functional cost analysis application in manufacturing

7/30/2019 Functional Cost Analysis Application in Manufacturing

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international journal ofproductioneconomicsELSEVIER Int. J. Production Economics 36 (1994) 53-64

Applying functional cost analysis in a manufacturing environmentTakeo Yoshikawa,*, John Innesb, Falconer Mitchell

a Yokohama National University. 156 Tokiwadi, Hodogaya-ku. Yokohama 240, Japanb University of Dundee, UK

Uniwrsify qf Edinburgh, UK

AbstractValue engineering is a technique initially developed in the West and widely employed by engineers to enhance product

design. It has been further developed largely through the involvement, in Japan, of cost engineers. Most large Japanesemanufacturers use it as an important element in their cost reduction and cost management policies. They employ it asa team activity to encourage the interaction and contribution of a range of disciplines. Accountants participate in theseteams and provide a major input to the functional analysis of value engineering, and this has been termed functional costanalysis by the authors. This paper explores the nature and impact of functional cost analysis as it is used in valueengineering. The first half of the paper is concerned with the more conventional application of functional cost analysis toindividual products. This illustrates how and why the functions rather than the parts or resource inputs to a product canprovide a valuable focus for costing activity. Functional cost analysis is examined within the context of different stages inthe product life cycle and the application of cost management policies including competitive analysis, benchmarking andtarget costing. The second half of the paper examines an extension of the functional cost analysis approach from productsto areas of manufacturing overhead costs and this includes drawing upon activity-based costing information. Thisinvolves the application of functional cost analysis methodology to business processes such as procurement, ordering,quality control and production scheduling. These are analysed and costed in terms of the functional service required bythe customers of each business process. It thus provides a structured way of bringing visibility to many overhead areasin a manner which facilitates not only cost reduction but also incremental investment. Functional cost analysis allowscost information to be presented in a way which can reflect not only the technical capabilities of the firm but also theviewpoint of its customers. It also draws on the range of skills possessed by a variety of staff which can contribute to thecost management effort. These strengths have resulted in functional cost analysis becoming a highly effective and widelyused technique for cost management.

1. Introduction and definition A systematic interdisciplinary examination of factors affect-ing the cost of a product or service in order to devise means ofValue engineering or value analysis is a tech-

nique originally developed in the West by engineersachieving the specified purpose most economically at therequired standard of quality and reliability (British Stan-dard 3138).as a means of providing:

* Corresponding author.This definition emphasises that value engineering(VE) itself is an interdisciplinary activity. The core

0925-5273/94/$07.00 0 1994 Elsevier Science B.V. AH rights reserved.SSDI 0925-5273(93)E0147-N


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54 T. Yoshikuwcr of ul.:Int. J. Production Gonomic~s 36 11994) 53 64

relevance of cost information has inevitably createdan important role for the management accountant.The accounting contribution to the VE process hasbeen termed functional cost analysis by the authorsand it is this aspect which provides the particularfocus of this paper.

The technique of VE originated in the 1960s inthe USA. Among its first users were Univac-SperryRand, Ford tractors, General Electric and Chrysler[I]. However, it is not a technique which hasachieved much prominence in the Western manage-ment accounting literature. For example, the twobest-selling management accounting textbooks inNorth America and Europe are, respectively, thoseby Horngren and Foster [2] and Drury [3], andneither contains any detailed material on either VEor functional analysis. In contrast, in Japan func-tional cost analysis in the VE process has becomeone of the most important and widely used costmanagement techniques [4]. Hiromoto [S] andMonden and Sakurai [6] provide descriptions of itsrole in Japan as part of the process of achievingtarget costs.

VE is a team activity. The team may have onemember from each of various departments such asdesign, engineering, accounting, production, pur-chasing and marketing. To initiate and support thisteamwork, most Japanese companies have a VEdepartment with employees who work full-time onselecting the topics for analysis and on organisingthe secondment of the team members. This teamactivity encourages the interaction and contribu-tion of a range of disciplines.

