Assignment III – Nissan Motor Company, Ltd.
INTRODUCTION
Nissan Motor Company, Ltd., founded in 1933, was considered as the most
highly globalized of the Japanese automobile companies and the world’s fourthlargest automobile manufacturer. It implemented a plan to achieve annual domestic
sales of 1.5 million cars by 1992 and to obtain the number-one rating in terms of
customer satisfaction in additional of its corporate strategy of providing high quality
products, short delivery times, and high functionality.
Automobile firms had been steadily increasing their range of products since
the 1950s. This increase was driven primarily by changes in consumer preferences.
Thus, Nissan had chosen to systematically reduce the number of distinct model it
would introduce in 1990s. These trends suggested to Nissan top management that
overall profitability would be increased by reducing the number of distinct models
supported, while maintaining the same level of effort to design and market the
remaining models.
Over the years Nissan had developed a formal procedure to introduce new
products, which is target costing system. The procedure to introduce new models was
divided into three distinct stages: the conceptual design stage (2 years), the production
development stage (4 years), and the production stage (4 years).
OVERVIEW OF NISSAN’S TARGET COSTING SYSTEM
In the conceptual design stage, projects to introduce new product models were
initiated. First, it described the matrix that contained qualitative information about
each model. The primary purpose was to ensure that Nissan achieved the desired level
of market coverage. The conceptual design was sufficiently developed to allow a
rough estimate of the number of vehicles to be sold and the costs associated with its
development. The purpose of this study was to ensure that the new model was likely
to generate a positive contribution over its life by determining the life cycle
contribution study. As the conceptual design of the new model progressed, additional
consumer analysis and financial analysis was undertaken. The latter one consisted of
rough profitability study in which the profitability of the highest volume variant of the
new model was estimated using historical cost estimates and the latest estimate of that
variant’s target price. This target-selling price was determined by taking into account
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Assignment III – Nissan Motor Company, Ltd.
a number of internal and external factors, while the target profit margin was
determined by careful consideration of available information on the customer. Then
the allowable cost can be calculated by the following formula:
Allowable cost = target selling price – target profit margin
The first value engineering process was conducted when the allowable costs were
considered to be too far below the estimated cost. After the first value engineering
stage was completed, a major review of the new model was conducted, including an
updated profitability analysis and an analysis of the performance characteristics of the
new model.
In the product development stage, the first step was to prepare a detailed order
sheet for the new model. Suppliers were expected to provide price and delivery timing
estimates for each component. The next step was to produce the engineering drawings
for trial production. Value engineering was used at this stage to determine allowable
costs for each of the component in every major function of the automobile. To avoid
having to develop target costs for all 20,000 components in a typical new model line,
the engineers only performed detailed target costing on two or three representative
variations. The next phase was to construct two or three prototype vehicles. The
output of this stage was called the final target cost.
For clearer information about Nissan’s target costing system, in the following
(figure 1 and 2) we will introduce the overview scheme of the system separated by 2
different stages:
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Assignment III – Nissan Motor Company, Ltd.
The Conceptual Design Stage
TheProduct Development Stage
The Product
Matrix
Detailed
Order Sheet
Suppliers Cost
Estimation
Consumer
"Mind-Set"
Engineering
Drawings
Consumer
Analysis
Selection of
Models
Value
Engineering
Stage 2
Estimation of
Sales & Costs
Allowable Cost
for Each
Component
Current Cost
No
Life Cycle
Contribution
Study
Deemed
Satisfactory?
Simulation
Cost Reduction
Objectives
Develop
Target Profit
Margin
Develop Target
Cost for Some
Components
Yes
1
2
3
4
5
6
Figure 1. Scheme of Nissan’s Target Costing System
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Assignment III – Nissan Motor Company, Ltd.
The Conceptual Design Stage
1
TheProduct Development Stage
2
3
4
5
6
Yes
Choose
The New Model
Sum of The
Allowable Costs
Financial
Analysis
Extend Target
Cost for All
Components
Develop The
Target Selling
Price
Sum of The
Component
Costs
Making
The Order
Sheet
Current Cost >
Allowable Cost?
No
Current Cost
Allowable Cost
Current Cost >
Allowable Cost?
Yes
No
Yes
Value
Engineering
Stage 1
Construct
Prototype
Vehicles
Update
Profitability
Identified The
Process
Value Engineering
Stage 3 / Redesign
Current
Target Cost
Final TC >
Previous TC?
