Target Costing
-An allowable amount if cost that can be incurred on a product and still earn the required profit from
that product.
-A system under which a company plans in advance for the price points, product costs, and margins
that it wants to achieve for a new product.
Cost gap – The estimated cost less the target cost. When a product
Competitive market considerations drive cost planning
Prices determine costs
Only profitable products produced
Customer input guides cost reduction
Supplier involve early
Minimizes cost of ownership to customer
Target Cost = Market determined price – Profit margin
Market Research – Market research is an organized effort to gather information about target markets
or customers.
Competition/Competitor Analysis – An assessment of the strengths and weaknesses of current and
potential competitors.
Define Customer niche – Product features aimed at satisfying specific market needs, as well as the
price range
Understand customer – It involves getting to know your customers so well that you can anticipate
their needs and exceed their expectations.
Define product features – Characteristics of your product that describe its appearance, components,
and capabilities.
Market price – The price of a commodity when sold in a given market.
Profit margin – The amount by which revenue from sales exceeds costs in a business.
Key Features of Target Costing
The company is a Price Taker rather than a Price Maker.
The minimum required profit margin is already included in the target selling price.
It is part of management strategy to focus on cost reduction and effective cost management.
Product design, specifications, and customer expectations are already built in while formulating
the total price.
The difference between current cost and the target cost is the “cost reduction,” which
management wants to achieve.
A team is formed to integrate activities such as designing, purchasing, manufacturing,
marketing, etc. to find and achieve the target cost.
Methods to Reduce Cost
Reduce number of components
Use standard components
Improve labor efficiency
Cheaper materials
New technology
Cut non-value added
Pricing
Set by research
What market will bear
Not cost determined
Benefits of using Target Costing
The organization will have an early external focus so its product development.
Only those features that are of value to customers will be included in product design. Target
costing at an early stage considers carefully the product that is intended. Features unlikely to be
valued by customer will be excluded.
Cost control will begin much earlier in the process. If it is clear at the design stage that the cost
gap exists than more can be done to close it by the design team. Traditionally, cost control takes
place at the ‘cost incurring’ stage, which is often far too late to make a significant impact on a
product that is too expensive to make.
Cost per unit are often lower under target costing environment. This enhances profitability.
Target costing has been shown to reduce product cost by between 20% and 40% depending on
product and market conditions.
It is often argued that target costing reduces the time taken to get a product to market. Under
traditional methodologies there are often lengthy delays to the team ‘back to the drawing
board’. Target costing, because it has an early external factors, tends to help get things right first
time and this reduces the time to market.
Example:
ABC Inc. is a big Fast-Moving Consumed Goods (FMCG) player that operates in a very competitive
market. It sells packaged food to end customers. ABC can only charge P20 per unit. If the company’s
intended profit margin is 20% on the selling price, calculate the target cost per unit.
Solution:
Target Profit Margin = 20% of 20 = P4.00 per unit
Target cost = Selling Price – Profit Margin
P20 – P4
Target Cost = P16.00 per unit