Functional cost analysis uses the functions ofa product as the basis for a structured approach tocost management. For example, the major functionof a pen is to make a mark or the major functionof a staple remover is to remove a staple. Thesefunctions represent a view of the service potential ofthe product to the customer in contrast to the partswhich provide a physical representation of theexisting product. The major advantage of thinkingin terms of functions rather than parts is this moreabstract approach. For example, if you take theexisting parts as a starting point for product re-design, the chances are that you will finish witha new product which is only a slightly modifiedversion of the original product. In contrast, if you

begin with the functions of the existing product youare more likely to find completely different, andmore cost effective, ways of achieving these func-tions. Indeed, the functional cost analysis approachcan often lead to the invention of new products.

Historically, Western costing systems have con-centrated on the product as the cost objective.Indeed, Johnson and Kaplan [7] have suggestedthat very often the predominant purpose ofWestern cost management systems is the valuationof inventory for external financial reports. More-over, product cost information has conventionallybeen presented in terms of resource inputs, namelydirect material, direct labour and overhead. Thistype of information concentrating on the total re-sources used may not be the most appropriate typeof information for cost management. Cost manage-ment involves not only the identification of costreduction possibilities but also the possibilities forincreasing costs where the extra investment willenhance profit. The individual functions of a prod-uct are an alternative cost object and their use infunctional cost analysis can aid cost managementfor profit improvement not only by identifying op-portunities for cost reduction but also by leadingthose involved to discover beneficial new featuresfor a product.

2. Application to productsFunctional cost analysis can be used throughout

the different stages in the life cycle of a product. Forexample, functional cost analysis can be applied toan existing product to redesign it to achieve a par-ticular objective such as reducing the cost of theproduct by 25% without affecting its quality. Theexample discussed in this section illustrates func-tional cost analysis applied to an existing product.However, functional cost analysis is an even morepowerful tool when it is applied at the planning anddesign stages for a new product. Bellis-Jones[8, p. 1043 suggests that approximately 85% offuture unit product costs are determined by the endof the testing phase. Indeed, Japanese companieshave concentrated on the application of functionalanalysis at the preproduction stages where thebenefits gained tend to be the greatest.


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T. Yoshikawa et al.llnt. J. Production Economics 36 11994) 5344 55

The various steps in the application of functionalcost analysis are (linking with VE) basically thesame at whatever stage in the product life cycle it isused. These are:(1)(2)(3)(4)(5)(6)(7)

(8)

Choose the field for analysis.Define the objective including the target cost.Select team members.Gather information.Define the functions of the object.Draw a functional family tree.Evaluate the functions in terms of(a) existing cost of each function and(b) value of each function to the customer.Suggest alternatives and compare these withthe target cost.

(9) Decide on alternative.(10) Review the actual results.The first step of choosing the field for analysis(such as product or component or service or over-head area) is particularly critical and this is wherethe full-time VE employees play an important role.The criteria used to select a particular product orcomponent includes very heavy or very bulky orvery complex combined with the total cost in-volved. After choosing the object for analysis, thefull-time VE employees also set the objective of theanalysis. For example, the objective could be toreduce the weight of the product by 25% withoutaffecting its existing quality, while also reducing thecost of the product by 30%. Cost and managementaccountants should be involved in helping to setthe cost objective and this is generally done withina target cost framework.

The idea of applying target costing to productshas been used for many years (see, for example,[9, lo]), but its popularity has grown in the lastdecade. In contrast, to much of conventional man-agement accounting with its internal emphasis, tar-get costing emphasises the external approach byworking back from an expected future market priceto an internal target cost. This process of establish-ing the target cost will involve competitive analysis(i.e. analysis of competitors costs, products andpossible future plans) and establishing variousbenchmarks in relation to competitors. However,the Japanese use of target costing is a topic in itsown right and further details can be found in

[ll, 121. The important point for functional costanalysis is that a major aim of the analysis will be tohelp meet a target cost objective. For example, letus assume that the product is a propelling ballpointpen and the target cost objective is $2.39 with anexisting cost of $3.10 for this pen.

