In my second series in continuation to my previous article ‘Costing Methods/Cost Management in Turkey-Series 1′ I would be discussing about one of the researches on one of the world’s most luxury automobile company where adoption of Cost Management and Costing Methods made a stupendous turn around. The story is all about shifting of accounting practices to improvise the profitability, cost allocation and efficient use of resources. It gives an eye opener to the Indian government about abolishment of Cost Audit and Costing methods for the Indian Automobile Industry. This research article for those industry players who think that Cost Audits a leakage of business information and are unproductive for the automobile industry.
Cost Management demand has increased over the last decade due to the change in organizational culture of the ‘New Economy’, which is characterized by innovation, fast-paced operations, informal practices and the entrepreneurial spirit of risk investment. But its unfortunate that India is ignoring the same and global market are growing stronger hold on the subject.
Before I name the company I would like to discuss the problems being faced by that company. During the recession beginning in the early 1990s, the company struggled with product development, cost efficiency, material purchasing, and problems in adapting to changing market demand and conditions. In 1993, these problems caused the worst sales drop in decades, and the luxury carmaker lost money for the first time in its history. Target costing All Activity Vehicle concepts were implemented to make the company become viable financially. The company was too big to lose its name. We are talking about Mercedes-Benz one of the Gems of the global automobile industry.
The company developed All Activity Vehicle was launched in 1997 and it was one of the most radical; projects of Mercedes-Benz. A modular construction process was used to produce the AAV. First-tier suppliers provided systems, rather than individual parts or components, for production of approximately 65,000 vehicles annually. A rough cost estimate was developed that included materials, labor, overhead, and one-time development and project costs. Based upon the estimation the company the company searched for a feasible production country. Monthly departmental meetings were held to discuss actual cost performance compared with standards developed during the cost estimation process. Thus, the accounting system served as a control Mechanism to ensure that actual production costs would conform to standard costs.
Target costing was adopted so that production cost can be well aligned with the selling price and cutting down the abnormal losses of the system. Activity based costing and Target costing both were adopted for making the business strategy of AAV to be successful.
Cost reduction targets were set by comparing the estimated existing cost with the target cost for each function group. These function groups included the following: doors, sidewall and roof, electrical system, bumpers, powertrain, seats, heating system, cockpit, and front end. Next, cost reduction targets were established for each component. Now in order to do a competitive analysis the company adopted competitive benchmark process and tore down competitors’ vehicles to help understand their costs and manufacturing processes. In India we are raising the voice that Cost Audits and data related to that are high risk to the industry where as a company like Mercedes-Benz adopted the same process to understand the business and its changing dynamics.
Costing methods helped the company to create cost benchmarks. This index was created to support the target costing. The company gathered various information from the end user about the various demand and requirements they are looking forward from the car. Based upon these demands and requirements matrixes were created to derive target costing. In that survey it was found that:
After this the company derived the target cost of the various ancillary auto parts of the car based upon the survey and ranked them based upon the index. Target costing was implemented based upon the function group of the products to the end user. To gain a better understanding of the various sources of costs, function groups were identified together with target cost estimates.
Function Group Contribution to Customer Requirements
The compnay used these indexes during the concept design phase to understand the relationship of the importance of a function group to the target cost of a function group. Indexes less than one may indicate a cost in excess of the perceived value of the function group. Thus, opportunities for cost reduction, consistent with customer demands, may be identified and managed during the early stages of product development. This is how target costing was implemented by , Mercedes-Benz and the company made history of journey of new product launches and gained a successful market share.
Now after all these stories and process analysis we all know the current status of the company and how its dominating the global automobile industry in terms of luxury cars. Well this target costing and other costing methods adoption has lead Mercedes-Benz India has registered a good 25 percent year-on-year growth in sales during the first six months of 2014. The German car maker sold 4,717 units in the January-June period, against 3,758 units during the same period last year. Flagship S-Class sedan, the ML-Class SUV and the compact portfolio comprising the A-Class and B-Class, has been the biggest contributors in this growth story. The same company, Mercedes-Benz India has recorded an annual growth of 32 per cent during 2013, with sales at 9,003 units against 6,840 units in 2012, making the year just gone by the luxury car maker’s best ever for retail sales in the country.
This clearly shows the application of costing methods in these fast changing market dynamics is the only survival tool. If we make a quick look to wards the Indian automobile industry we would find that over the last decade the sector has:
Now the surprising part of this story is that Costing Methods and Cost Audit was applicable for this automobile industry over all these period in which India attracted the FDI investments. At that point of time nobody thought that Cost Audit was damaging the industry and was not required.
When the global standards area adopting and developing cost methods into their business process how India would match with the same standards without cost audit is a billion dollar question. India automobile industry would fail to capture the changing the dynamics of the industry in the long term and this would lead India to be less hot destination for global players to fix up their plants. The future of auto industry is quite dark if cost audit is abolished.
I would like to thank Mr. Amit Apte, Mr.Sanjay Bharghav & Mr. Vijendra Sharma for their, support & inspiration.
Global Macro Economic Researcher and Business Strategist
Master of Economics, MBA in International Business Management, ICWAI (Final)/CWM Final/Journalist