Yes
No
Final
Target Cost
Figure 2. Scheme of Nissan’s Target Costing System (con’d)
As we can see from the diagram given above, the target costing system in
Nissan Motor Company, Ltd. is rather complicated and complex to be put into one
single scheme. However, the basic idea of making such system is still in the corridor
of target costing theory, which provided in the common textbooks. They separated the
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Assignment III – Nissan Motor Company, Ltd.
system into 2 stages, where in fact there is no difference in contents with those we
know already; market-driven costing, product-level target costing, and componentlevel target costing. Although they did not mention explicitly that they set up a
strategic cost-reduction challenge in order to deal with the unachievable part of costreduction, but they actually used it as we can see from the exhibit 6 given in the paper.
Thus, by using the formula below, we can determine the product-level target cost and
strategic cost-reduction challenge:
Cost-reduction objective = current cost – allowable cost
Product-level target cost = current cost – target cost-reduction objective
Strategic cost-reduction challenge = product-level target cost – allowable cost
Following the explanation above, the production cost system in Nissan’s
assembly plants will be discussed. Nissan used the same system throughout all of its
manufacturer, which basically divide the cost into two subjects; direct and indirect
expenses. Three different product profitabilities were calculated as well, where the
first one was the direct material marginal profit, the product contribution, and last
operating profit. The product costs reported by the cost system had four primary uses.
First, they were used in the long-range strategic plan as a basis for estimating future
profitability. Second, they were used for cost-control purposes. Third, they were used
to help select the product mix, and finally they were used to identify unprofitable
variants that were candidates for discontinuance. For clearer information on this
approach can be referred to the figure 3 below.
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Assignment III – Nissan Motor Company, Ltd.
# of units
Direct Material
# of units
Direct Manufacturing Cost
Direct Expenses
# labor hours
R&D Expenses
Corporate Expenses
(Directly related to
product)
Total direct cost of the products
Service Expenses
Indirect Expenses
Indirect Manufacturing
Cost
Total direct cost of the products
Administration
Expenses
Total direct cost of the products
Corporate Expenses (Exc.
directly related to product)
Product
Total direct cost of the products/
Total direct cost of the products using the facility
Figure 3. Two-stage diagram of Nissan’s Product Cost System
ADVANTAGES OF THE TARGET COSTING APPROACH
There are several advantages of target costing system approach in Nissan we
found and are going to be discussed in the following:
1. The target costing system is embedded in a team environment, a cross-functional
process that often called as concurrent design. The team members include
representatives from design, engineering, purchasing, manufacturing, and
marketing, which all of them are focused on the same objective: to deliver a
product with a target functionality, quality, and price to a specific market
segment. In this environment, there is no room for individual groups to specify
product features that reflect a functional fixation.
2. Each subgroup within the team is assigned cost reduction targets that it is
expected to meet in order to achieve the team’s overall target cost objective. This
approach has the effect of assigning individual responsibilities but within an
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Assignment III – Nissan Motor Company, Ltd.
overall structure of group objectives relating to product quality, functionality, and
price.
3. Another major strength of involving different functional areas concurrently in the
product and process design is that it reduces product development time and cost
by reducing required design changes. All of these time and costs reduction for
components can be achieved with the help of critical decisions about the design of
the model. As a result of the consumer analysis, the designers aim to reach the
consumer requirements. In target costing, first determining the cost and then
designing is an advantage from the design point of view.
4. The target costing system is deployed at a time, the product and process design
phase, when design choices can have a maximum impact on a product’s cost.
However to be reminded that without the discipline of a team approach to product
design, an engineering group might design a production process that uses the
latest production technology without regard for its effects on cost or
manufacturability. The same case may be happened as well for marketing group
where it might specify many products features that customers would like to have
but do not consider essential in the product and therefore would not be willing to
pay to have included in the product design.
5. The target costing system in Nissan includes representatives from their suppliers
on the design team of components. The purpose of this program was to elicit their
expertise, stronger their relationship by long-term contracts, a negotiated return on
the investment they make in product design and manufacturing, and sharing of
development cost that they might generate. Alternatively, suppliers can offer their
expertise when new components or parts are required so that, for a given level of
functionality, the part can be supplied at the lowest cost. Rather the approach is to
use lower-cost commodity components rather than custom-designed components
and to reduce production costs.
