TARGET COSTING:
Target costing is a strategic cost management approach used in managerial accounting to determine the
maximum cost that can be incurred for a product while still allowing the company to achieve its desired
profit margin. It involves setting a target cost based on the price the market is willing to pay and then
working backwards to determine the allowable costs at each stage of the product's life cycle.
The target costing process can be summarized into the following steps:
Conduct Research: Review the marketplace to understand customer preferences, product
features, and pricing expectations.
Calculate Maximum Cost: Determine the maximum target cost by subtracting the desired gross
margin from the projected product price.
Engineer the Product: Design the product while considering cost implications. Engineers and
procurement personnel collaborate to optimize the design, select suppliers, and identify cost-effective
components or materials.
Ongoing Activities: After product design approval, focus on continuous cost reduction efforts.
These may include waste reduction in production, planned supplier cost reductions, or other measures
to improve cost efficiency.
Throughout these steps, cross-functional collaboration and regular review of costs and
performance are essential. Target costing is an iterative process that aims to align product
costs with customer value, maintain profitability, and respond to market competition.
Here are the key aspects of target costing:
1. Market-Driven Approach: Target costing begins with the market demand and price
expectations. It focuses on understanding customer requirements and determining the
maximum price customers are willing to pay for a product. This market-driven approach
ensures that costs are aligned with customer value.
2. Target Cost Calculation: Once the target selling price is determined, the target cost is
calculated by subtracting the desired profit margin from the selling price. The target
cost represents the maximum allowable cost that the company can incur to achieve the
desired profit.
3. Cost Reduction Strategies: Target costing requires a proactive approach to cost
management. If the estimated cost exceeds the target cost, cost reduction strategies are
employed to identify and eliminate non-value-added activities, streamline processes,
optimize material and labor costs, and explore alternative designs or sourcing options.
4. Cross-Functional Collaboration: Target costing involves cross-functional collaboration
among various departments, such as engineering, manufacturing, marketing, and
purchasing. This collaboration is essential to identify cost drivers, make design choices
that meet customer requirements at the target cost, and implement cost reduction
initiatives.
5. Early Cost Considerations: Target costing emphasizes considering costs early in the
product development or design phase. By involving cost considerations from the outset,
companies can design products with cost efficiency in mind, optimize value, and reduce
the need for expensive redesigns later in the process.
6. Life Cycle Costing: Target costing considers the entire life cycle of a product, including
costs associated with development, production, distribution, customer service, and
disposal. It aims to manage costs across the product's entire life cycle to maximize
profitability.
7. Continuous Improvement: Target costing is an iterative process that involves ongoing
monitoring and review of costs. Companies regularly assess actual costs against target
costs, identify any gaps, and take corrective actions to improve cost performance and
maintain competitiveness.
Target costing is widely used in industries where competitive pricing and cost
management are critical, such as automotive, electronics, and consumer goods. By
aligning costs with customer expectations and market demands, target costing helps
companies develop cost-effective products that meet customer needs while ensuring
profitability.
