Target Costing Cooper

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rget costing lets customers not the product set the price.

Control

Tomorrows

by Robin Cooperand W. Bruce Chew

Over the past \5 years, company af-ter company has learned that qualitymu st he designed into prod ucts beforethey are m an ufa ctu red -tha t i t is ex-pensive, if not misguided, to attemptto Inspect in quality after tbe producthas left the production line. Todaythe most comp etitive com panies are . |

applying the same logic to dete rmin - 11ing the price of new products. Beforea compa ny launch es a p roduct (orfamily of products), senior managersdetermine its ideal selling price, es-tablish the feasibility of meeting thatprice, and then control costs to ensurethat the price is met. They are usinga m an ag em en t p r o ces s k n o w n astarget costing.

Target costing drives a product de-

velopment strategy that focuses thedesign team on the ultimate custom erand on the real oppor tuni ty in themarket. Leading Japanese electronicsand vehicle manufacturers have usedtarget costing to their advantage, andcompanies are now introducing it inthe United States, Germany, and else-where. I ts r igorous cost-managementtechnique helps prevent senior man-ag e r s fr om I au n eb in g l o w - m a r g in

products that do not generate appropri-a te r e tu rns to the company , hu t i t s

OPF

through the chain of production to produdesigners. Target costing ensures that dev

opment teams will bring profitable produto market not only with the r ight level

quality and functionality but also with apropriate prices for the targeted custom

segments. It is a discipline that harmnizes tbe labor of disparate participan

in the development effort, from desigcrs and manufactur ing engineers

market researehers and suppliers.The logic of target costing is simp

Looking at tomo rrow s m arketplace, to rgan iza t ion maps cus tomer segmen

and targets the most attractive ones. It dtermines what level of quality and funt ional i ty wil l succeed within each sement, given a predetermined target pr[and volume and launch date). The orgazation then designs the sourcing, produ

3 t i o n , and del ivery processes tha t w il l eable it to achieve its desired profits

- this target. In effect, the com pan y r

sons backward from c ustom ers needs awillingness to pay instead of followithe flawed but common practice of co



osts Through T od ay sDes igns

o s t D is c iplin e W h y N o w ?

The logic of target costing is so simple and com-der why it has only recent-

before it was designed.

undue influence over the company's competi-

ex post facto by cuttin geliminating frills, outsourcing, or reengineer-

t as mu ch as 70 to 80 of a produ ct's costs

hand s. As product and process technologies

even more strongly tied to its design.Nevertheless, although a preemptive and disci-

able, it has not always been urgent, and companiesdo not usually und ertake difficult tasks if the task sare avoidable. These days, however, price and costtargeting are no longer avoidable, largely because ofthe erosion of important first-mover advantages inthe new global economy. In the past, many leadingcompanies, especially those that led by technicaldifferentiation, found that they could take a cost-plus approach to releasing new products becausethey anticipated profiting from serial generation s ofproducts. They believed that being first to marketwas most important; that in preparing to be first,

design teams needed to focus only on selecting andexecuting well the appropriate bundle of productattributes; and that ultimately, over several itera-

Robin Cooper is a professor at the Claremont Gradua teSchool s Peter F Drucker Graduate Management Centerin Claremont, CaU fornia. and author of When Lean Enterprises Colhde: Competing Through Confrontation(Harvard Business S chool Press. 1995). which draws onCooper s five-year study of the managem ent systems of20 Japanese companies. W. Bruce Chew is a senior con-sultant at Monitor Com pany, a global consulting firm inCam bridge, Massachusetts. He is a former associate pro-fessor of technology an d operations manag ement at theHarvard Business School in Boston, Massach usetts.

