Nissan Motor Company, Ltd.: Target Costing System Nissan Motor Company, Ltd. (Nissan) was by 1990 the world's fourth-largest automobile manufacturer. In 1990, Nissan produced just over 3 million vehicles, supplying approximately 10% of the world's demand for cars and trucks. Of these vehicles, slightly over two million were passenger cars. Nissan, founded in 1933, considered itself the most highly globalized of the Japanese automobile companies, producing vehicles at 36 plants in 22 countries and marketing in 150 countries through 390 distributorships and over 10.000 dealerships. Nissan had a stated policy of increasing its globalization through a five-step process: first by increasing local production; second, by raising the local content of its products through expanded use of locally sourced parts and components, third, by strengthening local research and development capabilities, fourth, by localizing management functions, and finally, by localizing decision-making processes. As a result, four out of the five major overseas manufacturing plants were matlaged by local chief executive officers, and in 1990 regional headquarters were opened in Europe and North America. The domestic Japanese passenger automobile market was intensely competitive. The largest manufacturer was Toyota, with approximately 45% of the domestic market. Nissan was second with approximately 25%, followed by Honda and Mazda, who together represented about another 20% In an attempt to increase its market share in the expanding but fiercely contested domestic market, Nissan implemented a plan to achieve annual domestic sales of 1.5 million cars by 1992 and to obtain the number one rating in terms of customer satisfaction. This strategy depended on designing products that were engineered around clearly defined concepts chosen to offer customers automobiles that matched their lifestyles. Automobile firms had been steadily increasing their range of products since the 1950s. This increase was driven primarily by changes in consumer preferences. For example, US consumers in the 1950s viewed the automobile as a status symbol, using the make of automobile they owned to signal the level of their economic success. Nissan executives characterized the consumer in this era as "keeping up with the Joneses." As automobile ownership became more widespread, consumers began to view their automobiles as making a statement about who they were. Nissan executives characterized the consumer of this em doing lus or her own thing Consumer deed of the 1960s required moet variations and broader mange of model types than in the 1950s As the 1960s closed and individualism became less important consumers came to view their automobiles is making statements shout war they were. Nissan executives characterized this era as being dominated by a desire for a consistency of lifestyle, le, bankers wanted tomobiles that were appropriate for bunkers. This Shift required that more models and variations de produced to satisfy consumer demand During the 1981, consumers started to demand automobiles that suited multiple lifestyles As one executive Rumia up the transition, the old segmentation the somad single lifestyle no longer worked, we now have to design cars that allow people to be bankees by day and punk rockers se night. This transcen consumer preference placed ditonal pressure on the tim to increase sa range of product offerings Despite this pressure, Nissan had chosen to systematically reduce the number of distinct models it would introduce in the 1990s. This decisice reflected two additional trendi First, the differences between consumers in the three major markets Japan, North America and Barope-were decreasing, and second, the costs acciated with introducing new models were increasing The decrease in differences among consumers in the three major markets reduced the need to develop models specific to a single market. The increased costs associated with launching new models made it difficult to make cutable prots at the number of new models introduced each a year with large These trends suggested to Nissan top management the overall profitability would be increased by reducing the number of distinct models supported, while maintaning the same level of effort to design and market the remaining models Introducing Now Products Over the years, Nissan had developed a formal procedure to introduce new products. One of the major elements of this procedure was a sophisticated tage costing ysten latus system, target selling price for each sew model was fire established then, a target margin was determined based upon comporte profitability objectives, finally, the models tres cost was identified as the difference between the target selling price and the target murgia Once the targer cost of the new model wa established, value engineering was used to ensure that the new mode, when it entered production would be manufactured at the desired target cost The procedure to introduce new models was divided into these distinct sages in the conceptual design stage, projects to introduce new product models were initiated; in the product development stage, the new models were readied for production and in the production stage, they were manufactured Taken together, these three stages listed about 10 years, the average life cycle of a modem passenger utomobile. The conceptul desige stage equired about two years to complete, the product development stage required to four years, and the production stage typically led about another four years. This, it was not for Nissan to be smultaneously producing the current model, preparing its replacement for introduction, and concqutualizing the next model's replacement The Conceptual Design Stage New product models were designed in the conceptual design stage is the designers identified the mixture of models that Nissected to sell over the next years. This mix w desented in a man of vehicles by major market and body type les came or sedan) The matrix contained qualitative information about each model, such as a price range, target customers and their income level, and the range of body types supported. This information was maintained for both current and future models and effectively described each model's market position The primary pepose of the product matrix was to ensure that Nican achieved the desired level of market coverage New autres in the matrix were identified using consumer analysis. This malysis was undertaken by market consulting from manga mamber of afferent techniques, including general Economic, psychological and antheopological surveys as well as direct observac. In recent years, this analyses had identified over 30 potential models that theoretically could be successfully introduced by Nissan However, top management that identified the optimum number of models that Nissan could successfully support at under 30 This member was limited by sesend factors, including the cost of differentiating each model in the minds of consumers, reseach ind development, and the ci fow Associated with matang dealer floor inventory. Thus, the challenge that Nissan management faced was to select the approximately 30 models that would maximize market coverage New models were conceptualized by identifying consumer mind-sets Mind-sets captured characteristics of the way consumers viewed themselves in relation to their cars. These mind-sets could be used to identity desige attributes that consumers took into account when purchasing a new Typical mind-sets included value seeker, confident and sophisticated, egressive endiusiast, and badgetspeedste By identifying clusters of these mind-sets, Nissan