Kaizen Costing

Kaizen is a Japanese term for continuous improvement in all aspects of an

entity's performance at every level.
Often associated with total quality management, many firms limit Kaizen to
improving production.
Characteristics

Kaizen involves setting standards and then continually improving these

standards to achieve long-term sustainable improvements.

The focus is on eliminating waste, improving processes and systems and

improving productivity.

Involves all employees and all areas of the business.

Illustration - Kaizen
Many Japanese companies have introduced a Kaizen approach:

In companies such as Toyota and Canon, a total of 60-70 suggestions per

employee are written down and shared every year.

It is not unusual for over 90% of those suggestions to be implemented.

In 1999, in one US plant, 7,000 Toyota employees submitted over 75,000

suggestions, of which 99% were implemented.

What is continuous improvement?

Continuous improvement is the continual examination and improvement of
existing processes and is very different from approaches such as business
process re-engineering (BPR), which seeks to make radical one-offchanges to
improve an organisation's operations and processes.The concepts underlying
continuous improvement are:

The organisation should always seek perfection. Since perfection is never

achieved, there must always be scope for improving on the current
methods.

The search for perfection should be ingrained into the culture and mindset
of all employees. Improvements should be sought all the time.

Individual improvements identified by the work force will be small rather

than far-reaching.

Eliminating waste
Kaizen costing has been developed to support the continued cost reduction of
existing components and products. Cost reduction targets are set on a

regular,e.g. monthly basis and variance analysis is carried out at the end of each
period to compare the target cost reduction with the actual cost.
One of the main ways to reduce costs is through the elimination of the seven
main types of waste:

Over-production - produce more than customers have ordered.

Inventory - holding or purchasing unnecessary inventory.

Waiting - production delays/idle time when value is not added to the

product.

Defective units - production of a part that is scrapped or requires rework.

Motion - actions of people/equipment that do not add value.

Transportation - poor planning or factory layout results in unnecessary

transportation of materials/work-in-progress.

Over-processing - unnecessary steps that do not add value.

Lifecycle Costing
Rather than simply looking at a product's costs for one period, lifecycle costing seeks to understand costs over
the whole lifecycle.

Managing Lifecycle Costs

A product's costs are not evenly spread through its life.
According to Berliner and Brimson (1988), companies operating in an advanced
manufacturing environment are finding that about 90% of a product's
lifecycle costs are determined by decisions made early in the cycle. In
many industries, a large fraction of the life-cycle costs consists of costs incurred
on product design, prototyping, programming, process design and equipment
acquisition.
This had created a need to ensure that the tightest controls are at the design
stage, i.e. before a launch, because most costs are committed, or 'locked-in', at
this point in time.
Management Accounting systems should therefore be developed that aid the
planning and control of product lifecycle costs and monitor spending and
commitments at the early stages of a product's life cycle.
Maximising a product's lifecycle return
There are a number of factors that need to be managed in order to maximise a
product's return over its lifecycle:
Design costs out of the product

It was stated earlier that around 90% of a product's costs were often incurred at
the design and development stages of its life. Decisions made then commit the
organisation to incurring the costs at a later date, because the design of the
product determines the number of components, the production method, etc. It is
absolutely vital therefore that design teams do not work in isolation but as part
of a cross-functional team in order to minimise costs over the whole lifecycle.
Value engineering helps here; for example, Russian liquid-fuel rocket motors are
intentionally designed to allow leak-free welding.This reduces costs by
eliminating grinding and finishing operations (these operations would not help
the motor to function better anyway.)
Minimise the time to market
In a world where competitors watch each other keenly to see what new products
will be launched, it is vital to get any new product into the marketplace as
quickly as possible. The competitors will monitor each other closely so that they
can launch rival products as soon as possible in order to maintain profitability. It
is vital, therefore, for the first organisation to launch its product as quickly as
possible after the concept has been developed, so that it has as long as possible
to establish the product in the market and to make a profit before competition
increases. Often it is not so much costs that reduce profits as time wasted.
Maximise the length of the life cycle itself
Generally, the longer the life cycle, the greater the profit that will be generated,
assuming that production ceases once the product goes into decline and
becomes unprofitable. One way to maximise the lifecycle is to get the product to
market as quickly as possible because this should maximise the time in which
the product generates a profit.
Another way of extending a product's life is to find other uses, or markets, for the
product. Other product uses may not be obvious when the product is still in its
planning stage and need to be planned and managed later on. On the other
hand, it may be possible to plan for a staggered entry into different markets at
the planning stage.
Many organisations stagger the launch of their products in different world
markets in order to reduce costs, increase revenue and prolong the overall life of
the product. A current example is the way in which new films are released in the
USA months before the UK launch.This is done to build up the enthusiasm for the
film and to increase revenues overall. Other companies may not have the funds
to launch worldwide at the same moment and may be forced to stagger it.
Skimming the market is another way to prolong life and to maximise the revenue
over the product's life.
Customer lifecycle costing

Not all investment decisions involve large initial capital outflows or the purchase
of physical assets. The decision to serve and retain customers can also be a
capital budgeting decision even though the initial outlay may be small.
For example a credit card company or an insurance company will have to choose
which customers they take on and then register them on the company's records.
The company incurs initial costs due to the paperwork, checking
creditworthiness, opening policies,etc. for new customers. It takes some time
before these initial costs are recouped. Research has also shown that the longer
a customer stays with the company the more profitable that customer becomes
to the company.
Thus it becomes important to retain customers, whether by good service,
discounts, other benefits, etc.
A customer's 'life' can be discounted and decisions made as to the value of, say,
a 'five-year-old' customer. Eventually a point arises where profit no longer
continues to grow; this plateau is reached between about five years and 20 years
depending on the nature of the business. Therefore by studying the increased
revenue and decreased costs generated by an 'old' customer, management can
find strategies to meet their needs better and to retain them.
Many manufacturing companies only supply a small number of customers, say
between six and ten, and so they can cost customers relatively easily. Other
companies such as banks and supermarkets have many customers and cannot
easily analyse every single customer. In this case similar customers are grouped
together to form category types and these can then be analysed in terms of
profitability.
For example, the UK banks analyse customers in terms of fruits:

At the top of the tree are plums - which are classified as 'college educated
married men aged 44-65 living in the south of England with high income
and high savings'.

Other customers are classified as pears, apples, oranges, dates, grapes

and lemons.

Customers tend to move from one category to another as they age and as
their financial habits change. Customers with large mortgages, for
example, are more valuable to the bank than customers who do not have
a large income and do not borrow money. Banks are not keen on keeping
the latter type of customer.