REYMARD SAVIO SAMPAIO DE MELO
Guidelines for target costing introduction in the real
estate products development process
Diretrizes para introdução do custeio-meta no processo de
desenvolvimento de produtos imobiliários
CAMPINAS 2015
UNIVERSIDADE ESTADUAL DE CAMPINAS
FACULDADE DE ENGENHARIA CIVIL,
ARQUITETURA E URBANISMO
REYMARD SAVIO SAMPAIO DE MELO
Guidelines for target costing introduction in the real
estate products development process
Orientador: Prof. Dr. Ariovaldo Denis Granja
Diretrizes para introdução do custeio-meta no processo de
desenvolvimento de produtos imobiliários
Tese de Doutorado apresentada a Faculdade de Engenharia Civil, Arquitetura e Urbanismo da Unicamp, para obtenção do título de Doutor em Engenharia Civil, na área de Arquitetura e Construção.
Doctorate thesis presented to the School of Civil Engineering, Architecture and Urban Design, University of Campinas, to obtain the Ph. D. degree in Civil Engineering, in the area of Architecture and Construction.
ESTE EXEMPLAR CORRESPONDE À VERSÃO FINAL DA TESE DEFENDIDA PELO ALUNO REYMARD SAVIO SAMPAIO DE MELO E ORIENTADO PELO PROF. DR. ARIOVALDO DENIS GRANJA.
ASSINATURA DO ORIENTADOR ______________________________________
CAMPINAS 2015
ABSTRACT
MELO, R.S.S. Guidelines for target costing introduction in the real estate products
development process. Campinas, 2015. Dissertation (Doctorate in Civil Engineering) –
School of Civil Engineering, Architecture and Urban Design, University of Campinas.
The problems associated with the traditional practice of reducing costs in construction and the need to increase business competitiveness in the real estate sector guided this research. In this sense, the target costing is a promising approach to improving the competitiveness of companies by ensuring that products launched on the market do not jeopardize the company's profit margin or the value delivery to customers. However, there is little research to support the real estate industry organizations wishing to implement gradually the target costing principles in real estate product development process. Thus, the main objective of the research was to propose guidelines for introduction of target costing in the real estate products development process. Design science was the research method applied. The research was divided into three phases: solution incubation, solution refinement and explanation. The proposed guidelines are related to the three main sections of target costing process: market-driven costing, product-level target costing and component-level target costing.
RESUMO
MELO, R.S.S. Diretrizes para introdução do custeio-meta no processo de
desenvolvimento de produtos imobiliários. Campinas, 2015. Tese (Doutorado em
Engenharia Civil) – Faculdade de Engenharia Civil, Arquitetura e Urbanismo, Universidade Estadual de Campinas.
Os problemas relacionados com a prática tradicional de redução de custos na construção civil e a necessidade de aumentar a competitividade de empresas do setor de real estate nortearam essa pesquisa. Neste sentido, o custeio-meta é uma abordagem promissora para melhorar a competitividade de empresas garantindo que os produtos lançados no mercado não comprometam a margem de lucro da empresa nem a entrega de valor para os clientes. No entanto, há uma escassez de pesquisas visando apoiar as organizações do setor imobiliário que desejam implementar de forma gradual os princípios do custeio-meta no processo de desenvolvimento de produtos imobiliários destinados à venda. Diante disso, o principal objetivo da pesquisa foi propor diretrizes para introdução do custeio-meta no processo de desenvolvimento de produtos imobiliários destinados à venda. A design science foi o método de pesquisa utilizado. A pesquisa foi dividida em três fases: incubação da solução, refinamento da solução e explanação. As diretrizes propostas estão relacionadas as três principais seções do processo do custeio-meta: custeio orientado ao mercado, custeio-meta no nível de produto e custeio-meta no nível de componente.
TABLE OF CONTENTS ABSTRACT ... VII RESUMO ... IX 1. INTRODUCTION... 1 1.1 RESEARCH BACKGROUND ... 1 1.2 RESEARCH PROBLEM ... 3
1.3 RESEARCH QUESTIONS AND OBJECTIVES ... 5
1.4 LIMITATIONS ... 5
1.5 DISSERTATION STRUCTURE ... 6
2. TARGET COSTING ... 7
2.1 WHAT IS TARGET COSTING? ... 7
2.2 ENVIRONMENT IN WHICH TARGET COSTING IS BENEFICIAL ... 14
2.3 IMPLEMENTING TARGET COSTING IN ORGANIZATIONS ... 18
2.4 TARGET COSTING IN CONSTRUCTION ... 20
2.5 TARGET VALUE DESIGN ... 23
3. TARGET COSTING PRINCIPLES ... 29
3.1 PRICE LED COSTING ... 29
3.2 CUSTOMER FOCUS ... 29
3.2.1 The concept of value ... 30
3.2.2 Value Engineering... 32
3.1 FOCUS ON DESIGN OF PRODUCTS AND PROCESSES ... 38
3.1.1 Set-based concurrent engineering ... 38
3.2 CROSS-FUNCTIONAL TEAMS ... 41
3.2.1 Lean product development ... 41
3.3 LIFE CYCLE COST REDUCTION ... 43
3.4 VALUE CHAIN INVOLVEMENT ... 44
3.4.1 Supplier involvement in the target costing process ... 44
3.4.2 Relational contracts ... 47
4. RESEARCH METHOD... 49
4.1 DESIGN SCIENCE APPROACH ... 49
4.2 RESEARCH STRATEGY ... 50
4.2.1 Solution Incubation ... 52
4.2.2 Solution Refinement ... 56
4.2.3 Explanation... 60
5. RESEARCH FINDINGS ... 63
5.1.1 Background ... 63
5.1.2 Enablers for TVD implementation ... 64
5.1.1 Lessons Learned from Case 1 ... 74
5.2 CASE 2:DEVELOPER AND MANAGER OF REAL ESTATE ASSETS... 75
5.2.1 First round discussions ... 75
5.2.2 Second round discussions ... 77
5.2.3 Lessons Learned from Case 2 ... 78
5.3 CASE 3:RESIDENTIAL PROJECT... 81
5.3.1 Understanding Phase ... 81
5.3.2 Implementation Phase ... 87
5.3.3 Assessment Phase ... 90
5.3.4 Lessons learned from Case 3 ... 91
5.4 CROSS-CASE COMPARISON ... 92
5.5 PROPOSED GUIDELINES ... 94
5.5.1 Evaluation of the guidelines from a theoretical point of view ... 103
5.5.2 Evaluation of the guidelines from a practical point of view ... 105
6. CONCLUSIONS ... 107
6.1 SUGGESTIONS FOR FUTURE RESEARCH ... 109
REFERENCES ... 111
APPENDIX A - UCSF TVD INTERVIEW: PROJECT MANAGER... 119
APPENDIX B - UCSF TVD INTERVIEW: SENIOR PROJECT MANAGER ... 123
APPENDIX C - UCSF TVD INTERVIEW: LEAD PROJECT ARCHITECT ... 127
ACKNOWLEDGEMENTS
The four-year period at the University of Campinas will certainly remain a memorable experience for the rest of my life. I would like to express my gratefulness and appreciation to my parents and all my colleagues who have provided invaluable help and support during these years.