The third step for the full-time VE employees isto choose the members of each team. If you havemore than one team doing the same VE exercise, itintroduces an important element of competitionbecause at the end of the exercise each team willpresent their results to several top managers. Eachteam usually consists of five or six members drawnfrom different departments within the company.However, it is also quite common for employees inboth subcontractor and customer companies to beinvited to participate in the VE teams. It has beenfound that this is a good way to deepen relation-ships both with subcontractors and customers.

Once the teams have been selected, they beginthe fourth step of gathering information about theproduct including technical specifications, cost andmarketing data. The technical specifications wouldinclude information about the detailed design ofthe existing product and full manufacturing in-formation including details of suppliers, subcon-tractors, materials, manufacturing process andscrap. The market data would include informationabout competitors products. The fifth step involvesdefining the functions of the product and mostpeople find this very difficult. The basic problem isthat they think in terms of the existing parts ratherthan the functions of a product. A helpful guidelineis that you can describe each function with a verband a noun. For example, some of the functions fora staple remover might be remove staple, holdstaple, open staple, detach staple, gather staple andprevent rust.

Having determined the functions of the product,the sixth step is to draw a functional family tree. Anexample of a functional family tree for a propellingballpoint pen is given in Fig. 1. The primary func-tion is make mark with two secondary functionsof put colour, guide tip, and prevent loss. Thefunction of put colour itself has further subsidiaryfunctions. An indirect function denoted by the dot-ted line in Fig. 1 is prevent loss. As you move tothe right-hand side of the functional family tree, the


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56

Fig. I. Propelling ballpoint pen functional family tree.

Table 1Parts, functions and costsPart no. Name of parts Function cost ($)

Transitiveverb

Noun

8910

Tip Flow Ink 0.80Barrel Hold Pen 1.20Cartridge Store Ink 0.30Top Store Ink 0.20Ink Put Colour 0.15cap Pull in/out Tip 0.12Spring Pull in/out Tip 0.10Stopper Fix Spring 0.08Clip Prevent Loss 0.13Screw Attach Clip 0.02

3.10Note: This is an illustrative example. The costs are notional andhave been selected by the authors purely for the purpose of thisarticle.

functions such as fix spring become less abstractand more directly related to the parts of the existingproduct. A major advantage of the functional fam-ily tree is to try to arrange the functions of theproduct in a logical fashion. A useful check of thefunctional family tree is to ask the question howreading from left to right and the question whyreading from right to left. For example, how do youmake a mark by putting colour and guiding tipand why do you put colour namely to makemark.

With reference t the functional family tree, theseventh step is to evaluate the functions. During theprevious steps the management accountant has beenoperating very much as one of the team membersbut has an important individual role to play incalculating the existing cost of each function. Table 1gives an example of how the functions of the propel-ling ballpoint pen identified in Fig. 1 can be relatedto the parts of the existing product and costed.

In Table 1 the existing cost of the pen is $3.10 butin step two the target cost for the pen was set at $2.39.The target cost of $2.39 can be assigned to eachfunction on the basis of the customers perceivedvalue of each function. Ideally, the customers wouldbe asked what they would be willing to pay for eachfunction (such as prevent stains), but in practiceusually each member of the team plays the role of thecustomer and values each function. The team thendiscusses the individual results and agrees on a finalvalue for each function from the customers view-point. Table 2 gives an example of how the actual costfor each function can be compared with its target costbased on the customers viewpoint.

