Eric A. Hiller Reviews Top Mistakes Made by Executive Champions in Product Cost Management and DtV
Product cost management (PCM) and design-to-value (DtV) are two areas in companies capable of delivering the greatest of impact, but are sadly prone to the biggest blunders by leadership.
Eric A. Hiller, the managing partner of Hiller Associates and a specialist in product development and procurement, has unveiled some of the crucial errors that even the elite executives tend to commit in their PCM and DtV journeys.
· Trying to save one’s way to growth
As great as product cost management and some of its sub disciplines like should-costing are at increasing your profit, but they will not grow your top line. To do that you’re going to need to focus on design-to-value. Make sure that you understand both the benefits and the limitations of these techniques.
· Not understanding the massive leverage of COGS savings on margin
Cost of goods sold (COGS) is almost always the largest expense on the income statement of a product company. Often it is 70 to 90% of each dollar of revenue. People think of cost reductions in terms of big percentages (e.g. reducing product cost by 50%). That is one of the things that often scares people off from attempting such a transformation period, however you do not need to save massive percentages on cost of goods sold to meaningfully impact the bottom line People forget that margins at product companies are often thin, often less than 10%. Therefore, the leverage is huge. For example, if a company had a COGS of 80% and reduced it to 79%, they only saved 1% as a percent of sales. But, if the margin was 5%, reducing COGS of 1% equates to a 20% increase in margin. Executives might think design-to-value or product cost management transformations are “too expensive.” They are; they are too expensive NOT to do.
· Focusing on short term savings without a plan for long term Product Cost management (Sisyphean projects)
Executives will often start a PCM or DtV project and reap initial impressive rewards. However, because the project was poorly managed at the executive level and no one is looking to the future, there is no plan in place for capability building within the organization to continue those savings. Therefore, what happens is that each foray into DtV or PCM becomes a Sisyphean task, where you roll the boulder up the hill on the initial project, but then everyone lets go of it and it rolls right back down.
· Not believing cost avoidance is more important than cost savings (the dark side of year-over-year cost reduction incentives)
Executives always need to pay attention to the incentives they are setting up. Historically, purchasing and, often, ongoing engineering is incentivized by year-over-year savings that they are delivering. However, this does not incentivize bringing the lowest cost product to market. In fact, it sets up a negative incentive to “pad” the product cost so that you can take it out later. In fact, there is even kind of a dirty word people use, “cost avoidance,” associated with bringing the lowest cost product to market. People do not believe cost avoidance is real, because the costs never appeared in the first place, so executives would rather incentivize people for taking costs out later.
· Thinking that a tool is the solution, not simply an enabler
Another error executives are often guilty of in product cost management and DtV is believing that getting a software tool is the primary solution to the PCM or DtV challenge, rather than an enabling aid, Eric Hiller observes. Such a thought generally stems from ignoring underlying deficiencies in the organization’s culture, team, and process. If any or all of these have fundamental problems, the tool will not help, and may make things worse.
· Under investing in a separate team and capability building for the organization
Another big pitfall is under investing in capability building within the organization, and specifically failing to set up a separate team to drive PCM and DtV efforts. Certainly, management should expect engineering, supply chain, procurement, etc. to fully participate in these efforts, but they should not be expected to lead and drive these efforts when they already have a full day job. Eric Arno Hiller says a separate group with both the focus and the unique skill set needs to be set up, an often trained from scratch.
· Having the DtV / cost management team report to purchasing or product development, rather than the P&L owner or CFO, etc. — Companies who do have the good foresight to set up their own PCM and DtV teams often fall into another trap. Often the set up such team to report to purchasing, or in some cases, product development. This sets up a bad incentive structure. If the team is within purchasing, it can feel pressure from the organization to not identify over cost items that would embarrass category managers. If they report to engineering, their efforts can be seen as a barrier to time-to-market targets. Therefore, the PCM or DTV team should be viewed as independent auditors. They should report to the business owner of the product line or another independent group, such as the CFO’s office.
· Trying to do PCM / DtV in isolated teams with specialists in the background
Historically, even companies who are early adopters of these powerful methods often experience them becoming marginalized in a small group of experts. Sometimes this is driven by the personalities of the experts working in these groups, as well. To be successful, product cost management or design-to-value need must become embedded in the standard processes of product development or supply chain. They cannot be one-off efforts going on in the background. Part of driving success is also executive visibility. These teams need to be led by someone of significant seniority in the organization that reports to C-level leaders. This executive governance holds the PCM/DtV team accountable, broadcasts their importance to the company, and helps prioritize the most profitable work.
· Not acknowledging the importance or knowing the priority of other organizational goals (e.g. growth, time-to-market, quality, etc.)
Finally, executives sometimes over emphasizing cost, especially when using product cost management. Cost is directly related to profit, but it is not always the most important thing to a given function or organization. There may be other goals that are more important at a given time such as time-to-market, revenue growth, etc. On the other hand, emphasizing design-to-value is often a strategy. The trap with DtV is when executives truncate Design-to-VALUE to Design-to-COST. Value is the end goal and it is often desirable to increase the cost of a product, if that investment drives a multiplier to value that will increase profitable revenue.
Eric Hiller concludes by saying noting that as with any organizational transformation technique, product cost management and design-to-value hold a lot of promise, however, executive leadership is one of the important things that can make or break the effort. The items above are the most often seen mistakes that are made in the transformations in which he is part. If you get these things right, Hiller says that you have a high chance of success.