VCMS and Product/Service Development
The man who will use his skill and constructive imagination to see how much he can give for a dollar, instead of how little he can give for a dollar, is bound to succeed.
Henry Ford1
One of the most important activities of a company is using the profit earned in the market to develop new products and services that bring future sales into the company. As we’ve seen, the value-based cost management system (VCMS) captures this investment from across the organization with BVAF, or Business value-add—Future. The VCMS has even more power, though, helping to focus spending based on customer-defined preferences and supporting the costing exercise that is critical to new product development. Clearly, the costing exercise can be supported by any well-developed cost management system, but only the VCMS allows costs to be prioritized based on how closely they map to future customer value creation.
In this chapter we focus on the development efforts of three of the companies where VCMS field work was performed—Universal Lifts, Windows, Inc., and Frangor. In the first two cases, a new product launch was supported by the VCMS. At Frangor, the augmentation of service responsiveness resulted from the study. In all of these cases, the VCMS provided support for understanding the development costs and also the potential value-added proportion of total costs. Using an incremental costing framework, these new product/service offerings were changed as a result of the supporting analysis. Let’s turn to the facts of these three cases to see what happened.
Value Engineering and VCMS
Value engineering entails the use of customer value data in the design and development of a product or service. We saw how Impact Communications changed its job management approach using customer input—it was a service that was modified based on the value creation model. Value engineering is most often used for tangible products, such as automobiles and machines, but it can be applied anytime a product or service is being developed with customer input as the driving force.
What has been learned through the value engineering logic is that fully 90% of the cost of a product or service over its lifetime is locked in at the development stage.2 This fact was laid out in the CAM-I3 conceptual design as a vital new piece of information. Why is design so important? The design of the product locks in place the components that will be needed, the assembly sequence, and the type of support processes that will be required to make the product/service bundle attractive to customers. It ties the product to a certain internal build structure and often defines the amount of administrative work that will be used in its maintenance.
The VCMS ties to the value engineering exercise by laying out the structure in terms of what level of value-add is going to be possible given the structure of the firm. It places a value on the attributes in terms of revenue equivalents and then compares the current projected costs to these revenue equivalents to get prelaunch multipliers. If the design is too heavy on one value attribute, say colors available, over another, the multipliers will be low for this attribute. This is an important signal that provides diagnostics on where the value engineering analysis should focus to take cost and waste out of the production process. It can also signal where not enough value has been built into the product if a value multiplier is too high. In the constant give-and-take of the value engineering design process, customer input is used to drive the design process and influence important decisions that will ultimately spell the success or failure of the new product launch. It is a critical function, one that needs to be completed with care to ensure the product meets customer expectations.
At one site, Universal Lifts, value engineering was not done on the launch of a new lifting device for automobiles being serviced in a garage. Replacing the sunk bays that had hydraulic lifts that had high propensity to leak, causing environmental problems, these free-standing above ground lifts were seen as a major innovation in the lift industry. Unfortunately, so much value was built into the product that it ended up costing more to make the product than the market price would bear. Customers were very satisfied with the product, but the company lost money on every lift made. And, as noted above, 90% of this cost was locked in by the design, so there was very little that could be done ex post, except to identify the sources of major design problems.
Universal Lifts ended up pulling the plug on the first above ground lift and then going back to the drawing board, this time using value engineering to design a new lift that met customer needs but could be sold at a profit. Re-launching the product line allowed adjustments in both features and price, resulting in a redesigned product that generated a profit for the company. The new design was limited, though, to the machinery that had been purchased for the first above ground lift, making even the redesigned product more expensive than it would have been if value engineering had driven the design from the inception. Old problems were brought forward, but managed in a different way to reduce some of the cost that was embedded in the product.
Avoiding these types of problems is one of the driving forces behind value engineering efforts. Finding out once a product is launched that it cannot possibly make money for the company is not a good option—it was a recipe for disaster that this medium-sized manufacturer barely survived. Putting the customer value first in the design process, using constant customer feedback when design decisions are being made, and keeping an eye on the costs to meet customer expectations are at the heart of value engineering. While a product or service is in the design phase, changes can be made to drive costs out and focus the final offering on those attributes customers care about. It is the most logical way to approach product/service development.
Gaining Customer Input—Windows, Inc.
When Windows, Inc. decided it wanted to launch a less expensive line of windows to meet competition in the replacement window market, it turned to customer data to gain information. As was shown earlier in this book, the company research showed that it had three primary customers for its products—homeowners, small builders, and architects. The preliminary readings from the brand pulse analysis are detailed in Figure 10.1.
Figure 10.1. Customer value attributes.
In this field work it was discovered that there were some very different preferences for the final product across segments. Specifically, there were many costs that had to be incurred to provide value for the architects and small builders that the final consumer—the homeowner—did not value. We have talked about this problem before, noting that the costs incurred to support an industry value chain actually come out of the end-firm’s profits because the final product’s value in terms of revenue earned is determined by customers. The final customer may not care about such things as distribution and ease of assembly. They may be paying the builder for these services. The builder charges for assembling the window, but the final customer doesn’t really care who does this task—it is assumed that basic functionality as defined by the competitive market price incorporates all the nondifferentiating features of a window.