I would like to thank my PhD defense committee members: Prof. Dr. Ariovaldo Denis Granja, Prof. Dr. Flávio Augusto Picchi, Prof. Dr. Orlando Fontes Lima Júnior, Prof. Dr. Carlos Torres Formoso, Profa. Dra Patricia Tzortzopoulos Fazenda.
I would like to thank the members of Construction Management Research Laboratory (LAGERCON, by its acronym in Portuguese) who shared some of the hardships of the PhD experience: Alessandra Yokota, Joyce Ruiz, Carolina Oliva, Renato Mariz.
My appreciation also goes to the research directors of the University of California, Berkeley's Project Production System Laboratory: Professor Glenn Ballard and Professor Iris Tommellein. I would also like to thank the researchers with whom I have had the opportunity to collaborate during my dissertation: Doanh Do, Paz Arroyo, Nawras Skhmot and Amit Kaushik.
I would like to express my gratitude to the organizations involved in the three cases. I gratefully acknowledge the funding sources that made my Ph.D. work possible. I was funded by São Paulo Research Foundation (FAPESP, by its acronym in Portuguese). My work was also supported by the Coordination for the Improvement of Higher Education Personnel (CAPES, by its acronym in Portuguese). Any opinions, findings, conclusions, or recommendations are those of the author and do not necessarily reflect the views of any of the funding organizations.
LIST OF FIGURES
Figure 1: Three main elements of the target costing process (Cooper and Slagmuder, 1999) ... 8
Figure 2: Target costing integrated in the product development process (Jacomit and Granja, 2011) ... 22
Figure 3: Research streams on perceived value (Sánchez-Fernández and Iniesta-Bonillo, 2007) . 30 Figure 4: Types of customer input information in product development stages (Ansari et al, 1997) ... 31
Figure 5: 26 illustrative cards (Kowaltowski and Granja, 2011) ... 33
Figure 6: Value engineering interventions (Ellis et al., 2005) ... 35
Figure 7: Feature to Function Mapping (Ansari et al., 1997) ... 35
Figure 8: Value Methodology approach process flowchart for cost reallocation (Ruiz et al., 2014) ... 36
Figure 9: Function analysis (Ruiz et al., 2014) ... 37
Figure 10: Compare graph (Ruiz et al., 2014) ... 38
Figure 11: Point-based design versus set-based design (Ward et al., 2005) ... 39
Figure 12: Product Development Process (Amaral et al., 2007) ... 41
Figure 13: Conventional batch-and-queue product development (Cooper and Slagmulder, 1997) ... 42
Figure 14: Lean product development (Cooper and Slagmulder, 1997) ... 43
Figure 15: Specific roles of supply management (Ellram, 1999) ... 45
Figure 16: Research design ... 51
Figure 17: Fabrication materials ... 55
Figure 18: Integrated Center for Design and Construction ... 64
Figure 19: Big room layout ... 69
Figure 21: Towers built in the first round (Team 1 on left and Team 2 on right)... 76
Figure 22: Towers built in the second round Team 1 (right) and Team 2 (left) ... 77
Figure 23: Activities of the Engineering & Budget Department... 79
Figure 24: Product Development Process ... 83
Figure 25: Design charrete ... 85
LIST OF TABLES
Table 1: Factors that influence the target costing process (Adapted from Cooper and Slagmulder,
1997) ... 15
Table 2: TVD elements (Denerolle, 2013) ... 25
Table 3: Participants of the simulation game ... 54
Table 4: Cost of materials ... 55
Table 5: Research activities of case 3 ... 57
Table 6: Enablers for TVD implementation and their respective source of evidence. ... 65
Table 7: Evidence of Money Moving Between Boundaries ... 74
Table 8: Tower costs ... 76
Table 9: Family of products ... 82
Table 10: Desired value attributes (21 cards rated from a total amount of 26) ... 88
Table 11: Participants of value engineering exercise ... 89
Table 12: Cross-case comparison ... 93
Table 13: Pre-target costing guidelines... 99
Table 14: Market-driven guidelines ... 100
Table 15: Product-level guidelines... 101
1. INTRODUCTION
The first section of this chapter presents the background in which this research takes place. The second section presents the research problem that governs the flow of this research. The third section presents the questions and objectives that guided this research. In the fourth section, the limitations of the research are listed. The fifth section summarizes the contents of the dissertation.
1.1 Research Background
The view that the construction industry has an opportunistic culture, prone to conflict and resistant to change is widely widespread. Such a culture usually limit the competitiveness and the overall efficiency of the construction industry. This culture known as "claims culture" comes from economic conditions in the industry, which include low entry barriers and competitive bidding (ROOKE et al., 2004).
The competitive bids have been used as forms of contracting in construction. In this model, the contracts serve as a means of coordinating the work through work packages to be performed. This leads to a situation where attempts to reduce costs are performed by applying an increasing pressure on those who are downstream in the supply chain, rather than encourage cost savings through collaboration in the design or innovation processes (NICOLINI et al., 2000). Given the growth of subcontracting, the construction industry is increasingly concerned about the transaction costs1 rather than
internal costs of an organization (ROOKE et al., 2004).
1 According to Williamson (1985), transaction costs are divided into anterior and posterior (ex ante and ex
post) of the completion of the transaction itself. The ex ante costs are the costs of negotiating and
Any initiative to change this traditional cost reduction practice needs to deal simultaneously with the design and construction processes as well as business practices throughout the supply chain. The use of target costing can be a promising approach to achieving a more proactive cost management.