could identity ruches that contained a sufficient percentage of the matomobile-purchasing public to weat froducing a model specifically tored for the nice. For example, the Sentre (and peace family stan) was designet to satisfy the confidentsoplexicated and value sesker mind-sets, while the ZX (a lugh-performance sporta cury was designed to satisfy the budges speed star and aggressive enthusiast mind-sets As Nisan marketing executive commend, "If we believe that a sufficient market will exist in four to Eve years then we will develop a model to fit it. Thus, each model and its body shage variations such as sedan, coupe, hatchback and wagon, was specifically designed to satisfy a different group of constien As a final check on the appropriateness of the proposed model line-up, each model was categorized using the primary imbutes performance, aesthetics, and comfort. For example, comfort was considered the most important attribute for de Sentra model and performance the lens important, while for the ZX model, performance was considered the mos important and comfort the Text A plot of the attribute characteristics of both curent, future, and competitive models allowed top management determine that the proped peoduct mix covered an atoque percentage of the marker At this stage of the product introduction process, the conceptual design w sufficiently developed to allow a rough estimate of the member of selules to be sold and the costs associated with its development. These estimates were used in a life cycle contributice study to estimate the overal profitability of the propied model . The purpose of this stady was to ensure that the new model likely to generate a partive contribution series lifeThe life cycle retributice study consisted of comparing the estimated severes med by the new model to de efected cost of the product its life see Estribit 1) The model's revenue wis estimated by using a rough estimate of the selling price and the anticipod volume of sales From this estimate the ancipated direct materia cost, wluch included raw matend paint and purchased puts, was subracted. The difference between these two qualities was the estimated direct material marginal profit of the new model From the peotit, for addition sets of expenses were subtractol The first set contained the direct manufacturing and sales expenses. These were egenses that were predominantly driven by die manber of units produced and sold. The direct manufacturing expenses citaded elements such as the cost of the energy, cutting tools and indirect maten als casumed the direct sales exenses included logistics costs such as the costs of shipping and delivery The second secondained the estimated direct la costa The third set contained the depreciatice charges fox machining, die casting and other major production step Finally, the estimated resouch and development expenses were subtracted to give the life cycle ceritation of the particular model under development The depreciation charges used in the life cycle contribution walyes were estimated by taking the total depreciatice for each machine o process and dividing that by the number of its expected to be produced on that equipment over as lite. If the equipment was dedicated to the new model, was typically the case with stamping dies, then the number of units was the estand volwe of production for the model if the equipment was common to several models, as was often the case with conveyors, then the number of its was the tool of all units expected to be produced of all models using that equipment The depreciation charge used for the life cycle contributie malysis wii noe the one used for fancial reporting purposes. Nissan reported depreciatice using declining boce approach for both tax and financial sporting pups However, for the life cycle contributice calculation it wed a straight-line approach Management modified de depreciation calculation because I felt that the straight-line proach better captured the relationship between wet se and models produced than the declining balance approach if the life cycle contribution was deemed satisfactory, the conceptual design process was allowed to continue As the conceptual design of the new model progressed, additional cosumer analysis and Anancial malysis was undertaken. Comme malysis was used to obtain a better idea of the price range over which the model would sell and the level of functionality that the consumer expected the incial analysis consisted of a rough profitability stay in wluch the profitability of de highest vobinie vanuit of the new model was estimated using historical cost estimates and the latest of that variant's target price. This target price was determined by taking into account a number of intamal and external factors. The internal factors includes the position of the model in the marked the strategic and profitability objectives of top management for the model The extemal factors considered included the corporation's image and level of customer loyalty in the model's nice, the expected quality level and functionality of the model compared to competitive offerings, the model's expected market share, and finally, the expected price of competitive modele The first stage of value engecening was designed to determine whether the new model cold benutactured at an acceptable profit (see Exhibit 2) The proces ten by developing an order she detailing the characteristics of the 20 to 30 major functions of the proped model. Examples of the major functions included the engine, ar conditioner, trs, and sound system. The characteristics of each mejor functice were chose to satisfy the collection of consumer mind-sets for which the model was designed For example, the engine specified for a ZX would be a high- pertemance one, while for the Sentra it would be smaller, less powerful, and less expensive. The current cost of the model was determined by simming the current manufacturing cost of each major function of the new model This current cont was compared with the models allowable cost to determine the level of cost reduction required to achieve the desired level of profitability The dowable cost of the new model was determined by subentang is target profit margin from its target peice The targer margin was determined by careful consideration of available Information on the consumer, the film's ticipated fitue product mix and its long-term profit objective. Each new model's target marginwide bilished by naning sunulations of the firm's overall profitability for the next 10 years if it was selling the models identified in the product matrix expected sales voluntes The simulations started by plotting the actual profit margins of existing products (see evening product curve a Exhibit 3) The desired profitability of planeet models was then added (see Eshibit 4) and the firm's overall profitability determined over de yenes at various sales levels. Tlus peedicted overall peofitability was compared to the firm's long-term pofitability objectives set by senior management ise Eshibit 5 Once a satisfactory future product mateix will stablished that achieved the fim's profit objective, the target margins for each new model were set. To help minimize the risk that Nissan would not achieve its overall profitability turgess, the simulations explored the impact on overall profitability of different perice margin curves for different product mixes. For example, historically tugher margins had been earned on higher priced vehicles se existing product curve in Exhibit 3). However, with the reduced product offering and the increased profitability expected the future curve might be higher