Target Costing

Target Costing is primarily a technique to strategically manage a company’s future profits. It makes cost an input to the product development process, not an outcome of it.

Target Costing is a highly disciplined process having three main elements:

1. Market Driven Costing
2. Product Level Target Costing
3. Component Level Target Costing

MARKET DRIVEN COSTING

It focuses on customer requirement and uses the concept of allowable cost to transmit the competitive pressure of the marketplace to the company’s product designers and suppliers. It consists of five steps:

Ø Set Long Term Sales and Profit Objective

Ø Structure the Product Line

Ø Set Target Selling Price

Ø Establish Target Profit Margin

Ø Compute Allowable Cost

PRODUCT LEVEL TARGET COSTING

The process of product level target costing increases the product’s allowable cost to a target cost that a company can reasonably expect to achieve. It consists of three steps:

Ø Set Product-Level Target Cost

Ø Discipline the Product –Level Target Costing Process

Ø Achieve the Target Cost

COMPONENT-LEVEL TARGET COSTING

This enables the company to achieve the second objective of target costing; transmitting the competitive cost pressure it faces to its suppliers. It consists of three steps:

Ø Decomposes Target Costs of Major Functions

Ø Set Target Costs of Components

Ø Manage Suppliers

Target costing is reversible cost accounting technique. Instead of calculating costs first and then setting the price based on these calculated costs, target costing does it the other way around. Target costing is convenient for firms operating in perfect competition. Target Costing recognizes that the costs of a product are established very early in the development cycle. It is seen that by the time a product reaches the manufacturing stage – where traditional cost-reduction takes place -- most of the costs are “locked in”, and it is quite difficult to find substantial cost improvements.

Target costing represents a fundamentally different approach. It is based on three premises: 1.) orienting products to customer affordability or market-driven pricing, 2.) treating product cost as an independent variable during the definition of a product's requirements, and 3.) proactively working to achieve target cost during product and process development. This target costing approach is represented in Figure 2.

Target costing builds upon a design-to-cost (DTC) approach with the focus on market-driven target prices as a basis for establishing target costs. The target costing concept is similar to the cost as an independent variable (CAIV) approach used by the U.S. Department of Defense and to the price-to-win philosophy used by a number of companies pursuing contracts involving development under contract.