Product Costing

Elon Musk has a magic touch. Whatever he does seem to be a success and he thinks big. He successfully built and sold PayPal, sends gigantic rockets to space, designs and builds the best electric cars on earth, plots how to turn earth to run completely on solar energy and does a lot more. You would have rightly guessed that these are not purely luck and unexplained magic. As in all magic, there is a design to Elon Musk's magic too. One of his magical tools is First Principle thinking against Analogy Thinking. First Principle is a concept in physics where you reduce a given problem into fundamental facts and from there work your way up. How does Elon Musk use this principle to his advantage? Let's hear from the horse mouth.

In case you are not able to watch the video above(for whatever reason), a quick summary here. People normally use Analogy Thinking approach to arrive at a decision, but by using "First Principle" approach you can get significant insights. Let's taken an example, if you ask a battery company how much it costs to make a 1kwhr lithium ion battery, they would think 'currently it costs 1500$ to make so and so battery and based on that it should cost 700$ for a 1kwhr lithium ion battery'. This is "Analogy Thinking". Instead, if they go by "First Principle", they would start from basically what the battery is made of, like lithium, nickel, cadmium etc. What these metals and other raw materials cost in the commodity market for the given quantity. So, it turns out for making 1kwhr battery they would need 80$ worth of these raw materials. So essentially they need to figure out a clever way to put together all these raw materials to make a battery so that it costs just 200$. That's it.

So, here the problem is redefined and simplified and when you succeed in figuring out that clever way you become successful like Elon Musk. This is a great lesson for companies dealing with products. Companies should know what is the "First Principle" cost of their products at any given time and in the future too. This will provide them with breakthrough advantage against competitors. This is where an effectively implemented product costing solution would help. With increased maturity of PLM solutions enterprise the product costing solution is  becoming easier to implement. 

What does a product costing solutions consist of? Essentially, it should tell how much it would cost to produce, maintain and retire a given product, right from the conception till the product becomes obsolete. The cost of end product is calculated by exploding the Bills of Material of the product and calculating the cost of an individual part and way up to the product. So, calculating the cost of the individual part cost forms the core logic in "Product Costing" application. The cost of an individual part is a function of time, place, location in addition to its engineering specifications. That is where you need, when you need, how much you need and from whom you buy. 

In addition to the above variables there is one more dimension; the "maturity of the calculated cost". When the product is in initial, not-mature state the calculated cost is also of low maturity arrived based on a lot of assumptions and historical data. As the product design is finalized, manufacturing processes are charted out, suppliers are identified, quotations from them are received the cost arrived at becomes much more certain.

Hence the most important thing in a "Product Costing" solution is that it needs to be flexible enough to capture and use these varied information effectively. In the process the solution should always track the "First Principle Cost" because that's the real cost everything else is an opportunity to beat competition.