Target costing

Target costing is defined as the 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. When a new product is launched into the market it starts to compete based on its new technology, concept, and/or service. The basis of competition is emerged to areas such as cycle time, quality, or reliability.

Target costing a method that is reverse of Target Pricing. Under target costing a manufacturer would start with a target price which is set by adding a profit margin to the actual cost. If it product is not easy to sell at that price, then the manufacturer would resort to target Costing. Here the market price for similar products is taken as a base and then the desired profit is deducted from this to arrive at a target cost. The target costing is a systematic process of cost management and profit planning. There are six key principles of target costing. They are:

• Price-led costing.  Under this principle the market prices are used to determine the target costs. Target costs are calculated using a formula-- market price - required profit margin.
• Focus on customers. The main features are customer requirements for quality, cost, and time are included in product and process decisions and guide cost analysis. The value must be greater than the cost of providing those features and functionality.
• Focus on design. The cost control at this phase is emphasized at the product and process design stage. This results in lower costs and reduced "time-to-market" for new products.
• Cross-functional involvement. The main involvement is done by the cross-functional product and process teams who are responsible for the entire product from initial concept through final production.
• Value-chain involvement. The value chain enablers i.e. the suppliers, distributors, service providers, and customers are involved in the process.
• A life-cycle orientation. Total life-cycle costs which includes purchase price, operating costs, maintenance, and distribution costs are minimized for both the producer and the customer

 Questions

• What is target costing?
• What are the key principles of target costing?