6. The target costing idea reflects the reality that most product and process design
decisions are not the lowest-cost designs but rather designs that the organization
has decided it can live with. Moreover, the system takes the organization beyond
the effort levels usually chosen in satisficing operations and drives the planning
activity toward the target cost.
7. Target costing is a flexible way of determining the profits. When it considers the
target cost is too low, it allows the target profit margin to decrease, but only if it
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Assignment III – Nissan Motor Company, Ltd.
can increase another product’s target profit margin sufficiently to offset the loss.
The outcome for the product with the decreased target margin is an increased
target cost; the outcome for the product with the increased profit margin is a
decreased target cost. The objective is to maintain the group’s profit target.
8. Target costing may motivate the members of the manufacture (from engineering
and finance through to manufacturing and sales) to do continuous improvement
since there is a universal belief that there is always some components, activity or
area where it is possible to achieve further cost reduction, while maintaining
acceptable levels of quality and functionality. Success does seem to be dependent
on fostering a firm-wide appreciation and commitment to the idea that there will
always be opportunities to reduce cost and on the development of integrated
systems to support cost reduction activities.
DISADVANTAGES OF THE TARGET COSTING APPROACH
Instead of having some advantages of the application of target costing system
in Nissan, we also found some of drawbacks of that model:
1. The target costing system places huge pressures on the design team. The design
team has a common objective: to meet target cost, but unfortunately there is no
possibility of negotiation in target costing; the product will not be launched unless
the team meets the target cost, which ultimately reflects what the customer
demands. Therefore, there is an excessive pressure on design teams to develop
and use tools that can help them reach their target cost objectives.
2. Being the first in the market is rather hard to achieve by using target costs since
they really depend on the market research and the historical data from previous
variant and competitor. Imagine in the condition where the company wants to
invent an innovative product for the first time, then this is a big problem because
they may not conduct the benchmarking/comparison. Even more, by using the
target costs in this condition may stimulate a longer time to develop than by using
standard costs. The actual example of this case can be found more obviously in
Walkman market, where being the first is more critical than being the lowest price
in the market.
3. Confusion on the market
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Assignment III – Nissan Motor Company, Ltd.
4. Organizational conflicts may occur when the pressure on reducing the target cost
is too high and everybody in the team loses the discipline and starting to point-out
to each other. Imagine the condition where the senior managers push the smallest
number possible on strategic cost-reduction challenge, while the chief engineer
pushes for the number high enough to ensure that the product-level target cost is
achievable. The conflict is likely to be happened in this case.
5. Target costing system may lead to shifting the company motivation from
product’s performance to product’s cost. Hence, it will bring the company to
focus only on reducing the cost as much as possible without considering the effect
on marketing and engineering point of views. The company will always try to set
overaggressive target costs, and last it would commonly violate the cardinal rulethe target cost must never be exceeded- and lose the discipline. Even worse, if the
company knows the target cost is unachievable, the design team might give up
even trying to achieve it and never effectively reduce costs.
THE MAIN DIFFERENCES BETWEEN TARGET COSTING AND ABC
COSTING SYSTEM IN HP CASE
1. The target cost is a financial goal for the full cost of a product, derived from
estimates of selling price and desired profit (price-based pricing). In a targetcosting framework, product-selling price is constrained by the marketplace and is
determined by analysis along the entire industry value chain and across all
functions in the firm. Top management sets the desired level of profit on the basis
of firm strategy and financial goals. In contrast with ABC costing (cost-based
pricing), product cost does not drive the estimated selling price but rather
developed from the cost occurred then followed by determining its selling price.
Instead, the target cost is the goal that a firm must achieve to meet its strategic
objectives (see figure 4).
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Assignment III – Nissan Motor Company, Ltd.
Cost-Based Pricing
Price-Based Pricing
Market
Research
Market
Research
Product
Characteristics
Product
Characteristics
Design
Planned Selling
Price - Desired
Profit
Engineering
TARGET
COST
Supplier Pricing
If cost is
too high,
return to
design
phase
COST
Design
Engineering
Supplier Pricing
Target cost for each component force marketers,
designers, and engineers from all departments and
suppliers to struggle and negotiate tradeoffs
Manufacturing
Manufacturing
Periodic Cost
Reduction
Continuous
Cost Reduction
Figure 4. Comparison of ABC Costing and Target Costing System
2. Activity based costing (ABC) techniques are predetermined from internal analysis
of the production process; that is, ABC techniques are production-driven.