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tions of the product, the marketplace would allowthe company to earn a reasonable return on totalcapital employed.

tha t logic, wh en th e product w as first released,it might carry a comparatively high price consid-ered affordable by only a small number of lead

users, such as businesses hoping to turn a new tech-nology to their advantage or comp aratively wea lthy,adventurous technophiles. Lead users would paya pre m ium for the first-generation produc t andhelp create excitement for its new features; theywould even help estahlish the brand. The revenuesfrom lead users w ould rarely cover the cost of devel-oping the product. Hewlett-Packard Company, forexample, did not expect the first releases of itslaser printers to recover R&D costs. But first-mover companies have assumed that they wouldhave time to scale up to mass production and intro-

duce serially cheaper versions of products for in-creas ingly broader segments of customers . Themass market would be the source of most profits-as indeed it was for consume r products such as the

Market leaders have no choicebut to manage costs from the

design phase forward.35-millimeter camera and the fax, and for compo-nents such as ABS brakes and digital TV controls.

Today that strategic assumption would be disas-trous for all but the most advanced products, thosewith highly proprietary technologies. Global mar-kets no longer allow a company tim e to introduce aproduct and then scale up. Now im itato rs-u sua llylean enterprises - can bring me too products tomarket so rapidly that first-mover companies have

no time to inculcate brand loyalty, let alone recovertheir development costs. Lean competitors, withfaster reflexes than old mass-production compa-nies, work on shorter product-developm ent and lifecycles, and they manufacture almost anywhere -Korea, Mexico, Israel,

Tbe growing number and increasing ubiquity oflean competitors means that copycat versions ofmost new products will be available with in mo nths,not years. So if market leaders ean't recover costsas they used to, they have no choice but to manage

costs from the design phase forward and to launchproducts a t prices that wil l a t t ract broad seg-ments of customers and forestall imitation. How

often depend on how quickly they can offer grefunctionality without raising price.

For companies to gain and hold market leadship today, tbey have to design the cost out of tproducts when tbey set initial levels of quality functionality and they have to calibrate prod

performance to an identified price nicbe. In owords, senior managers need to approach new pruct development controlling for tomorrow's conot just today's. And tomorrow comes more quly than it used to.

O lym pu s From Cost Targets toTarget Costing

In Japan, com petition among lean comp anies become so intense that aggressive cost manament is critical to survival in some sectors. Ithu s no accident that leading organizations suchOlympus Optical Company and Komatsu devoped and adapted target costing early on.

Olympus was a leader in single-lens reflex (Scameras, which had no technolocal competitor for a generation. by 1987, com pac t cam eras baround a min ia tu r iz ed e lec t roshutter had absorbed so many vanced electronic con trols - featus u ch as au t o m a t i c ex p o s u re

zo om -th at c onsumers began to vthem as a serious alternative to

SLR. Olym pus had introduced a com pact of its oas early as 1978, but not as a main focus of its pruct portfolio. In the mid-1980s, Olympus began ing money, and by 1987 its losses were substan

Senior managers saw severe problems. Cameincorporating the new electronic technologies fered from poor quality and there were no indivual product hit s. The managers concluded the planning and development of product famineeded improvement. Externally, Olympus sfered from the sudden shift from SLR camerascompetitors' compact cameras and from a steappreciation of the yen.

Th e com pany rea cted first wi th an effort to reglost share by introducing a number of new pructs-for example, SLRs with advanced electronand compacts with an advanced zoom. A secinitiative was aimed at improving quality, whhistorically had been high at Olympus and whcontinued to be crucial to its ability to lower

total costs associated w ith its produc ts.But most important to Olympus was the thinitiative: reconciling production costs to a vola



T RGET COSTING

ity to manufacture cameras t a cost that wouldmee t the increasingly stringent expe ctations of its

customers would be central to the success of any

new product. Moreover, the company's product de-velopment process would have to meet challengingprice and profit ta r^jts with in 18 mon t hs of theirbeing set - before the c ompe t i ti ve e nv i ronme n tcould shift again.

This was not the first t ime that Olym pus man-

agers had set cost targets for new products, but ear-

lier targets had been more or less bypotheticai. Se-

nior managers had created no imperative to meetthem, and missed targets did not prevent productsfrom being launched. Essentially, designers did

their best on functionali ty, m anu facturin g engi-neers pursued efficiency, and mark eting sold what

changed in 1987.

