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Target Costing is a simple, straightforward process that can have significant impact on the health and profitability of many, if not most, businesses. It doesn't require an army of specialists, large-scale software implementations, or complex management structures and procedures. It's mostly logical, disciplined common sense that can be imbedded into a company's existing procedures and processes. We spent our recent professional careers applying Target Costing to a wide range of products, processes and procedures in a large manufacturing company. We quickly came to learn that Target Costing helps to:
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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 with conceiving, marketing, planning, developing, manufacturing, selling, distributing and installing a product. engage customers and suppliers to design the right product and to more effectively integrate the entire supply chain.
Target Costing has been shown to consistently reduce product costs by up to 2040%, depending on the product and market circumstances. What is Target Costing? Our working definition, adapted from Cooper, is as follows: Target Costing is a disciplined process for determining and realizing a total cost at which a proposed product with specified functionality must be produced to generate the desired profitability at its anticipated selling price in the future. Target Costing is a disciplined process that uses data and information in a logical series of steps to determine and achieve a target cost for the product. In addition, the price and cost are for specified product functionality, which is determined 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 there are important variables in the process that are essentially beyond the control of the design group or even the company. For example, the selling price is determined by the marketplace -- the global collection of customers, competitors and the general economic conditions at the time the product is being sold. The desired profit is another variable that is beyond the control of the design organization. It may be set at the corporate level. It is influenced by the expectation of the stockholders and the financial markets. And, the desired profit is benchmarked against others in the same industry and against all businesses. In this complicated environment, it is the role of Target Costing to balance these external variables and help develop a product at a cost that is within the constraints imposed. In short, traditional approaches, such as simple “cost-plus” is a recipe for market failure, and giving the customers more than they are willing to pay for is a recipe for insolvency. http://www.focusmag.com/pages/targetcosting.htm
As a totally new product and its industry develops, it starts to compete based on its new technology, concept, and/or service. Competitors emerge and the basis for competition evolves to other areas such as cycle time, quality, or reliability. As an industry becomes mature, 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. As companies begin to realize that the majority of a product's costs are committed based on decisions 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. Most development personnel have viewed a product's cost as a dependent variable that is the result of the decisions made about products functions, features and performance capabilities. Because a product's costs are often not assessed until later in the development cycle, it is common for product costs to be higher than desired. This process is 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's requirements, and 3.) proactively working to achieve target cost during product and process development. This target costing approach is represented in Figure 2.
Determine the target cost. This is a fundamental change from the attitude in most organizations where cost is the result of the design rather than the influencer of the design and that pricing is derived from building up a estimate of the cost of manufacturing a product. the target price is based on analysis of the price to win considering customer affordability and competitive analysis. and elasticity of demand. The target cost is allocated down to lower level assemblies of subsystems in a manner consistent with the structure of teams or individual designer responsibilities.S. these are also subtracted. Department of Defense and to the price-to-win philosophy used by a number of companies pursuing contracts involving development under contract. Re-orient culture and attitudes. The first and most challenging step is re-orient thinking toward market-driven pricing and prioritized customer needs rather than just technical requirements as a basis for product development. If a bid includes non-recurring development costs. warranty reserves. A target price needs to be established based upon market factors such as the company position in the market place (market share). targeted market niche or price point. competition and competitive price response. . 1. Once the target price is established. a worksheet (see example below) is used to calculate the target cost by subtracting the standard profit margin. business and market penetration strategy. 2. and any uncontrollable corporate allocations. The target costing concept is similar to the cost as an independent variable (CAIV) approach used by the U. The following ten steps are required to install a comprehensive target costing approach within an organization.Target costing builds upon a design-to-cost (DTC) approach with the focus on marketdriven target prices as a basis for establishing target costs. If the company is responding to a request for proposal/quotation. Establish a market-driven target price. 3.