The major advantage of this approach is that theteam is forced to consider the market and cus-tomers and does not concentrate only on internalinformation such as internal costs. This compari-son of the actual costs and the target cost of eachfunction in Table 2 is a useful starting point for theeighth step of suggesting alternatives. Table 2 givesguidance on the functions where the team shouldconcentrate its efforts. For example, the flow ink,store ink and pull in/out tip functions all have


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T. Yoshikawa et al.lI n~. J. Production Economics 36 (1994) 5364 57

Table 2Costs and values of functionsFunctions Actual cost

($)(a)

Relative value tothe customerW)(b)

Assignment of target costbased on customersrelative function value(W(c) = $2.39 x(b)

Valueratio (c)(d) = w

Flow ink 0.80Guide tip 1.20Store ink 0.50Put colour 0.15Pull in/out tip 0.22Fix spring 0.08Prevent loss 0.13Attach clip 0.02

3.10

25501261141

100

0.60 0.751.20 1.000.29 0.580.14 0.930.02 0.090.02 0.250.10 0.770.02 1.002.39

These figures are rounded

an actual cost which is at least 20 cents greater thanthe target cost. Another method of analysing thedata is to calculate a value ratio for each functionwhich is the assigned target cost divided by theactual cost. Where the value ratio is less than one,this means that the functions actual cost is greaterthan its target cost. One weakness of the value ratiois that it may be low (such as 0.25 for fix spring),but the absolute amount involved (such as 8 centsfor fix spring) is relatively small and offers littlescope for significant cost reduction.

This step of generating alternatives is basicallya brain-storming session where no suggestion isdiscarded in the first instance. Experience hasshown that what at first might seem to be an absurdsuggestion may turn out to be the best suggestion.In addition to making suggestions, the manage-ment accountant has an important role to play incosting the various alternatives which the teamdecides to consider. Cost tables assist the manage-ment accountant in costing suggestions such asusing new materials, eliminating or combining cer-tain functions and using a new manufacturing pro-cess. They provide answers to what if questions.Japanese companies have used cost tables forseveral decades (see, for example, [13]). They arecomputer databases with very detailed information

Fig. 2. Disposable ballpoint pen functional family tree.

including not only details of a companys own inter-nal costs but also the costs of using different types ofmaterials or production technology. Further detailsof Japanese cost tables can be found in [14].

Having generated various alternatives, costedthese and compared the results with the target costfor the pen of $2.39, the team will take the ninthstep of choosing their alternative. Fig. 2 gives anexample of a chosen alternative where the propel-ling ballpoint pen in fact becomes a different prod-uct, namely a disposable pen without the propellingelement. Functions such as pull in/out tip, fixspring and attach clip have been eliminated andthe functions of prevent stains and prevent losshave been combined. It is important to check that


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Table 3Parts, functions and costsPart no. Name of parts Function cost (8

TransitiveVerb

Noun

1 Tip Flow Ink 0.502 Barrel Hold Pen 1.003 Cartridge Store Ink 0.204 Top Store Ink 0.105 Ink Put Colour 0.126 Cap Prevent Stain 0.08

Loss -_2.00

this concentration on the individual functions ofthe product has not affected adversely the overallintegrity of the product. Before taking their finaldecision, the VE team must take into considerationfactors such as customers reactions and environ-mental considerations in addition to technical andcosting data. The final decision is very much a busi-ness decision. Table 3 illustrates the effects of thefinal decision on both the number of parts and thecost of the new pen.

Table 3 shows that the number of parts has fallenfrom ten to six in the new product and the cost hasfallen from $3.10 to $2.00. In other words, the targetcost of $2.39 has been more than met. To ensure thatno overoptimistic claims are made by the VE teamsand also for feedback purposes to improve futureanalyses, a postcompletion review or audit is con-ducted within a year after the changes have beenimplemented to check the actual results against theforecast results of the analysis. Further informationabout functional cost analysis is given in [IS].

Functional cost analysis is a technique which canbe applied during various stages of a products lifecycle, although it is a particularly beneficial tech-nique during the planning and design stages fora new product where its basic objective of profitimprovement can be most effectively achieved.A major advantage of this technique is that theteam approach brings together individuals who canuse and combine their different skills in relationto a specific product. Hopefully. this might meana competitive advantage in terms of a better

product (including perhaps new features) moreclosely geared to customers needs. A second ad-vantage of functional cost analysis is that it inte-grates in the cost management exercise both theview of customers and the market context in termsof a target cost based on a market price. Anotherimportant benefit is the more abstract approachrequired by considering the functions rather thanthe parts of a product. Moreover, in benchmarkingit can also be helpful to analyse competitors prod-ucts in terms of their functions and, where possible,the estimated cost of these functions.