First, Olym pus tried to establish a clearer pictureof what features future customers would value in

It produced a corporate plantha t identified the future mix of businesses by ma-

the desired levels of profitability, of each produ ct to the cultiva-

of the brand. And it performed a technology re- to learn how current and future technologies

the camera business. The technology an audit of Olympus's proprietary

e turned to the company's Its market mapping included an analy-

s of the general business environment to deter-ine how ma croeco nom ic factors, such as changing

and the further segm entat ion of

to affect con sum er the marke t ing re-

a survey of infor-

at fashioninterviews w ith photog-

as w e l l as a c o m p e t i t i v e

led pate nts.

With a clearer sense of wha t the

and wha t Olympu s ' sty goals required, the com pany identified

at which new compact cameras The U.S. m arke t price for basic com-

in 1991 was about $100. With as a basel ine , Olym pus analyzed con-

and for-

to establish wha t rela- it could ant ic ipate between dis t inct ive

as mag nification capability

price point , Olympus subtracted the appropriatemargins for dealers and its U.S. subsid iary and a lsosubtracted import costs, such as freight and duties,to arrive at the price that would be paid to the fac-

tory for any new model. Then, by subtracting its

own margin requirement, Olympus finally arrivedat a prelimin ary target cost for each new product.

Now what it needed was a disciplined process for

developing products that could be made at thosecosts. The responsibility ft r ensuring that th e com -pany could produce cameras with the features cus-tomers wanted and at cos ts wi thin the targetedlimits fell to a product-development managem entteam at Ta t suno, the site of Olym pus 's pr imarymanufactur ing operat ions . Only when des ignersand manufactur ing engineers could demonstra tethat estimated production costs did not exceed tar-get costs would a camera be sub mitte d for release to

production.

Olympus Moves to lose the Gaps

This process may sound straightforward, but it

was not: Only about 20% of proposed new modelscleared Olympus's hurdle on the first p ass. How ev-er, tbe 80% th at m issed were not abandoned. As at

many companies, it was not unc ommon at Olym-pus for product m anagers to design nice-to -hav ebut not need -to-have features into their prod ucts.

The product-development management team's jobwas to ask whether the value those features addedreal ly outweighed thei r cos ts . Correspondingly,they would ask whether an enhanced product could

If target costs could not be metor price points could not be

changed, the product wasreturned to R&D for redesign .

justifiably be moved to the next higher price po intso that its estimated costs would generate accept-able returns.

Soon enough, those reviews ended. If target costscould not be met or price poin ts cou ld not be

changed, the team returned the product to researchand development for redesign.

In the context of tbis review, Olympus managersused a life-cycle analysis to reckon the costs of

impor tan t new technologies incorporated in new



TARGET COSTING

a technology's contribution to features that couldbe expected to serve a variety of models over the lifecycle of a whole product family; they did not at-tribu te the techn ology's costs only to the first m od-els introduced. Further, they separated the wholecost of a new technology into its two components:

the costs of research and development and the costsof prod uction.

The Olympus product-development team deter-mined that in allocating research and developmentcosts, product designers should consider how longa camera family is likely to be on the market (onthe order of th ree years} or how long a specific fea-ture is likely to find application in other camerafamilies. As for production costs, Olympus manag-ers learned that even after a product family comesto market, the costs associated with new technol-ogy often decline quickly and dramatically withthe adoption of manufacturing programs that actu-ally increase product quality-for instance, by re-ducing the nu mb er of parts in a suhassemhly, elimi-nating labor-intensive mechanical adjustments, ormoving from me tal or glass to plastic. The num berof parts in the shutter unit of one entire class ofcompact cameras, for example, fell from 105 to 56,a redu ction tha t led to a 58 decrease in produc-tion costs for this widely used component. By

Target cos ting is an iterativeprocess that cannot bedecoupled from the push andpull of the design pro cess .

1990, Olympus managers had discovered that thecompany could generally reduce its produc tion c osts

by approximately 35 across the production life-time of its new products. The product-developm entmanagement team incorporated this figure into itstarget costing of future products.

