Cost Control in Product Design and Development: The Volvo Car Corporation Experience - Essay Example

Cost Control in Product Design and Development: The Volvo Car Corporation Experience a) Established in 1972, Volvo Car Corporation (VCC) is a renowned automobile manufacturer. In around 20 countries, the company has the staff of some 72,000 employees. Not only this, the company is famous for managing around 28,000 external employees, which is the largest in the whole group. VCC is mainly recognized for manufacturing cars based upon strong identity and unique features. The identity of Volvo revolves around strategic values of the company which include safety, quality and environment. Apart from this, VCC is also popular in family car segment for its innovative models which are especially designed and personalized as per the customer’s requirements. This part of the paper focuses on three major areas such that the first area covers the triggers to bring about a change in VCC followed by barriers in change implementation process and lastly, management accounting theories associated with change triggers and barriers. VCC was facing several issues due to increased cost mechanism. There were serious triggers which made the management think to bring about different cost control mechanism in the company. The most obvious change trigger in VCC was the over reliance on the suppliers of the company. The company had the trend of outsourcing major quality parts and components which increased dependency as well as cost in manufacturing process. Increased level of suppliers’ dependency also created an environment of confusion and lack of trust especially among engineers and managers. Another important change trigger in VCC was the existing communication system in the company that failed to provide coordination in the activities of different departments. As far as the barriers to implement a change in the company are concerned, the company had to confront on various levels. Cost estimation was the biggest barrier in implementing a change into the company. The company did not have enough resources and expertise to conduct a feasibility study of implementing change. Without having reliable cost estimates and budgets, it was quite risky for VCC to initiate the change process in the company as the cost of implementing such change would have increased sharply in the absence of cost estimates. Another important barrier to change was the alliance the VCC had made with Renault. According to that alliance, both the companies were bound to provide their resources to conduct research and development projects which lately failed. Due to this strategic alliance, Volvo did not focus on several competences such as competitors’ surveillance and reverse engineering processes. Due to failure of this alliance, Volvo had to pay a higher cost in the form of termination of its mega projects. Lastly, manufacturing speed of the company was quite slow and it was quite difficult for the company to manage a higher speed of production. Cost reduction is the ultimate objective of majority of the firms. This objective is set because of the increasing competition among the industry participants which does not let a single manufacturer to increase the price of the products itself. So every firm toils it hard to bring a mechanism of cost control in the organization. From researches, it has been found out that around 80% of the firms consider the effective cost control mechanism as a core competence as well as a source of having competitive advantage on the rivals. Bringing in an effective cost control mechanism is considered as a change trigger in companies. Cost drivers are the major considerations before taking important decision in respect of product design and development. VCC could not manage such cost mechanism which resulted in low performance due to lack of competences and resources. There are three major components of strategic cost management including cost drivers, value chain and strategic position of the company. Since VCC could not develop its own cost structure, therefore the company experienced significant mishaps. Strategic position of the VCC also deteriorated due to failure of the alliance with Renault which resulted in termination of several pre-planned and well-decided projects as well as product design and development structures. Value chain of the company is mainly dominated by the suppliers. Because of this, suppliers of the company made the most of mishaps in the value chain of VCC and caused serious losses to the company. Another theoretical concept which is aligned with the existing issues faced by VCC is the effective cost management system. The cost management system can enable VCC to estimate the cost of the resources prior to design and production of cars. Once the resources are estimated then further costs can be evaluated in order to reach at a target cost. This system can assist VCC in controlling its costs substantially. b) The part under study deals with the major changes that were implemented in the cost mechanism of Volvo during period of 1980 and 1988. The scheme of this section is drafted in such a manner that the initial discusses the change drivers in aforesaid period followed by a section in which similarities and differences between the decisions of that time and current time are assessed. The final part of this section concludes with the opinion for the case of VCC. Project control system in VCC was introduced in 1980 mainly due to a visit conducted by representative team of management accountants of VCC to Renault. That representative team identified two major areas that were causing problems to VCC in its cost control mechanism. The first problem that VCC was encountering was the excessive spending habit. The second problem includes the incompetence of the management to implement proper internal control set up in the whole organization which also acts as a change driver. The representatives were quite confident that if VCC can troubleshoot these problems, then this can lead the company on the way to further growth and development. This shows that how badly VCC required a better control mechanism at that point of time. If 1988 changes are taken into consideration, those changes were implemented due to certain problems in the old project control system of 1980 as well as the introduction of more sophisticated project control system that Renault already implemented. However, VCC hardly managed to implement a sub-part of Renault’s project control system. This section discusses the similarities and differences in the decisions taken by the management of VCC in order to implement better control system between 1980 and 1988. Product life cycle was the method implemented by VCC in 1988 which was not present in 1980s for the purpose of profit estimation. Similarly, some practical aspects of cost measures were focussed more in 1988. Not only this, VCC also had taken into conisation other important areas of 1980 in which economic goals associated with project control system were highlighted. Moreover, instead of market driven strategy, VCC adopted the strategy on the basis of goals and budgets for the expansion and development process. In the revised manual, more