In the early stages of development. This process needs to be based on early and proactive consideration of target costs and incorporate tools and methodologies described subsequently. 5.4. it must be considered in conjunction with product requirements. The models need to be comprehensive to address all of the proposed materials. The second most significant opportunity to achieve cost reduction is through consideration of multiple concept and design alternatives for both the product and its manufacturing and support processes at each stage of the development cycle. The greatest opportunity to control a product's costs is through proper setting of requirements or specifications. Brainstorm and analyze alternatives. and finance. these models are based on parametric estimating or analogy techniques. A target cost worksheet can be used to capture the various elements of product cost. compare alternatives. Product cost models and cost tables provide the tools to evaluate the implications of concept and design alternatives. These opportunities can be achieved when there is outof-the-box or creative consideration of alternatives coupled with structured analysis and decision-making methods. . 7. engineering. manufacturing. 6. Before the target cost is finalized. Further on in the development cycle as the product and process become more defined. purchasing. and use of techniques such as quality function deployment to help make these tradeoff's among various product requirements including target cost. Further. Establish a target costing process and a team-based organization. a teambased organization is required that integrates essential disciplines such as marketing. and assembly process and need to be validated to insure reasonable accuracy. Balance target cost with requirements. as well as track changing estimates against target cost over the development cycle. Responsibilities to support target costing need to be clearly defined. A well-defined process is required that integrates activities and tasks to support to support target costing. use of conjoint analysis to understand the value that customers place on particular product capabilities. This requires a careful understanding of the voice of the customer. fabrication processes. Establish product cost models to support decision-making. these models are based on industrial engineering or bottom-up estimating techniques.
8. Use tools to reduce costs. Current estimated costs need to be tracked against target cost throughout development and the rate of closure monitored. as a result. Since a significant portion of a product's costs (typically 30-50%) are indirect. re-engineer indirect business processes.npd-solutions.html . Use of activity-based costing and an understanding of the organization's cost drivers can provide a basis for understanding how design decisions impact indirect costs and. and value analysis or function analysis. allow their avoidance.com/target. Measure results and maintain management focus. Reduce indirect cost application. development personnel generally lack an understanding of the relationship of these costs to the product and process design decisions that they make. These methodologies will consist of guidelines. these costs must also be addressed. and supporting analytic tools. and minimize non-valueadded costs. procedures. But in addition to these steps. training. Management needs to focus attention of target cost achievement during design reviews and phase-gate reviews to communicate the importance of target costing to the organization 9. design for inspection and test. modularity and part standardization. Use of tools and methodologies related to design for manufacturability and assembly. databases. http://www. The enterprise must examine these costs. 10.
We can work with the materials organization to help structure a supplier involvement program based on Target Costing. eliminate non-value-added activities. help establish DFM guidelines. building. We can help organize the data gathering. Product cost models and/or cost tables are required to evaluate concept and design alternatives and support decision-making. can help with the following eight-step approach: 1. A team-based organization needs to be established to support development. Value analysis and design for manufacturability are two primary methods to provide focus on functions of value to the customer. Target costs must be established based on analyzing market niches. A Target Costing process needs to be defined and established. and facilitate the use of tools such as quality function deployment to support requirement trades. work with key suppliers to establish a Target Costing program. understanding cost drivers. the associated costs. and the DFM principles to reduce costs.Meeting customer affordability requirements is critical to a successful product. More detailed cost models based on analogy or industrial engineering build-up are needed in the later stages to evaluate product and process design alternatives. We can provide value analysis training and design for manufacturability training. We can help define roles and responsibilities to support Target Costing and provide TeamBuilding training or Team Launch training as required. 6. target costing is key to a successful product. determining elasticity of demand. 7. Since typically 80% of product costs are committed based a decisions during concept development. Supplier involvement in a Target Costing program is critical since typically 50-70% of product costs are materials. We can help in selecting. Indirect costs are the second most significant cost element. These objectives must then be communicated to the rest of the organization. and establish an activity-based costing system to better support decision-making. to support analysis of concept alternatives. assessing customer affordability requirements. Parametric cost models are needed in the early stages of a development program to develop a proposal or establish a business case. Achieving Target Cost / Design-to-Cost Objectives. We can work with the team to facilitate their use of Target Costing practices. Initiation of a Target Costing program begins with management understanding and commitment. define a process for the application of value analysis and DFM. 3. guide this analysis. other requirements. We can then develop and conduct training to deploy this process to the organization. DRM Associates. The concepts of target costing that form the basis for our consulting process are described in a paper titled. Our Target Costing training can provide an understanding of the concepts and essential elements of a Target Costing approach. and perform trade studies. validating and establishing these cost models and cost tables and define a process for their use. 8. and analyzing volumecost relationships. We can review the current development process and define the changes and additional activities to establish a Target Costing Process. and develop pricing programs. 5. and facilitate the use of these practices on a development project. a leading consulting organization specializing in product development. 4. We can help in establishing metrics and determining baseline performance. provide Target Costing training to suppliers. 2. considering trade-offs in costs vs. We can assist with business process reengineering indirect activities. .
