PRODUCT COST DOWN 2.0 FOR CONSUMER AND ......FOR CONSUMER AND DURABLE GOODS TAKING PRODUCT COST OPTIMIZATION TO THE NEXT LEVEL 1 Traditional cost reduction approaches are reaching

PRODUCT COST DOWN 2.0 FOR CONSUMER AND DURABLE GOODSTAKING PRODUCT COST OPTIMIZATION TO THE NEXT LEVEL

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Traditional cost reduction approaches are reaching the end of the road at a time when cost

efficiency is becoming ever more critical. Consumer product companies face flat customer

demand in most Western markets, intense low-cost competition and input factor increases

but little to no headroom for price increases.

To achieve today’s targets, a step-change in thinking is required, one that takes a

completely fresh look at the sources of cost. Product Cost-Down (PCD 2.0), a next-

generation approach, produces a multidimensional view that comprehensively examines

the sources of cost. The secret to its success lies in its holistic approach, enabling

companies to root out product cost in a sustainable way while maintaining high levels of

customer satisfaction.

Uncertainty surrounding demand and supply is an inescapable condition—and one

that is growing. Industries far and wide—from manufacturing to consumer goods, from

automotive to telecommunications—are all talking about becoming recession-proof.

The desire is to generate free cash flows and profitability buffers to ensure they can weather

whatever the market throws at them.

For example, automotive original equipment manufacturers (OEMs) are spending

hundreds of billions of dollars on e-mobility transformation over the next five to ten years.

That level of investment is not sustainable without fundamentally rethinking how additional

efficiencies can be achieved.

This, however, will only be possible by for saking well-worn processes and by turning to

next-generation cost-reduction approaches. These methods entail a shift in focus to the

core of each cost structure: the product. It is time to address the 80 percent of total product

cost, which provides critical leverage for each identified opportunity. The traditional targets

of most cost cutting, non-product cost, or general overhead, are no longer sufficient, given

that they typically represent only 20 percent of total cost. Additionally, because these areas

have long been addressed by traditional cost-reduction efforts, the low-hanging fruit has

long since been picked. This can no longer meet today’s needs.

Exhibit 1: Typical product cost structure

FOCUS OF PRODUCT COST DOWN 2.0

LOW TOTAL COST IMPACT AREAS

• Purchased parts• Raw materials• Manufacturing

and assembly

• Researchand development

• Selling• Distribution• Administrative

overhead

80%Direct product cost

20%Non-product cost

Source: Oliver Wyman analysis

Copyright © 2019 Oliver Wyman

MAKING COST REDUCTION A WIN-WIN OUTCOMEWhile some industries are more advanced in cost-reduction methodologies than others, addressing product cost in-depth generally represents a sensitive topic. Companies rightly fear that changes to their products could potentially lead to poor customer reception and thereby to lower sales. This is not the only worry. Past experiences sometimes create the feeling that reducing product costs is a complex and slow business. Furthermore, many companies believe that product-cost reduction is already being fully tackled by development and industrial teams.

The hard truth is that customer product perceptions have little or nothing to do with inherent product cost. Substantial reductions can be achieved by redesigning products to focus on the features that are highly valued by customers, while removing unnecessary complexity and rarely used functionality. This can result in a 10–20 percent reduction of total costs. By taking this approach, companies can eliminate over-specified or unnecessarily customized components, while working with suppliers to move towards standardized designs that improve efficiency.

When approached in the right manner, product cost reductions can create genuine win-win opportunities, benefitting customers by providing a more efficient product at a more competitive price, as well as increasing profitability in cash-strapped industries.

REACHING THE LIMITS OF PCD 1.0Cost-efficiency programs have a familiar ring to industry executives. Most corporates have undergone decades of such traditional “PCD 1.0” programs, many of which have successfully delivered incremental benefits.

All too often, however, companies have treated product cost reduction primarily as a procurement-focused exercise. Costs are reduced either through lifecycle cost reduction schedules agreed with suppliers or through onetime supply-base restructurings. Many companies have leveraged commercial tools, such as structured market tests and e-auction platforms, to drive down the price of purchased parts and raw materials. While in some cases changes to product specifications have been introduced to open up further savings opportunities, most of these programs have been inherently cautious and lacking in ambition, leaving products largely unchanged.

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Even where companies have looked at engineering and design cost reduction levers, these have largely been used in just a few key product areas, those identified as having the highest cost impact or highest reduction potential. The areas selected have then been optimized in-depth, but without looking at the areas to the left and right of the particular focus. Rarely have companies taken a holistic view of their products, identifying opportunities and cost reduction impacts across functionalities and product areas. As a result, past approaches have had only limited impact at best.