Developed over the past 40 years by a number of Japanese companies (KATO, 1993), target costing is defined as a profit planning and cost management system that is price led, customer focused, design centered, and cross-functional. (ANSARI et al., 1997).
Target Costing differs from the cost-plus approach traditionally used in the construction industry. The cost-plus approach starts by estimating the costs of production, adds a profit margin and then derives a market price. If the client is unwilling to pay the price, then some activities are put in place, such as lowering specifications, reducing quality, and trimming profit (NICOLINI et al., 2000). On the other hand, the target costing approach implies that an allowable cost is determined by a target price less an appropriate profit margin.
Construction industry often operates without a full understanding of costs along the supply chain. The norm is of first developing designs, then quote prices to suppliers who were not involved in the design process. The result is usually a series of prices based on commercial judgments, not true costs. Costs, as opposed to prices, are rarely investigated, and as a result, margins are dependent upon expediency. (NICOLINI et al., 2000).
1.2 Research Problem
This research involves a practically relevant problem, which also has potential for theoretical contribution. From a practical point of view, most of the companies operating in the real estate sector face high levels of competition. Real estate developers compete for land acquisition, access to financial resources for development and the search for buyers for their products. More recently, the drop in real estate prices added further pressure for Brazilian homebuilders. Quality, time, and cost are key factors in a competitive environment. Today quality is no longer a competitive advantage, but rather a prerequisite. Cost and time remains as big differentials in a competitive environment. As the competition in real estate sector becomes increasingly intense, a lower cost structure is critical for a company's survival.
Moreover, a traditional approach to profit planning and cost management is not appropriate for today's competitive environment. Traditional approaches attempt to control costs and quality after production while target costing manages cost before they are incurred.
Besides the high levels of competition, anecdotal evidence suggests that there is an increasing demand to reduce the time of real estate development cycle. In the real estate sector, companies do not have the time of designing houses/apartments, realizing that they cost too much and then redesigning them. Such practice extend the product development cycle and delay the product launch. In competitive environments such as real estate products for sale, the timing for product launches is critical to sales success.
Given the competitive environment and the demand of reducing the real estate development cycle, the discipline that the target costing brings to the product development process can help increase the likelihood that the costs of new products are
acceptable when launched. Target costing is intimately related to an organization's competitive strategy and its product development cycle (ANSARI et al., 1997).
From a theoretical point of view, little research has been conducted on target costing implementation in the product development process of real estate organizations. Whereas target costing in the manufacturing industry has a market-driven product development and its intellectual roots relies on open system theory2 (ANSARI et al.,
1997), most studies on target costing in construction have an internal focus. For instance, to name a few examples, Nicolini et al. (2000) examined target costing applicability as a way of supporting supply-chain integration in view of an improvement of the level of profitability and quality of the UK construction industry. Ballard and Reiser (2004) documented a target costing implementation in a project, which the client had a limited amount of money to spend and wanted to spend all of it into value adding investment opportunities. Jacomit and Granja (2011) investigated target costing applicability within a non-profit low-income housing provider as a trigger of Brazilian social housing projects transformation, aiming to increase value by improving product functionality without raising costs. None of these studies has pursued a target costing implementation in an environment in which companies seek competitive advantages.
Moreover, far too little attention has been paid to target costing implementation in environments with sophisticated customers. Sophisticated customers are highly educated about available product offerings, can detect minor differences, and will switch freely among developers to buy the best products (COOPER and SLAGMULDER, 1997). In such environment, target costing will have a strong external orientation because understand the customers’ requirements is critical. Upper and middle class customers tend to be sophisticated customers who are demanding better
2 Open systems theory is a body of knowledge that recognizes that is better to manage proactively systems before they deviate from their intended paths than take corrective action after they have deviated (ANSARI et al., 1997).
quality products with more features at an affordable price. The focus of this research is limited to real estate projects for customers with more freedom of choice.
1.3 Research questions and objectives
Based on the research problem presented in the previous section, it has been proposed the following research questions:
a) What are the enablers for the adoption of target costing in the development of real estate products?
b) How to introduce the target costing in real estate product development process?
Based on these research questions, the objectives are:
a) Identify enablers for the introduction of target costing in the development of real estate products;
b) Propose guidelines for introduction of target costing in the real estate product development process.
1.4 Limitations
The guidelines presented for introduction of target costing in real estate product development process have not been tested empirically. Some guidelines are based on empirical evidence while other are based on existing literature of target costing.
1.5 Dissertation structure
The rest of the dissertation is divided into five chapters. The second chapter presents the target costing approach. The third chapter presents the target costing principles. In the fourth chapter, the adopted research strategy is presented. The fifth chapter discusses the results of each of the three cases, a cross-case comparison of the lessons learned in each case and the proposed guidelines. Finally, the sixth chapter presents an evaluation of the research objectives and suggestions for future research.
2. TARGET COSTING
2.1 What is Target Costing?
Target Costing was originally introduced in Japan under the name of Genka
Kikaku (Nicolini et al. 2000) and became popular in the management accounting
literature in the 1990s. Target costing is a broad concept and has been used with a variety of meanings in the literature. Ballard (2008) defined it as a dialogue of allowable and expected cost. Cooper and Slagmulder (1997) defined target costing as “a structured approach to determine the life-cycle cost at which a proposed product with specified functionality and quality must be produced to generate the desired level of profitability over its life cycle when sold at its anticipated selling price”. In Japan, lean companies have learned to view target costing not as a stand-alone program, but as an integral part of the product development process (COOPER and SLAGMULDER, 1999).
For the purpose of this dissertation, the term target costing is used in its broadest sense to refer to a “market driven costing system in which cost targets are set by considering customer requirements and competitive offerings. Cost targets are achieved by focusing on product and process design and by making continuous improvements in all support processes” (ANSARI et al., 1997).
While the target costing procedures at companies can vary considerably, Cooper and Slagmulder (1997) proposed a general structure, which is divided into three major sections: market-driven costing, product-level target costing, and component-level target costing as show in Figure 1.
Figure 1: Three main elements of the target costing process (Cooper and Slagmuder, 1999)
The market-driven costing section can be broken into five steps: (i) Set long-term sales and profit objectives; (ii) Structure the product lines; (iii) Set target selling price; (iv) Establish target profit margin and (v) Compute allowable cost (COOPER and SLAGMULDER, 1999).
