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Target Costing

Target Costing

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Published by: api-3701467 on Oct 17, 2008
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03/18/2014

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TARGET COSTING:Delighting Your Customers While Making a Profit
Target Costing is a simple, straightforward process that can have significantimpact on the health and profitability of many, if not most, businesses. It doesn'trequire an army of specialists, large-scale software implementations, or complexmanagement structures and procedures. It's mostly logical, disciplined commonsense that can be imbedded into a company's existing procedures andprocesses.We spent our recent professional careers applying Target Costing to a widerange of products, processes and procedures in a large manufacturingcompany. We quickly came to learn that Target Costing helps to:
assure that products are better matched to their customer's needs.
align the costs of features with customers’ willingness to pay for them.
reduce the development cycle of a product.
reduce the costs of products significantly.
increase the teamwork among all internal organizations associated withconceiving, marketing, planning, developing, manufacturing, selling,distributing and installing a product.
engage customers and suppliers to design the right product and to moreeffectively integrate the entire supply chain.Target Costing has been shown to consistently reduce product costs by up to 20-40%, depending on the product and market circumstances.
What is Target Costing?
Our working definition, adapted from Cooper, is asfollows:
Target Costing is a disciplined processfor determining and realizing a total costat which a proposed product with specifiedfunctionality must be producedto generate the desired profitabilityat its anticipated selling price in the future. 
Target Costing is a disciplined process that uses data and information in a logicalseries of steps to determine and achieve a target cost for the product. Inaddition, the price and cost are for specified product functionality, which isdetermined from understanding the needs of the customer and the willingness of the customer to pay for each function.
 
Another interesting aspect of Target Costing is its inherent recognition that thereare important variables in the process that are essentially beyond the control of the design group or even the company. For example, the selling price isdetermined by
 
the marketplace -- the global collection of customers, competitorsand the general economic conditions at the time the product is being sold. Thedesired profit is another variable that is beyond the control of the designorganization. It may be set at the corporate level. It is influenced by theexpectation of the stockholders and the financial markets. And, the desired profitis benchmarked against others in the same industry and against all businesses.In this complicated environment, it is the role of Target Costing to balance theseexternal variables and help develop a product at a cost that is within theconstraints imposed. In short, traditional approaches, such as simple “cost-plus”is a recipe for market failure, and giving the customers more than they are willingto pay for is a recipe for insolvency.
 
As a totally new product and its industry develops, it starts to compete based on its newtechnology, concept, and/or service. Competitors emerge and the basis for competitionevolves to other areas such as cycle time, quality, or reliability. As an industry becomesmature, the basis of competition typically moves to price. Profit margins shrink.Companies begin focusing on cost reduction. However, the cost structure for existing products is largely locked in and cost reduction activities have limited impact. Ascompanies begin to realize that the majority of a product's costs are committed based ondecisions made during the development of a product, the focus shifts to actions that can be taken during the product development phase.Until recently, engineers have focused on satisfying a customer's requirements. Mostdevelopment personnel have viewed a product's cost as a dependent variable that is theresult of the decisions made about products functions, features and performancecapabilities. Because a product's costs are often not assessed until later in thedevelopment cycle, it is common for product costs to be higher than desired. This processis represented in Figure 1.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'srequirements, and 3.) proactively working to achieve target cost during product and process development. This target costing approach is represented in Figure 2.

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