On the whole, life-cycle analysis helped manypotentially profitable products clear the hurdle.The practice may sou nd vaguely like the old strate-gy of distributing costs over successive generationsof buyers, from lead users to m ass m ark ets, but it isdifferent. There is no thought here of introducingthe product family at high prices that then fall as

volum e incre ases. Cost, not price, is expected to fall.Cost reductions of tbis magnitude don't happen

costs , purchased-parts costs , rout ine produccosts, the eosts of defective production, capautil ization targets, and overhead expenses. AOlym pus used its falling production costs in a nuber of ways. At times, it raised margins; at ott imes, it selectively dropped price points. On

whole, however, the company used cost savingsimprove its products over tim e. The one thing itnot do was take a short-term profit, which, in unfo rgiv ing env i r onm ent of l ean c om pet i t iwould have been the most dangerous optioncompany that just cashes in its market advantinvites imitation and invests nothing in sustainits technic al differentiation.

Komatsu s Sup pliers Bring Costs Do w

As the Olympus experience i l lus t rates , tarcosting issues a clear-cut but daunting challeto product designers. They cannot call a desigsuccess unless they meet the functionality neof the customer, the price demands of the distrit ion channel, the manufacturabili ty requiremeof the plant, and the financial projections of corporation.

Komatsu's experience illustrates another wayuse target cos tin g- in this case to pressure suppl

to drive their costs down. Komate a r t h - m o v i n g p r o d u c t s c o n t

m an y m o re co m p o n en t s t h an Olympus 's cameras , and the cpany relics more heavily on outssuppliers for complete subsystehydraul ic devices , e lectr ical sassemblies, and the like. In 1993,ex am p l e , Ko m a t s u m an u fac t uroughly 30 of the con ten t inheavy equipment products, desig

and subcontracted 50 , and purchased the remaing 20 from outside suppliers.

Moreover, the number of choices Komatsu mmake regarding components makes it difficulcontrol developm ent costs. Wbicb features w illcompany offer on which models? Which teneed additional support? Where should the cpany be refining designs and where should it bethinking entire design approaches? Komatsu minvolve suppliers in product design early in ordema ke informed decisions in those and other imptant matters.

Th ro u g h o u t t b e en t i r e p ro d u c t -d ev e l o p m

process, Komatsu poses a challenge to its supers; to maintain the performance specificationcomponents and deliver at prices consistent w



Targeting osts in Process and Service Industries

Target costing has made its mark in industries inwhich products require a good deal of production as-semhly - cars, cameras, and bulldozers, for example.However, the discipline target costing offers has usesoutside the assembly e nvironm ent.

In processing companies, where the characteristicsof the proc ess- t ime , temperature,and pressure - determine the per-formance of the product, the focusof target costing shifts from theproduc t to the process . A s tee lcompany would tend to focus onthe costs associated with routingsand processing time; a paper mill,on those associated with speed and

breakage. The key issues - under-standing market needs, ensuringsatisfactory financial performanceat a given price, not exceeding thetarget cost -remain.

Similarly, target costing can heapplied to services, for which thefocus is the service delivery sys-tem. As in process-intensive man-ufacturing, process is inextricablefrom product. Think of the issuesthat are important to the delivery

of health care and fast-food func-t ions. Where services and process-intensive man ufacturing diverge is in their flexibility.It is enorm ously expensive to convert a paper ma chin eso that it can produce a grade or weight that was notconsidered in its initial design. Service delivery sys-

With service delivery system s it is tempting

to add new services and difficult not to.

tems, however, are a different matter. In people-inten-sive, customer-responsive service-delivery systems, itis not only possible to add new services, it can e hardnot to. Menus are easy to extend. Room services caneasily be added. Consulting firms or law firms can al-ways enter a new area of practice. Where is the disci-

pline that ensures that these exten-sions are profitahle?