Set long-term sales and profit objectives
The credibility of the long-term plan is paramount in establishing target costing discipline. Two factors help establish this credibility. First, the company derives long-term sales and profit plans from careful analysis of all relevant information. Second, the company approves only realistic plans.
Structure the product lines
Structuring the product line typically is based on a thorough analysis of how customer preferences change over time. The product line should not contain several products that they confuse customers.
Set target selling price
At the core of the price-setting process is the concept of perceived value that is further discussed in the next chapter. A company can raise selling prices only if the perceived value of the new product exceeds not only that of the product's predecessor, but also that of competing products. Companies often set prices by considering the market conditions during the product's launch.
Establish target profit margin
Two important considerations in setting target profit margins are to ensure that the margins are realistic and that they are sufficient to offset the life-cycle costs of the products. A company can set target profit margins in two ways. In the first method, it begins with the actual profit margin of the predecessor product and then adjusts for changes in market conditions. The second method, the company starts with the target profit margin of the entire profit line and raises or lowers the target profit margin for individual products, depending on the realities of the marketplace.
Companies with products that require large up-front investments typically analyze their life-cycle profitability. These analyses include a determination of the investment, both capital and marketing related, required to bring the new product to market. The objective of the analyses is to ensure that target profit margins are set large enough so that products will earn an adequate profit margin over their lives.
Compute allowable cost
The allowable cost is calculated by subtracting the target profit margin from the target-selling price. However, the allowable cost does not take into account the cost-reduction capabilities of the company's product designers or supplies. Therefore, there is no guarantee that the company can achieve it. When a product's allowable cost is considered unachievable, the company must establish a higher cost in the product-level target costing process.
The second section of target costing deals with setting achievable product-level target costs. It can be broken into three steps: (i) Set Product-Level Target Cost. (ii) Discipline the target costing process and (iii) Achieve the target cost.
Set Product-Level Target Cost
Since the allowable cost is derived from external conditions, the risk is that the allowable cost will not be achievable. In this situation, to maintain the discipline of
target costing, the company has to identify achievable and unachievable parts of the cost-reduction objective. The achievable or target cost-reduction objective is derived by analyzing the ability of the product designers and suppliers to reduce costs from the proposed product.
The product-level target cost is then determined by subtracting the new product's target cost-reduction objective from its current cost:
Product-level target cost = current cost- target cost-reduction objective
The unachievable part of the cost-reduction objective is called the strategic cost-reduction challenge, which is the difference between the allowable cost and the target cost:
Strategic cost-reduction challenge = product-level target cost - allowable cost
It identifies the profit shortfall that will occur when the designers are unable to achieve the allowable cost, and signals that the company is not as efficient as demanded by competitive conditions. The emergence of a strategic cost-reduction challenge is a sign for all involved in the new product development to create additional pressure on the designers and the company's suppliers to reduce the challenge to zero for the product's next generation.
Discipline the target costing process
Once the company has established the target cost reduction objective, it can begin the process of designing the product so that it can be manufactured at its target cost. This monitoring ensures that the company can take corrective actions as early as possible and that it does not violate the cardinal rule: "The target cost must never be exceeded".
The cardinal rule is enforced in three ways. First, whenever improvements in the design result in increased costs, the company must find alternative, offsetting savings elsewhere in the design. Second, the company does not launch products whose
costs exceed the target. Finally, the company carefully manages transition to manufacturing to ensure that it achieves the target cost.
Achieve the target cost
Once the target cost is set, the next task becomes finding ways to achieve it. Target costing requires a set of core tools and other process tools that work together with systems already available in an organization. Core tools are those support tools which their absence can seriously hinder target costing. Ansari et al. (1997) suggest nine core target costing tools: (i) value engineering and value analysis, (ii) quality function deployment, (iii) design for manufacturability and assembly and design to cost, (iv) cost tables, (v) feature to function costing, (vi) component cost analysis, (vii) process costing, (viii) multiyear product and profit planning, and (ix) benchmarking.
Value engineering is further discussed in the next chapter. Design for manufacturability and assembly focuses on reducing costs by making products easier to
assemble or manufacture, while holding functionality at specified levels (COOPER; SLAGMULDER, 1999).
Quality function deployment (QFD) provides a structured approach to ensure
that customer requirements are not compromised during the design process (COOPER; SLAGMULDER, 1999). The use of QFD in product concept stages of target costing is a way to bring together the relationship between competitive offerings, customer requirements, and design parameters (ANSARI et al., 1997).
Cost table is used as the database for allocating the target cost effectively in
order to decide in the design and specifications of a building, determine strategic contract price, and develop a construction plan. The Society of Japanese Value Engineering recommends using a zoning cost table that is based on the functionality of a building. For instance, a hotel building can be divided into an accommodation zone, food zone, banquet zone, shopping zone, lobby zone, and parking zone. A cost table can
be developed to estimate the cost of each zone since it would be relatively easy for the client to figure out how much to invest in each zone (YOOK et al., 2005).
Feature to function costing is a way to cost the many features and functions of a
product. It aims to provide information about costs of providing a function that in turn satisfies a feature desired by customers. Component cost analysis is threefold. First, it identifies the costly components in a product. Then, it deals with the cost relationships between components. For instance, the use of steel studs instead of lumber can increase materials costs but decrease electrical wiring and window installation costs due of the predrilled holes. Finally, it ensures that no outdated or soon out of productions are used.
Process costing is the analysis of costs by manufacturing process. This analysis
provides information that allows management to eliminate or modify costly or non-value added operations. Multiyear product and profit planning is used to integrate information on revenues, spending, and investment for an organization’s product portfolio over a three to seven year period. A multiyear profit plan integrates long-range forecasts of products markets, technology and investment into a product strategy.
Benchmarking requires comparing process or operations in a business against the “best in
class”. The importance of this tool for target costing is its ability to provide estimates of competitive product offerings, prices, margins, and costs (ANSARI et al., 1997).
Other process tools refer to tools and techniques that support other business process as well as target costing such as: capacity measurement, supplier ratings, process testing, Activity based management, Pareto analysis, regression analysis, net present value analysis, etc (ANSARI et al., 1997).