Alemas vely, because there was no gurite da se existing relationship between price and margin would remain unchanged Simulations were also run to explore the impact of fundamentally different relationships between selling price and margine The first stage of value engineering and the idea fiction of target price was interactive proces. When the allowable costs were considered to be too far below the estimated cost, the appropriate price range and functionality were reviewed until an allowable cost that was considered achievable was identitled (see Eshibit The excess of the current manufacturing cost over the allowable cost determined the level of cost reduction that had to be identified by value engineering For example, the current manufacturing co of the model might be *5,000,000 and the low cost 2,700,000, which identified as required cost reduction of 20% The next step in the value engineering process was to identify the allowable cost of each major function. This cost was set by teams derived from me every functional area of the fins, including product desga, engineering, pechasing, productie engreenng, manufacturing and puts supply. Although the allowable cost was wally lower than the current cost, sometimes the Nilowable cost was higher because the new product specifications demanded higher performance and Tunctionality than existing designs In to the sum of the cost reduction for each tajor component was meant to equal the required level of cost reduction to achieve the model's allowable cost (see Exhibit) Several critical decisions about the model were made during this stage of the conceptul design process, including the number of body variations, the number of angae types, and the base technology used in the vehicle. For example, the original concept for the model might include a five- door vanit. However, if during this stage of the analysis was determined that developing such a variant would be too costly or take in excessive amount of time, plans for a five-dixerinant would be postponed to the next version of that futomobile Once the projected coz of each major component had been idenified the expected cost of manufacture could be computed After the first valoe engineering stage was completed a major review of the new model was conducted. This review included an updated protitability study and an analysis of the performance characteristics of the model. le the profitability study, the expected profitability of the model given by the target price minus the target cost was compared to the latest estimates of the capital investment and semaining research and development expenditures required to complete the design of the product and allow production to commence in the perfomance stalysis, factors such as the quality of the hardwart, engite capacity, exhanstens, and safety were considered. If both the financial and performance wyses were considered acceptable, the project to introduce the new vehicle was authod and the model shifted from the conceptual design to the product development stage The Product Development Stage The first step in the product development stage was to prepare a detailed order sheet for the new model. This ceder sheet liged all of the components required in the new model and was analyzed to see which components would likely be sourced intemally verses extemally Suppliers, both termal and external, were provided with a description of each component and their potential production volumes Suppliers were equested to provide price and delivery timing estimates for each component The next step in the development of a new model was to produce the engineering drawings for til production value engineering was of this stage of product development o determine allowable costs for each of the components in every major function of the atomobile. This eximate was achieved by identifying a cost reduction objective for each component (see Exhibit 8). There were several ways that correduction objectives for components were identified Furst, competitie products were purchased, diesemblet, and analyzed From this malysis, dem for cost reduction were sometimes generated Second, parts suppliers were asked to generate cost reduction des An incentive plan was med to motivate the suppliers. For example, if an idea was accepted the supplier that suggested the cost reduction idea would be awarded a significant percentage of the contract for that component for A specified time period, say 50% for 12 months. This incentive scheme was viewed as particularly important because even it a cost reduction could not be achieved for this model, it goed to the supplies that when the next model was developed this is component would be subject to cost reductie pressures Thurd, ways to increase the commonality of parts across vanations and models were identit les, the sette seats might be used in two different models). Fouth, ways to reduce the nanber of components in each model were identified. For example, ontginally the kick plates used to protect the door were held in place by plastic nuts. However, a way to mold the plastic interior of die door so that no nuts were required had been developed To avoid during develop target comes to al 20,000 components in a typical new model ling the engines only perfond detailed target casting on two or three representative Each variation contained aproximately 3.500 components, and typically 80s of the components were common cross vanations. Therefore, about 5,000 components were subjected to dealed target costing The target costs of the other 15,000 components were estimated by comparing them to simile components in the 5,000 already target custod The completion of this target costing exercise provided cost reduction objectives for all of the components in the new model. The comparison of the allowable cost of each function and the sum of the equested cost of the components in the function after cost reduction indicated whether the mayor function could be product at about the wlowable cost. When the sum of the component costs was the high, additional cost redactices were identified until the total target cost of the representative variation was acceptable. The target costs for each component were compared to the prices qussed by the suppliers. If the quested prices were cceptable, the quote was equalIf the salute was too high, then further negotiations were undertaken til an agreement could be reached The next phase in product development was to contact two of these pronotype vehicles Several important lessons were leamed from the construction of these prototypes First components that were difficult to assemble were identified Typically, these components or the assemblies into which they find were redesigned to improve the ele of assembly, Socced, sembly times could now be niced quite accurately in the third stage of value engineering, the effect of these redesigns on the target costs of the components was determined and bly target costs were identified the output of this stage of value engineering was called the final tages cost (see Exhibit 9 lt differed from the draft target cost in two waya Fust, it chaded cably costs and second the indirect manufacturing costs. The indirect manufacturing costs were signed to products using the same procedures as the firm's cost system. This the final target cost for a model vanant wa expected to be equal to its reported produce cost danng manufacture. A comparison of the final target costs for each model variant and its expected selling pnce allowed de mticipaned profe on the vehicle to be detemined the expected selling price was reviewed by marketing in light of recent