costs were included in control activities computation such as standard factory cost and entry ticket cost. There were three cost controlling steps introduced in the revised manual which were designed to counter the problems arisen in 1980s manual. After the breakup of the strategic alliance of VCC with Renault, VCC could have wiped out from the automobile industry, had it not implemented the major changes into its control system by revising its strategies. It was of worth importance that VCC required to implement such changes in its control mechanism which could bring more cost efficiency and enhance new product development. VCC also needed to amend the cost control mechanism in the company at regular time intervals in order to cope up with the upcoming challenges that might expose the previous hidden flaws in the cost control mechanism. For instance, VCC had to meet an issue of increasing production rate after the introduction of new cost control mechanism. The situation demanded that VCC should have changed the product development and its cost measurement along with cross function production process. c) This part of paper deals with PKS system and VCC system as a mechanism for cost controlling such that their characteristics are compared with the new identified costing approach known as target costing. These characteristics of the three costing controlling mechanism are matched in order to ascertain the key similarities and differences between them which have come along with passage of time. Project Control System (PKS) was introduced in Volvo after the visit of management accountant representative team to Renault in order to design and implement a better cost control mechanism. In PKS manual, various guidelines were provided throughout the product development level including up-gradation of the old models of automobiles as well as the newly launched models. Product life cycle costing was the major technique adopted by Volvo in order to estimate the profitability of the company. Proactive measures for cost controlling were set out in PKS which were not present in the earlier situation. For this cost controlling mechanism, three major steps were found out to control the costs. In first step, the cost targets had to be ascertained first and to be kept at a lowest possible level. Not only this, this cost target had to comply with the overall cost control mechanism. In next step, approvals from the responsible persons were to be obtained relating to cost targets along with the information sharing from those responsible persons. For instance, cost identified for product development should be approved once it is discussed with the engineers and designers. Last step focuses on the cost follow-up such that every cost should be closely compared with its estimated costs in order to control it from exceeding the budgets. The current VCC system of controlling the cost included two steps which were pre-study stage and the actual project stage. The first stage ensures the profitability of the whole project along with all the accompanying details at every level of project. Sensitivity analysis is carried out in order to simulate the price, volume, costs, profitability and the related variations can be estimated and sorted out. On the other hand, the project stage deals with further two categories such that costs targets are set out separately for car manufacturing and organization functions. However, cost follow-up were the most necessary element at every cost level on timely basis. The engineers of Volvo were supporting the implementation of target costing system. This technique is considered as an improved version of the previous two cost controlling techniques i.e. PKS and VCC. Under target costing system, market prices are determined first prior to the design and development stages of the product. The target price set includes the margin for both the cost and the profit in such a manner that the profits can be increased or decreased depending upon level of costs incurred. This mechanism was quite supportive for Volvo as it did not have much control over its costs as well as on its suppliers who have the major powers. Volvo adopted the cost determining decision prior to product design, and development process which is a likely step towards adopting the target costing approach. d) Target costing is also known as reverse analysis of the product such that in this technique, selling price is determined first followed by the determination of product cost. Under the conventional system, the market price is set after adding the profit margin with the cost of the product. However, in target costing, price per unit of the product is set first and then the appropriate profit is subtracted in order to arrive at the target cost. There are various advantages of target costing system such that it enables the organization to consider proactively on the cost of the product, improves business processes, enhance more collaboration and coordination between various departments and above all, provides safety measure for over expenditure and budget misbalance. Improvement in operations of the business can be achieved as target costing takes into account the labour requirements, materials, processes and the related costs. Nor only this, it also enhances the efficiency and least to cost reduction. Collaboration is better developed among the various departments because it has been the demand of the engineer to share information among design department production and finance department in respect of the budget allocated for a specific product development along with its price. Target costing mainly assists in reducing costs of the product and it is used as a measure of controlling costs. In automobile industry, major giants have adopted target costing in order to control their costs and they have remained quite successful as well. Elram (2000) states that there are various reasons for the implementation of target costing system which includes internal cost development, redesigning cost structures associated with suppliers, cost reduction and monitoring and accelerating cost accountability. Swenson, et al (2003) provided a brief view of the major firms implementing target costing in their organizations such as Boeing, Caterpillar, etc. Nicolini et al (2000) provided the implications of target costing such as increased collaboration, implementation of effective organizational structure, supply chain development etc. Swenson, et al (2003) has also highlighted those factors which drive firms to implement target costing such as increased competition, supply chain extensions, longer product development cycles etc. Various cross-functional activities are also benefitted from target costing like marketing, procurement and design etc. References Ellram, L. M., 2000. Purchasing and supply managements participation in the target costing process. Journal of supply chain management, 36(2), pp. 39-45. Nicolini, D., et al., 2000. Can target costing and whole life costing be applied in the consumption industry? Evidence from two case studies, British journal of management, 11, pp. 303-324. Swenson, D., et al., 2003. Best practices in target costing. Management accounting quarterly, 4(2), pp. 12-17. Read More