The final section of the target costing deals with decomposing the product target cost to the component level. This section consists of three steps: (i) Decompose
target costs of major functions, (ii) Set target costs of components and (iii) Manage suppliers.
Decompose target costs of major functions
Identifying major functions allows the design process to be broken into multiple, somewhat independent tasks. Typically, the design of each major function is the responsibility of a dedicated team. Design teams usually include representatives from a number of disciplines. The overall responsibility for coordinating the design of a new product typically rests with the product manager, who selects the distinctive theme of the new product and sets its functionality.
Set target costs of components
Once a company has established the target costs of the major functions, it decomposes them to the group component and parts level as appropriate. The objective is to set a purchase price for every externally acquired component.
Manage suppliers
Supplier management has two primary aspects that are particularly important in the component-level target costing process: Selecting suppliers and Reward Supplier creativity. The target costs for externally acquired components are typically set through negotiation. This process starts with suppliers, both internal and external, providing estimates of their selling prices to the company. The target costs for all components are compared to the suppliers' quoted prices. If satisfactory, the company accepts the quote. If the initial quote is too high, the company undertakes further negotiations until reaching an agreement.
Many companies use incentive plans to encourage their suppliers, both to reward innovator and to signal where additional cost reduction should occur. Even with the discipline of target costing, the lowest cost or highest-value supplier does not always
win the bid. Companies actively manage their suppliers to ensure that they remain both efficient and innovative.
2.2 Environment in which Target Costing is Beneficial
Although the three sections of target costing are present in all target costing systems, their importance and the way they are accomplished varies by company. A number of factors influences each one of the three sections of target costing. These influence factors (see Table 1) emerged from the original target costing application environment (Japanese manufacturing companies). They help determine the magnitude of the benefits that a company can derive from target costing (COOPER; SLAGMULDER 1997). The influence level of each factor may differ given the construction industry's peculiarities (one-of-a-kindness, temporary organization and site production), however, these factors could still be relevant for guiding target costing applications in the construction industry.
The intensity of competition primarily influence the entire target costing process (COOPER and SLAGMULDER, 1997). It influences how much attention the firm should pay to competitive offerings in the target costing process. As the intensity of competition increases, so does the value of target costing to the company.
Nature of customer
The degree of Customer Sophistication determines how good customers are at detecting differences between the price, quality, and functionality of competitive products. In environments with sophisticated customers, the target costing process will have a strong external orientation because understanding the customers’ requirements is critical.
Table 1: Factors that influence the target costing process (Adapted from Cooper and Slagmulder, 1997) Market-driven costing Intensity of competition Nature of the customer
Degree of Customer Sophistication
The rate at which customer requirements change
Degree of understanding of future product requirements
Product-level target
costing
Product strategy
Number of Products in the line Frequency of redesign
Degree of Innovation
Characteristics of the product
Product Complexity
Magnitude of Up – front investments Duration of product development
Component-level target costing
Supplier base strategy
Degree of horizontal integration Power over major suppliers Nature of supplier relation
The rate at which customer requirements change defines how quickly survival zones (cost, quality and functionality) move over time. Target costing is more beneficial in environments where costumer preferences change rapidly because under such conditions a company is more likely to launch products that are outside their survival zones.
As the degree of understanding increases, it becomes more beneficial to rely on known customer preferences to determine the future location of survival zones. Target costing is less beneficial in environments where the future locations of survival zones are hard to predict.
Product Strategy
Cooper and Slagmulder (1997) highlighted that the greater the variety of products in a line, the more benefits it could render, since it increases product
development priority and further justifies the allocation of funds to the budget. However, in construction, a small variety of products being produced and replicated could, in fact, increase a product’s development priority and its budget, reducing the impact of construction peculiarity one-of-a-kindness (JACOMIT and GRANJA, 2011).
Frequency of redesign
Increase product functionality is a strategy pursued by many firms in the manufacturing industry. This objective is achieved by rapidly introducing new products, with each new generation incorporating the latest technology. The higher the rate of product introduction, the greater the benefits derived from target costing because the product development budget is higher, and therefore more is at risk (COOPER and SLAGMULDER, 1997).
Degree of Innovation
As the degree of innovation increases, so does the cost of product development. Furthermore, information about early product becomes less valuable. Customer, competitor and supplier information can be invalidated by significant innovations in product design. Target costing is most difficult to apply to revolutionary products (COOPER and SLAGMULDER, 1997). On the other hand, for products with low innovation, the information for the market-driven section will be easy to collect and of high value.
The characteristics of the product have a particularly strong influence on the benefits derived from target costing. These characteristics are the product complexity, the magnitude of up-front investments, and the duration of product development.
Product Complexity
It captures the number of components in the product and the number of distinct production steps required to manufacture it, the difficulty of manufacturing the components it contains, and the range of technologies required to produce them. As the
complexity of product grows, the benefits of target costing increase (COOPER and SLAGMULDER, 1997).
Magnitude of Up – front investments
Companies that produce products with very low product development cost are often willing to launch numerous products each year with the expectation that only a few will be successful. When up-front investments are small, the benefits of target costing are lower (COOPER; SLAGMULDER, 1997).
Duration of product development
The length of time taken to develop a new product also helps determine the benefits derived from product-level target costing. In fact, the duration of product development increases the importance of the three sections of target costing. The importance of market-driven section is increased by the higher risk that customer requirements will change during the product development process. Similarly, the longer development cycle means that suppliers have more time to experience changes such as input prices.
Supplier-base strategy is the factor that influences the component-level target costing section. The supplier-base strategy shapes the amount of information the company has about the cost and design capabilities of its suppliers.
Degree of horizontal integration
It captures the percentage of the total cost of the firm’s products are sourced externally. When a greater percentage of the product is externally sourced, the potential savings are greater because target costs can be developed for each of the externally acquired component and can be used to create pressure on suppliers to reduce price.
Power over major suppliers
It helps establish the ability of the firm to legislate selling prices to its suppliers. The more power the firm has over its suppliers, the more benefits it can derive from target costing by using it to create cost pressure on its suppliers.
Nature of supplier relation
It deals with the degree of cooperation the firm can expect from its suppliers and in particular the amount of design and cost information sharing. As supplier relations become more cooperative, the target costing process in general and the component-level step, in particular, become richer and more beneficial.