competitive products and market conditions, and a final selling price recommended Accounting was responsible for authonzing the actual selling price of each vanie. It took into account marketing's review of existing condition, the find target cost of the vehicle, and the target murgia for the valuele Orace set, accounting notified marketing of the recommended selling price in Japan, this was the price at which the car would be sold to life In other markets, such as North America, ince ve plans and other marketing techniques could conse the effective price to change across the life of the product Accounting was not involved in the value engineering process, tuch was the responsabia of the cost design and engineering department. The primary function of accounting was to set the final target cost for each model vanant and disure that the vehicles were manufactured for that amount As the vehicle entered production, accounting would monitor al component and assembly costs and if there were not in line with the final target co, accounting would notify cost design and engineering that the final target costs were not being met. When the target costs were exceeded additional value engineering was performed to reduce costs back to the target levels. Thus, the fourth and final value angineering stage ensured that de actual component and assembly costs were equal to their final target costs Unless the prodoction cost exceeded the target cost, no costruction efforts were undertaken during the production stage Management had determined that the incremental savings from such efforts were more than ottiset by distraces they created to the production process. When inton or other factors caused costo ne pressure was exerted up the suppliers to find ways to keep components at the final target levels Sumilarly, pressure was exened on the assembly plants to achieve the sembly target The Production Stage The sta facility, Kocated a few males tiom Tokyo, was one of Nissan's five mejor domestie manufacturing facilities Built in 1964, it was $32,000 square meters in wes and contained two complete stamping and assembly facilities. In addities, the facility house a car delivery won and the firms machinery design center. No production parts were produced at Zame The plant was cely involved in producing prexed metal parts, welding them together, assembling the body, painting it and then wesembling die finished tomobile The Zona plant was designed to produce 90 curs per hour operating on a two-shirt basis with productie occurring for 15 hours and 20 minutes per day A two-shift operation enabled the plant to produce between 1.300 to 1,400 cars per day at till capacity. While preventative maintenance was seried ca thoughout the day, primary maintenance was performed during the hours and 40 minutes in which production was scheduled Zame was a highly automed plant of the appesamately 3,1800 spot weld percaser 97% were performed autically. This high level of automatice had been achieved over a mante of years The current lugh level of sutomatic spot welding was achieved around 1950. To sustain this high level of action, Zuma contandourty 300 mbots. All of these mbots were designed by Nica but cely about 40% were actually manufactured by the fim In 1990, the facility was dedicated to the production of two models and three body types. The Sunny, or Sentras it was called in the North American market was produced in two body types, the four-door and two-door coupe configurations and the Pesca na sangle four-door configuration. Each body type could be produced in numerous vanations of key components, such as engine, conditioning and transmisie When dilable on variations were included, Za produced approximately 20,000 different variations of each of the two distinct body types The large mumber of vanation forced the facility to produce cars to customer oder Thus production strategy fit well with Nissan's corporate stegy of providing customer satisfaction, high quality, short delivery tintes, and high functionality In fact, fast delivery was considered so important that the production strategy was called by a nane the translated to "deliver the car with the paint still wer. In 1990, a car ordered from a Japanese dealer and produced in the plant could be delivered to the customer within 2 weeks because in Tokyo e required at leas a week to get die cerificate of space required to enable a car to be purchased the effective wait for a new Now negligible. This short delivery time despite high product diversity was achieved vaggressive use of just-time production The Product Cort System The same cost system was used throughout Nissan's assembly plants It reported fill product costs that included both direct and indirect expenses the indirect egenses were the de products in two different ways Direct and indirect manufacturing expenses were directly charged to the production cost center in which they were consumed, and then allocated to the products Service and administrative expenses and corporate expenses were allocated to the product without first beng wlocated to a production center Corporate expenses were equal to about is of the sales revente The custod of three major types of expende product-related expenses that included advertisements, warruty and delivery expensex geographic-related egenses, such as the Associated with the sales division in Tokyo that supported sales in all the major markets and finally, Nun Motor Company, Lad: Target Coating System 154-640 there were the egenses sociated with pre administration, legal and counting The produce related portion of corporate expenses was approximately 30%, the geographic-related portion 50% and the oder expeces about 20% Three different product profitabilities were calculated (see Exhibit 10). The first was the direct material marginal profit This was calculated by subtracting the cost of the raw materials and purchased parts from the selling price The second was the product tobution, determined by Subtracting direct manufacturing costs, rescuch and development expenses, and corpore expenses directly related to the product from the direct aterial mengenal profit Direct manufacturing expenses included manufacturing supplies such as cutting tools and machine depreciation. The procedures used to these expenses to products with depending upon the nature of the expenses and how they were consumed. For example, the costs of manufacturing supplies were assigned to the products based upon the number of direct labor hours the product consumed in the center if the deputet produced several different models, and number of units if only one model was produced machine depreciation was signed to products based upon the umber of cits inespective of model, Research and development expenses included the cost of the labor, facilities, and supplies consumed in the research and development facility. They were allocated to products based up the lace hours consulted in research and development on that product The comporte egenses directly related to the product included items such as product advertisements, product incentives, warranty costs, and delivery expenses. The third product profitability, operating profit was calculated by subtracting indirect manufacturing service, Administrave, and the remaining corporate expenses from the product contribution Indirect manufacturing expenses were directly charged to the productie cost center in which they were incurred Examples of indirect manufacturing expenses included trasportation, maintenance, and facility depreciation. These expenses were asigned to the products based on the total direct cost of the products