Once the design of the product has been established. and insure appropriate management focus to a Target Costing program. over time. DEFINITION OF TERMS The following definition of terms will provide a common basis for discussion: . and general and administrative expenditures. develop design review guidelines. Second. Similarly. more performance at less cost.9. the problem is that it is too late and too little. customers or users of a product will demand more and more. establish Target Costing tracking systems. sales.npd-solutions. aesthetics. First. performance. relatively little latitude exists to reduce the cost of a product. When a company faces a profitability problem and undertakes a cost reduction program. sales and marketing. Monitoring of Target Costing results is key to a successful program.html ACHIEVING TARGET COSTS/ DESIGN TO COST OBJECTIVES INTRODUCTION A competitive product must address factors such as cost. a successful product supplier must focus more attention on managing product cost. A cost reduction or profitability program has to start with the design of the company's products at the very beginning of the development cycle. We can help 10. e. The management of product cost begins with the conception of a new product.. typically seventy to eighty percent. Cost will become a more important factor in the acquisition of a product in two situations. In either case. schedule or time-to-market. A large percentage of the product's ultimate acquisition or life cycle costs. http://www. Most of the cost structure in a company has been locked into place with the design decisions made about the company's products. and product distribution activities and policies account for another ten to fifteen percent of the product's cost. And . a customer's internal economics or financial resource limitations may shift the acquisition decision toward affordability as a more dominant factor. While not suggesting that these are inappropriate steps to take. as the technology or aesthetics of a product matures or stabilizes and the competitive playing field levels. is determined by decisions made from conception through product development cycle.g.com/targetcons. competition is increasingly based on cost or price. it will typically reduce research and development expenditures and focus on postdevelopment activities such as production. decisions made about general and administrative. Decisions made after the product moves into production account for another ten to fifteen percent of the product's costs. The importance of these factors will vary from product to product and market to market. and quality.
In other companies. The result is extended development cycles and added development cost with these design iterations. Commitment by development personnel to development budgets and target costs. A design to cost approach consists of the following elements: • • • • An understanding of customer affordability or competitive pricing requirements by the key participants in the development process. but ultimately competition will catch up and the product will no longer be competitive. Companies may get by with this approach in some markets and with some products in the short term. In some organizations. product cost or life cycle cost considerations are an afterthought. DESIGN TO COST Effective product cost management requires a design to cost philosophy as its basis since a substantial portion of the product's cost is dictated by decisions regarding its design. The primary focus is on product performance. general & administrative + warranty costs + profit Life cycle costs = Acquisition costs + other related capital costs + training costs + operating costs + support costs + disposal costs TRADITIONAL APPROACH In many companies. If these projected costs are too high relative to competitive conditions or customers requirements. There may not be a rigorous planning and budgeting process for development projects. Costs are tallied up and used as the basis for determining the product's price. . Budgets are established without buy-in from development personnel resulting in budget overruns. cost is a more important factor. or technology. but this emphasis is not acted upon until late in the development cycle. Design to cost is a management strategy and supporting methodologies to achieve an affordable product by treating target cost as an independent design parameter that needs to be achieved during the development of a product. Projected costs of production are estimated based on drawings and accumulated from quotes and manufacturing estimates. Establishment and allocation of target costs down to a level of the hardware where costs can be effectively managed.Recurring production cost = production labor + direct materials + process costs + overhead + outside processing Non-recurring costs = development costs + tooling Product costs = Recurring production costs + allocated non-recurring costs Product price or acquisition costs = Product costs + selling. development costs receive relatively little attention as well. design changes are made to varying degrees to reduce costs. aesthetics. Stability and management of requirements to balance requirements with affordability and to avoid creeping elegance. This may occur before or after the product has been released to production.
