Toyota (target costing)

Toyota Motor Corporation started as a subsidiary of the Toyota Automatic Loom Works, Ltd. It was founded in 1937 as the Toyota Motor Company, Ltd. It changed its name to the Toyota Motor Corporation in 1982 when the parent company merged with Toyota Sales Company, Ltd. In 1 993, Toyota Motor Corporation (Toyota) was Japan's largest automobile company. It controlled approximately 45% of the domestic market. Its next largest Japanese competitor was Ionians, with approximately 25% market share, followed by Honda and Mazda, which together represented about another 20%.The remaining 10% of the domestic automobile market was made up of several domestic manufacturers, including Issue, and several foreign competitors, such as Mercedes Benz and the â€Å"big three† American firms: General Motors, Ford, and Chrysler. The domestic and world automobile markets were characterized by Intense competition. Models were brought out rapidly despite their high development costs. Fractions of a pe rcentage of market share were often viewed as representing the difference between success and failure.No Globalization Over the years, Toyota had evolved into a global firm. In 1993, a considerable part of the firm's overseas markets were serviced by local subsidiaries that frequently designed and manufactured automobiles for local markets. For example, local plants produced almost one-third of the vehicles sold in the North American market. These vehicles were produced in three plants, one in Kentucky, another in Ontario, Canada, and the New United Motor Manufacturing Inc. (MINIMUM) Joint venture plant with General Motors.These plants produced approximately 400,000 vehicles per annum, including 220,000 Camera, 170,000 Corollas, and the remainder being pickup trucks. Production volumes for pickup trucks were expected to increase to approximately 100,000 in the next Professor Robin Cooper of the Peter F. Trucker Graduate Management Center at The Claremont Graduate School and Professo r Take Tanana of Tokyo Aziza University prepared this case as the basis for class discussion rather than to illustrate either effective or ineffective handling of an administrative situation.Copyright 1997 by the President and Fellows of Harvard College. To order copies or request permission to reproduce materials, call 1-800-545-7685 or write Harvard Business School Publishing, Boston, MA 02163. No part of this publication may be reproduced, stored in a retrieval system, used in a spreadsheet, or transmitted in any form or by any means-?electronic, mechanical, photocopying, recording, or otherwise-?without the permission of Harvard Business School. This document is authorized for use only by Lingua Wang at Chinese University of Hong Kong until May 2013.Copying or posting is an infringement of copyright. [email  protected] Harvard. Du or 617. 783. 7860. 197-031 few years. In 1994, the firm expected to begin exporting vehicles from North America to markets such as Japan and Taiwan. In addition to automobiles, the firm also manufactured and sold forklifts. Toyota controlled 70% of the forklift market in the United States. The same commitment to local manufacture and control was apparent in Toast's other major overseas markets. In Europe, two new UK plants began producing to reach 100,000 by 1995 and 200,000 units before the end of the century.Altogether, Toyota vehicles were either manufactured or assembled in more than 20 nations. These local manufacturing facilities provided Jobs for nationals and business for local supplier firms. The relative importance of the international supplier business to Toyota was increasing. In 1992, for example, Toyota purchased locally approximately 70% of its parts requirements (or $5 billion) for its North American operations. The other 30% was imported from Japan, but this percentage was expected to decrease over time. By 1994, Toyota expected to purchase $6. Billion of parts from local suppliers worldwide and import $2. 9 bi llion for domestic use. Supplier Relationships Product design was also international in scope. Salty Research, Inc. , a Toyota subsidiary formed in California in October 1973, was responsible for the body styling ND interiors of new models scheduled for production in North America. The design styling for European markets was coordinated from the firm's design and technical centers located in Brussels. Third-party suppliers were responsible for approximately 70% of Toast's parts and materials.In particular, the cost and quality of third-party supplied parts was considered critical to the firm's success. In recent years, Toast's expansion into international production had required increased interaction with non-Japanese suppliers to raise their efficiency and quality to the same level as that of Toast's Japanese suppliers. Etc To help non-Japanese supplier firms manufacture acceptable parts, Toyota had developed programs to transfer Japanese manufacturing techniques. At the heart of t hese so-called design-in programs was Joint work by suppliers and Toyota engineers on new components.This Joint work began in the early stages of the vehicle- development process, because prospective suppliers cited a lack of involvement in the early stages of vehicle design as an obstacle to winning business in highballs components. In a typical design-in program, several designers competed for a part interact; the firms were evaluated on the prices bid, the technology applied, and their performance. The winning firm was granted a contract for the life of the model. When the next model was developed the contract was once again thrown open for bidding.By 1993, more than 120 U. S. Suppliers had participated in design-in programs and firms were involved in such programs but had yet to sign contracts for parts. A similar program was in place in Europe. Toyota engineers also helped its overseas suppliers to adopt the Toyota Production System. Many Toyota overseas suppliers had now succe ssfully implemented modified erosion of the Toyota Production System. The system contained four key elements: just-in-time production, Kanata, total quality management, and multi-functional work teams.Just-in-time production avoided the build up of excessive work-in-process inventories and increased the firm's ability to respond quickly to customer demands. Kanata was the driving force behind KIT, tying production closely to customer demand. Total quality management ensured high-quality products and minimized the risk that the reduced levels of inventories would lead to stock-outs because of poor-quality components. Finally, multi-functional workers, capable of performing several tasks, dealt with the increased complexity of the production process. 