produced in that center Service and administrative expenses were assigned to the products without first being assigned to the productice centers. These expenses were assigned head on the total direct cost of the product Corporate eqenies were first signed to the facility and then to the products based on the total direct costs in de seme way as were serve and administrative expenses. The breakdown of product profitability and cost is shown in Exhibit 11 The Nissan cost system was continuously undergoing modification. In particul, a program had been med to trace as many costs as possible directly to the production departments Plus, over time the service and administrative categories were dropping in relationship to the direct and indirect mandacturing costs. The success of this program and the heavy reliance upon external puts and service suppliers were visible from the relative portance of the there major a categories The direct costs, ie, dosents that were traced directly to the products, represented 85% of all manufacturing cons, the direct and indirect manufacturing that were chwged to the production departments and then signed to the products represented about 10% of total manufacturing costs while service and administrative cost mounted to only 5% of total cost The product costs ported by the cost system had four primary wes First sey were used in the long-range Strategic plan as a basis for estimating future profitability Second, they were used for cost-control purposes, in particular ensure that the production life of product its target most was mainted Third, they were used to help select the product mix, in particular with respect to the variations of a given model. Finally, they were used to identify pottable vanants the were candidates for discontinuance Suggested assigment questions What we the strengths and weaknesses of the target sing system? 2 What would you change? 3 Descente Nissan's cost system. Is it strong enough to support the target outing system? 4 How does your fim (or firms with which you are familiari determine the cost to mas ufacture new products Is target coming wastewable to U.S. companies? (2) + Selling Price - Direct Material Cost Direct Material Marginal Profit - Direct Manufacturing Expenses - Direct Labor - Depreciation - Research and Development (4) Life Cycle Contribution Notes: (1) Thesecosis include raw material purchased parts and paint 2) These expenses include drect sales expertos 31 Depreciation is charged on machinery, dias, and comeyorines. (4) Excludes all capitales for which depreciation charged. 18404 184-040 - 11- Exhibit 2 Setting the Draft Target Cost Projected Cost/ Functionality Analysis Order Sheet VE Stage 1 Cost Estimated Allowable Cost Cost Reduction Required Draft Target Cost (Total and by Function) 184-040 -12- Exhibit 3 Identifying the Target Margin (Existing Models) Existing Models % I r 0 0 - - 20.03 Selling Price 184-640 Be.se -13- Ethibit 4 Identifying the Target Margin (Existing Models and New Model) % Existing Models New Model P Target Margin M a LO) Target Price n Selling Price Ethibit 5 Setting the Target Margin Consumer Analysis Firm's Profit Objective Future Product Matrix Target Margin (Each Product) 184-040 -16- Exhibit 6 Identifying an Achievable Allowable Cost Consumer Analysis Mind Set Analysis Price Range Order Sheet Price Rangel Functionality Analysis Near to Far from Allowable Cost Allowable Cost Target Price Projected Cost Functionality Analysis Target Margin Allowable Cost 184-040 -18- Exhibit 7 Identifying Cost Reduction Targets by Major Function Major Function Required Level of Cost Reduction Major Function 2 Major Function 1 Major Function 2 Existing Cost Major Function 3 Major Function 3 Na Alowable Cost Function 4 Major Function 1 Major Function N Mejo Function N 184-040 -17- Exhibit 8 Identifying Cost Reduction Targets by Component Component 1 Required Level of Cost Reduction Componert Component 2 Component Existing Cost Existing Cost Component 3 Major Function Draft Target Cost Component 3 Componen Component Component M Component M Exhibit 9 Setting the Final Target Cost Draft Target Cost VE Stage 2 H VE Stage 3 Final Target Cost Niuan Motor Compery, Lad: Target Corting Sorten BEL. B. Exhibit 10 Breakdown of Product Profitability Rere Derect Material Co Puede 2a materiale Direct Direct Material Marginal Profit Cast EXPERT Dract Mandaluring Court 1) Direct labore 2 Marfacturing predmety wwiille Droty to the sher of sprede gel Characted 3 Tel & minery Deprecibe urge toista Men Serg.com 13 RAD laber expenses, facili Corporate ageren Direct Related to dat dvertisement 2) Products 3) Waranty 4) Delivery *** B. Indirect Chat Product Contribution Indirect Manufacturing Coat Cormed by Mancing Shop Floors Indirect and coney wrench and papers 2 Indraber cod 5) Shop iler. Deprecharge ME Service 1 lity spection (laber, eges, facilitica) 2 logistic labeep 1) Cred in credement Mariana ed in service department ES 2008 Ime of dat Chandi ROBE 1) Later 21 Gerlopen 2008 Depeche Mure SBD BEBE *** Campo Corporate per molding directly related product 1 pensaned by geographie de * Maine biler root in the Eleni expected in the divisie 2) Cien Administratie 8 EE Operating Profit 100 Exhibit 11 Breakdown of Product Profitability and Cost Manufacturing Shop Floors Service Departments Administration Departments Direct Materials Indirect Materials Direct Labor Indirect Labor Cost Variable Expenses Labor Cost Labor Costs Expenses Expenses Tools & Machinery Doprociation Maintenance Energy Facilities Depreciation Maintenance Energy Fachines Depreciation Maintenance Energy Facilties Depreciation Maintenance Energy Direct Manufacturing Cost Indirect Manufacturing Cost Services Administration Nissan Motor Company, Ltd.: Target Costing System Nissan Motor Company, Ltd. (Nissan) was by 1990 the world's fourth-largest automobile manufacturer. In 1990, Nissan produced just over 3 million vehicles, supplying approximately 10% of the world's demand for cars and trucks. Of these vehicles, slightly over two million were passenger cars. Nissan, founded in 1933, considered itself the most highly globalized of the Japanese automobile companies, producing vehicles at 36 plants in 22 countries and marketing in 150 countries through 390 distributorships and over 10.000 dealerships. Nissan had a stated policy of increasing its globalization through a five-step process: first by increasing local production; second, by raising the local content of its products through expanded use of locally sourced parts and components, third, by strengthening local research and development capabilities, fourth, by localizing management functions, and finally, by localizing decision-making processes. As a result, four out of the five major overseas manufacturing plants were matlaged by local chief executive officers, and in 1990 regional headquarters were opened in Europe and North America. The domestic Japanese passenger automobile market was intensely competitive. The largest manufacturer was Toyota, with approximately 45% of the domestic market. Nissan was second with approximately 25%, followed by Honda and Mazda, who together represented about another 20% In an attempt to increase its market share in the expanding but fiercely contested domestic market, Nissan implemented a plan to achieve annual domestic sales of 1.5 million cars by 1992 and to obtain the number one rating in terms of customer satisfaction. This strategy depended on designing products that were engineered around clearly defined concepts chosen to offer customers automobiles that matched their lifestyles. Automobile firms had been steadily increasing