Value Engineering at Cool Cars - Case Study Example

Value Engineering at Cool Cars Section a Key strategic, operational and cost management problems that Cool Cars must solve during Five key strategic, operational and cost management problems that Cool Cars must solve during 2010 are noted explained below. Inadequate knowledge of competitors Cool Cars does not have adequate knowledge of its competitors. The company assumes that it has a cost advantage over its rivals. In developing a strategy for the organisation, management needs to be aware of not only the prices charged by its competitors but their cost structure. This information will assist Cool Cars compete effectively. Knowledge of competitors’ technologies, products, costs and financial conditions are required in order to determine how they will react to the company’s strategies. Cool Cars recently found out that Japan Motors, the manufacturer of the Su4 obtained the air conditioning unit for £640 while Cool Cars paid £1,600 to its subcontractors for an inferior type - a difference of £960. Cool Cars also spent an additional £186 for additional work on the units. To resolve this problem information about the cost structure of its competitors is required so that it can bargain effectively with suppliers/subcontractors in order to obtain quality components and raw materials at the best price. Outsourcing Cool Cars outsources certain key components. The engine is outsourced as far away as Detroit in the USA. These components have to be fine tuned before assembling at additional costs. Another issue is that delays in shipment has disrupted production and may have caused loss of sales. The company almost closed its plant in June 2009 because of delayed shipment due to a strike at a French port. Cool Cars have to do further work to correct problems on subcontracted products. The company should therefore consider whether it should continue to outsource. The most important factors in make-or-buy decision are quality, dependability of suppliers and cost (Horngren et al, 2000 p. 385). Supply chain management The company does not have long term contracts for supplying direct materials. This is important for proper strategic planning. Cool Cars will get the opportunity to negotiate prices. Most successful companies have suppliers with whom they have a good relationship that is mutually beneficial to both parties. The company will get the opportunity to influence both the quality and price of its direct materials. Marketing information has not been used The company has not made use of marketing information it has had since 2007 and therefore has not responded to the needs of its customers. Customers indicated that they would like ABS anti-lock brakes which are currently in all Cool Cars competitors’ models. They also require a more energy efficient model. Cool Cars should consider making these changes order to compete effectively. Use of Outdated Information Cool Cars currently revises its standards every eighteen months as management believes that more frequent revisions diverted time from the key objective of producing better quality car. In achieving this key objective real time information is important. A number of events impact on standards could have taken place over that lengthy period. To carefully predetermined price, cost or quantity needs ongoing revision and requires the most up-to-date information. Section b (i) The standard cost estimates for the cyclone is not up to date. Standards are revised every eighteen months. This is unacceptable for a company that is considered to be efficiently run. A number of things have changed since the standard cost was derived in July 2008. The cost of the engine has increased, there has been a lot of wastage, reworking and fine tuning of subcontracted components, and the cost of materials have also increased. Further, the allocation of fixed production overheads on a per unit basis is questionable. As the case suggests, no one has ever challenged this accounting approach. Since the Cyclone is the most complex product it means that a higher proportion should be allocated to it. This of course has further implications for more meaningful cost reductions at Cool Cars. (ii) Calculation of an estimate of the Cyclone’s ideal target cost. Horngren et al 2000, p. 428 states: “There are four main steps in developing target prices and target costs.” They are: develop a product that satisfies the needs of potential customers; choose a target price; derive a cost per unit by subtracting target operating income