Because a single service-deliverysystem may he used to deliver awide range of services, determin-ing the profitability of individualservices becomes an exercise in thearbitrary allocation of costs. In ser-vices, particularly those in which

waiting time is critical, it is thesystemic effects of individual newservices-for instance, the extent towhich they m ake the process morecomplex - that determine w hethertheir revenues and value to cus-tomers offset their costs. Targetcosting can still facilitate a discus-sion of the appropriateness of anew service, hut only if it focuseson the systemic impact of the ser-vice extens ion and ques t ions

whether this impact aligns withcompany strategy and profitabilitygoals. In service industries as in other industries, tar-get costing can help organizations resist the urge tocreate new market offerings simply hecause they havethe ability.

costing program provides the parameters that guide

mance needs and the com pany s mar-

ma tsu s design team can track the performance

To develop system and component targets for itsatsu relies on data on historical per-

containing information about the costs of compo-nents , help designers identify the low-cost com-

ponents. By, in effect, overlaying one table on theother, Komatsu engineers identify the target cost ofthe best component for a given project. This targetcost becom es the suppliers target price.

In developing th e target co st of an e xcav ator scooling system, for instan ce, K om atsu s engineersdetermined that the most important performancefactor was the surface area of the sy stem s radia tor.They consul ted funct ion tables to calcula te theminimum radiator surface area required. They con-sulted cost tables to calculate the most cost-effec-

tive design. Then they calculated the target cost oftheir radiator to reflect both minimums: least sur-face area and m ini m um cost per unit of area. In de-



TARGET COSTING

system be both the m ost efficient at cooling and themost cost-effective, Komatsu forced its suppliersto push the frontiers of their own technology toachiev e more efficient designs.

It is important to remember that subsystem tar-get costs must fi t within an overall target cost ,

which has been derived from a projected ma rketprice. But if subs ystem 's cost exceeds its projectedshare of the produ ct's target cost, Kom atsu does notautomatically reject the design or reduce the costtargets for other components. Like Olympus, Ko-matsu focuses not on some mechanistic algorithmbut on the complex relationship between cost andprice and the effects of both on value. Komatsu askswhether particular functions need to be continued.It provides engineering support to suppliers thatcannot meet targets. It seeks unexploited opportu-nities to reduce costs even further among compo-

nents that have already met their targets. Komatsumanagers do not measure success one departmentat a t ime . They know that the m arketplace does notreward an outs tanding eomponent , only an out-standing integrated design.

Smoothing Out theTarget Costing Process

clearly, target costing involves more than listingdollar targets and projected margins. It is a highlystructured product-development discipline, adaptedto such specific elements of a company's strategicpositioning as industry pricing dynamics, product-

complexity and l ife-cycle analyses, and supprelations. It requires a company to make a seof decisions that include defining the product cus tomers want , ascer ta ining the economics quired for profitahility, allocating targets to comnents, and identifying the gap between target c

and initial projections of manufa cturing costs. the diagram Th e Target-Costing Process. )

On the other hand, as the experiences of Olpus and Komatsu suggest, target costing is notexact science. It depends on credible data andpeople who hav e the courage to ma ke difficult juments. Target costing is an iterative process cannot be decoupled from the ordinary push pull of the design process. The targets evolveteam s seek to balance functionality, price, volumcapital investment, and costs. Also, because tacosting is integrative, responsibility for achiev

targets must be shared across functions. Finallythey are to use target costing, com panies m ust ttheir suppliers as partners both during the desprocess and wh en they are setting cost targets.

Our description may make target costing solike a smooth ride, but troublesome roadblocks show up at different stages.

Defining the Product, Targeting the MarketplThe choices that drives the entire target-cosprocess arc the customer's. What prices will ctomers accept? What functionality will they in

on? What will competitors offer them? Becauseult imate goal of target costing is to maximizproduct's total profitability, not minimize its c



The Target Costing Process

Current

Production

Economics

Quality and Functionality Targets \ Costs The Design

Challenge:

Closing the

Competitive Gap

Market

Mopping

Price Volume and Timing) Targets Target

Costs

Corporote

Financial

Requirements

their custom ers' preferences and their co mpetitors'

of the cu stomers' behaviorch market segment.