When estimating the cost of functions. activity-based costing can play a role in helping to cost theoverhead elements. Cost driver rates can be used tolink overhead costs to individual functions. How-ever, activity-based cost information can be usednot only in the functional cost analysis of productsbut also in applying the technique to overheadareas. The second part of this paper describes thisdevelopment and also how activity-based costinginformation can be used to improve the functionalcost analysis of manufacturing overheads.

3. Application to overheadsActivity-based costing has proved useful not

only in product costing but also in the cost man-agement of overheads (see, for example, [16, 171).One popular approach is to categorise activities asvalue-added or non-value-added (see, for example,[ 181). The basic question is whether or not anactivity adds value to the product from the cus-tomers point of view. Brimson [19, p. 641 suggeststhat most companies have between 20% and 40%of total cost consumed in performing non-value-added -wasteful - activities. The basic objective isto eliminate or to at least minimise non-value-ad-ded activities such as rework or expediting.

Another popular approach is to categorise activ-ities as core or support or diversionary. Bellis-Jones[S] argues that core activities provide a service tocustomers either inside or outside the organisationand are usually associated with a special expertisewhich forms part of the competitive advantage ofthe organisation. For example, a core activity fortravelling salesmen is the negotiation of sales with


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T. Yoshikawja et al.lInt. J. Production Economics 36 (1994) 5354 59

customers. Their support activities are those re-quired to make the core activity possible, such asthe salesmen driving to the premises of a customer.Diversionary activities are caused by deficiencies inthe system and must be eliminated or at least mini-mised. These include the salesmen listening tocustomer complaints about the products receivedfrom previous sales.

Both the value-added or non-value-added andthe core or support or diversionary approachestend to focus cost management efforts on the non-value-added and the diversionary activities. Thereis a tendency to ignore the opportunities for im-proved cost management in the value-added andcore activities. Furthermore, the cost managementefforts tend to concentrate on cost reduction ratherthan on profit improvement by identifying over-head areas where extra expenditure should be in-curred to increase profits. This part of the paperdiscusses how functional cost analysis is being ap-plied to manufacturing overheads and how, with itswider view of business processes, it could com-plement the value-added or core approaches tooverhead cost management. It should be pointedout that, although companies apply functional ana-lysis to their overheads, in the following discussionwe have assumed the availability of activity-basedcost information to illustrate how it could comp-lement such an approach.Japanese companies apply their functional anal-ysis approach to business processes such as produc-tion scheduling. The cost objective changes froma product sold to external customers to a serviceusually provided to internal customers, namelymanagers in other departments within the com-pany. As with products, the major aim is not just toreduce the cost of the overhead service but also toimprove the service provided to internal managersand, therefore, to benefit ultimately externalcustomers.

The criteria used to select the overhead area forfunctional cost analysis include increasing staff, thegrowth of bureaucratic or complex procedures andsteep rises in cost. The team members for the func-tional cost analysis exercise are again interdisci-plinary and include not only a member from theoverhead area but also at least one representa-tive from the internal customers of the overhead

service. Just as it was helpful to explain functionalcost analysis of products with the simple example ofthe pen, so applying functional cost analysis tooverheads will be illustrated with a basic exampleof the purchasing of direct materials.

In this example the purchasing of direct mate-rials includes the assessment of material require-ments, the search for suppliers and through theprocess to the delivery of materials to the produc-tion line and the final payment to a supplier. Inother words, it is a business process which involvesseveral departments such as production planning,purchasing, stores and accounts payable. To distin-guish this business process from the purchasingdepartment itself, it will be called the procurementprocess. The objective set by the full-time VEdepartment is assumed to be the reduction of thecost of the procurement process by 25% (from &3million to &2.25 million), while at the same timeimproving the service provided to internal cus-tomers. Such stringent targets are a common start-ing point for this type of work.

