Target Cost Management of Taiwanese Manufacturersin China

– A Case Study of Sporting Good Manufactures

Man-Li Lin, Ren-Jye Liu

Tung-HaiUniversity, Industrial Engineering and Enterprise Information Dept., Taichung, 40744, Taiwan

Abstract

Taiwanese manufacturers have dominated the world’s largest shoe, bicycle and apparelmanufacturing plants, now located in China for the past decade. The competitive strength of Taiwanese manufacturers no longer depends on low labor costs and cost reductions in the production stages. Just-in-time (JIT) production system concentrates the effort to eliminate wastes in production phase. While 80% of the product cost has been fixed once a specification has been developed, target cost management has become a powerful technique for managing product costs in the earlystages of product development. Target cost management is an approach to help companies achieve significantly lower product costs. The mechanism of target cost system providesgood criteria for examining the price management process in product developmentof Taiwanese manufacturers. We examinethree specific cases in which manufacturers received orders from a well-known sports and fitness companyfrom both organizational and technical perspectives. This study aimed to investigate how Taiwanese manufacturers manage their cost system and if target cost management techniqueshave been applied, and then construct propositions to discover factorsthat keep Taiwanese manufacturersmaintain their competitive advantages.

Key words: Target costing; Product development;China; Taiwanese manufacturers

  1. Introduction

In 1976, TaiwansurpassedItaly and Korea and to became the leading shoe supply exporter in the world. Later on, in 1983, Taiwanese manufacturers started moving their factories to Chinain order to take advantage of lower labor and land costs. Taiwanese manufacturers have dominated the world’s largest shoe, bicycle and apparel manufacturing plants, now located in China for the past decade. The United States imports 80% of “China made” apparel and footwear products [7]. The competitive strength of Taiwanese manufacturers no longer depends on low labor costs and cost reductions in the production stages. As product life cycles shorten, and consumer demands for customization escalate, predetermining costs and profit margins across a product life cycle becomes increasingly important [2]. New product developmenttakes more than the accepted basics of high quality, low cost, and differentiation to excel in today’s competitive market; it also takes speed and flexibility [12]. Many companies react to cost pressure by simply accepting lower profit margins or reducing cost in production processes. Just-in-time (JIT) production system concentrates the effort to eliminate wastes in production phase. Since price can become the ultimate battleground, product cost management has become vitally important. Target costing can be a proactive approach to cost competitiveness in the marketplace and is accomplished in the earlier phase of product development.

Target cost management (TCM) provides the concept of interactive control for product cost. The traditional practice of cost reduction, such as JIT, provides the company tremendous cost saving in production stage, however, once a specification has been developed, over 80% of the costshave been fixed [8]. Therefore, to look in other directions for cost competitiveness is essential for a company to reduce costs. There are two ways, downstream and upstream, to achieve cost reductions [8]. Downstream is in production process involveslogistics, sales and customer services. Upstreaminvolvesdesign, research and development, and product planning [8].Both directions are considered probable and this paper focuses on the later one for managing product costs in the earlystages of product development.

Target costing is not only a cost reduction technique, but is also important in managing product cost during the design stage. The mechanism of target costing management provides criteria for examining the product development process of Taiwanese sporting goods manufacturers.In general, product development processcan be divided into fourstages:product concept, product plan, product design,and process design [1]. The target price is generated from market survey and analysis duringthe concept development and product plan;the target costing is to control the costs over the consumer’s need and expectation before product design isstarted.In the sports industry, product development activities consist of concept development, product development, andproduction process design. The goal of target costing is to work through product design and production design to achieve the target cost set previously.The target costing management mechanisms are examined from organizational and technical perspectives and through the product development activities.

Three Taiwanese firms whose major manufacturing facilities are located in China are examined in this paper. These factories receive orders from multinational companies of leading brands in the sports industry. The objective is to investigate the cost management in product development stages by using the mechanism ofTCM systems to find out their worldwide competitive advantage and the meaning behind. This research was conducted by on-site interviews, observations, and personal work experience with Taiwan's athletic shoes and sports equipment manufacturers who collaborate with a well known multinational sportscompany in the U.S., referred to as Company Y in this study. According to conclusive findings from the interviews and observations, inferences are provided regarding the TCM at the end of this paper.

  1. Background and Rationale
  2. Industrial background

In the 1960s, low labor costs and Taiwangovernment policy attracted countries, such as Japan, the U.S., and Germany, to enter the manufacturing industries in Taiwan. Labor-intensive industries, such as shoe, bicycle, textile, etc., began to emerge as leader inTaiwan booming economic growth spurt. In 1976, Taiwan became the world’s number one supplier of shoes [7]. At the same time, some Taiwanese companies were forced to move entire factories or outsource part of their manufacturing to othercountries, such as the Philippines, because of U.S. quota restrictions on shoes and other products. However, due to transportation andlabor managementproblems in the Philippines, most of the manufacturers moved back to Taiwan in 1983. Then, during the nexttwenty years, manufacturers have been forced to move again to lower-wage countries, such as China, because of the raising wages, highcost of land, and environmental protection awareness in Taiwan. In 1988, Taiwan’s largest shoe manufacturer invested in China and now holds 15.8% of the world-wide market share. In 2001, China was the main producer and exporter of athletic shoes for the U.S.[7]. In 2001, eighty percent of the U.S. imported rubber rubber-canvas and nonrubber footwear was made in China [7]. However, the number ofTaiwanese manufacturers invested in Chinastill remain undisclosed due to political conditions.