In this brand-based marketing study, price was the major attribute. Since this window was designed and produced to fill the commodity market niche, most of its value was captured by the price, or table stakes attribute. This indicated that there was a significant bundle of functions provided in the market by many other suppliers of windows. Interestingly, the final consumer did not place any value on sizes available. It was simply assumed that standard sizes would exist that would fit their needs—size was part of table stakes for consumers. The final list of customer-defined attributes was large compared to many identified in the study, but reflected the high risk nature of this type of purchase.
This data was then used to develop revenue equivalents, as shown in Figure 10.2. Here you see conditional weights, which are the weightings in terms of how important the particular stakeholders’ expectations are to the value profile of the final product. The projected revenues for each of the value attributes was then used to guide the development process using VCMS-supported value engineering to gain a solid understanding of how much it would cost to provide the desired attribute. Once again, delivering a product that meets the competitive standard is of utmost importance to the customers. Interestingly, the builder didn’t seem to care about attributes that were deemed critical by the homeowner, such as weather-tightness. To the builder this was a table stakes issue, to the homeowner and architect segment it was an attribute that provided differentiation and opportunity for receiving additional value.
Figure 10.2. Revenue equivalents for Windows, Inc.
What was interesting in the Windows, Inc. field study was that the marketing data used was modified after it was collected to make it fit the VCMS’ structural requirement that the weightings add up to 100%. The customer segment value data provided by marketing were complemented by additional information containing customer segment attribute valuation. Each attribute’s weight was then divided by the total, transforming the results into the table above. It was interesting that some of the attributes that had been included in the marketing analysis “fell off the table” when converted—they simply weren’t very important in the overall delivery of customer value. This result provided valuable information for Windows, Inc., which was ultimately used to discipline the value engineering process.
The results of the cost analysis are provided in Figure 10.3. Here we observe that the profit required was first taken out, resulting in an allowable cost. This was then divided by the number of units projected to be sold to calculate a value-add profile, or target cost, for the proposed window. Once again, some attributes were removed from the analysis as this was focused solely on the consumer, not the trading partners that had been included in the earlier studies. Trading partner costs would need to come out of BVA-Administrative. The design process itself, including the marketing studies, comprised the BVA-Future in the study, providing a discipline on the costs of actually designing the product. The limits by cost category were set based both on what management felt was reasonable and results of the internal VCMS study.
Figure 10.3. VCMS target costing structure for Windows, Inc.
This was one of the first organizations where VCMS was used to insert discipline into the product/service development process. It was natural to use the target costing approach, where the target price is reduced by desired profit to get the allowable cost for a unit. Actual costs could then be compared to this set of targets to determine where cost cutting in the design process needed to take place. It was in this field study where table stakes began to take on meaning. Adding such things as weather-tightness to the table stakes area helped reduce the number of attributes that the company had to manage in designing its new window line. And, as is common with all target costing exercises, the first design did not meet its targeted cost projections. This is where value engineering and the VCMS come together—to bring the costs down to attributes that the engineers can actually use to make adjustments to the design before the product launches.
One of the interesting findings of this field study was that some attributes served a larger role in the development of a potential customer than they did in the final sale. Customers usually buy an entire system of windows and doors when they remodel their homes. When they first look at windows, they want to have lots of options for color and shape, for instance. But, when the final buying decision occurs, the majority of the market prefers standard windows with white trim.
Windows, Inc. had to be able to offer variety to the customer even if very few ever decided on purchasing the options offered. The risk of failing to make variety available was a potential loss of sales of an entire system of doors and windows. That means the value attributes used in creating a list of potential suppliers is different from that used in the final decision, a lesson that had profound implications for the new product launch. Meeting trading partner demands added cost to the final product design that most likely would not be recouped downstream through actual sales.
The Cost of Support
What can also be seen in the Windows, Inc. example in Figure 10.3 is that the cost of support is recognized when a VCMS approach is taken. This can sometimes be overlooked in the design process, resulting in reduced profits once the product actually launches. Unless some tool or approach is used that specifically recognizes that back office functions also are impacted by a new product launch, they can be overlooked. The cost of support includes the business-to-business costs that the final consumer is unwilling to pay for in setting a market price on a good. These costs can be hidden in a flat charge of overhead to a project if a purely engineering approach is taken.
This is the crux of the matter. Support costs occur in all organizations—they cannot be avoided. The question is are they covered in a flat charge for overhead that probably distorts the actual costs of a specific product or service support functions or are they traced to specific outcomes? In most firms, the overhead approach is taken. Many years of activity-based costing research, though, have underscored the fact that products don’t use support processes to the same degree. The higher the degree of variety in a product line, for instance, the more likely it is to require more support work.
If the costs of this support work are made visible through a system such as the VCMS, using a process framework, as much attention can be paid to the development of support processes as is paid to the design and development of the product itself. There are better and worse ways to provide support. It is important that support processes be defined, measured, and controlled as tightly as product/service costs are measured.
