XYZ Company is a large manufacturer of auto parts for the auto manufacturers and parts distributors. XYZ has plants throughout the world, but most are located in North America. XYZ is known for the quality of its parts and for the reliability of its operations. Customers receive their orders in a timely manner and there are no errors in the shipment or billing of these orders. For these reasons, XYZ has been able to prosper in a business that is very competitive, with competitors such as Delphi, Visteon and others.
XYZ just received an order for 100 auto parts from National Motors corp., a major auto manufacturer. National proposed a $1,500 selling price per part. XYZ usually earned 20% operating margin as a percent of sales. XYZ recently decided to use target costing in pricing its products. An examination of the production costs by the engineers and accountants showed that this part was assigned a "standard" full cost of $1,425 per part (this includes $1,000 production, $200 marketing, and $225 general & administration costs per part). A value Assessment Group (VAG) undertook a cost reduction program for this part. Two production areas that were investigated were the defective unit rate and the tooling costs. The $1,000 production costs included a normal defective cost of $85 per part. Group leaders suggested that production changes could reduce defective cost to $25 per part.
Forty-five different tools were used to make the auto part. The group discovered that the number of tools could be reduced to 30 and less expensive tools could be used on this part to meet National's product specifications. These changes saved an additional $105 of production cost per part. By studying other problem areas, the group found that general & administration costs could be reduced by $50 per unit through use of electronic data interchange with suppliers and just-in-time inventory management.
In addition, XYZ's sales manager told the Group that National might be willing to pay a higher selling price because of XYZ's quality reputation and reliability. He believed National's proposed price was a starting point for negotiations. Of course, National had made the same offer to some of XYZ's competitors.
1. What should be XYZ's target cost per auto part? Show calculation.
2. As a result of the Value Engineering Group's efforts, determine XYZ's estimated cost for the auto part. Will XYZ meet the target cost for the part? Do you recommend that XYZ take on the National offer? Explain your reasons.