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Mercedes Benz All Activity Vehicle Essay

The target costing case literature contains numerous examples of Japanese cost management practices; however, few cases describe the use of target costing by large companies outside Japan. The purpose of the Mercedes-Benz AAV case is to consider the competitive environment of a leading German automotive manufacturer and the company’s response to changing competitive conditions. The teaching plan generally follows the suggested student assignment questions. In places, I recommend considering additional material during the case discussion. These questions are identified by a check mark.

Student Assignment Questions
1. What is the competitive environment faced by MB?
Students will identify a number of changes, including significant market share lost to Japanese companies such as Lexus. Stress the importance of a cultural change taking place within top management at Mercedes. Reinforce that Mercedes is a company that had never lost money. They simply built the best car their engineers could design and priced it above cost. Demand often exceeded supply. As a result, cost had never been a primary consideration. Changes include: cost competition;

product innovation.
2. How has MB reacted to the changing world market for luxury automobiles? Students should identify the following changes implemented by management at Mercedes; try to get them to explain how different these approaches were from traditional strategies at Mercedes: many new product introductions;

partnering with suppliers;
reduced system complexity;
new emphasis on cost control;
layers of management reduced;
lead time from concept to introduction reduced.
3. Using Cooper’s cost, quality, functionality chart, discuss the factors on which MB competes with other automobile producers such as Jeep, Ford, and GM. If the instructor wishes to give a brief mini-lecture on Robin Cooper’s survival triplet and confrontation strategy, this is a good point in the case discussion to do so. (Robin Cooper, When Lean Enterprises Collide, Boston: Harvard Business School Press, 1995.) The factors are:

price-at mid to upper range of zone;
quality-at upper range of zone;
functionality-at upper range of zone.
An interesting point to discuss is that Mercedes does not produce the most expensive sports utility vehicle. This distinction is reserved for the Land Rover; however, they strategically placed themselves toward the luxury end of the spectrum. Also, unlike many Japanese examples, Mercedes does not use target costing as a strict cost control mechanism to produce the lowest priced product in its class. 4. How does the AAV project link with MB strategy in terms of market coverage? The new introductions expand the product line of the traditionally luxury-oriented manufacturer. Recent product introductions include the following:

A class;
C class;
E class;
M class.
These new introductions include new sports cars and off-road vehicles. The C-class is a mid-sized vehicle sometimes referred to as the baby-Benz.
Let’s discuss the elements of the target costing model and how these elements are developed. At this point in the discussion I usually write the target costing formula on the board and ask students to consider sources of various inputs: selling price;

target cost.
What are the sources of input for the projected selling price? Students will most likely identify the following sources of information: customer focus groups
comparable products:
– existing;
– potential.
Stress the broad, cross-functional aspects of acquiring consumer information. To compare products, the company had to evaluate existing competitive vehicles as well as vehicles under development.

What factors are considered when developing the required margin? This question provides a link to finance classes. Most students have studied the concepts of weighted-average cost of capital. I recommend spending a few minutes reviewing these concepts and linking cost of capital to net present value (NPV) analysis. Because of the capital-intensive structure of automobile manufacturing, production volume is a critical factor in determining each model’s NPV. Students may identify the following points for determining a required margin. long-run profitability;

cost of capital;
profitability across the entire product mix (classes of vehicles); sales volume by class.
The MB case suggests the target cost is “alive.” Is this consistent with the ideals of target costing? I generally emphasize that Mercedes did not consider the target cost to be locked in. It was a moving target. As engineering changes became necessary, the target cost was allowed to move. However, before making a change, market forces were considered. For example, changes included the addition of side airbags. In addition, the European press was critical of a simulated wood-grain part. Management decided the part would remain plastic because costs could not be passed on to the consumer. The main point to emphasize is the design of the vehicle is dynamic; thus costs must evolve to reflect the changing design characteristics.

5. Explain the process of developing a component importance index. How can such an index guide managers in making cost reduction decisions? The index development process has five steps, as follows: consumer importance category rankings;

target cost percentage by function group;
category: function group matrix;
importance index;
target cost index;

I recommend making slides of Tables 1-5 to facilitate discussion. Index development is an important element in the early conceptualization phase of the AAV. The indexes help to quantify some very abstract concepts. Table 1. From conversations with potential consumer groups, a list of key categories was developed. Next, potential customers were asked to rate the importance of each category. Their responses were computed as a percentage. Thus, safety and comfort of the AAV were viewed as significantly more important than economy and styling. Table 2 represents a rough estimate of the cost by function group and the relative percentage. The information is used later to create a target cost index. Table 3 is best understood by reading each category as a column.

The rows explain the relative importance of each function group to satisfying each category defined by customers. An interesting aspect of this table is that the link between consumer preferences and engineering components is made explicit. Table 4 builds on Table 3 by weighting the percentages computed in Table 3 by the importance percentage calculated in Table 1. The key point is to understand which function groups contribute the most (least) to important (less important) consumer categories. Table 5 results in a target cost index that attempts to capture cost and benefit trade-offs. As discussed in the case, this index may indicate a cost in excess of the perceived value of a function group. Thus, opportunities for cost reduction (aligned with customer requirements) may be identified.

6. How does MB approach cost reduction to achieve target costs? At this point, ask students to identify various value-engineering strategies. At Mercedes, reducing the cost of each function group was accomplished by reducing costs of various components that make up the function group. Stress the importance of this approach over an “across-the-board” cut.

7. How do suppliers factor into the target costing process? Why are they so critically important to the success of the MB AAV? From the conceptual phase through the production phase, the suppliers of systems for the AAV truly were partners. Suppliers attended regular meetings with the cost planners throughout the entire process. Thus, suppliers were design and development partners from very early stages of development, responsible for meeting cost targets. Why is the relationship with suppliers a crucial element in the success of the AAV? Suppliers provide entire systems for the AAV.

The facility uses a JIT production system. In fact, many suppliers deliver directly to the assembly line, rather than to a small warehouse. The Black Warrior River separated Mercedes and a major system supplier. This supplier built a new production facility on the same side of the river as the Mercedes Benz plant to avoid possible delays associated with accidents on a major bridge.

8. What role does the accounting department play in the target costing process? Stress the fact that accountants were watchdogs in the target costing process. Their primary responsibility was to ensure costs did not exceed targets during the production phase. Thus, the accountants’ role was as follows: cost control;

actual vs. target:
development stage;
production stage.
What are some of the organizational barriers that may challenge managers attempting to introduce TC systems? Try to get students to identify various impediments to target costing systems in the United States. Examples may include:

willingness to share cost data with suppliers;
suppliers treated as adversaries;
government regulations affecting exchange of information.

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