2 Cost Planning Cost planning at Toyota worked to reduce product costs at the design stage.Toyota first set its cost planning goals and then set out to achieve those goals through aggressive design changes. To correctly assess the gains m ade, the exact amount of cost reduction achieved through design changes was estimated after excluding all other factors that affected costs, such as increases in material and labor prices. The measurement process started with cost tables that helped engineers estimate he current cost of existing models. These cost tables were kept up-to-date for changes in material prices, labor rates, and production volume levels.The updated production volumes helped determine both depreciation and overhead charges that would be allocated to the new model. Comparison of this estimated cost to the vehicle's target cost gave the desired level of savings, or cost-planning goal, as it was called. At the profit-estimation stage, also referred to as the â€Å"target cost-setting stage,† Toyota calculated the differences between the costs of the new and current models, strutted the appropriate portion of the cost-reduction goal to the design divisions, and then assessed the results.Profit targets f or the life of the new model were also calculated as differences between estimates and targets. This process constituted the essence of budget control at Toyota. Toyota clearly specified cost reduction goals for each control unit to ensure that the company's overall goals were attained. Target Costing Toyota invented its target costing approach in 1959. Although many major manufacturers in Japan use target costing, Toast's system is the oldest and insider by many the most technically advanced.While the idea of systematic cost reduction had existed at Toyota since it was founded, the process was first codified in the mid-sass, when the firm set itself the objective of producing a $1,000 car. Existing cost estimation played a role in target costing, but there are differences between the two. First, cost estimates relied upon existing standards while target costs were adjusted for any future savings due to design changes. Second, cost estimates had a horizon of six months while the hor izon for target costs was the time engaging until the launch of the new product.Target costing brought the target cost and the estimated cost of a product into line by better specification and design. Toast's target costing system was designed not simply to estimate the cost of new products but to enable a product to attain its profit targets throughout its life. Product Planning Toyota used two broad categories of product development, one for completely new types of automobiles and the other for changes to existing models. The development of an entirely new model, such as the Lexus, was relatively unusual.Most of the reduce development projects focused on modifications to existing models. Japanese passenger cars usually underwent major model changes every four years. However, recent industry trends suggested that the period between full model changes may The firm used target costing primarily to support model changes, though the same general cost control procedures were applied to the design of entirely new vehicles. Cost estimates for new vehicles involved a greater degree of uncertainty than for model changes. 3 A model change began with a proposal from chief engineers for development of a new model.The proposal usually included: Specifications such as size (length, width, wheelbase, and interior space), weight, mileage, engine (type, displacement, and maximum power), transmission (gear and moderation ratios), chassis (suspension and brake types), and body components; Development budget; Development schedule; and Retail price and sales targets. New models basically maintained the same product concept as their predecessors. Styling was not specified at this stage; usually no more than a vague image was mentioned. Most of the cost incurred in any model change was for prototyping. Retail Prices and Sales Targets oodles.The retail price remained the same unless a change in function or performance altered the perceived value of the vehicle in the eyes of the cus tomer. In theory, therefore, prices changed as the perceived value of the vehicle changed. Formula for List Price of a New Model The selling price of a new car model was composed of the selling price of the equivalent existing model plus any incremental value due to improved functionality. For example, adding air conditioning to the standard version of a model would increase its price by the value of air conditioning as perceived by customers.The incremental value of a new model was determined by analyzing market conditions. Because the automotive industry was mature, most new features already existed in some form on other models. For example, if air conditioning was to be included in the standard version, its added value was determined using the list price of optional air conditioners for other models. In the unlikely event that no equivalent option existed, then the firm's design engineers and market specialists would estimate how much customers were willing to pay for the added f eature.The price increase for an added function did not always equal its selling price as a attendant option. The incremental price for an increase in functionality might be lowered because of the firm's strategy for the vehicle and because of competitors' pricing strategies. As functions were added to the standard version, Toyota increased the selling price until it reached the upper limit for that class of vehicle. When this limit was reached, the only potential benefit from adding functionality was increased sales.Because new models were introduced some four years after the design project began, Toyota delayed setting the functionality of the standard version as long as possible. Therefore, the target price and margin for a new model, and thus the associated target unit price, were set quite some time before product launch. The exact functionality