Today, many Taiwanese manufacturers have not changed their role of original equipment manufacturers (OEMs)whose products are marketed under multinational companies’ brand names.Taiwanese manufacturers are under constant pressure to reduce product costs and to enrich their competitive capabilities by reducing production and operation costs, thereby increasing process flexibility, and delivering products and services to the market faster. To cope with this problem, this study will provide a closer look at Taiwanese manufacturers in China and investigate the cost control mechanisms needed for these firms to maintain their competitive strength.

  1. Overview of Target Costing

Target costing, also called target cost management (TCM), is to achieve the price that the market can bear. It has almost forty years of history in Japanese industry [8]. Target costing emerged fromToyota in 1963 and has spread to other Japanese automobile companies and their suppliers. It is now used in most assembly companies and even in some process-type companies in Japan [8,10]. Target costing became popular because of the essential of achieving the prices accepted by customers.

In general, product development process can be divided into four stages: product concept, product plan, product design, and process design [1]. Product concept creation generates and evaluates the idea from customer’s needs as expressed in the target market surveys and transforms into product images. The product plan is to transform the product concept into product specifications, functions, and properties. The target price is generated from market analysis during the concept development and product plan and target costing is to manage the consumer’s need and expectation about the product before product design is started, and then designs competitive and acceptable target costs to satisfy the customer’s need. The product design is to transfer the information in the product plan to the actual component design, including system-level design and detail design. The process design is to convert the product design to a plan for the production needs, including standard working process of tooling and molding equipment. Target cost can be managed in the product planning and design stages and workedthrough inter-departmental integration and value engineering to ensure the function, quality and price are accepted by consumers.

The target cost of a new product is determined by subtracting its target profit margin from its target selling price which is obtained from market research. The formula is listed below:

Target Cost = Target Price (Expected Sales Price) – Target Profit

Fig. 1 explains the logic behind the use of target costing.It also demonstrates factors that influence the target price (expected sales price), such as the competitors’ price, product function, market segmentation, sales forecasting and dealer incentives.Target price is the first element needs to be determined before any target cost activity started. Allowable cost is derived from computing the external factors, expected sales price, minus target profit. The target profitshould be driven by corporate strategicmid-term profit planning and be harmonious with business planning. The gap between target cost and allowable cost will need to be closed by various techniques, such as cross-functional team work, value engineering (VE), target setting, cost table andlong-term supplier relationship. In many cases, there are products derived from previous models or series of products. If there are some minor changes inexisting products, it will provide valuable cost information(called “existing cost”) about the new product. The new product costs are generated from new ideas and new functions during the product development processes. Cost reduction activities focus on the new ideas or new functions. Therefore, closing the gap between the “as-if cost” (existing cost plus new idea costs) and target cost is another major focus of target costing [8]. The most important goal of adopting target costing is to reduce product costs, however, target cost is not a costing system; rather it is an activity which is aimed at reducing the life-cycle costs of new products, while ensuring quality, reliability, and other customer requirements, by examining all ideas for cost reduction at the product planning, research and development processes [8].

Consumers require a minimum level of quality and function. Sophisticated consumers make decisions between price and quality which make the use of target costing important in the beginning stages of product initiation. Designing a product’s cost in the early stage is a comprehensive strategic profit management process. Target costing is a costing technique used to manage a firm’s future profits by explicitly including target costs in the product development process [4].

TCM has multiple objectives of cost reduction, quality assurance, timely introduction of a new product into the market place and product development to attract customers [10]. However, target costing management and target costing activities are closely related to new product development, which is considered a trade secret in most companies. Therefore, the author is entrusted not to disclose specific information about the companies interviewed for this paper.

Fig. 1 Target cost computation

(Source: Revised from Kato, 1993)

  1. Objectives and Methodology of the Research

The main objective of this paper is to review the cost management system of sporting goods development in Taiwanese manufacturers in China. The firstconstructs the theoretical framework through conducting literature reviews to find out the mechanism of TCM. This will help determine if target costing techniques are used or notin product development activities, and what factors keep Taiwanese sports manufacturers as competitive leaders in the world. Due to the field of sociology is associated most strongly with case study research; this paper is preceded with case studies as a research strategy. These case studies focus on the background, process, and influence of their cost management system. The study also provides a qualitative review of the Taiwanese sports manufacturers in Chinafrom their organization and technique perspectivesto research design and analysis.