After gathering the necessary information aboutthe nature of the procurement process, its costs andmanufacturing material requirements, the functionscan be defined. The primary function may beprovide materials with secondary functions suchas meet schedule, control cost and assurequality. At this stage it is very important to avoidlisting the activities involved in the procurementprocess. Such activities in the overhead area areequivalent to the parts of a physical product. Thefunctions should be defined at as abstract or gen-eral a level as possible so that team members for thefunctional cost analysis exercise are given a frame-work which does not constrain them to simplytinkering with the existing procurement process.

When the functions of the procurement processhave been defined, the next step is to draw theprocurement functional family tree. Fig. 3 containsthe functional family tree for this illustrativeexample.

Fig. 3 shows both the primary or basic functionand also three further sublevels of function (forexample, assure quality, meet specificationsand ensure colour) are apparent. Just as the phys-ical product application related the functions to theexisting parts of the product, so the functions of the


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60 T. Yoshikawa et al.lInt. J. Production Economics 36 (1994) 53-643rd levelfunctions

Fig. 3. Procurement functional family tree.

procurement process can be related to its existingactivities. Table 4 summarises the links between thevarious family tree functions and the activitieswhich comprise the procurement process.

However, Table 4 also includes the costs of theactivities involved in the procurement process andtherefore the existing cost of meeting the variousfunctions. It provides a useful starting point tobegin the cost management analysis. For example,the analysis at the foot of Table 4 reveals eachfunctions percentage of the total cost (such as F3assure quality is 40% of the total cost), the num-ber of activities involved in each function (forexample, 12 activities are involved in FZ1 matchcost target) and each functions percentage of thetotal number of activities (for example, F 1 meetschedule involves 65% of the total number ofactivities). This type of analysis is very much

a starting point because it represents only an inter-nal perspective on the procurement process. Tosupplement it, the views of the customers of theprocurement process must also be incorporatedinto the analysis.

As with the physical product, in addition toevaluating the costs of the functions, it is critical toevaluate the customers perceptions of the value ofeach function. With most overheads such asprocuring materials, the customers for the serviceare within the company and, therefore, it is relative-ly easy to ask the customers (for example, produc-tion staff) how they value each function. In thephysical product example, the target cost was as-signed to each function on the basis of thecustomers weighting. This procurement exampleillustrates an alternative approach where the cus-tomer weightings are used in percentage termswithout being turned into monetary amounts. Thisallows them to be matched against the relative costpercentages for the functions determined from thecosting work outlined above.

Table 5 shows that the internal customers haveweighted equally the three first-level functionsof meet schedule, control cost and assurequality. However, with the second-level functionsthe internal customers have weighted match costtarget three times as heavily as fix cost. As withthe physical product the internal customersweightings for each function (I,) can be comparedwith the relative costs of each function (C,) and canbe expressed as the value ratio V, divided by Cr.Where this value ratio is less than one it means thatthe relative costs of that function exceed its relativevalue to the customer. This provides a signal toinvestigate these functions - particularly wheretheir absolute costs are significant. Table 5 showsthat the value ratios for both F 1 meet scheduleand F3 assure quality are less than one. Further-more, the lower-level functions reveal that thereasons for this appear to lie with functions F 12provide-on-time and F 3 1 meet specifications.As the function of provide-on-time represents22% of the total cost and that of meet specifica-tions 34% of the total cost, these functions wouldbe targeted for close examination.

However, the type of analysis derived fromTable 5 is very much a starting point in the process.


