How to Achieve Product Cost Objectives

By Michael Chase. This page is available under the Creative Commons Attribution License

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Within moments of giving birth to your new product, senior management told you to reduce its cost. So, your team shifts into a cost-reduction mode and begins sorting the product’s sub-assemblies by their material cost, attacking those at the top of the list. This is a great way to shrink the bill of material, but it doesn’t guarantee that the results will make it to the bottom line.

The best time to focus on hitting new product cost goals is during the design phase. If you get this right, you can avoid cost reduction programs altogether. However, if you find yourself off-target on an existing product, you must construct your cost reduction effort to ensure that it will result in improved profitability.

Better to Prevent High Costs Than to Reduce Them

Product architecture and design decisions can determine more than eighty percent of capital equipment’s final product cost. If that seems a little high, try to recall the last time your organization took more than twenty percent of the cost out of an existing product without a redesign effort. See a model for contributors to capital equipment product costs in the figure below.

A model showing architecture selection, design implementation, and production contributors to capital equipment product costs
A model showing proportions of architecture selection, design implementation, and production to capital equipment product costs

Your architecture selection can lock in more than half of your product’s cost structure. At this stage, you are selecting fundamental technologies and building blocks that will remain with the product over its lifetime. Design implementation, which includes material selection, tolerances, and make-versus-buy decisions, can bring the total design contribution cost up to eighty percent. In comparison, production execution on things like yield, fixturing, and supplier selection is only responsible for a small fraction of your total cost.

Once you design a product, decreasing or removing costs is very difficult. Therefore, you must make a design-to-cost framework a cornerstone of your development process. Design-to-cost is a discipline that treats target costs as an independent product development design target. Critical design-to-cost tenets include the following:

  • Explore concept, architecture, and design alternatives for developing lower-cost approaches. There are usually trade-offs between cost and performance. Make sure that you consider them.
  • Allocate the total target cost to the subsystem and component levels of the product structure. This is where costs can be effectively managed. Describing cost targets only at the final product level isn’t actionable by the individual design team members. Break costs down to a level such that every design project has a cost target.
  • Use documented, revision-controlled, design requirements to avoid creeping elegance and feature sets.
  • Review and drive development-program progress against cost targets as rigorously as you do performance targets. Make sure that every program review looks at both.
  • Establish and document design standards to avoid over-engineering finishes and tolerances. Make compliance to standards a criterion for design approval.
  • Emphasize common platforms and modularity to drive manufacturing volumes up. The more a part or subsystem is utilized across a product line, the more efficient your development, testing, manufacturing, and servicing will be.

How to Cost Reduce an Existing Product

If this section applies to you, it means that your design-to-cost efforts didn’t go as planned. As discussed already, a product’s cost is tough to reduce once you have locked in the design. However, that doesn’t mean you should give up before trying if you have a cost problem. Here are four guidelines to help improve your likelihood of success.

1. Make sure that you’ll get a return on your investment.

Usually, cost reduction on existing products involves some design change coupled with improvements in supply chain and manufacturing efficiencies. Make sure that the cost of developing and implementing the change will be paid back by the cost savings within the product’s expected life. Also, watch out for unintended consequences. Sometimes one change can force a cascade of other design changes. As a result, the design effort and associated costs can snowball.

2. Never just reduce cost.

In the capital equipment world, performance benchmarks are constantly rising. Competitive advantages can evaporate if you don’t keep investing in performance improvement. Consequently, you will fall behind if you only focus on cost reduction.

Let’s say you spend a year stripping cost out of your flagship product. At the same time, your competitor works on advancing performance. At the end of that year, your value relative to your competition will have diminished. Everything you gained in cost reduction, you could potentially be given back in price due to a weakened position.

Cost-reduction-only strategies are a lot like treading water. You exert a lot of energy, but you don’t get anywhere.

3. Merge cost reduction with performance improvement efforts.

Instead of driving cost reduction efforts based on just a bill-of-material sort, merge cost reduction with performance improvement initiatives. Do this by tackling cost reduction as a requirement for every performance improvement project. This way, cost reduction comes along for the ride as you advance the product’s competitiveness.

Another benefit of this approach is that you don’t need to launch individual cost-reduction programs. Fewer program means reduced management overhead and resource conflicts.

4. Synchronize cost reduction and performance improvement market introduction.

Not only is it best to combine performance and cost improvement efforts, but it’s also imperative that the results be introduced to the market simultaneously. If you make a customer-noticeable change to your product that you can only explain as a supplier cost reduction, your cost reduction will quickly become a price reduction. Instead, bundle cost reduction with performance improvements. That way, you will lower costs while setting up an opportunity to increase prices.

Cost Reduction Case Study

In this example, the company manufactures and sells high-vacuum semiconductor process equipment. The current-generation product, released last year, is installed at most of the company’s key customers. So far, the product has been very successful.

Then came the pressure to reduce its costs.

In response, the company’s engineers figured out how to eliminate one of the system’s two vacuum pumps. This change saved more than ten thousand dollars on each system shipped. Furthermore, extensive testing demonstrated that system performance did not degrade. However, the change did not produce any performance improvement. Since cost reduction was the only goal, management dubbed the project a success and cut the change into the standard bill of materials.

Customers began ordering follow-on systems at about the same time the company released the new, low-cost configuration. They immediately noticed that their new systems had fewer pumps. Since the company couldn’t articulate a customer-focused reason for the change, nearly every customer insisted that the company add the missing pump or lower the price.

The result was that very few systems were sold with the projected gross margins. The company had to do something different to prevent its cost-reduction project from becoming a loser.

The project team brainstormed ideas for recovering the situation. One engineer pointed out that vacuum-chamber-pump–downtime was the throughput bottleneck in the system. By making a small change, they could reduce this time and therefore raise the throughput specification. The team confirmed that the system could achieve higher throughput with the lower-cost, single-pump configuration.

Now the cost reduction could be bundled with a throughput performance improvement. Customers not only accepted the cost-reduced configuration but, in many cases, paid a premium over their previous purchases.