During the early 1990s recession, Mercedes-Benz (MB) faced challenges in product development, cost efficiency, material purchasing, and market adaptation. These issues resulted in the company’s worst sales slump in decades in 1993, marking the first financial loss in its history. Subsequently, MB has implemented measures to streamline its core business, reduce complexity in parts and systems, and initiate simultaneous engineering programs with suppliers.
MB began creating a variety of new products in their quest for increased market share, new segments, and new niches. These new product introductions encompassed the C-class in 1993, the E-class in 1995, the revolutionary SLK sportster in 1996, and the A-class and M-class All Activity Vehicle (AAV) in 1997. The AAV was perhaps MB’s most significant and ambitious endeavor. In April 1993, MB unveiled plans to construct its initial manufacturing facility for passenger vehicles in the United States.
The decision highlighted the company’s aim to globalize and establish proximity to its customers and markets. Mercedes-Benz United States International employed function groups consisting of representatives from various departments (marketing, development, engineering, purchasing, production, and controlling) to develop the vehicle and production systems. A modular construction process was employed for manufacturing the AAV. Rather than individual parts or components, first-tier suppliers supplied systems for the annual production of approximately 65,000 vehicles.
THE AAV PROJECT PHASES
The development of the AAV has been rapid, going from concept to production in a short time. The project started with the concept phase in 1992, which involved a feasibility study that was approved by the board. After receiving approval, the project moved into the project realization phase in 1993 and officially began production in 1997. Below are descriptions of each phase.
CONCEPT PHASE, 1992-1993
In this period, the project team compared the existing production line with various market segments to identify opportunities for introducing new vehicles.
The analysis discovered chances in the fast-growing market for sports utility vehicles, which was mainly controlled by Jeep, Ford, and GM. A market research study was conducted to evaluate potential global sales opportunities for a luxury autonomous aerial vehicle (AAV) with similar features to a Mercedes-Benz. An initial cost estimate was created, taking into account materials, labor, overhead, and one-time expenses for development and project. Projected cash flows were analyzed over a period of 10 years using net present value (NPV) analysis in order to secure project approval from the board of directors.
The examination of various scenarios assessed the sensitivity of NPV by considering potential risks and opportunities. These scenarios accounted for factors like fluctuations in monetary exchange rates, changes in sales levels due to consumer preference for a different MB product instead of the AAV, and variations in projected product and manufacturing costs. Following an economic feasibility study conducted during the concept phase, approval was granted by the board for the project, leading to a search for potential manufacturing locations. Evaluation was conducted on sites within Germany, other European countries, and the United States.
In line with the company’s global strategy, the plant was brought to the United States primarily because of its proximity to the main market for sports utility vehicles. During the project realization phase from 1993 to 1996, regular customer clinics were conducted to showcase the prototype and introduce the new vehicle concept. These clinics provided valuable insights about how potential customers and the press would perceive the proposed vehicle. Customers were requested to rank the significance of different features, including safety, comfort, economy, and styling.
Engineers organized in function groups designed systems to deliver these essential characteristics. However, MB maintained its internal standards for components, regardless of lower initial customer expectations. For instance, automotive experts acknowledged that MB’s superior handling was achieved through manufacturing the world’s best automobile chassis. As a result, each class within the MB line adhered to strict handling standards that might surpass customer expectations for some classes.
MB did not utilize target costing to create the most affordable vehicle within a certain automotive category. The company’s strategic goal was to offer products that were slightly pricier than rival models. However, this extra expense needed to result in a higher perceived value for customers. The vehicle and its target cost remained flexible throughout the project implementation stage due to shifting market dynamics. For instance, the market trended towards more luxury options during the development of the AAV. Moreover, the evolving AAV design incorporated crash test findings.
For the aforementioned reasons, MB found it advantageous to colocate the design and testing team members with other functions within the project, in order to facilitate prompt communication and decision-making. Occasionally, MB was responsible for developing new technical features, like side air bags. The determination to incorporate this new feature into all MB lines was made at the corporate level, as previous experience had demonstrated that customers’ responses to a particular vehicle class can impact the entire brand. The production phase of the project took place in 1997 and was overseen through annual updates of the NPV analysis.
In addition, a three-year plan (including income statements) was prepared annually and reported to the headquarters in Germany. 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 target (or standard) costs.
The process of achieving target cost for the AAV began with an estimate of the existing cost for each function group.
The next step in the process involved identifying the components of each function group and determining their associated costs. To reduce costs, targets were set by comparing the estimated existing cost to the desired target cost for each function group. These function groups encompassed various areas such as doors, sidewall and roof, electrical system, bumpers, powertrain, seats, heating system, cockpit, and front end. Additionally, targets for cost reduction were established for each individual component. As a part of the competitive benchmark process, MB purchased and dismantled competitors’ vehicles in order to gain insight into their costs and manufacturing processes.
