Target Costing

History

Target costing was invented by Toyota in 1965.

•Target costing which has been widely used by Japanese firms since 1970s now is spread all over the world

•Main industries: transportation and heavy equipment industries (Intensive competition, extensive supply chains, and relatively long product development cycles)

•80-90% of the life cycle cost is determined at the design phase of the product

Definition• Target Costing is defined as a cost

management tool for reducing the overall cost of a product over its entire life-cycle with the help of production, engineering, research and design.

• A target cost is the maximum amount of cost that can be incurred on a product.

• Target Cost = Market Price – Expected Margin

TARGET COST MANAGEMENT

Target costing objectives• To identify the cost at which the product must be manufactured if

it's to earn its target profit margin at its expected or target selling price.

• To decompose the production process and then to set cost targets for each product element.

Approaches to target costing

• Price-based targeting

• Cost-based targeting

• Value-based targeting

Price-based targeting

• Sets target cost for the product through comparison with that of competitors

• This means setting the price of the product by observing what the market will bear, then deducting the desired profit margin from the price, and thereby obtaining the target cost.

Cost-based targeting

• It sets the cost 1st, then the desired profit margin is derived at the price of the product.

• This method requires the suppliers to reveal the very details of their cost structure and will sour the buyer-supplier relationships so itsn’t good for the long run.

Value-based targeting

• It sets the price by what it thinks the market will ‘value’ the product

• After that, the producer sets the desired profit margin and then tries all ways to keep the cost below that of the target cost.

Benefits• Delivering the optimal value proposition to

end customers. • Minimizing production-line complexity.

• Selecting appropriate product and process technologies.

• Lowering product design late in the innovation process.

• Eliminating cost overruns.

Implementation

1. Price-led costing ~ Market prices are used to determine target costs

2. Focus on customers ~ Value to the customer must be greater than the cost of the product itself

3. Focus on design ~ Cost control must occur before production

4. Cross-functional involvement ~ Interfunctional product and process teams

5. Value-chain involvement ~ All members of the value chain included

6. Life-cycle orientation ~ Minimizing total life-cycle costs

Negative points• Possible misuse of the technique.

• Producers might make use of cost-based target costing to squeeze the profit margins of suppliers, thereby getting materials at the lowest cost possible.

• The stress on the design team of companies using target costing

• disadvantage to the company- Product development time might be lengthen as product is repeatedly designed to bring cost below that of target.