their range of products since the 1950s. This increase was driven primarily by changes in consumer preferences. For example, US consumers in the 1950s viewed the automobile as a status symbol, using the make of automobile they owned to signal the level of their economic success. Nissan executives characterized the consumer in this era as "keeping up with the Joneses." As automobile ownership became more widespread, consumers began to view their automobiles as making a statement about who they were. Nissan executives characterized the consumer of this em doing lus or her own thing Consumer deed of the 1960s required moet variations and broader mange of model types than in the 1950s As the 1960s closed and individualism became less important consumers came to view their automobiles is making statements shout war they were. Nissan executives characterized this era as being dominated by a desire for a consistency of lifestyle, le, bankers wanted tomobiles that were appropriate for bunkers. This Shift required that more models and variations de produced to satisfy consumer demand During the 1981, consumers started to demand automobiles that suited multiple lifestyles As one executive Rumia up the transition, the old segmentation the somad single lifestyle no longer worked, we now have to design cars that allow people to be bankees by day and punk rockers se night. This transcen consumer preference placed ditonal pressure on the tim to increase sa range of product offerings Despite this pressure, Nissan had chosen to systematically reduce the number of distinct models it would introduce in the 1990s. This decisice reflected two additional trendi First, the differences between consumers in the three major markets Japan, North America and Barope-were decreasing, and second, the costs acciated with introducing new models were increasing The decrease in differences among consumers in the three major markets reduced the need to develop models specific to a single market. The increased costs associated with launching new models made it difficult to make cutable prots at the number of new models introduced each a year with large These trends suggested to Nissan top management the overall profitability would be increased by reducing the number of distinct models supported, while maintaning the same level of effort to design and market the remaining models Introducing Now Products Over the years, Nissan had developed a formal procedure to introduce new products. One of the major elements of this procedure was a sophisticated tage costing ysten latus system, target selling price for each sew model was fire established then, a target margin was determined based upon comporte profitability objectives, finally, the models tres cost was identified as the difference between the target selling price and the target murgia Once the targer cost of the new model wa established, value engineering was used to ensure that the new mode, when it entered production would be manufactured at the desired target cost The procedure to introduce new models was divided into these distinct sages in the conceptual design stage, projects to introduce new product models were initiated; in the product development stage, the new models were readied for production and in the production stage, they were manufactured Taken together, these three stages listed about 10 years, the average life cycle of a modem passenger utomobile. The conceptul desige stage equired about two years to complete, the product development stage required to four years, and the production stage typically led about another four years. This, it was not for Nissan to be smultaneously producing the current model, preparing its replacement for introduction, and concqutualizing the next model's replacement The Conceptual Design Stage New product models were designed in the conceptual design stage is the designers identified the mixture of models that Nissected to sell over the next years. This mix w desented in a man of vehicles by major market and body type les came or sedan) The matrix contained qualitative information about each model, such as a price range, target customers and their income level, and the range of body types supported. This information was maintained for both current and future models and effectively described each model's market position The primary pepose of the product matrix was to ensure that Nican achieved the desired level of market coverage New autres in the matrix were identified using consumer analysis. This malysis was undertaken by market consulting from manga mamber of afferent techniques, including general Economic, psychological and antheopological surveys as well as direct observac. In recent years, this analyses had identified over 30 potential models that theoretically could be successfully introduced by Nissan However, top management that identified the optimum number of models that Nissan could successfully support at under 30 This member was limited by sesend factors, including the cost of differentiating each model in the minds of consumers, reseach ind development, and the ci fow Associated with matang dealer floor inventory. Thus, the challenge that Nissan management faced was to select the approximately 30 models that would maximize market coverage New models were conceptualized by identifying consumer mind-sets Mind-sets captured characteristics of the way consumers viewed themselves in relation to their cars. These mind-sets could be used to identity desige attributes that consumers took into account when purchasing a new Typical mind-sets included value seeker, confident and sophisticated, egressive endiusiast, and badgetspeedste By identifying clusters of these mind-sets, Nissan could identity ruches that contained a sufficient percentage of the matomobile-purchasing public to weat froducing a model specifically tored for the nice. For example, the Sentre (and peace family stan) was designet to satisfy the confidentsoplexicated and value sesker mind-sets, while the ZX (a lugh-performance sporta cury was designed to satisfy the budges speed star and aggressive enthusiast mind-sets As Nisan marketing executive commend, "If we believe that a sufficient market will exist in four to Eve years then we will develop a model to fit it. Thus, each model and its body shage variations such as sedan, coupe, hatchback and wagon, was specifically designed to satisfy a different group of constien As a final check on the appropriateness of the proposed model line-up, each model was categorized using the primary imbutes performance, aesthetics, and comfort. For example, comfort was considered the most important attribute for de Sentra model and performance the lens important, while for the ZX model, performance was considered the mos important and comfort the Text A plot of the attribute characteristics of both curent, future, and competitive models allowed top management determine that the proped peoduct mix covered an atoque percentage of the marker At this stage of the product introduction process, the conceptual design w sufficiently developed to allow a rough estimate of the member of selules to be sold and the costs associated with its development. These estimates were used in a life cycle contributice study to estimate the overal profitability of the propied model . The purpose of this stady was to ensure that the new model likely to generate a partive contribution series lifeThe life cycle retributice study consisted of comparing the estimated severes med by the new model to de efected cost of the product its life see Estribit 1) The model's revenue wis estimated by using a rough