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Table 4

T. Yoshikau,a et al./Int. J. Production Economics 36 (1994) 53154 61

The composition of first- and second-level function costsActivities Basic

functionFirst-level functions Second-level functions

Fll Fl F2 F3 F,, FI, F,I F 22 F 31 F 32Assessment of material requirementsPotential supplier searchPotential supplier vettingApproval procedures new supplierGathering price dataNegotiating price ~ existing suppliersNegotiating price potential suppliersSetting and monitoring budgetsRequisitioning and orderingStock control proceduresReceiving goodsIncoming inspectionGoods returnedStorageDelivery to lineSupplier expediting - qualitySupplier expediting - deliveryMaking paymentMaintaining documentationGeneral management

% of total costNumber of activities involved% of total activities

200 50190 50270 50150 401601206080

290 20080 80

100 100290120 120130 13090 90

25090 9080

130 30120 50

3ooo 1080100 3620 13

100 65

40304020

160120608020

805030

730241260

11011018090

70

290

250

5040

119040

945

10

50505030

10 19030 5080 20

40303010

14090406010

12013090

902040

1010

803020

410 670 58014 22 198 11 12

40 55 60

101020302020IO

2010

15059

45

11080

10070

60

290

220

4030

100034

945

For simplicity, third-level functions have been excluded. All figures used are fictitious

It is important to be open-minded and to examineas many alternatives as possible. An element ofbrain-storming is also necessary to consider rad-ical change involving additional new functions, theelimination and combination of existing functions.A variety of new ways of achieving the basic fimc-tion of provide materials should be identified.Again, the management accountant plays an im-portant role in estimating the cost of different alter-natives and this is where the activity-based costswill be helpful with cost driver rate informationbeing used to derive the cost estimates.

The alternative chosen in this illustrativeexample was a fundamental change involving thedevelopment of longer-term relationships withfewer material suppliers and the delivery of mate-rials directly to the production line. The longer-

term relationships with suppliers meant that thecompany relied on the suppliers quality after care-ful initial vetting. The revised functional family treewas simplified and is shown in Table 6 and Fig. 4.Table 6 and Fig. 4 show that the basic and first-level functions have not changed but the second-and third-level functions have been simplified byplacing much more reliance on a few carefullychosen suppliers. Table 6 and Fig. 4 illustrate howthe activities relate to the five functions in the newproposal.

The functional cost analysis has eliminated eightactivities, namely gathering price data, stock con-trol, incoming inspection, goods returned, storage,delivery to line, supplier expediting - quality - andsupplier expediting - delivery. Some of these activ-ities such as delivery to line have been taken over


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Table 5Costs and weighting of functionsFunction % cost (Cf) % customer Value ratio

weighting (V,) (V,Cf)F, 36 33 0.92F, 24 33 1.38F.3 40 33 0.83Subtotal 100 100F II 14 16.5 1.18FSlll;ltotal

22 16.5 0.7536 33

F 21 19 25 1.32SZLotal 24 33 I .60F 31 34 25 0.14F,, 6 8 1.33Subtotal 40 33

by suppliers. However, although the suppliersincurred some extra costs, these were more thancompensated by the benefits of larger orders andlonger-term contracts. Indeed, the prices for thematerials may actually fall as a result of such

Table 6Modified procurement functional family tree

Fig. 4. Modified procurement functional family tree.

changes. An additional activity was added to theprocurement process and that was the running ofjoint courses with the suppliers in total qualitycontrol and functional cost analysis on the materialor component supplied. Such joint courses and thelonger-term contracts with fewer suppliers meanthat better relationships are developed with thesesuppliers leading to fewer controls and administra-tive procedures. This new activity of running jointcourses involving suppliers costs El 60 000 per yearbut, despite this, the cost of the procurement pro-cess has fallen from &3 million to El.66 million. This

Activities Function CostfOOos

Comment

Assessment of material requirementsNegotiating price -- existing suppliersSetting/monitoring budgetsRequisitioning and orderingReceiving goodsMaking paymentMaintain documentationGeneral managementRunning of joint courses in TQC and FCAPotential supplier searchPotential supplier vettingApproval procedures -. new suppliersNegotiate price - potential suppliers