WHY PCD 2.0 IS UNLIKE ITS PREDECESSORSPCD 2.0’s approach to cost reduction sets it apart from traditional approaches. Three aspects

differentiate it: Firstly, it focuses on the root causes of cost across the value chain; secondly,

it combines advanced technical and commercial approaches to optimizing cost structures;

and, thirdly, it takes a holistic approach to cost reduction using cross-functional teams and

the latest agile methods. Additionally, we believe PCD 2.0’s potential organizational impact

means that it also serves as an essential change-management tool that can ensure that the

high level of savings is sustainable.

Exhibit 2: Differentiators of PCD 2.0

TRADITIONAL APPROACH PCD 2.0 APPROACH

Savings approach

Treatment of cost symptoms

Strong procurement focus

Specific functionalities, functional silos

Elimination of cost root causes in value chain

Advanced technical and commercial methods

Holistic product coverage, agile methods

Improvement lever focus

Focus and teaming



Focusing on root causes across the value chain

Compared to traditional approaches, PCD 2.0 takes a very different approach to cost on two dimensions.

Firstly, PCD 2.0 looks at the product as customers do—holistically, in terms of its functionality and overall value to the customer. It does not treat the product merely as a series of components. Secondly, it examines the sources of cost from a companywide perspective, from design to sales, and not as the property or responsibility of a single function or department, or as inherent in a single aspect of supply or design. This difference in perspective enables cost reduction without loss of functionality.

Unlike other approaches, the reductions achieved through PCD 2.0 are sustainable over the longer term because its holistic view encompasses all aspects of the product, from design to manufacture and sales, ensuring that there are no hidden and unforeseen consequences. Just as important, the reductions achieved through PCD 2.0 are sustainable because the approach tackles the underlying non-optimized elements of the operating model that have led to higher cost levels in the first place.

To achieve this, PCD 2.0 focuses on “cost topics” rather than cost elements. For each topic, a cross-functional team seeks out the root causes of high product costs. Once these root causes have been identified, the impact of their removal or reduction is then considered across all stages of the value chain. This ensures that the changes have a sustainable, positive effect across the company, rather than resulting in a local saving that produces higher costs in other areas.

This is best understood by looking at a real-life example. In one plant engineering company, the PCD 2.0 team identified that, compared to the competition, there were excessive costs in the electric motors that drive the propellers for air circulation. The team discovered that the root cause of this cost was not limited to a particular model or supplier but was the result of a safety buffer specified in the design guidelines. This specification was excessive for current-day conditions. It appears that at some time in the distant past, in order to resolve specific technical issues, the company had introduced a general 5x safety buffer in the performance rating for its fan motors. Although the technology had improved over the years, no one had gone back to examine the reasons for the original specification. The result was that the buffer remained unchallenged, even though it was no longer necessary. Where traditional cost reduction approaches would have eliminated the safety buffer in a specific model or series, PCD 2.0 traced back the issue to its root causes and eliminated the underlying driver for all future products.

Another dimension on which PCD 2.0 differs from previous approaches is in what happened next. The solution the team proposed was not the obvious one of introducing a new but lower specification for this particular performance buffer. Instead, it designed a recurrent specification review process. The new process examines each of the specifications from the customer’s point of view. It scans continuously for all such inefficiencies to ensure that the current specifications match, but do not unnecessarily exceed, customer requirements.

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In seeking to eliminate the root causes of cost, PCD 2.0 does much more than look at production as an integral activity. It also examines the organizational factors that frequently underpin high costs. This includes identifying the role played by such things as the misalignment of incentives during the engineering and sales phases, excessive focus on extra features in design, and the elimination of a silo mentality between functions.

PCD 2.0 safeguards the sustainability of cost savings by ensuring they are reapplied automatically to future model variants and product generations.

Leveraging in-depth technical methods

The second aspect differentiating PCD 2.0 from other procurement approaches is in how it actively leverages technical expertise to drive deep into the design and production process. Engineering and design experts work side-by-side with internal experts to challenge existing thinking. The internal experts involved in the process are drawn from multiple sites and/or product lines. Their presence stimulates a robust approach to internal benchmarking, complementing that of the external challenge. This combination of internal and external expertise ensures rigorous testing of existing designs and specifications.