of the standard version was set only when factors such as competitive offerings, foreign exchange rates, and user demand were better u nderstood. Changing the functionality of the standard version increased the probability that the new model would achieve its 4 desired level of profitability.Similarly, the actual selling price was not fixed until Just before product launch. Delaying these two critical decisions reduced significantly the uncertainty faced by the firm. For example, suppose the incremental value assigned to an air bag in the US market was $450 but the competition had set it at $700. In this case, Toyota might increase its price by the difference. Similarly, if the competitive prices were lower, Toyota would drop its prices to match. The sales division proposed anticipated production volumes based upon past sales levels, market trends, and competitors' product offerings.The sales division typically proposed a figure that was considered safe (I. E. , achievable), based upon the model's current sales level. Optimism was restrained in favor of realistic goals. Development Plan Assisted by engineers in the design, test-production, and technical divisions, a chief engineer drafted the development plan for the new model and then led the development project. Well over a hundred engineers from the various divisions worked with a chief engineer on a typical project, but since they belonged to different divisions, probably only about a dozen people reported directly to the chief engineer.In this sense, the chief engineer was more a project leader than a supervisor of product development. The chief engineer coordinated the design process at the design divisions, which were relatively autonomous; the chief engineer was expected to develop a â€Å"concept† for the new vehicle that spanned multiple design divisions. Toyota considered the tensions created by this matrix approach beneficial to the creative design process and worth any conflict that might arise. Toyota set the cost-planning goal based upon the product plan and the targets for the product's retail price and production volum e.Because an estimated price had the expected profit from product sales over its production life (usually, four years). The product's target cost was the unit cost upon which the profit target was based. Calculating Target Profit and Target Cost Toyota calculated the lifetime target profit for a product, such as the Celiac, by multiplying the target sales volume by the model's return on sales (or, as it was known at Toyota, profit ratio of sales). Toyota set the sales profit ratio with reference to the corporation's long-term target profit ratio.Estimated cost was determined from the firm's cost tables. Estimated profit was calculated using this figure. Estimated profit was less than the target profit because the target cost included the estimated cost savings due to value engineering and other cost reduction activities. The difference between target and estimated profit was the amount to be cut from costs through cost planning. The cost-planning goal was obtained by subtracting the estimated total profits from the target profits.The goal of cost planning was to determine the unit profit needed to achieve the profit target, and thus the amount to be trimmed from the new product's cost through cost planning activities. Estimated profit equaled the retail price minus the estimated cost per unit times the production volume. As cost reduction activities were implemented, the product's estimated costs decreased. If the goal was achieved, the target cost and expected cost became equal, as did the expected and target profits. Estimating Difference Costs Rather than adding together all of the costs for a new model, Toyota added the determined at the major function level. Thus, cost planning could begin even before blueprints for the first test model were drawn. Also, estimating the total difference instead of the total cost tended to be more accurate because the typical new model was heavily based upon existing designs. Trying to estimate the cost of a new vehicle fro m scratch would, in management's opinion, introduce more errors than using existing data and modifying it accordingly. And it helped the related divisions understand cost fluctuations. The approach was more helpful to the design divisions because it highlighted the areas of the new model that were different from existing designs. New designs required most of the work in the design divisions. Thus, the estimated cost of a new model was the cost of the current model plus the cost of any design change. Thus, for every increment in the functionality of a new del there was an estimated incremental price and cost.This approach allowed the firm to measure the incremental profitability of each new function it built into a new model. A full model change required many design modifications. Consequently, the cost of the design change was broken out into the costs of a number of different design modifications. The design team analyzed each modification and assigned it an estimated cost. The sum of these cost estimates had to equal the cost planning goals for the new model. Estimating differences helped clarify the cost-planning goal and wowed accurately how much was accomplished through cost planning.Cost planning focused on new model design. Its effectiveness was measured as the amount of cost reduction achieved through design. Therefore, other factors that affected cost, including wages and fluctuations in indirect costs incurred by related divisions, had to be eliminated from overall cost reduction in order to identify the portion due to cost planning. By fixing the cost of the current model and calculating the differences between the current and new models, Toast's system dealt only with cost changes resulting from changes in design and production volume.Without actual drawings for the new model, the estimate often began with Just an idea. Since rough sketches provided by the design division were often the only sources of information, estimates were made under the gui dance of the cost planning division rather than the accounting division. Toast's 20 design divisions designed each major function of the new vehicle, including the engine, transmission, air conditioner, and audio system Because the people at the design and cost planning divisions had the latest in-house