2.3 Implementing Target Costing in Organizations
Target costing can be applied in a number of different ways within an organization. The range of target costing application varies from a stand-alone to a full integration application. In a stand-alone application, a single department within an organization can apply target costing to offer goals for itself and its suppliers. Second, a target costing application can support a specific program. In this approach, target costing is used on ad hoc basis to tackle a particular issue and it is not institutionalized within the organization (ELLRAM, 1999).
Third, a target costing application can be externally driven process to meet specific market conditions, customer requirements, and competition. Fourth, a target costing application can be institutionalized as a way of doing business within the organization. Finally, a target costing application can also be used as an integral effort across the supply chain. At this stage, suppliers and key sub suppliers are involved on the product development through early participation, value engineering and value analysis (ELLRAM, 1999).
Cooper and Slagmulder (1997) emphasize the importance to determine whether the company's environment is changing in ways that support the adoption of the target costing and value engineering and whether the benefits exceed the costs. They pose six key questions that organizations should ask in deciding if the direction of their organization is supportive of target costing:
Question 01: Is profit management becoming more critical to your firm’s survival?
Question 02: Is satisfying your customers becoming more critical to the survival of your firm?
Question 03: Is product design becoming more critical to your firm’s survival?
Question 04: Are supplier’s relations becoming more critical to the survival of the firm?
Question 05: Is cost management the right place for your firm to expend resources?
Question 06: Can you create the right organizational context to support target costing and value engineering.
The question of whether supplier relations are becoming more critical to the survival of the company focuses on how supplier relations are changing. As the degree of horizontal integration increases, the role of supplier relations become more critical in the target costing process.
The organization context in which a new cost management system is implemented is also critical to its success. Ansari et al. (2006) suggested three aspects that an implementer should have in mind prior to target costing implementation: (i) obtain a formal mandate from top management. This mandate should convey the importance of the target costing implementation to organizational participants; (ii)
clarify the degree and scope of the change envisioned by top management before beginning the project and (iii) assess the organization's readiness for change.
Ansari et al. (2006) have also proposed a seven-steps implementation process: (1) Build Support; (2) Do a pilot; (3) Develop an implementation plan; (4) Form teams; (5) Provide training; (6) Acquire tools and (7) Institutionalize.
In the first step, the implementer should collect and present evidence to support a business case. Top managers should also demonstrate commitment to target costing through their participation in selected target costing activities, e.g., target costing workshops. In the second step, the implementation is best to begin with a pilot project or a series of pilots with limited scope. This step is followed by an implementation plan derived from the lessons learned of the pilot project. Furthermore, the organization should develop a multi-year implementation plan, as it is unlikely to complete and institutionalize target costing within one year.
The fourth step should cover the formation of a central implementation team, product teams, and functional teams. The fifth step should focus on building awareness and acceptance of target costing, facilitating communication about target costing, and increasing the technical capability of its participants. In the sixth step, the implementer should identify which tools are already used within the organization and the specific tools needed to support the target costing implementation process. Finally, the last step is focused in the institutional process.
2.4 Target costing in construction
Previous studies have made a significant contribution to the understanding of Target Costing within the project-based environment of construction. Knott (1996) reported one of the first attempts to apply the manufacturing target costing concept in
the construction of a large oil and gas platform in the North Sea's Andrew field. The Target Costing application resulted in savings of the order of 30%.
Nicolini et al. (2000) examined the application of Target Costing in the UK construction industry based on two case studies of Ministry of Defence projects. Although Target Costing was very promising, some of its principles and conditions of application contrasted with the extant commercial and procurement practices in the UK construction industry. The results of the action research applied in the UK pilot projects suggested that the existence of long-term relations with suppliers is one of the preconditions for applying a fully-fledged version of target costing.
Yook et al. (2005) investigated target costing within the construction industry in Japan. The results of their study showed that 15 % of the Japanese construction companies are using some of the major concepts of Target Costing. Sobotka and Czarnigowska (2007) highlighted that the highest potential of applying target costing approach to public projects occurs in public-private partnership arrangements because the product sold by the contractor (the private partner) is not a building, but an infrastructure-based service.
Jacomit and Granja (2011) proposed a framework (see Figure 2) that intends to demonstrate how the target costing system could be applied in association with the product development process of Brazilian public social housing projects.
Besides prosing this framework, Jacomit and Granja (2001) confronted the target costing literature with the current product development process of social housing projects in order to identify contextual characteristics that would (i) raise Target Costing applicability, (ii) reduce target costing applicability or (iii) drive its implementation process. They concluded that the standardization and replication of design could be seen as opportunities to Target Costing applicability. The development of standardized solutions provides a portfolio of proven designs, which in turn enables developers to make reasonably accurate estimates of costs, price and production time without delay. Conversely, the bidding process and the outsourced portions of design were features that could reduce target costing applicability in this context. The bidding process reduces cost reduction opportunities associated with the supply chain. It tends to prevent cost reduction through the production phase and enhance transactional costs. The outsourced portions of design raises the complexity of value analysis and trade-offs between costs, quality and functionality.
2.5 Target Value Design
Target Value Design (TVD) is an emerging practice being adopted in the US construction industry to achieve cost predictability during the design, construction and delivery of building assets. The term TVD was coined by Macomber et al. (2007). TVD is viewed as an adaptation of the manufacturing target costing method and its processes were created, tested and improved through experimentations on projects first by an US general contractor, then by a healthcare service provider in association with their supply chain (ZIMINA et al., 2012).
TVD adopts Target Costing principles to the construction industry with consideration to such factors as project organization, commercial terms based on
economic and non-economic motivation, a lean system of operation, and striving for a change of culture (ZIMINA et al., 2012).
The first successful TVD application in US construction industry was reported by Ballard and Reiser (2004) in a design-build project. Since the introduction of TVD, anecdotal evidence suggests that, to date, over 100 TVD projects have been completed in the USA. Most of them testing and developing modifications in the TVD process (BALLARD, 2011). TVD implementation reduces the likelihood of cost overrun (DO et al., 2014) and its implementation has led to significant improvement of projects performance, with the final cost of projects being an average of 15% less than the market cost (TOMMELEIN et al., 2011).