The PCD 2.0 process also provides companies with an important advantage by enabling them to generate their own design improvements for cost reduction. Doing so provides them with a trump card in negotiations, as they no longer have to rely on suppliers for technical input.

For each cost topic, PCD 2.0 makes use of technical design levers across short, medium, and long-term time horizons. In order to understand how these levers impact outcomes, it is useful to look at three examples of how they are used in practice.


Exhibit 3: Examples of technical improvement levers

Levers

IMPLEMENTATION TIME FRAME

Short Medium Long

Feature optimization and reduction

Change request optimization

Variant optimization

Standardization

Testing optimization

Cost performance value engineering

Platform strategy development

Analytics-driven DFMA

Design simplification

Modularization and standard interface

Overspecification and tolerancing

Material selection and substitutes

Rapid prototyping


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Analytics-driven DFMA (Design for Manufacturing & Assembly) is an example of a powerful technical lever that can produce impact in the relatively short term. DFMA integrates data from multiple sources on products, processes, suppliers, and quality into an analytics engine. The engine generates optimization insights, uncovering correlations previously hidden to the company. These are then addressed individually.

By leveraging technical insights, based on a more granular understanding of cost structures, it is possible to implement DFMA to unlock new opportunities in traditional commercial negotiations or for internal improvements once the components are produced in-house. For example, in the volume segment of one automotive OEM, the approach has enabled comprehensive analysis of the cost drivers of a safety-critical assembly, identifying the root causes of prolonged cycle time and labor intensity. This analysis led the OEM to revise its design so that it is better tailored to the assembly process. The impact has been to reduce the number of individual components and to design simpler ergonomics.

In a second example, the introduction of new technologies, such as rapid prototyping, can be used over the medium-term horizon to produce significant cost reduction opportunities. Rapid prototyping enables functional samples to be validated quickly, thereby helping to accelerate discussions with internal engineering teams, suppliers, and other external stakeholders. At one international automotive manufacturer, this approach has enabled them to redesign and simplify a crucial electronic assembly, producing a functioning prototype within ten days using 3D-printed engineering-grade thermoplastics. The new design was implemented in six months, saving more than 50 percent.

Long-term levers, such as modularization and platform strategies, with a high degree of reusability across a wide range of different product variants and derivations, typically unlock the biggest savings opportunities, since they address simultaneously the vast majority of product cost categories. However, they typically come with an implementation horizon of at least 12 months due to the significant amount of product development and verification activities required. In the example of a satellite manufacturer, which was facing technological disruption on one of its key platforms, the company managed to reduce its cost base by greater than 30 percent in the areas within scope. It achieved this within 24 months through the fundamental redesign of its platform strategy. This has enabled the manufacturer to secure a leading position in the market.


Adopting agile processes to produce rapid resultsThe third aspect that differentiates PCD 2.0 from traditional approaches is that it relies on

agile methods to ensure holistic coverage of the product as a whole, rather than focusing on

individual aspects of functionality.

PCD 2.0’s agile process involves stakeholders from all the major product areas and functions.

The approach uses clusters of experts to address two dimensions: Firstly, it uses specialists

to identify particular root causes or “cost topics.” Secondly, it uses clusters of experts across

product functionalities to take a holistic product view. By rotating through the different

combinations of topics and functionalities, this approach ensures that the various perspectives

as well as downstream and upstream consequences are taken into account when developing

new cost-reduction ideas. This avoids the problems of traditional cost reduction approaches,

where lower costs in one area often are offset by unexpectedly higher costs in another.

The approach enables the agile teams to rapidly generate ideas. The ideas are then

validated and refined in multiple sprints in the drive towards an implementation-ready

business case. Depending on the complexity, first results can be placed on the table within

weeks of the start date.

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Exhibit 4: Agile sprint process

1–2 weeks

3 weeks

3 weeks

4–6 weeks

2–5 weeks

2–4 weeks

• Identify major costissues

• Layout project planand select analysis

• Agree on datacollection andanalysis

• Perform costinnovationworkshops

• Set-up root causeanalysis as well aspotential supplierdeep-dives

• Work out solutionsfor root causes

• Perform costinnovation supplierworkshops

• Prioritizelevers/measures

• Specifylevers/measures withsuppliers and detailbusiness case as wellas risk register

• Set-upimplementation plan

• Perform finalvalidation

• Approveimplementation

• Confirmimplementation

SET UP

IGNITE

INNOVATE

Sprint 0

Sprint 1

Sprint 2

SOLVE

SPECIFY

VALIDATE

Sprint 3

Sprint 4

Sprint 5

IMPLEMENT

Sprint 6



SEIZING THE OPPORTUNITYPCD 2.0 represents a major opportunity for companies to unlock step changes in efficiency.