In order to more completely examining the target costing techniques, three companies were selected from the author’s working experiences to present different types of sporting good manufacturers. Three interviewees are hold from the top leadership position of management teams within each firm and three developersfromthree different companies. Interview topicsincluded company profiles, marketing interests, selling prices, product development, and the organizational and technical perspectives of target costing management. Because target costing activities are closely related to new product development, the interviewed companies were not directly asked about new product developments and many terms were not used directly, such as target costing, value engineering and target margin/profit, to avoid misunderstandings; however, relatedinformation was gathered through equivalentquestions. The theoretical basis and working experienceswereexaminedand supported by the theoretical propositions which then provided suggestions for further research.

  1. Case Study

Three companies were selected to represent three different types of sporting good manufacturers: athletic shoes, sports accessories and team sports equipment who are contracted manufacturers of Company Y, a well known leading brand in sporting goods industry. In general, Company Y focuses on marketing and initiates the product concept generating from thecustomer’s need. The responsibility of thecontracted manufacturer is to produce the prototype.

Company Ais the second largest shoe manufacturer in Taiwan established in 1971 with US$129 million registered capital; and currently has 1,700 employees in Taiwan. The Taiwan office serves as the headquarters withan advanced researchcenter and new product development departments.Company A moved their entire production facility to China in 1989. Their facilities in China are located in Fu-Zhou and Shanghai,haveabout 30,000 employees, and are the exclusive athletic shoe factories providing goods to Company Y.

Company B is a sports accessory manufacturer established in 1979 with US$3 million registered capital; and currently has 500 employees in Taiwan. The Taiwan facility continues its research and development functions as well as maintains some production capabilities.Company B moved their production facility to China in 1997. Their facilities in China are located in Donguang and Wusi with 2,000 employees in total, and about 15% of their orders comefrom Company Y.

Company C is a team sports equipment manufacturer. It wasoriginally established in 1962 by Japanese investors, but is now managed and controlled by Taiwanese stockholders. It registered with US$0.94 million capital, and currentlyhas 50 employees in Taiwan. All order receiving and processing is kept in Taiwan and a small sample line still remains for special orders.Company C moved theirproduction facility to China in 1988. Their facilities in China are located in Guang-Dong with 2,000 employees and have about 20% of their orders from Company Y. Table 1 provides a profile summary of Company A, B, and C.

Table 1. Profile of Company A, B and C

Co. / Product / Registered capital / % of orders from Co. Y / Location of overseas subsidiary / Established year / Employees
Taiwan / China / Taiwan / China
A / Athletic shoes / US$129 millions / Exclusive / China, Vietnam,
Indonesia, Mexico / 1971 / 1989 / 1,700 / 30,000
B / Sports accessory / US$ 3
millions / 15% / China, Vietnam / 1979 / 1997 / 500 / 2,000
C / Team sports equipment / US$0.94 millions / 20% / China, Philippians / 1962 / 1988 / 50 / 2,000

In the sports industry, product development activities consist of concept development, product development, and production process design. The concept development includes product concept creation and product plan. The product development consists of system-level design and detail designin product design stage and testing and refinement in final product development stage. Production process activities include lean system and process value engineering. The above-mentioned three companies receive technical packages which include artwork drawing, material and function specifications, etc. from Company Y for product development. Company Y initiates product concepts, makes product plans, designs new products, and then sell it to the customers; the factories are responsible for producing the product from prototype to commercialization. Company A, B and C do not know the term “target costing,” but the process they use are fairly similar to it. From the viewpoint of target costing,none of the company interviewed get involved in product concept development, but the product development abilitiesare recognized.

Company A takes the product plan and then it designs the product, including the selection of materials and actually constructing the product. It also is responsible for making the production plan and finding ways to improve and streamline the process.Theorganization of development team inCompany A includes a project leader, developers, pattern engineers (technicians), pricing staff and processing (production) staff which presents a cross-functional organizational structure. Developers are responsible for any communication needstoCompanyY. Developer acts as a product development leader and coordinates activities with functional managers to shorten the development lead-time. Technicians are responsible for product and process engineering and translate the product design into the actual sampling process and production process. Pricing staff are responsible for quoting product costs and maintaining the cost break-down data. Production staffare responsible for production bulk and making sure the quality meets customers’ demands. The material purchasing team workrelativelyindependently and serves the needs or requests from the development and production teams. There is a close working relation in the early stage of the product development meetings.The developer at Company A takes the lead in calling for a meeting as soon as a new technical package is received from Company Y. The meeting involves Company Y and Company A’s development teams and simultaneous teamwork is exercised during the meeting; the pattern can be revised, the materials team is informed,the sampling schedule is booked, and due date can be met while cost, quality, development, pre-production and production areaccommodated at the same time. Product price will be submittedand negotiated with a cost breakdown worksheet after the prototype sample is completed.