per unit from the target price; and perform value engineering to achieve target cost. Calculation of Cyclones Ideal Target Cost £ Target Price 28,000 Target Operating Income 1,832 Target Cost 26,168 (iii) An updated version of Josh’s strategic cost analysis Target variable production cost Functional Group Target DM costs (£) Target DL cost Assembly (£) Target DL cost Tuning (£) Target DL cost Finishing (£) Target VMO Electric (£) Total Target cost per function (£) % of target cost per function Chassis/body work 5,523.50 200.00     21.50 5,745.00 22.6% Engine suspension & brakes 3,900.00 80.00 2,500.00 40.00 4.30 6,524.30 25.7% Electrical systems 1,700.00 80.00   20.00 4.30 1,804.30 7.1% Indoor fixtures and fittings 1,820.00 80.00   100.00 4.30 2,004.30 7.9% Air conditioning 640.00 80.00   20.00 4.30 744.30 2.9% Other systems 8,285.25 280.00   20.00 4.30 8,589.55 33.8% Total 21,868.75 800.00 2,500.00 200.00 43.00 25,411.75 100.0% Material Current use (A) Current waste 5% (B) (A) minus (B) Adjustment for recycled material Target cost of DM Steel £270.00 £13.50 £256.50 £8.10 £248.40 Aluminium £12,750.00 £637.50 £12,112.50 £38.25 £12,074.25 Plastic £440.00 £22.00 £418.00 £33.00 £385.00 Glass £1,000.00 £50.00 £950.00   £950.00 Water £20.00 £1.00 £19.00   £19.00 Rubber £60.00 £3.00 £57.00 £0.90 £56.10 Paint £80.00 £4.00 £76.00   £76.00 Total £14,620.00 £731.00 £13,889.00 £80.25 £13,808.75 Allocation of DM costs Function Current (£) Target (£) Chassis & bodywork 5,848.00 5,523.50 Other systems 8,772.00 8,285.25 Total 14,620.00 13,808.75 Attribute Functional Group Safety 25% Comfort 20% Economy 5% Acceleration 20% Styling 30% Importance Index Chassis/body work 45% 20% 10% 15% 15% 0.2325 Engine suspension & brakes 35% 30% 50% 75%   0.3225 Electrical systems 5%   10% 5% 5% 0.0425 Indoor fixtures and fittings 5% 25%     30% 0.1525 Air conditioning   10%       0.0200 Other systems 10% 15% 30% 5% 50% 0.2300 Total 100% 100% 100% 100% 100% 1.0000 Index Functional Group Importance Index (A) % of target cost per function (B) Strategic cost index =A/B Chassis/body work 0.2325 0.2261 1.03 Engine suspension & brakes 0.3225 0.2567 1.26 Electrical systems 0.0425 0.0710 0.60 Indoor fixtures and fittings 0.1525 0.0789 1.93 Air conditioning 0.0200 0.0293 0.68 Other systems 0.2300 0.3380 0.68 Total 1.0000 1.0000   (iv) Opportunities for redesigning the product The Cyclone can be redesigned to make it more attractive to customers. This can be done through value engineering. Horngren et al 2000, p. 428 states: “Value engineering is a systematic evaluation of all aspects of the value chain business functions with the objective of reducing costs while satisfying customers needs.” This could result in improvements in the design of the Cyclone. The customer survey done in 2007 did not indicate that customers value the design so it could be modified in order to gain some cost advantage over competitors’ products. There could also be changes in the material specifications. A number of car manufacturers use a percentage of recycled material and Cool Cars could gain some savings by doing so. The analysis suggests that the company could save £80.25 on each of the Cyclone produced. Further, modifications in the process methods to prevent waste and therefore improve efficiency will reduce material costs and labour costs by £731 and £250 respectively. So far we have a total of £1,051 per unit. We have not yet added the £960 savings we expect from each air conditioning unit in order to be on par with Japan Motors Su4. Furthermore, we expect major savings in electricity costs per unit in keeping with industry standards of approximately £317 per unit of the Cyclone produced. However, some of these gains will be offset by modifications that should be done to make the Cyclone energy efficient and to add the ABS ant-lock braking system. In order to attain these targets company should combine Kaizen methods which aim at improving productivity and eliminating waste with value engineering and batter designs. These have to be managed properly in order to prevent undesired consequences and all departments need to be involved in the process. The strategic cost index shows that the company can major improve is needed in the functional area of Indoor fixtures and fittings, moderate improvement in engine suspension and brakes and a minor improvement in chassis/bodywork. (v) Can the Cyclone survive against the new overseas competition? The Cyclone can survive against the new overseas competition. In order to do this Cool Cars must develop a