When the Japanese targeted the luxury car mar-already knew one critical fea-

of luxury cars: They had to be quiet. For years,

ry cars and found the task inheren tly difficult.

engines tended to be lou d-b ut

om many other design com ponents, includ-rivetrain, tires, and door seals. Japanese re-

, the nature of the sound was as important as

could try to tu ne the car in a pleasing

The relationship between volume and frequency

ers, Do you like this offering better than thatand stops there will not yield much insight.

must then be expressed as innovative designoptions-what we might think of as quality andfunctionality targets. It is at this point that compa-nies might use such interfunctional design tech-niques as the House of Quality, which maps the re-lationship between custom ers' desired features andspecific engineering characteristics.

It is not enough to focus on the customer; com-

petitors are parallel concern. Most companies de-fine competitors as companies that make thingssimilar to what we make, which is the producers'view of com petition. In target costing, the Japanesecompanies we have studied tend to define competi-tors from the customers' perspective: I am aboutto make a purchase, so what are my options?Olympus, for example, benchmarked itself not onlyagainst camera manufacturers but also against themakers of CD players and Walkman-type products.The company understood that it was competing for

discretionary dollars against makers of all kinds ofconsumer gadgets, not just against camera makers.

Computing Overall Target Costs. Companies de-rive overall targets in a number of different ways,but the purpose is always the same: to think rigor-ously ahout the company's future profitability. Infact, some Japanese companies classify target cost-ing as a profit-management tool rather than as acost-control tool. In any case, the task is to com-pute the costs that must not be exceeded if accept-able margins from specific products at specific price

points are to be guaranteed.For most companies, this order of logic repre-sents radical shift in thinking. Traditionally, com-



TARGET COSTING

with product development only after much of thedevelopment work has been done, and then only todeterm ine whethe r to continue in vestm ent. In con-trast, a financial analysis done early in the designprocess can accomplish much more. In target cost-ing, it can tell design team s and general manag ers a

great deal about w hat is required to ma ke the prod-uct a success. The n ature of the analysis may he thesame, but shifts in timing and focus make a hugedifference.

One U.S. vehicle maker we have worked withperformed a financial analysis to estimate a likely

Aggressive targets focus theefforts of the design team on

creative solutions and pressvalue engineering to its limits.

re tu rn on inves tm ent for a redes igned produc tlaunched under a single set of hypothetical condi-t ions. The purpose of the analysis was to make se-nior managers more comfortable with their deci-sion to go ahead. So although the an alysis aided theapproval process, it provided little guidance to the

design team. It displayed no sensitivity to the factthat conditions such as launch date, cost, and vol-ume are variable and that small changes matter.Our analysis of the company's data showed thatto miss cost targets would have been catastrophic:A 5% error would have eliminated any return onthe company's $200 million investm ent.

Allocating Target Costs, Identifying the Gap.Once a target cost has been calculated for a newproduct, the design team has to divide it up amongthe product's various functions. How much can the

team spend on one function as against all the oth-ers: The team must first calculate the gap betweenthe target cost and what it estimates it would costto build the product with today's processes, suppli-ers, productivity levels, and materials. The differ-ence is a good approxim ation of the excess cost th atm ust be wrung ou t of the new p roduct.

It usually m akes no sense to apply cost-reduc tionrequirements uniformly across all the componentsa nd s ubs ys t e ms o f t he c on t e mpl a t e d p roduc t .Rather , the des ign team can consul t cus tomer-

value surveys, historical trends, and other data toguide it in determining how much cost it can re-move from each component or subassembly. The

(allowing for increased engine cost in a car thaintended to have a peppier ride, for example). every extra dollar i t al locates to improving product feature mu st come from another functioallocation, because the target cost rema ins fixed

Isuzu Motors' target-costing system, like othe

aims to keep prices constant while adding as m ufunction ality as possible to each new g enerationvehicles. The system therefore attaches great portance to determining what features and levelperformance the customer will want most, anduses those preferences as the basis for allocat

costs to major functions and grcom ponen ts. Market researchers cus tomers to es t imate how muthey wo uld pay for a given functiThen they develop ratios of prefence by asking cus tomers to emate tbe relative importance of efunction on a 100-point scale.