Without this level of attention, total costs can grow out of control as supporting the actual value-added work becomes more and more complex, increasing haphazardly through the budgeting process. Using the VCMS to monitor and control these expenditures before they take place is the only way to ensure that the organization’s profits don’t become the victim of poor support process performance. As was the case in Windows, Inc. the VCMS target costing exercise identified an acceptable level of support cost as well as value-added costs. This is the recipe for success in the design and development of a product or service.
Extending the Service Profile
As has been noted in earlier chapters, the VCMS approach works very well in service settings. This means that when the service profile of a company needs to be changed or perhaps even developed as a result of changes in market trends or customer preferences, the VCMS can be used in the same way as it was at Windows, Inc. An example of this occurred at Frangor, a company discussed in Chapter 5. The company focused on its manufacturing base, not investing enough time and effort into its service support processes. Once the VCMS study was completed, it became very clear that that customer really cared about timely customer assistance when a machine went down. Customers valued quick service very highly as a result of tremendous cost of a malfunctioning machine in the middle of the harvesting season.
Frangor took the information from the VCMS study and developed a new service profile for the company, including an estimate of how much of the price being paid for products was actually earned by the service function. Instead of waiting one or more weeks for service, management put in place a highly responsive repair network including parts distribution that could get a broken tractor or other farm implement back up and running in hours rather than weeks.
This change greatly improved the competitiveness of Frangor in the farming implements market in Italy, where small machines are needed due to space constraints and farm sizes in terms of both land and maneuvering room. It was a prime example of how the VCMS can guide a company to improve its processes or, in this case, redevelop its service delivery and improve its position in the market. By putting a dollar amount on the service component, management could estimate how much it should be spending on this important activity.
Don’t Ignore the Hidden Waste
As has been noted earlier, one of the primary challenges when implementing the VCMS in any setting is that employees may be hesitant to identify any level of waste in their operations. This may be especially true during the development phase, when designers and engineers are thinking that they are putting together flawless processes and products. As was seen at Windows, Inc. there was waste in the newly designed product. This waste is normally in the administrative areas, but it can also be in the design itself, as we saw with Universal Lifts. When products are designed without careful attention being paid to the processes that are used to produce them, waste may enter every step of the product.
At Universal Lifts, the traditional processes for making a lift were streamlined, but when the new plant was constructed the lessons learned from earlier development projects was ignored. The product was moved during construction multiple times, which given the size and weight of the component parts created unnecessary processes and activities. This embedded waste was eliminated when the product and supporting processes were redesigned, but this redesign took away valuable funds that could have been used elsewhere in the organization.
Waste also occurs in the support processes that the new product or service uses. Usually little or no attention is paid to the impact of the new product on support processes, where wasteful activities may already abound. These hidden pockets of waste rob the firm of its profitability and are often overlooked during the target costing phase of the analysis. How and where components are sourced, for instance, can have a major impact on the costs of the company when developing a new product. If price rather than effectiveness drives the purchase decision, the organization can be burdened with excess inventories that were bought in bulk to gain a purchase price savings. This inventory may clog up the plant floor and take away important resources from other purposes.
Using the VCMS approach, the entire set of processes required to support the launch of a product is documented. This documentation means that the designers know what is currently done in the support area and can make suggestions for changes that might better meet the needs of the new product or service. They can also factor in the costs of this service with more than a general overhead charge, which is otherwise how these support activities are included in the estimated cost. A full bill of activities can be developed and the level of recorded waste in these activities acknowledged early in the design process. Fixing broken support processes is one of the side benefits of a VCMS-focused development project. Making the hidden waste visible means that it will be acted upon, with the entire organization benefitting, not just the new product. Designing in excellence in operations has to extend to the entire support system of the organization.
Summary
In this chapter we’ve seen how the VCMS can be used to support the development of a new product or service. At Windows, Inc., the marketing study data was transformed through a simple weighting approach to show the value profiles of the three customers segments—small builders, architects, and the ultimate consumer. While the business-to-business expenses were all BVA-Administrative costs, at least the company had an idea of what level of investment would be needed to serve their trading partners. The VCMS data helped focus the design process, ensuring that the final product met customer expectations.
At Frangor we learned that an entire service support system was redesigned once the VCMS had identified how much of the revenue the company was receiving for its products was actually tied to post-purchase service support. Using this information, improvements were made both in the product manufacturing process (to reduce costs) and in the service support area. A new service process was developed that was far more responsive, earning Frangor a competitive advantage in the relevant farm implements market. Without the VCMS data, this shortfall in meeting customer expectations would not have been recognized or as clearly defined in monetary terms.
The VCMS, then, places dollar amounts on specific aspects of a product or service during the design phase that can be used to discipline the development process. Instead of adding features to products because the company is capable of doing so, a company adds features when these are valued and desired by customers. In this manner the VCMS is linked to the two most valuable tools used in product/service development efforts—value engineering and target costing. The VCMS helps focus these efforts using revenue equivalents and projected direct and indirect costs to keep everyone’s eyes on the total impact of the new product or service on the company’s manufacturing and support processes. The VCMS makes key value attributes more visible, and hence actionable, in the organization.
Knowledge and human power are synonymous, since the ignorance of the cause frustrates the effect.
Lord Bacon4