Consistency of accounting methods between cost systems and product cost models as well as periodic validation of product cost models. more attention will need to be paid to managing these non-recurring development costs. Application of design for manufacturability principles as a key cost reduction tactic. Prices and target costs will also have to consider projected production volumes and amortization of nonrecurring development costs. and development team personnel all need to have an understanding of customer affordability constraints or competitive market place requirements. Non-recurring development cost will be a function of the extent of new product and process technology and the extent of use of new materials. Active consideration of costs during development as an important design parameter appropriately weighted with other decision parameters. TARGET COSTING AS A FOUNDATION Executive management. If product is an evolutionary step with minimal development risk. A keener awareness of design to cost requirements is needed. and Continuous improvement through value engineering to improve product value over the longer term. Creative exploration of concept and design alternatives as a basis for developing lower cost design approaches. function analysis system technique) to understand essential product functions and to identify functions with a high cost to function ratio for further cost reduction. features and performance in excess of their needs and wonder how much is money is wasted on these unneeded capabilities. This will establish a measurable objective for a product development team where multiple teams are involved in a development project. This happens when product development team members and executive management have direct contact with customers to understand their true needs and hear their sensitivity to costs directly. program/product managers. These targets should be developed based on pricing formulas and strategies and consideration of price elasticity. In a more complex product or system. Meaningful cost accounting systems using cost techniques such as activity-based costing (ABC) to provide improved cost data. the top-level target cost will need to be allocated to lower level subsystems or modules. nonrecurring development costs will be lower.g. cost targets should be formally established. Access to cost data to support this process and empower development team members. parts and subsystems. This suggests a strategy of not letting product and process technology application get too far ahead of . Use of value analysis / function analysis and its derivatives (e. Everyday customers buy products with functions. marketing. The use of standard parts and modules from other existing products will also lower non-recurring development costs. Product cost models and life cycle cost models to project costs early in the development cycle to support decision-making. In an environment where development cost is significant relative to total recurring production costs.. or when they are exposed to competitor's product pricing in the market place.• • • • • • • • • • An understanding of the product's cost drivers and consideration of cost drivers in establishing product specifications and in focusing attention on cost reduction. Based on this awareness of customer affordability or design to cost requirements.
g. a management team. Tools and information need to be provided to a product development team so that they can more proactively and objectively consider the cost implications of various design approaches on a regular basis. secondarily consider a subjective estimate of the relative costs of the design alternatives. and critical parameter tolerances. other users of this manufacturing process.customer affordability requirements. they will begin exploring alternatives as part of the design process. the targets and budgets should be carefully reviewed with the team members to insure they understand these cost objectives and the assumptions behind them. As the organization proceeds through the design of both product and process. Later in the development cycle. If the budgets or targets are established by someone outside the product development team (e. the requirements and targets will need to be re-evaluated and modified. at best. COST MODELS AND COST DATA Once a team has a set of requirements and a cost target established. The model will be driven by general design parameters. sizes and tolerance requirements. If it is determined after extensive evaluation that the product requirements cannot be achieved at the target cost. by a product or program manager. the product cost model is used to project and accumulate product costs to use as a factor in evaluating design alternatives and to refine the design to meet cost targets. they will tend to evaluate a product concept primarily based on its performance merits and. new manufacturing processes will need to be considered. The model will be implicitly based on assumptions about existing processes and process relationships to types of materials. facility engineers. Early in the development cycle. a different type of product cost model will be used that will consider the specific manufacturing processes. or a project engineer). Information to support this model development can be obtained from equipment suppliers. Ad-hoc cost studies or trade studies may be prepared for significant issues.. Product development team members should buy-in to or commit to these product cost targets and development budgets to improve the chances of meeting these objectives. a system integration team. the product cost model will be based primarily on characteristics of the product design with relatively little consideration of the actual manufacturing process. a sense of commitment to these budgets or targets develops. This type of model will be built around existing processes where relatively good historical cost data should exist. but tools to regularly support this process are lacking. and . product/part characteristics. When empowered product development teams actually develop these budgets and targets. Data will need to be gathered as a basis for creating or extending the product cost model for the new process(es). While competition will generally dictate that stretch goals be established. In the absence of other information. A product cost model or life cycle cost model provides an objective basis for evaluating design alternatives from a very early stage in the development cycle. these goals should be accepted by the team as achievable. On occasion.
