The Japanese Cost-Management System Like its famed quality philosophy, Japan’s cost-management system stands Western practice on its head. For example, American companies developing a new product typically design it first and then calculate its cost. If the expected unit cost is too high, the product goes back to the drawing board or the company settles for a smaller profit. In a reversal of this typical American process of product development, the Japanese first start with a target cost based on a market price that is likely to appeal to consumers.
All else follows from this crucial judgment. After deducting the desired profit margin from the expected selling price, product managers develop cost estimates for each of the elements that make up total costs: design and engineering, manufacturing, and sales and marketing. Each of these cost categories is first sub divided into the finished product. As a result, all parties involved with the product development process have a precise estimate of the cost implications of each individual product characteristic.
Then, designers, engineers, and marketing staff are directed to meet these stringent cost and pricing targets. Every manufacturing part or function thereby becomes the focus of an intense bargaining process among departments of the manufacturing company, as well as between the company and its outside suppliers. While initial estimates may exceed cost target by 20% or more, the final result of intense bargaining between product designers, process engineers, and marketing specialists often results in final cost projections that are well within the original target.
This is in sharp contrast to US companies where roughly 85% of product costs are determined by design specifications. There is often too little feedback between design and engineering personnel on how slight modifications to product design could cut costs without any resulting penalty in terms of product reliability. Japanese manufacturers also use cost-targeting techniques to improve existing products. In what is known as “tear down” analysis, such manufacturers often methodically take apart and analyse different products manufactured by ctual or potential competitors. Companies analyse the raw materials utilized and the way the product is assembled or molded to estimate the probable cost of manufacturing. From this tear down method, of analysis, the company is able to adopt the probable lowest cost as its own cost target. Thus, the cost target for an automobile manufacturer might derive the target cost for a steering mechanism from a Toyota, the brake pedal from a Ford, and so on.
Engineers also use this typical of reverse engineering to better understand and imitate their competitor’s most successful products. What results is better quality products at the absolute minimum cost. The Japanese cost management system also encourages managers to make cost-based judgments for each individual product in terms of the long-term cost and revenue implications for related products. Sony, for example, believed that even a smaller version of its so-called Pixy personal stereo component system would be hit with the consumers.
Despite uninspiring market forecasts, the company went ahead with the product as a means of heading off potential competition to its existing line. To Sony’s surprise, the smaller version was an instant hit and soon became the industry standard. The Japanese have taught Western managers that pricing precision can sometimes be an impediment to rational costing. Obsessive attention to allocating expenses from labour to overhead against each product consumes effort that could better be spent on systematic efforts to drive the costs down.
It also limits the ability of managers to strengthen a product line by enhancing it with low-margin products that themselves may have large untapped potential. Direct performance indicators that employee can readily grasp and influence, such as the set-up time for a manufacturing line, also have the potential to prove more effective than goals based on complex, financially oriented yardsticks that are incomprehensible to workers.
Effective cost management requires that all employees clearly understand how their work directly affects company performance. Adopted from: Hirschey Mark and Pappas James L (1996): managerial Economics, 8th Edition (managerial Application 8. 3, page 409), The Dryden Press, Florida For further details on this see: 1. Ford S. Worthy, “Japan’s Smart Secret Weapon”, Fortune, August 12, 1991, 72-75; and 2. Brenton R. Schlender, “Japan’s New Realism”, Fortune, October 31, 1994, 117-136