Balancing Product Cost and Innovation

Dec. 15, 2010
How manufacturing leaders are making cost management part of the fabric of a company's operations and innovation efforts.

Product costs comprise 60% to 80% of a typical manufacturer's total cost structure. And if that isn't daunting enough, the global economy continues to roil; raw material, labor and transportation prices are tougher than ever to predict; and low-cost competitors seem to appear constantly -- and not just in emerging markets.

However, the cost-management headache is even bigger than that, since most manufacturers are also pressed to develop products that can be rapidly and inexpensively tailored to changing (and increasingly local) customer expectations. This ability to mass-customize is vital but expensive, which is why leadership in manufacturing often stems from a company's ability to balance product cost and innovation.

Unfortunately, few organizations have been able to raise innovation levels without upping costs. The main reason, we believe, is that a natural byproduct of increased innovation is complexity, and complexity is innately expensive. Thus the more companies strive to build upon an existing innovation, the more product complexity increases and the more costs remain high. This is why a formal, institutionalized approach to managing total (end-to-end) product costs is so important. This article looks briefly at the key elements of such a capability.

Juggling Complexity, Volatility, Agility and Cost

Seeking to contain or reduce costs, most companies don functional lenses: They focus on things such as (the cost of) product development, sourcing, logistics, manufacturing and so forth. But without a complete, product-lifecycle view, larger opportunities to really control costs remain elusive. And of course, combining cost-reduction efforts with innovation initiatives frequently makes things even more unwieldy.

Another cost-versus-innovation problem is the product development process. Engineers often find it easier to create altogether-new designs rather than deal with the bureaucratic muddles needed to ensure that design changes are compatible with existing products. Of course, new designs create costs that quickly become "sticky," and these costs can seldom be reined in through de-contenting, value analysis or supplier negotiations.

A third (closely related) problem is that designers and engineers incorporate varying levels of input from manufacturing, depending on a product's launch timing, design feasibility, level of design risk and other variables. As a result, the metrics used to determine an initiative's impact seldom account for costs in a comprehensive way. For example, although one additional part number or product variant might seem to have a negligible impact, the cumulative effect is widely felt -- with added cost and complexity "bull-whipped" across the supply chain.

What's clearly missing from the above scenarios is a focus on making cost management part of the fabric of a company's operations and innovation efforts. Following are several emerging practices that can help make this happen.

Complexity Reduction

The mission here is to cut costs by creating products that are simpler (and therefore less expensive) to design, upgrade, manufacture, store, transport and service. Complexity-reduction programs also benefit companies by streamlining the planning/forecasting function and bringing new economies to the transition from one product design to a next-generation design. A complexity-reduction initiative's two principal components are:

• Lean configuration -- minimizing the complexity of current offerings at the design stage.

• Design interface management -- provisioning parts to enable "bolt-on" options and attachments. A company might, for example, provide wiring harnesses for a "navigation" option, even if this was not ordered by the customer.

The value of complexity-reduction initiatives is extensive: reduced direct material and capital equipment costs; fewer suppliers; less need for safety stocks and spares; and lower supplier management costs. Additional cost reductions may appear in the form of added flexibility, such as the opportunity to smoothly upscale or downscale engineering staff based on demand levels. Longer manufacturing runs also may result, since (as noted in the next section) less complexity often makes it possible to develop a single base product from which multiple variants are produced at a later date. Plus, less complexity makes it easier to share designs across divisions and with business partners, thus increasing compliance and encouraging commonality and reuse.

A consumer durables manufacturer launched a three-year initiative to reduce product costs by lowering product complexity. Part counts fell by 40% to 70%; inventory dropped 20% to 30%; and lead times went down 10% to 25% -- all of which contributed to more than $260 million in product cost savings.

Product Modularity

Modularity -- creating a common base product to which variations can be added quickly -- is complexity reduction's first cousin. It also is the heart of mass customization and improved product availability, as well as a major source of end-to-end cost reductions. Moreover, product modularity initiatives can increase a company's responsiveness to customer demands, simplify operations ranging from sourcing to service management, and help engineering organizations innovate more rapidly and effectively (e.g., by creating a single, revolutionary "base product").

The key to modularity's effectiveness is fewer everything: parts, product versions, suppliers, inventory, engineering changes, service complexity and manual interventions. There may even be less "order grief," with fulfillment staff finding it easier to decide if options selected by a given customer are compatible with one another. A company's ability to forecast and predict customer demand also can be enhanced by modularity because demand aggregation is forestalled.

How much to push the modularity envelope depends largely on the type of product, since not all items can or should be modularized to the same extent. Products with the following characteristics are often the best candidates:

• High annual volumes with myriad product variants serving a wide variety of applications and/or usage profiles.

• Clear existence of a "dominant design."

• Customer expectations that include short lead times and off-the-shelf availability of products and spare parts.

A commercial vehicle manufacturer set out to reduce product costs by increasing modularity -- making a cab module that would work with multiple bus body styles. Part numbers subsequently dropped from 800 to 250; required assembly hours fell by up to 60%; and manufacturing costs per vehicle decreased by 8% to 24%.

Collaboration and Cultural Change

End-to-end initiatives such as complexity reduction and modularity are complemented by shifts in an organization's core beliefs. Among engineers, that could mean rethinking the relationship between price, quality, durability and the customer's willingness to pay (what, for example, are the cost ramifications of "world-class" versus "good enough" designs?). Insourcing, collaboration and culture change might focus on new kinds of supplier relationships, such as joint forecasting, design partnerships, quality-improvement cooperatives and vendor-managed inventory programs. And across the company, new segmentation initiatives might be adopted that relate manufacturing cost decisions to the parsing of market characteristics, geographies, product categories and, of course, customer type, loyalty, longevity and a willingness to pay for a spectrum of product features. Hard decisions also may need to be made about locating and utilizing manufacturing plants and global design and distribution centers.

Cost Management for the "New Normal"

Product innovations are constantly being introduced, so business complexity will inevitably increase too. This is clearly the "new normal" for manufacturers. However, product and manufacturing costs do not have to increase correspondingly. The key, to paraphrase Albert Einstein, is that "everything should be kept as simple as possible, but not simpler." To make this happen, fundamental but worthwhile changes may be needed, accompanied by basic changes in perspective. And of these perceptual changes, the most important may be viewing product and innovation costs not as the sum of bill-of-material liabilities, but as the sum of all costs accrued from concept development to end of life.

Rob Forrest leads Accenture's Product Cost and Complexity Management (PCM) practice. Venkatesh Iyer is a senior manager in Accenture's Product Innovation and PLM Practice, part of the Accenture Supply Chain Management practice. He is based in Ann Arbor, Mich..

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