To turn it into a success story, companies need to embrace a new mindset that fundamentally

challenges the status quo across the value chain, from product design to assembly and

shipping. This requires full and continuous leadership involvement and a clear communication

of the new paradigm.

In our experience, the success of this transition depends on several key factors:

Treat product cost reduction as a proactive opportunity rather than a reactive tool.

Start re-evaluating the product cost base well before any crisis arises. This ensures the

company has sufficient flexibility when designing improvements.

Combine quick wins that result in rapid profitability improvements with longer-

term measures to create compelling success stories that inspire the organization

and to unlock short-term cash to fund more transformative levers.

Involve customers and suppliers in the product cost-reduction efforts

Integrating customer feedback on functionality and specification priorities can be crucial

for maintaining and expanding product value. Linking design improvements to supplier

capabilities creates benefits for both, strengthening strategic relationships by moving

them beyond the point of merely being transactional in nature.

Integrate the methodology and learnings from PCD 2.0 into the organization

to ensure they become an inherent part of the company’s cost management approach.

Whether a company is facing a major industry disruption or economic volatility, revisiting the

core tenets of their cost structure and value chain should be a key priority on any executive

agenda. The next level of product cost optimization lies within reach for any company that

seizes the opportunity.

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ABOUT

Oliver Wyman is a global leader in management consulting that combines deep industry knowledge with specialized expertise in strategy, operations, risk management, and organization transformation.

Oliver Wyman’s global Operations Practice specializes in end-to-end operations transformation capabilities to address costs, risks, efficiency, and effectiveness. Our global team offers a comprehensive and expert set of functional capabilities and high-impact solutions to address the key issues faces by Chief Operating Officers and Chief Procurement Officers across industries.

In the Retail & Consumer Goods Practice, we draw on unrivalled customer and strategic insight and state-of-the-art analytical techniques to deliver better results for our clients. We understand what it takes to win in retail: an obsession with serving the customer, constant dedication to better execution, and a relentless drive to improve capabilities. We believe our hands-on approach to making change happen is truly unique – and over the last 20 years, we’ve built our business by helping retailers build theirs.

AUTHORS

Christian Heiss Partner, Operations Practice

CONTACTS

Frederic Thomas-Dupuis Retail & Consumer Goods Practice Lead, North America [email protected]

Coen De Vuijst Retail & Consumer Goods Practice Lead, UK and The Netherlands [email protected]

Salim Poonawala Retail & Consumer Goods Practice Lead, France [email protected]

Rainer Muench Retail & Consumer Goods Practice Lead, DACH [email protected]

David Kaufmann Partner, Operations Practice

Mark Kiel Principal, Operations Practice

Wai-Chan Chan Retail & Consumer Goods Practice Lead, Asia [email protected]

Maria Miralles Retail & Consumer Goods Practice Lead, Iberia [email protected]

Ronan Gilhawley Retail & Consumer Goods Practice Lead, Australia and New Zealand [email protected]

For more information please visit: ww.oliverwyman.com

http://[email protected]

http://www.oliverwyman.com


All rights reserved. This report may not be reproduced or redistributed, in whole or in part, without the written permission of Oliver Wyman and Oliver Wyman accepts no liability whatsoever for the actions of third parties in this respect.

The information and opinions in this report were prepared by Oliver Wyman. This report is not investment advice and should not be relied on for such advice or as a substitute for consultation with professional accountants, tax, legal or financial advisors. Oliver Wyman has made every effort to use reliable, up-to-date and comprehensive information and analysis, but all information is provided without warranty of any kind, express or implied. Oliver Wyman disclaims any responsibility to update the information or conclusions in this report. Oliver Wyman accepts no liability for any loss arising from any action taken or refrained from as a result of information contained in this report or any reports or sources of information referred to herein, or for any consequential, special or similar damages even if advised of the possibility of such damages. The report is not an offer to buy or sell securities or a solicitation of an offer to buy or sell securities. This report may not be sold without the written consent of Oliver Wyman.

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PRODUCT COST DOWN 2.0 FOR CONSUMER AND ......FOR CONSUMER AND DURABLE GOODS TAKING PRODUCT COST OPTIMIZATION TO THE NEXT LEVEL 1 Traditional cost reduction approaches are reaching