Monden, Y. and J. Y. Lee. 1993. How a Japanese auto maker reduces costs. Management Accounting (August): 22-26.
Summary by Kerry A. Martin
Master of Accountancy Program
University of South Florida, Summer 2002
Japanese Management Main Page | JIT Main Page | Target Costing Main Page
costing techniques are created and implemented to aid manufacturers in
allocating costs to production items. Several
methods have been developed, and provide different results.
When developing a new product in the U.S., the typical approach is to design it first and then compute the cost using a standard cost approach. Direct material, direct labor, and overhead standard costs are summed, and the resulting total is the new product cost. If the cost is too high, the product goes back to design or the company accepts a smaller profit. This approach to costing is being questioned in today’s manufacturing environment.
In the U.S., the purpose of standard costing is to practice management by exception; i.e., management's attention is directed towards situations where the actual results differ from the expected results. The expected results are based on standards set relative to the current manufacturing process. Therefore, standard costing reflects existing technology and fails to motivate improvements in the process.
Monden and Lee’s discuss the Kaizen costing technique that is used at the Japanese car manufacturer, Daihatsu, and compares it to the U.S. method of standard costing. Kaizen costing is a Japanese technique used to manage costs during a product's planning and design stages and has been used by some Japanese firms for over twenty years. It is now widely used in Japan in such industries as electronics, precision machinery, and automobiles. Its objective is to reduce current costs by using various improvement tools such as value engineering and functional analysis for each manufacturing facility. The term “Kaizen” translates as “continuous improvement”.
A manager in the United States generally
expects to use cost information to make decisions about pricing or investments,
while a Japanese manager expects to use cost information to reduce costs, the
central theme of this article.
The chart below points out the primary differences in the two costing techniques.
vs. Kaizen Costing
Standard Costing Concepts
Kaizen Costing Concepts
control system concepts.
current manufacturing conditions.
Meet cost performance standards.
Cost reduction system concepts.
continuous improvement in manufacturing.
Achieve cost reduction targets.
Standard Cost Techniques
Kaizen Costing Techniques
Standards are set annually or semiannually.
Cost variance analysis involving standard costs
Investigate and respond when standards are not met.
reduction targets are set and applied monthly.
Continuous improvement (Kaizen) is implemented
during the year to attain target profit or to
reduce the gap between target profit and estimated profit.
variance analysis involving target Kaizen costs and actual costs reduction amounts.
Investigate and respond when target Kaizen amounts are not attained.
For a Japanese firm, like
Daihatsu, that uses target costing, a new product project is established when a
new product is proposed. The actual costing system is implemented during the
initial design stage. There are 6 plans involved in the product process:
Plan 1 – Production, Distribution, and Sales Plan (which includes projections of contribution margins from sales).
Plan 2 – Projected Parts and Materials Costs.
Plan 3 – Plant Rationalization Plan (projected reductions in manufacturing variable costs).
Plan 4 – Personnel Plan (for direct labor work force and service department personnel).
Plan 5 – Facility Investment Plan (capital budget and depreciation).
Plan 6 – Fixed
Expense Plan (for prototype design costs, maintenance costs, advertising
and sales promotion expenses, and general and administrative expenses).
These six projections and plans become the annual profit budget or “target”:
Forecast to Budgeted Operating Profit
|From Plan 1||Sales Forecast
(Less) Expected variable costs (=standard costs)
|From Plan 2 & 3||Budgeted contribution margin
(Less) Expected changes in variable costs
|From Plans 4,5 & 6||Adjusted contribution margin
(Less) Expected fixed costs
|= Budgeted operating profit|
Cost improvement through Kaizen is obtained by reducing variable and fixed costs. Functional analysis is applied at the design stage for a new product, and a target cost for each function is set. The functional target costs are summed, and the result is a product target cost. After the first year of production for a new product, the actual cost of the previous period becomes the starting point for further cost reduction. This process of continuous improvement is known as kaizen costing and encourages continual improvements by tightening the "standards."
Variable costs and fixed cost reductions are determined by separate methods. For variable costs, the actual prior year’s production cost serves as a standard base for current production. A reduction rate is then decided and variances are monitored. For fixed costs, the total budgeted amount is considered a target which is lowered by a reduction rate. Actual performance is compared to the budgeted amount with any reduction being considered favorable. The figure below provides a graphic view of Daihatsu's cost reduction approach.
For Daihatsu, standard costs are steadily reduced by continuous improvement efforts towards the target cost. While the target cost is established during the design stage, standard costs (as well as other cost reduction techniques) are used during the production stage to attain the target cost. Thus, the standard costing system tracks progress in achieving the target cost.
Cost reduction techniques include standard costing. However, standard costing has limited applicability and can lead to undesirable results. For example, to minimize the purchase price variance, a purchasing manager may purchase a cheaper, lower quality part. As a result, the quality of the product is likely to be reduced, and the company may experience higher overall costs in the form of rework or warranty problems. In contrast, Kaizen costing is performed on a company-wide basis and can be used in planning, design, and other processes as well as production. Kaizen costing activities do not reduce the overall quality of the product; they do ensure that expenditures result in the receipt of appropriate value.
Monden and Lee’s article provides insight related to Kaizen costing and guidance on how management accounting can play a significant role in creating sustainable competitive advantages for a firm.