Meanwhile, target costs come from both internal and external sources, primarily
the analysis of previous variant, markets, and competitors; that is, target costs are
market-driven (see figure 3).
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Assignment III – Nissan Motor Company, Ltd.
Internal Organization
External Organization
Corporate Strategy
Technology
Production
Market
Marketing
Profit Planning
Target Costing
Standard
Costing
Figure 5. The Relation between Target Costing and Standard Costing
3. Target costing is a more valuable cost management tool during the introduction
and growth stages of a product life cycle because it provides proactive, beforethe-fact information, rather than reactive, after-the-fact information. In the other
hand, ABC techniques are often used inappropriately and ineffective as a cost
management tool because they provide after-the-fact cost information during a
production phase that is changing rapidly as production is ramped up to meet
market demand.
4. Target costs are dynamic since they are often revised in the pre-introductory stage
and several times again during the introduction and growth stages of the product
life cycle. As a result, the target cost for a product may change several times over
its entire life cycle until the allowable costs are met closely. For ABC, they are
rather static since we cannot revise the cost incurred in every stage until it is
really happened in the production stage (current cost). This is related to the reason
above where ABC only can use the after-the-fact data.
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Assignment III – Nissan Motor Company, Ltd.
5. Related to the point above, then we can call the target costs as an effort of
continuous improvement, while ABC system is about efficiency improvement.
Thus, the final result from both of them can differ as well. Since the target costing
is using value engineering (VE), design for manufacture and assembly (DFMA),
and quality function deployment (QFD) as means to lower the cost during the lifecycle of a product, the product-level target costing can be reduced as low as
possible to every aspect of manufacturing. But unfortunately this is not the case of
ABC system in HP case because they only tried to reduce the costs that are
transparent and obvious to be eliminated (e.g., scrap, utilization, machineefficiency, etc) according to the improvement on efficiency rate. It believes that
fundamental cost breakthrough are much more probable when using target
costing.
6. In the target cost, co-operation with suppliers is one of the key factors for
successful. It is said that target cost is an activity where realization of cost targets
is pursued in co-operation with suppliers. Without their involvement in
determining the component-level target cost, it will be hard for such manufacturer
to gain the appropriate cost as low as possible like what the allowable cost
suggest. This relation is confirmed by the application of an incentive plan in the
effort of motivating its suppliers to find any ideas to reduce their component's
costs. This is totally different with ABC that never involved external suppliers
intensely when determining the cost as an object of management accounting (see
also figure 3).
7. In the target costs environment, the management gives a "freedom" for design
team to reduce their cost by modifying its product characteristics and process
planning as far as they are still in the form of product matrix developed earlier by
the marketing members. Meanwhile in the HP case we found that the
management had provided the design team with what they call as "design rules"
already and asked them to follow those rules before they might be thinking on
doing some modifications on a product.
COMPLEMENTARITIES BETWEEN ACTIVITY-BASED COSTING AND
TARGET COSTING
Activity-based costing systems can be used to set target costs by identifying
activities that are performed by companies throughout their activity value chain. With
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Assignment III – Nissan Motor Company, Ltd.
activity -based management, each activity is systematically analyzed so that nonvalueadded activities can be eliminated and value-added activities can be strengthened and
performed in the most efficient way possible, all in an effort to meet target costs.
Furthermore, ABC system enables design engineers to understand the impact of
different designs on product costs and manufacturing flexibility. For a clearer
understanding on this relation, the example of this value chain is shown in figure 6.
Research and
Development
Inbound
Logistics
- Researching
- Performing simultanous engineering
- Conducting quality
function deployment
- Prototyping and tes- ting
- Target costing
- Issuing purchase orders
- Receiving
- Inspecting
- Storing
- Materials handling
Production
- Setting up
- Cutting
- Drilling
- Lathing
- Painting & buffing
- Engineering
Outbound
Logistics
Marketing
and Sales
- Materials handling
- Storing
- Packaging
- Shipping
- Preparing shipping documents
- Installing
- Advertising
- Customer calls
- Travelling
- Processing sales orders
- Analysis of cust. problems
Service
- Field repairs
- Recalls
- Customer inquiries
Figure 6. Company’s Activity Value Chain
Activity value chain is used to develop and support an enterprise's production
and delivery of products and services throughout their life cycles. The activities linked
together represent strategic-level activities found in almost any enterprise. The items
listed under each strategic-level activity are a sampling of specific activities
performed to support the strategic-level activities.
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