FI. Fz> F, 200Fz 80 Easier due to more mutual understandingF2 20 More certainty due to long-term supplier relationshipsF, 250 More frequent ordering hut less bureaucraticF, 100 More frequent deliveries but less bureaucratic and direct tothe production lineF2F,, F2, F3 1: SimplificationF,. F,, F, 100 SimplificationFt. F,. F, 160 New investmentFS 160 Reduced due to increased stability of relationship with exist-ing suppliersF5 200 As aboveFS I50p, 60

1660 A cost reduction of 45% and a reduction of 35% in thenumber of activities

a Note the absence of inspection, storage and handling activities


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T. Yoshikawa e! al.lInt. .I. Production Economics 36 (1994) 5344 63

is a cost reduction of 45% and it is mirrored in thenumber of activities falling from 20 to 13, with eightactivities being eliminated and one being added.

Table 6 and Fig. 4 explain in more detail whathas happened to the cost of the 12 activities whichremained from Table 4 and Fig. 4. Four of theseremain unchanged, namely assessment of materialrequirements, making payment, approval proce-dures - new suppliers ~ and negotiating price -potential suppliers. The cost of another activityreceiving goods has remained unchanged, but thisis because of two compensating effects, namely in-creased costs from more frequent deliveries butreduced costs from less bureaucracy and deliveriesbeing made directly to the production line. Table 6and Fig. 4 give an explanation of why the costshave fallen for the remaining seven activities. Aswith the physical product, the results of the func-tional cost analysis of the procurement processwould also be reviewed in the broadest sense. Thisreview would cover not only the cost saving butwould also check factors such as ensuring thatsuppliers deliveries have been on time and up tothe required quality standard. It is of no benefit tomake savings on the procurement process if furthercosts are incurred elsewhere. This is where the focuson the internal customers ensures that the serviceprovided by the procurement process has actuallyimproved.

4. ConclusionsFunctional cost analysis focuses on the manage-

ment accountants contribution to the provision ofinformation to facilitate the VE of both productsand overhead services. Changing the cost objectivefrom physical parts to the more abstract functionswhich profile the service potential of productsprovides a structured approach which supports awide-ranging market-oriented analysis. The inter-disciplinary approach ensures that all the expertiseat the companys disposal is included in this ana-lysis. Above all, it is an approach which allows costmanagement to be undertaken in a constructiveand positive way.

Although functional cost analysis does encour-age the identification and exploitation of cost re-

duction possibilities, it also highlights creativeinvestment opportunities which will increase theprofit which the company derives from the product.Functional cost analysis does require a significanteffort from accountants to support the VE teamwith prompt estimates and revisions of the cost ofvarious functions. Information has to be producedquickly and while, in Japan, cost tables are a meansof providing this service, it is also possible thatactivity-based costing can make an important con-tribution.

Functional cost analysis is not just a techniqueapplied to physical products. It can be applied tointernal overhead services or business processesdemonstrating the flexibility and utility of this ap-proach to cost management. This paper has alsoillustrated how functional cost analysis of a busi-ness process can be integrated with an activity-based costing system. Functional cost analysisencompasses all elements of cost and addresses costmanagement in a structured manner which relatesthe consumption of resources to customer expecta-tions. The consideration of the costs of functions,the team approach, the customers viewpoint(including target costing) and the use of cost tablesto assess alternatives are the main strengths offunctional cost analysis which make it a powerfultechnique for cost management.

5. AcknowledgementsWe wish to acknowledge the Canon Foundation

in Europe which awarded visiting fellowships toFalconer Mitchell (1990) and John Innes (1992) andso facilitated the international collaboration neces-sary to write this article. This paper consolidatesand advances previous research by the authorspublished in J. Cost Mgmt., 1989, pp. 14-19 andalso forthcoming.

6. References[l] Creasy, R., 1973. Functional Analysis System Technique

Manual. Society of American Value Engineers, Irving.123 Horngren, CT. and Foster, G., 1991. Cost Accounting:

A Managerial Emphasis. Prentice-Hall, Englewood ClitTs,NJ.


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