TVD process starts with clients identifying allowable cost based on the minimum acceptable return on investment or maximum available funds, preferably from an operation model. Clients must state how much money and time they are able and willing to spend to obtain life cycle benefits. Then, the expected cost is the estimated project cost based on current best practice. The expected cost should not exceed the allowable cost. If the expected cost exceeds the allowable cost, the business case has to be either revisited or cancelled. Finally, the target cost is set bellow the expected cost to spur design innovation (BALLARD, 2008).
TVD research and practice have been carried out within the lean philosophy framework and rely on the benchmarking practices described in Table 2. These practices emerged from the lessons learned of TVD implementation in healthcare and educational facilities and are organized in three categories as suggested by Denerolle (2013): (i) “Organizing” refers to the commercial terms, the team integration, and everything that allows TVD implementation. (ii) “Defining” is what the team does to define the targets. (iii) “Steering” refers to the means by which the team steer the design to targets.
Table 2: TVD elements (Denerolle, 2013) TVD elements Or g an izi n g
Some form of relational contract is used to align the interests of project team members with project objectives.
The feasibility study involves all key members (designers, constructors, and customer stakeholders) of the team that will deliver the project if the study findings are positive.
The customer is an active and permanent member of the project delivery team. Co-location is strongly advised, at least when teams are newly formed. Co-location need not be permanent; team meetings can be held weekly or more frequently. A cardinal rule is agreed upon by project team members – cost and schedule targets cannot be exceeded, and only the customer can change target scope, quality, cost or schedule.
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With the help of key service providers, the customer develops and evaluates the project business case and decides whether to fund a feasibility study; in part based on the gap between the project’s allowable and market cost.
The business case is based on a forecast of facility life cycle costs and benefits, preferably derived from an operations model; and includes specification of an allowable cost—what the customer is able and willing to pay to get life cycle benefits. Financing constraints are specified in the business case; limitations on the customer’s ability to fund the investment required to obtain life cycle benefits. All team members understand the business case and stakeholder values.
Feasibility is assessed through aligning ends (what’s wanted), means (conceptual design), and constraints (cost, time, location,…). The project proceeds to funding only if alignment is achieved, or is judged achievable during the course of the project.
Targets are set as stretch goals to spur innovation.
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Target scope and cost are allocated to cross-functional TVD teams, typically by facility system; e.g., structural, mechanical, electrical, exterior, interiors, … The Last Planner® system is used to coordinate the actions of team members. The feasibility study produces a detailed budget and schedule aligned with scope and quality requirements.
Cost estimating and budgeting is done continuously through intimate collaboration between members of the project team—‘over the shoulder estimating’.
TVD teams update their cost estimates and basis of estimate (scope) frequently. Example from a major hospital project during the period when TVD teams were heavily in design: estimate updates at most every three weeks.
The project cost estimate is updated frequently to reflect TVD team updates. This could be a plus/minus report with consolidated reports at greater intervals. Often project cost estimates are updated and reviewed in weekly meetings of TVD team coordinators and discipline leads, open to all project team members.
The cost, schedule and quality implications of design alternatives are discussed by team members (and external stakeholders when appropriate) prior to major investments of design time.
TVD is often implemented with the support of others managerial concepts such as set- based concurrent engineering, the application of Last Planner System principles in the design phase, and tools such as Choosing by Advantages (CBA) to select from design alternatives and A3 format for proposals (BALLARD, 2011).
The Last Planner System is a production planning system developed by Ballard (2000) and designed to produce predictable and reliable workflow in construction projects. CBA is a decision-making system developed by Suhr (1999) that compares advantages of alternatives. In CBA, decisions relies on advantages of one alternative over another rather than advantages and disadvantages of alternatives.
A3 is the international standard name for the paper size 11″ x 17″. A3s are commonly used at Toyota as dialogue pieces and to document steps of the Plan-Do-Check-Act cycle that allow their continuous improvement process (Parrish et al., 2009). Sobek II (2008) enumerates the steps of the problem-solving A3 process: (1) Identify a problem or need, (2) Conduct research to understand the current situation, (3) Conduct root cause analysis, (4) Devise countermeasures to address root causes, (5) Develop a target state, (6) Create an implementation plan, (7) Develop a follow-up plan with predicted outcomes, (8) Discuss plans with all affected parties, (9) Obtain approval for implementation, (10) Implement plans, and (11) Evaluate the results.
TVD can be implemented in various project delivery methods; however, it is best suited to Integrated Project Delivedy (IPD), as it requires a close collaboration between the designer, the builder, and the owner. TVD is also applicable to other integrated approaches such as design-build and CM at-Risk (PISHDAD-BOZORGI et al., 2013).
In fact, TVD is appropriate for all projects except (i) those that have been pre-designed, whether completely or requiring only minor adaptation to local conditions, and the design is sufficiently optimized that further investment is not likely to pay off;
(ii) those for which the customer cannot find service providers that are capable and trusted to execute the TVD technique; (iii) those that are prohibited by statute from integrating organizationally (ZIMINA et al., 2012).
Since the TVD approach has not been applied in the real sector, the target costing approach proposed by Cooper and Slagumuder (1999) better suit to the environment under study (e.g. real estate sector). The rationale behind this reason is that the above-mentioned target costing approach offers a market oriented perspective of the target costing.
3. TARGET COSTING PRINCIPLES
Target costing is not a stand-alone effort. Six key principles within it represent a way of thinking on cost and profit management that is very different from traditional approaches. The six key principles are: price led costing, customer focus, focus on design of products and process, cross-functional teams, life cycle cost reduction and value chain involvement (ANSARI et al., 1997). These principles provide the conceptual foundations for target costing and are further discussed in this chapter.
3.1 Price led costing
A target costing system sets target costs by subtracting the required profit margin from the competitive market price as described in section 2.1. The target costing process is driven by dynamic competitive intelligence and analysis (ANSARI et al., 1997). Therefore, frequent, detailed and reliable market data provided by effective activities of market research and sensing are essential for the success of target costing (NICOLINI et al., 2000).
3.2 Customer focus
A target cost cannot be achieved by sacrificing the features customers desire, lowering the performance or reliability of a product, or by delaying its introduction in the marketplace (ANSARI et al., 1997). Therefore, understanding what is value for the customer and how use this understanding to guide cost reduction ideas is also essential in the target costing process.
3.2.1 The concept of value
A number of disciplines including marketing, architecture, economy and psychology studies the concept of value. Despite this wide interest, to date there is no consensus about the definition and scope of the concept of value. In fact, the concept of value has become one of the most overused and misused concepts in the social sciences in general (KHALIFA, 2004).