I suzu uses th i s in format ionspread a product's target cost amthe major specif ied funct ion

provements. If the target cost for a componentoo low to allow a sufficiently attr ac tive or safe vsion to be produced, the component's target cosincreased and the target cost of other componeis decreased. Thus, Isuzu continually uses its bsense of customer value to drive its design tea

cost-allocation decisions.Obeying the Card ina l Rule . Al l des ign- te

members, whatever their function specialty, mregard the overall final cost target as an unalteracommitment ; target commitments outrank descommitments. The idea is that aggressive targfocus the efforts of the design team on creative lution s and press value engineering to its limits.

In otber words, to say that target costing isiterative process is no t to say that target costs, oset, are then subject to ongoing debate. They

not. Targets must fall under the protection of wwe call the cardinal rule If you cannot meet targets, you cannot launch the product. That bethe case, the process of product definition and get generation con tinues, but not in the factory.

Some companies have a layered set of targThe first pass is the simplest, and failure here leto a m ore soph isticated life-cycle a nalysis. But approaeh must not become a game with ever lohurdles, each test becoming less rigorous than one before. As one ma nage r puts it, In the past,

specific project failed the test for funding, we kept chan ging the assu m ption s for the project orvising the test until the project passed. Target c



Th e cardin al rule applies to the pro duc t as awhole . When targets are ass igned to individualsubassembly team s, some team s will beat their tar-gets, some will m eet the m , and some will fall short.Bu t s uc c e s s is no t de t e r m i ne d c om pon e n t bycomp onent; i t is achie ved -or n o t- b y the final prod-uct. When com ponen ts turn out to be more expen-

s ive than ant ic ipated, that cos t must he offsetsomewhere else in the design. This requirement de-m and s a degree t)f cooperation and team spirit tha t

get osting and the Organization

A ny s ys t e m t ha t c u t s a c r os s o r ga n i z a t i ona lboundaries and communicates so many vital eco-

iness. One of the m ain ben efits of target costing

In many companies, clari ty of communicationay be sacr if iced to a general com m itm en t to

of the supplier were measured by m odu le.

All those measures were related, but none ad-

gned to a par ticula r s ubs ystem

uch do custome rs value this subsystem- or W hatsubsy stem cost?

Target costing requires that such problem s be ad-

about what customers want and what prices theyare prepared to pay. Finally, target costing createsoppor tuni t i e s to dem ons t ra te a com mi tm ent tocustomers. If targets cannot be met, the companycannot simply raise the price and launch the prod-uct. Such discipline may be painful to the peoplewho work on a project, but it sends an importantmessage to the organization as a whole: that cus-tomers come first and that if the company doesn'tcreate value for them , a com petitor will.

Making It Work

For target costing to succeed, targets must notonly be valid, people must also see them as valid.T he y c a nn o t be t he ou t c om e of a po l i t i c a lprocess. The market analysis that yields the targetprices, the financial analysis that generates the

target costs, and the d isaggregation procedures thatallocate costs among components and subassem-blies - all must be trusted. The target-costing pro-cess m ust, therefore, be highly transpa rent.

Moreover , cos t -reduct ion object ives must beachievable most of the time. Setting the bar toohigh can be as damaging as having no bar at all; infact, the Japanese set a series of what they call tip-toe objectives that i s , object ives that may hereached by standing on t iptoe s - a s tretch thatstrains the organization but does no t defeat it. Also,

the requirements for product functionality must beclearly and publicly articulated so that nobody triesto acbieve the target cost by reducing product func-tion ality below a ccepta ble lev els. It is no good to re-duce costs by shortchanging custom ers.

When target cos t ing works wel l , quant i f iablehurdles are established in a transparent process,and senior managers commit themselves to whatthe numbers show. Engineers receive goals that areclear and achievable, and everyone adheres to thecardinal rule. A company that meets those require-

ments is not guaranteed a victory in the markets itenters. It does earn th e right to com pete.

The authors gratefully acknowledge the assistance of ernard

Avishai in developing and writing this article.

Rep rint961 04 For ordering inform ation, seepag e 172.

Target Costing Cooper

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