estimate of the selling price and the anticipod volume of sales From this estimate the ancipated direct materia cost, wluch included raw matend paint and purchased puts, was subracted. The difference between these two qualities was the estimated direct material marginal profit of the new model From the peotit, for addition sets of expenses were subtractol The first set contained the direct manufacturing and sales expenses. These were egenses that were predominantly driven by die manber of units produced and sold. The direct manufacturing expenses citaded elements such as the cost of the energy, cutting tools and indirect maten als casumed the direct sales exenses included logistics costs such as the costs of shipping and delivery The second secondained the estimated direct la costa The third set contained the depreciatice charges fox machining, die casting and other major production step Finally, the estimated resouch and development expenses were subtracted to give the life cycle ceritation of the particular model under development The depreciation charges used in the life cycle contribution walyes were estimated by taking the total depreciatice for each machine o process and dividing that by the number of its expected to be produced on that equipment over as lite. If the equipment was dedicated to the new model, was typically the case with stamping dies, then the number of units was the estand volwe of production for the model if the equipment was common to several models, as was often the case with conveyors, then the number of its was the tool of all units expected to be produced of all models using that equipment The depreciation charge used for the life cycle contributie malysis wii noe the one used for fancial reporting purposes. Nissan reported depreciatice using declining boce approach for both tax and financial sporting pups However, for the life cycle contributice calculation it wed a straight-line approach Management modified de depreciation calculation because I felt that the straight-line proach better captured the relationship between wet se and models produced than the declining balance approach if the life cycle contribution was deemed satisfactory, the conceptual design process was allowed to continue As the conceptual design of the new model progressed, additional cosumer analysis and Anancial malysis was undertaken. Comme malysis was used to obtain a better idea of the price range over which the model would sell and the level of functionality that the consumer expected the incial analysis consisted of a rough profitability stay in wluch the profitability of de highest vobinie vanuit of the new model was estimated using historical cost estimates and the latest of that variant's target price. This target price was determined by taking into account a number of intamal and external factors. The internal factors includes the position of the model in the marked the strategic and profitability objectives of top management for the model The extemal factors considered included the corporation's image and level of customer loyalty in the model's nice, the expected quality level and functionality of the model compared to competitive offerings, the model's expected market share, and finally, the expected price of competitive modele The first stage of value engecening was designed to determine whether the new model cold benutactured at an acceptable profit (see Exhibit 2) The proces ten by developing an order she detailing the characteristics of the 20 to 30 major functions of the proped model. Examples of the major functions included the engine, ar conditioner, trs, and sound system. The characteristics of each mejor functice were chose to satisfy the collection of consumer mind-sets for which the model was designed For example, the engine specified for a ZX would be a high- pertemance one, while for the Sentra it would be smaller, less powerful, and less expensive. The current cost of the model was determined by simming the current manufacturing cost of each major function of the new model This current cont was compared with the models allowable cost to determine the level of cost reduction required to achieve the desired level of profitability The dowable cost of the new model was determined by subentang is target profit margin from its target peice The targer margin was determined by careful consideration of available Information on the consumer, the film's ticipated fitue product mix and its long-term profit objective. Each new model's target marginwide bilished by naning sunulations of the firm's overall profitability for the next 10 years if it was selling the models identified in the product matrix expected sales voluntes The simulations started by plotting the actual profit margins of existing products (see evening product curve a Exhibit 3) The desired profitability of planeet models was then added (see Eshibit 4) and the firm's overall profitability determined over de yenes at various sales levels. Tlus peedicted overall peofitability was compared to the firm's long-term pofitability objectives set by senior management ise Eshibit 5 Once a satisfactory future product mateix will stablished that achieved the fim's profit objective, the target margins for each new model were set. To help minimize the risk that Nissan would not achieve its overall profitability turgess, the simulations explored the impact on overall profitability of different perice margin curves for different product mixes. For example, historically tugher margins had been earned on higher priced vehicles se existing product curve in Exhibit 3). However, with the reduced product offering and the increased profitability expected the future curve might be higher Alemas vely, because there was no gurite da se existing relationship between price and margin would remain unchanged Simulations were also run to explore the impact of fundamentally different relationships between selling price and margine The first stage of value engineering and the idea fiction of target price was interactive proces. When the allowable costs were considered to be too far below the estimated cost, the appropriate price range and functionality were reviewed until an allowable cost that was considered achievable was identitled (see Eshibit The excess of the current manufacturing cost over the allowable cost determined the level of cost reduction that had to be identified by value engineering For example, the current manufacturing co of the model might be *5,000,000 and the low cost 2,700,000, which identified as required cost reduction of 20% The next step in the value engineering process was to identify the allowable cost of each major function. This cost was set by teams derived from me every functional area of the fins, including product desga, engineering, pechasing, productie engreenng, manufacturing and puts supply. Although the allowable cost was wally lower than the current cost, sometimes the Nilowable cost was higher because the new product specifications demanded higher performance and Tunctionality than existing designs In to the sum of the cost reduction for each tajor component was meant to equal the required level of cost reduction to achieve the model's allowable cost (see Exhibit) Several critical decisions about the model were made during this stage of the conceptul design process, including the number of body variations, the number of angae types, and the base technology used in the vehicle. For example, the original concept for the model might include a five- door vanit. However, if during this stage of the analysis was determined that developing such a variant