% of the population.
The opinion leaders are in the next group called Early Adopters. They take a little longer to try out and adopt new innovations. They read mass media, but they also network with innovators and learn about new innovations. They are different from innovators in that they are looked up to by their social group as a source of advice on new innovations. Once they adopt an innovation, they use their personal influence with their social network to encourage adoption. Early adopters make up about 13.5% of the population.
The next group to adopt is called the Early Majority, and they make up 34% of the population. To a great extent they rely on the opinions and experiences of the early adopters in learning about and deciding whether to adopt new innovations. Later adopter groups also rely on their social network for finding out about new innovations, but they take even longer to decide try and adopt.
Implications for New Product Development
Based on diffusion theory, Rogers notes several characteristics of innovations that encourage diffusion and affect the rate of adoption. This is excellent advice for new product developers. To encourage diffusion and adoption, create a product with:
• Relative advantage over other products – innovators and early adopters look for a better value proposition
• Compatibility with existing values, beliefs, past history and needs of potential adopters – the less a potential adopter has to adjust their behavior the greater the chance of adoption
• Minimal complexity of understanding and use – the more confident a person is that they can master and use the innovation, the more likely they are to adopt it
• Trialability – free trials and demos let a person try the product with no risk
• Observabililty – very often people need reassurance that they are making the right decision by adopting an innovation. If they can see many people have already adopted an innovation, they will feel more comfortable adopting it
As an example, Rogers presents the case of cellular phones. In 10 years time, starting in 1983, 13 million phones were sold in the U.S. During that time performance improved and prices came down, which encouraged adoption, but the design of the product has all of the above attributes, which encouraged very rapid adoption:
• Relative Advantage: Saves time in missed appointments and delayed schedules, can be used in an emergency, considered a status symbol
• Compatibility: For the user, the cellular phone operates just like a regular phone and it connects into the existing landline phone system
• Complexity: Because the cellular phone operates just like a regular phone, the user did not need to learn new skills
• Observability: The portable nature of the product and its use in public places helped emphasize the benefit of status to potential buyers
• Trialability: It is easy to borrow a friend’s phone and try it out. Also, many rental cars came with a cellular phone, providing an opportunity for trial
The next time you develop a new product, think about how you can incorporate these attributes into your product design. It will make a difference.