Applying target costing in the development of marketable and environmentally friendly products from swine waste

Engineering Economist, April-June, 2008 by Yuang-Sung Al Chen, Gilroy J. Zuckerman, Kelly Zering

COMPETITIVE MARKET ENVIRONMENT OF PRODUCTS FROM SWINE MANURE

The purpose of using the target costing system for the swine manure byproducts project is to enable researchers to develop a methodology for identifying and producing by-products that deliver functionality and quality at a cost that achieves the goals of minimizing swine manure treatment costs for hog farm operators and reasonable profit for treatment processors. Table 1 provides a list of innovative products from swine manure products that may become viable market products (Humenik et al. 2005).

Swine manure products face highly competitive markets because of existing substitutes (e.g., the chemical-based fertilizer industry), poor public perception, and other sources of feedstock (including, but not limited to, other manure, biomass and wastes). Each of the key marketable swine manure products identified by the market analysis has to compete with the existing products and/or emerging sources of supply. For example, the swine waste product ethanol faces direct competition from the traditional production methods using corn. Swine manure methanol has to compete primarily with methanol produced from natural gas and coal as well as agricultural residues, forest residues, and organic municipal solid waste, among others. However, the economic environment of upward pressure on oil, gasoline, electricity, and natural gas prices favors development of alternative energy products from renewable sources, such as biomethanol.

BIOMETHANOL TARGET COST

Target cost is calculated as target price minus the desired profit margin for the biomethanol production system. (1) Target price is calculated as the methanol average market price of $0.92 ($0.91-$0.93 per gallon, per August 2007) plus current tax credits and subsidies ($0.60 per gallon) (2) for a total of $1.52 per gallon of biomethanol. In this example, zero profit is assumed for the biomethanol production system because a non-zero required profit would lower the target cost and, thus, make it a more challenging goal to achieve. For this study, biomethanol production is assumed to be a no net-cost center where revenue is just sufficient to cover all investment and operating costs. Therefore, target cost is calculated in Table 2 as target price ($1.52 per gallon) minus biomethanol production profit ($0.00) for a net cost of $1.52 per gallon of biomethanol.

Given the market challenges, diversification of demand, and keen competition, innovative cost management methods must be applied to new product design and development to meet customer demands at the lowest costs. It is imperative to consider managing the total cost of new products, which includes the costs of product development, design, production, and life-cycle activities. Most of the costs in the production phase are determined in the stage of new product development and design, which supports the need for target costing (Cooper and Slagmulder 1997).

The next section describes the initial process for producing biomethanol from swine manure. The analysis relies heavily on published information, consultations with experts, and best rational assumptions to develop the improvement in the initial process that will produce the significant cost reduction mandated by the target costing process.

APPLYING VALUE ENGINEERING TO REDUCE THE COST OF PRODUCING BIOMETHANOL

Value engineering is a widely used methodology for achieving a set target cost. Value engineering (VE) can be used to redesign the existing system to achieve biomethanol's target cost. VE's purpose is to attain the desired function at a minimum cost. Cooper (1995) suggests that the task of VE is to "help a firm maintain the perceived value of its products by helping the firm's product engineers make appropriate trade-offs between functionality and cost" (pp. 166). VE is performed along with target costing during the design phase of product development. Both techniques are intertwined.

Cooper (1995) stated that VE has two objectives. The first objective is "to ensure that products are designed to have the highest value possible" (pp. 169) and the second is "to ensure that the prices paid for the purchased parts are low enough to achieve the product's target cost" (pp. 169). There are different techniques used in VE for target costing. One method is a cost deployment flowchart. Developing a cost deployment flowchart helps ensure that cost reduction activities are applied to a product in the early stages of development.

DESCRIPTION OF BIOMETHANOL INITIAL PROCESS DESIGN: PIPING METHANE FROM INDIVIDUAL FARMS TO A CENTRALIZED BIOMETHANOL FACILITY

The initial process includes producing methane on farms using ambient, covered anaerobic digesters. The gaseous methane is collected and piped to a centralized plant to be converted into biomethanol. This process calculates the number of pigs required to supply sufficient methane to the plant. A radius around the central biomethanol facility that contains the required number of pigs can then be determined and the piping costs can be estimated.