would be too costly or take in excessive amount of time, plans for a five-dixerinant would be postponed to the next version of that futomobile Once the projected coz of each major component had been idenified the expected cost of manufacture could be computed After the first valoe engineering stage was completed a major review of the new model was conducted. This review included an updated protitability study and an analysis of the performance characteristics of the model. le the profitability study, the expected profitability of the model given by the target price minus the target cost was compared to the latest estimates of the capital investment and semaining research and development expenditures required to complete the design of the product and allow production to commence in the perfomance stalysis, factors such as the quality of the hardwart, engite capacity, exhanstens, and safety were considered. If both the financial and performance wyses were considered acceptable, the project to introduce the new vehicle was authod and the model shifted from the conceptual design to the product development stage The Product Development Stage The first step in the product development stage was to prepare a detailed order sheet for the new model. This ceder sheet liged all of the components required in the new model and was analyzed to see which components would likely be sourced intemally verses extemally Suppliers, both termal and external, were provided with a description of each component and their potential production volumes Suppliers were equested to provide price and delivery timing estimates for each component The next step in the development of a new model was to produce the engineering drawings for til production value engineering was of this stage of product development o determine allowable costs for each of the components in every major function of the atomobile. This eximate was achieved by identifying a cost reduction objective for each component (see Exhibit 8). There were several ways that correduction objectives for components were identified Furst, competitie products were purchased, diesemblet, and analyzed From this malysis, dem for cost reduction were sometimes generated Second, parts suppliers were asked to generate cost reduction des An incentive plan was med to motivate the suppliers. For example, if an idea was accepted the supplier that suggested the cost reduction idea would be awarded a significant percentage of the contract for that component for A specified time period, say 50% for 12 months. This incentive scheme was viewed as particularly important because even it a cost reduction could not be achieved for this model, it goed to the supplies that when the next model was developed this is component would be subject to cost reductie pressures Thurd, ways to increase the commonality of parts across vanations and models were identit les, the sette seats might be used in two different models). Fouth, ways to reduce the nanber of components in each model were identified. For example, ontginally the kick plates used to protect the door were held in place by plastic nuts. However, a way to mold the plastic interior of die door so that no nuts were required had been developed To avoid during develop target comes to al 20,000 components in a typical new model ling the engines only perfond detailed target casting on two or three representative Each variation contained aproximately 3.500 components, and typically 80s of the components were common cross vanations. Therefore, about 5,000 components were subjected to dealed target costing The target costs of the other 15,000 components were estimated by comparing them to simile components in the 5,000 already target custod The completion of this target costing exercise provided cost reduction objectives for all of the components in the new model. The comparison of the allowable cost of each function and the sum of the equested cost of the components in the function after cost reduction indicated whether the mayor function could be product at about the wlowable cost. When the sum of the component costs was the high, additional cost redactices were identified until the total target cost of the representative variation was acceptable. The target costs for each component were compared to the prices qussed by the suppliers. If the quested prices were cceptable, the quote was equalIf the salute was too high, then further negotiations were undertaken til an agreement could be reached The next phase in product development was to contact two of these pronotype vehicles Several important lessons were leamed from the construction of these prototypes First components that were difficult to assemble were identified Typically, these components or the assemblies into which they find were redesigned to improve the ele of assembly, Socced, sembly times could now be niced quite accurately in the third stage of value engineering, the effect of these redesigns on the target costs of the components was determined and bly target costs were identified the output of this stage of value engineering was called the final tages cost (see Exhibit 9 lt differed from the draft target cost in two waya Fust, it chaded cably costs and second the indirect manufacturing costs. The indirect manufacturing costs were signed to products using the same procedures as the firm's cost system. This the final target cost for a model vanant wa expected to be equal to its reported produce cost danng manufacture. A comparison of the final target costs for each model variant and its expected selling pnce allowed de mticipaned profe on the vehicle to be detemined the expected selling price was reviewed by marketing in light of recent competitive products and market conditions, and a final selling price recommended Accounting was responsible for authonzing the actual selling price of each vanie. It took into account marketing's review of existing condition, the find target cost of the vehicle, and the target murgia for the valuele Orace set, accounting notified marketing of the recommended selling price in Japan, this was the price at which the car would be sold to life In other markets, such as North America, ince ve plans and other marketing techniques could conse the effective price to change across the life of the product Accounting was not involved in the value engineering process, tuch was the responsabia of the cost design and engineering department. The primary function of accounting was to set the final target cost for each model vanant and disure that the vehicles were manufactured for that amount As the vehicle entered production, accounting would monitor al component and assembly costs and if there were not in line with the final target co, accounting would notify cost design and engineering that the final target costs were not being met. When the target costs were exceeded additional value engineering was performed to reduce costs back to the target levels. Thus, the fourth and final value angineering stage ensured that de actual component and assembly costs were equal to their final target costs Unless the prodoction cost exceeded the target cost, no costruction efforts were undertaken during the production stage Management had determined that the incremental savings from such efforts were more than ottiset by distraces they created to the production process. When inton or other factors caused costo ne pressure was exerted up the suppliers to find ways to keep components at the final target levels Sumilarly, pressure was exened on the assembly plants to achieve the sembly target The Production Stage The sta facility, K