The AAV manufacturing process relied on high value-added systems suppliers, such as the purchase of the entire cockpit as a unit. This meant that systems suppliers were involved in the project from the beginning. MB expected suppliers to meet cost targets, and to enhance function group effectiveness, suppliers were included in early discussions. Quick decisions had to be made in the early development stages, and cost planners, who were engineers rather than accountants, led the target costing process.
Because the cost planners were engineers with manufacturing and design experience, they could estimate costs that suppliers would incur in providing various systems. Additionally, MB owned much of the tooling, such as sheet metal dies, used by suppliers to produce components. Tooling costs are a significant part of the one-time costs in the project phase. INDEX DEVELOPMENT TO SUPPORT TARGET COSTING ACTIVITIES I During the concept development phase, MB team members used indexes to determine critical performance, design, and cost relationships for the AAV.
To create the indexes, MB collected information from customers, suppliers, and their own design team. Table 1 demonstrates how customer responses to the AAV concept were measured. Despite the fact that MB used a larger number of categories, Table 1 showcases the calculations used to quantify the importance of each category for potential customers when considering the purchase of a new MB product.
Relative Importance Ranking by Category:
CategoryImportanceRelative Percentage
Safety3241%
Comfort2532
Economy1518
Styling79
Total79100
To gain a better understanding of the various sources of costs, function groups were identified together with target cost estimates. (MB also organizes teams called function groups whose role is to develop specifications and cost projections.)
As shown in Table 2, the relative target cost percentage of each function group was computed.
Table 2. Target Cost and Percentage by Function Group:
Function GroupTarget CostPercentage of Total
Chasis$x,xxx20%
Transmission$x,xxx25 Air conditioner$x,xxx5 Electrical System$x,xxx7 Other function groups$x,xxx43 Total$xx,xxx100% Table 3 summarizes the contribution of each function group to the consumer requirements outlined in Table 1. Safety was identified as a crucial characteristic by potential customers for the AAV; some function groups had a greater impact on safety than others. MB engineers discovered that chassis quality played a significant role in ensuring safety (50% of the total function group contribution). Table 3 displays the contribution of each function group to customer requirements.
Function Group/Category Safety Comfort Economy Styling
Chassis &nbs… Transmission 20%&n… Air conditioner 20%&n… Electrical system &nb… Other systems &nb… Total
100%
Table 4 combines the category weighting percentages from Table 1 with the function group contribution from Table 3. The result is an importance index that measures the relative importance of each function group across all categories. For example, potential customers weighted the categories of safety, comfort, economy, and styling as .41, .32, .18, and .09, respectively.
Table 4 displays the contribution of each function group to the various categories. The importance index for the chassis is determined by multiplying each row value by its corresponding category value and adding up the results. For the chassis, this calculation leads to an importance index of .33.
Table 4. Importance Index of Various Function Groups
Function Group/Category
Safety .41
Comfort .32
Economy .18
Styling .09
Importance Index
Chassis .50
.30
.10
.10
.33
Transmission .20
.20
.20
Air conditioner .20
.05
.05
.07
Electrical system
.05
.06
Other systems
.25
.
.
.
Total1. 001. 001. 001. 00 According to Table 5, the target cost index is determined by dividing the importance index by the target cost percentage based on function group. This index is used by managers at MB in the concept design phase to comprehend how the importance of a function group relates to its target cost. If an index is less than one, it may indicate that the cost exceeds the perceived value of the function group. Therefore, potential cost reduction opportunities that align with customer demands can be identified and controlled during the initial stages of product development.
During the project realization phase, decisions made were mostly permanent in the production phase due to the high cost of materials and systems provided by external suppliers, which accounted for approximately 80% of the production cost of the AAV. To expedite development, the AAV project employed a streamlined management structure, resulting in the creation of a completely new vehicle in just four years. By implementing target costing as a critical management strategy, MB successfully produced the first production AAV in 1997 (Table 5).
Target Cost Index Function Group/Index(A) Importance Index(B) % of Target Cost(C) A/B Target Cost Index Chassis. 33. 201. 65 Transmission. 20. 25. 80 Air conditioner. 07. 051. 40 Electrical Systems. 06. 07. 86 Other systems. 35. 43. 81 Total1. 00 Questions for Discussion:
1. What is the competitive environment faced by MB?
2. How has MB reacted to the changing world market for luxury automobiles?
3. Using Cooper’s cost, quality, and functionality chart, discuss the factors on which MB competes with other automobile producers such as Jeep, Ford, and GM.
4. How does the AAV project link with MB strategy in terms of market coverage?
5. Explain the process of developing a component importance index. How can such an index guide managers in making cost reduction decisions?
6. How does MB approach cost reduction to achieve target costs?
7. How do suppliers factor into the target costing process? Why are they so critically important to the success of the MB AAV?
8. What role does the accounting department play in the target costing process?