strategy to match its capabilities with the opportunities in the marketplace. The company needs to understand the industry in which it operates. Porters Five forces model is a tool that can be used to analyse the industry. These five forces that shape competition in an industry are: (1) the risk of potential competitors, (2) the intensity of rivalry among established companies within an industry, (3) the bargaining power of buyers, (4) the bargaining power of suppliers, and (5) the closeness of substitutes to an industry’s products (Hill & Jones 1007, p. 46). These five forces will determine Cool Cars profit potential. The company is not strong in any of the areas. However, it can develop strengths in bargaining with suppliers. The company has been ignoring the customers request for changes in specific aspects of the product for some time. Even though the strong competition has placed significant pressure on Cool Cars prices, there are things that the company can do to remain competitive. It could differentiate the product from others by making it more efficient. Things that the customers do not value could be removed in order to reduce cost. In order to implement its chosen strategy it could use the balanced scorecard. “The balanced scorecard has since evolved—particularly in those organizations where it has been most successful—to be an integral part of an enhanced strategic planning and management system” (Niven, P 2002). The promulgators of this technique - Kaplan and Norton states: “Building a scorecard can help managers link today’s action with tomorrow’s goals.”(qtd. in Young 2004, p. 212). Cool Cars must therefore decide what to do to succeed financially in the eyes of its shareholders, what to excel at in order to satisfy its customers and shareholders, how to achieve vision through its ability to change and grow. “The balanced scorecard provides a framework for selecting multiple performance measures that supplement traditional financial measures with operating measures of customer satisfaction, internal processes and learning and growth activities” (Banker et al 2004). The major influence on Cool Cars pricing decisions are customer, competitors and costs. Increase in customer satisfaction which is a non-financial objective can be translated into higher sales in the future. Employee education and skills level also translates into product quality which further translates into increased profitability and increased benefits for employees. Customer growth is important to the organisation as it can translate into increased profitability. Chase et al 1998, (p. 475) states: “Profitability is not a function of customer size; rather, profitability is a function of customer growth rate.” Grove et al 2008, p. 3 states that the economic value added (EVA) can be computed to answer the question of how to satisfy shareholders in accordance with the financial perspective quadrant of the balanced scorecard. Grove et al 2008, p. 4 also emphasized some guiding principles at the manufacturing company they studied. They include: Simplify and stabilise the process; eliminate non-value added time and waste; relentlessly pursue continuous improvement; find and fix root cause; know your cost; know your customers expectations; make decisions where work is performed; balance and optimise the overall process; and what gets measured gets done. Cool Cars should consider adopting these guiding principles in order to achieve its goals of profitability, increased market share, and employee and customer satisfaction. References Banker, R. J., Chang, H & Pizzini, M. J (2004). The Balanced Scorecard: Judgmental Effects of performance linked to Strategy. The Accounting Review. 79 (1), 1-23. Chase, Aquilano & Jacobs (1997). Production and Operations Management: Manufacturing and Services. 8th ed. USA: Irwin McGraw-Hill. Grove, H., Cook, T & Richter, K (2008). Coors Balanced Scorecard: A Decade of Performance. IMA Educational Case Journal. 1 (1), p. 3-4. Hill, C. W. L. & Jones, G. R (2007). Strategic Management Theory: An Integrated Approach. USA: Houghton Mufflin Company. Horngren, C. T., Foster, G. & Datar, S. M (2000). Cost Accounting: A Managerial Emphasis. 10th ed. New Jersey: Prentice Hall Niven, P. R (2002). Balanced Scorecard Step-By-Step: Maximizing Performance and Maintaining Results. The CPA Journal. 7 (1), Available: http://www.nysscpa.org/cpajournal/2002/0702/nv/nv8.htm. Last accessed 4th Jan 2011 Young, M. S., (2004). Readings in Management Accounting. 4th ed. New Jersey: Pearson Prentice Hall Read More