Case sample: Target costing down to the supplier level

By Staff -- Purchasing, 3/26/1998

Market research at the Gamma Watch Co. identified a significant consumer segment that wanted a sporty, yet stylish, watch. This group wanted a product with the functionality of a sports watch like the Timex Ironman series but stylish enough so that it could be worn on all occasions. The current offerings of premium sports watches by Tag Heuer and Rolex were stylish enough for all occasions. However, their products were priced too expensively for the target market which consisted of athletic men and women who were entry-level, white-collar workers.

Ultimately, market research determined a retail price point of under $100, which the design team translated to $97.50 per unit. Using a 40% markup in the channel, the wholesale price target was $69.64. The company had a goal of a 17% return on sales and a 7.6% allocation for sales and general administration costs, which were subtracted from the wholesale price to yield a target cost of $52.50.

Focus groups held during the preliminary market research also examined what "attributes" the targeted consumers wanted in a "stylish sports watch for just under $100." The focus groups highlighted a wide variety of attributes that could be organized into five "functional needs."

* Comfort described how the watch needed to be light, slim, and comfortable.

* Stylishness captured a set of attributes indicating that the watch needed to avoid an appearance of a standard, mass-produced product. Also, the watch needed to be appropriate for virtually any occasion since the consumers expected it to be their primary (if not only) timepiece.

* Reliability underscored the fact that the watch was a significant expenditure for these consumers and accordingly was expected to last.

* Simplicity indicated that the watch should be easy to read, use, and wear.

* Functionality denoted that, for the most part, only a lap timer was required beyond the basic functions of date and time to meet the needs of the "athletic consumer." A few consumers said waterproofing was desirable since they wanted to wear the watch when swimming and for water sports.

Even with all that information, the design team needed more detail: it needed to know the relative importance of each of the functional areas. Since any design offers a set of tradeoffs, the team needed to understand the relative weighting of each factor in order to make the right decisions.

To quantify the importance, the team conducted a survey of consumers to rate the attributes that would be key to the decision to buy a "stylish sports watch for just under $100."

Not surprisingly, the consumers ranked stylishness very high for that level of expenditure on a sports watch. Also, since the targeted price point was more than double the price of the primary competitive product (the Timex Ironman), the consumers ranked "reliability" very high as well.

The next most important functional need was simplicity. The team noted that this factor had often been overlooked by higher-priced competitors, whose designs were not very "user friendly." Still important, but further down the list was "functionality." This ranking was consistent with the focus group findings, which concluded that even though the consumers wanted to use the watch when they exercised, they really didn't need a lot of functions. In fact, many of the users of the popular Ironman had never figured out how to use some of its functionality.

The final functional need that made the cut for significance was comfort. The team converted the relative rankings to percentage scores and multiplied them by the overall target cost to set dollar values for each functional need.

Obviously, having a target of $6.83 for comfort doesn't provide enough guidance to the design team and suppliers. To create meaningful targets, the designers used their understanding of how different parts of the watch contribute to the functional needs expressed by the consumers. This translation of the "voice of the consumer" into engineering requirements begins with a breakdown of the major subsystems of the watch.

The first major subsystem is the watch band assembly, which includes the typical band plus the attachment screws and bar. The power supply is another major subassembly. It consists of the battery, coil block, and generating stator. The display subsystem includes the key elements making up the face of the watch. The clock subsystem consists of oscillator components that insure reliable time tracking. The timer includes the special functionality that makes the watch a sports watch: the switches, lap counter, and memory functions.

The next step--setting target costs at the subsystem level--was among the more complex and critical ones facing the team. The objective was to translate the cost targets for functional needs to the major subsystems. Once targets are set at that level, the team could work with suppliers to create the designs that provide the right trade-offs for cost and value.

The translation was performed by creating a matrix in which the five major subsystems are listed in rows while the five sets of functional needs are listed as column headings.

By comparing the primary functional needs and secondary attributes with the subsystems and components, the team allocated percentages of each need to the various subsystems. These percentages were then multiplied by the cost targets for each of the needs, as previously determined by their importance weightings. The sum of those multiplications (i.e., the addition of the numbers by row) generated cost targets for each subsystem.

Next, the tear-down analysis of the higher-end products offered by Tag Heuer and Rolex were used to create a composite, best-in-class subsystem design. The composite design was nearly 50% above the market-based price target. The team then compared the subsystem cost estimates to the value-based targets. The analysis showed that although the overall best-in-class design was over by 50%, the cost gap at the subsystem level ranged from 42% under target to 99% over.

The team also constructed a value graph, by plotting the targets against the tear-down cost estimates for each major subsystem. Appropriate areas of opportunity: the band and the power supply.

An internal sub-team was asked to examine a wide range of new concepts for the band other than the gold-plated style employed by high-end competitors. The team discovered that the gold-plating was viewed as "too flashy" by the target consumer segment and not practical for athletic use. The team visited a variety of suppliers--not just watchband makers--to get ideas. Ultimately, the team members agreed on a design employing a cloth-covered nylon strap that was stylish enough for business wear and rugged enough for athletic use--and at a significant cost savings.

To address the power-supply cost gap, the team conducted a design competition among the key suppliers in the industry--including some non-traditional sources for emerging markets in Asia. Simultaneously, the team members examined the option of deleting some memory functions, which required additional power but were not highly valued by the consumer. This option reduced the cost of the timer subsystem as well.

The value graph also persuaded the team to revisit the functionality provided by the displays of the competitive products. The team noted that neither of those products provided back-lighting for nighttime use--a want by some, but not all, of the target consumer segment. Given the current favorable gap on the display front, the team set out to add backlight functionality while still retaining some of the target cushion currently available.

When the team re-aggregated the new cost estimates, the design came in just under the overall cost target--and the individual subsystems now ranged from 30% under the value-based target to 69% over.

The team assessed whether more efforts to drive subsystem targets closer to the value-based targets would be needed, but concluded that the current design was appropriate to the target market. The team agreed that value-analysis efforts after product launch would focus on the remaining gaps and would be incorporated into the next version of the product, which would also reflect evolving customer desires.

Timothy M. Laseter is a VP at Booz-Allen, & Hamilton in New York and a part-time doctoral student in the Darden School at the U. of Virginia. His consulting and academic research address strategic issues in purchasing management. Jossey-Bass will publish his book on strategic purchasing next fall.