Given the complexity and lack of consensus in this area, Sánchez-Fernández and Iniesta-Bonillo (2007) provided an overview of the major approaches to the concept of perceived value. In their work, an overview of the literature revealed two main research approaches to the operationalization of value (see Figure 3). The first approach conceives perceived value as a one-dimensional construct. The second approach conceives perceived value as a multi-dimensional construct that consists of several interrelated attributes or dimensions that form a holistic representation of a complex phenomenon.
Among all the definitions given in literature, this dissertation adopts the one proposed by Ansari et al. (1997) which define value as “the difference between the benefits received and the costs incurred by customers in getting those benefits.” Benefits received include each customer’s selective perception and opinion of the utility derived from physical and aesthetic attributes of a product and the way the products meets the customers’ needs and demand. The costs include the price paid and related immediate outlays for transportation, installation and life cycle costs.
As mentioned in chapter 1, target costing has a market-driven section. Therefore, the understanding of what is value for the customer value is needed throughout the product development cycle as an input to set prices and profit targets, to guide design decisions , and to make function and feature trade-offs (ANSARI et al., 1997).
However, understanding value also means identifying the types of customer input to collect and when to collect them. Customer input is either forward looking data on what is the customer desired value or feedback data that reflect choices made by customers (ANSARI et al., 1997). Both feedforward and feedback information are important to target costing process and are used throughout the product development cycle as shown in Figure 4.
Several techniques are used for collecting data on customer requirements such as: customer panels, focus groups, beta sites, customer value surveys, face-to-face interviews, trade journals, warranty claims, market statistics about sales (ANSARI et al., 1997). This dissertation has focused on data collection instrument in the form of a card game (see Figure 5) with 5 suits and 26 cards representing desired values for residential design.
The rationale behind this choice was that previous experience of post occupancy evaluation with illustrated questionnaires attested the effectiveness of this type of instrument (KOWALTOWSKI et al., 2002). Each suit represent a value perspective: Financial aspects; Sociocultural perceptions; Cultural values; Indoor environmental quality, and Spatial qualities (KOWALTOWSKI and GRANJA, 2011).
3.2.2 Value Engineering
At the core of the process of achieving the product-level target cost is Value Engineering (VE) or Value Methodology. These terms are used interchangeably within the text to refer to a structured approach to product design. The Value Engineering approach can trace its roots back to World War II. The name Value Engineering has been applied to a problem-solving system and supporting techniques for the achievement of lower costs (MILES, 1989).
Larry Miles was the father of this problem solving method developed at General Electric in the late 1940s and the method had gained worldwide acceptance. The value engineering approach spawned an international organization dedicated to its practice, and the certification of competent practitioners called Society of American Value Engineers International or SAVE International).
Value Engineering is not aimed at reducing cost, but at augmenting value (NICOLINI et al., 2000). VE focuses on increasing the value of a company’s product, where value is defined by the following equation:
Cost Function
Value (1)
According to Miles (1989), value is increased in two ways: (i) by decreasing costs (while, of course, maintaining functionality) or (ii) by increasing functionality if the customer needs, wants, and is willing to pay for more functionality.
VE primarily focuses on product functions and only secondarily on cost. It is a multifunctional discipline, which analyzes products in terms of their basic and secondary functions. A product’s basic function is the principal reason for its existence. Secondary functions are consequences of the way the designers choose to achieve the basic function (COOPER and SLAGMULDER, 1997).
When VE is integrated with a target costing system, its objective is to increase the functionality of products while keeping their target costs. A deep understanding of perceived value is critical if the company’s VE programs are to increase the value of products. VE application starts with the conceptualization of the product and continues through the design process. The application also happens during the construction phase, but under the name value analysis (VA). The difference between VA and VE is not in the approach taken or tools used but in the point at which they occur in the life cycle of the product. VE is used during product design and development stages, while VA is used for the manufacturing stage and for purchased parts (COOPER and SLAGMULDER, 1997).
Figure 6 shows that there are opportunities for a sequence of VE interventions at the different stages of the product development process, however the
earlier it is introduced within the project cycle, the greater the potential impact (ELLIS et al., 2005).
Figure 6: Value engineering interventions (Ellis et al., 2005)
Value engineering is often conducted in four stages: (i) feature to function analysis, (ii) creative thinking and problem solving, (iii) analysis and (iv) idea development (ANSARI et al., 1997). Function analysis aims to determine what function an item performs, what it costs, and what it is worth to a customer. The relationships between a customer feature and a function are indirect or are many to one or one to many as show in Figure 7.
Value is often expressed as degree of importance to a customer and cost is expressed is a percentage of total cost devoted to each function. The ratio of degree of importance to percent of cost is named the value index. The second stage in value engineering is creative thinking. The goal is to discuss on cost reduction ideas for functions that have a low value index. These functions are evaluated to define if they can be removed, simplified or reduced so the needed functionality can be provided at lowest cost (ANSARI et al., 1997).
The third stage is the analysis of the most promising cost reduction ideas. Finally, these cost reduction ideas are converted into concrete proposals for changes in product design or specifications.
Value engineering is a systematic approach, which in turn uses many tools to do product or process analysis. Tools used in a value engineering exercise are specifically chosen during a detailed analysis of the product. Ruiz et al. (2014) proposed a value engineering approach (see Figure 8) to tackle problem-solving situations, considering the trade-off between cost constraints and proper value assessment.
After identifying an object study and customer value parameters, Ruiz et al. (2014) proposed the use of four value engineering tools (function analysis; FAST diagram; Mudge technique; and compare method) to deliver value for social housing end-users through simple cost reallocation.
The selected social housing project was decomposed into 19 functions (see Figure 9). Then, a second tool called Function Analysis System Technique (FAST) diagram was proposed but not used by the authors since the project under study was already completed. FAST diagram is used within a multidisciplinary group to discuss and analyze the product and its functions from different points of views, developing a logical representation.
Figure 9: Function analysis (Ruiz et al., 2014)
The third tool used was the Mudge Technique which is an evaluation matrix applied to relate all of the functions and analyze them pair-by-pair, assigning a larger weight to the function considered most important according to the value parameters. This tool provided a dataset called Relative needs, which corresponds to the end-users value proposition.