The focus is on accumulating and tracking estimated material. and costs as part of their capabilities. a close working relationship with the company's supplier base will allow preliminary cost projections to be obtained without the formalized commitment of a quotation.g. sheet metal. In addition. In addition. As the development cycle moves into the product design phase. Parametric techniques would take general characteristics about the product such as size. This information may be available in the form of catalog prices or supplier quotations. casting.. part and assembly costs. However. number of functions. printed circuit boards.. and use these parameters to develop a general cost estimate. This cost model would be based on parametric or analogy techniques. manual or automated assembly. several different costing tools may be used by an organization. Over the course of the development cycle. Multiple modules will typically be needed to support overall product cost modeling. an estimating system may be used to respond to a customer request for quotation or request for proposal or to develop an internal estimate to prepare a cost justification for the development project to management. a more sophisticated product cost model should be developed that will project costs based on the characteristics of parts and the overall product design. to support cost projections much earlier in the development cycle. These systems typically generate an estimate of fabrication or assembly labor time and costs or machine cycle time. The supplier relationship and company information needs may even develop to the point that the company works with the supplier to develop a supplier cost model based on the supplier's process capabilities. This type of cost model might be based on commercially available design for manufacturability (DFM) or design for assembly (DFA) software packages. These estimates would be more refined . These individual packages or modules will be oriented toward a limited part or product domain. Analogy techniques would take a similar product's cost and use a "same as except for" approach to develop a cost estimate based on the cost of an existing item. etc. In the early stages of product development. e. there are commercially available cost models that allow a company to develop a custom model of their manufacturing processes and project even more exacting cost estimates based on their product or part characteristics. weight. Cost data will also need to be obtained for many purchased parts and sub-assemblies. etc. injection molding. This summarization capability may start with cost estimates and update the estimates with quoted prices or catalog prices for purchased items or manufacturing's estimates based on preliminary drawings for fabricated items and assemblies.manufacturing engineers. Over time. A company's initial attempt with a product cost model may utilize a spreadsheet program or a bill of material cost roll-up capability. cost models and DFM/DFA tools as just described would be used. a database reporting capability or spreadsheet will be needed to accumulate the many individual elements of cost from these various cost modeling system components so that effective overall trade-off's can be made.
as the product moves into production. the quality of the cost data will improve. This data needs to be made available to support cost modeling. and operation. there is frequently a lack of understanding of sunk costs and fixed versus variable indirect costs. learning curves. Some companies try to restrict access to cost data to prevent this information leaking out to competitors. reliability and maintenance often is needed. direct labor is becoming an insignificant cost component in many products. maintenance costs. This means that a customer will need to provide this data or that the company have close working relationships with customers where this data is routinely gathered. training. the organization should establish procedures to periodically validate the cost models by comparing the projected costs with actual costs and adjusting parameters in the model to yield projections closer to actual experience. However. In addition. Typical data required will be labor rates. Costs will be more closely based on the consumption of resources and the aberrations associated with allocating indirect costs will diminish. Traditional approaches to allocating overhead or burden costs generally based on direct labor. This will add to the complexity of a cost model. To support the operation of these cost models. Data will need to be gathered on operating costs (e. efficiencies. Further. All of this has led to distortion of overhead cost allocations and inappropriate design and sourcing decisions. fuel or energy consumption. and disposal costs. cost data will need to be readily accessed.since more is known about the design of the product and its cost drivers. etc. In some cases.g.. As companies move toward activitybased costing. assembly. facilities. These costing tools should have a consistent basis for accounting for costs and a consistent set of rates. and escalation projections for labor and materials. part. tools and methods such as computer-aided and manual process planning and tools to support the development of labor standards would be used to develop even more refined cost estimates.). These costing tools are illustrated below. historical data related to operations. manpower. historical and projected parts costs. While these costs can be modeled. Finally. DECISION-MAKING . This restricted access undermines a design to cost methodology and empowerment of the product development teams. life cycle costs may need to be considered as the basis for making design decisions. Once the product design is essentially complete. overhead rates. cost accounting systems would collect costs by product.
Access to product cost projections early in the development cycle will improve decisionmaking about design alternatives and lead to refinement of the design to come closer to the established cost targets. trying to manage the elements of cost that they are responsible for. product cost management must begin with the start of product development. decisions to minimize nonrecurring design engineering expenditures may result in a less producible product. not merely accumulating costs as designs are completed. This increased focus on product or life cycle costs will lead to significantly reduced costs and more satisfied customers. Cost models provide the means for the team to objectively consider the implications of various development decisions. Target costs must be established at the start and used to guide decision-making. SUMMARY Since the decisions made during the product development cycle account for seventy to eighty percent of product costs. And the quality of information and the cost models must be continually improved and refined. Decisions to minimize tooling capital expenditures may also have the same effect in manufacturing costs. Product development personnel must understand competitive pricing or customer affordability requirements. These costs projections will aid decisions about the design of the manufacturing process as well.com/dtc. Cost models must be provided to support decision-making early in the development cycle.html IGN-TO-COST OBJECT .npd-solutions. each functional organization will make decisions from their own perspective. focusing attention of elements of the product costs that do not meet the target and allowing consideration of alternative processes while it is still early enough in the development cycle to introduce new processes.In the absence of product cost models and product development teams. A company operating philosophy that emphasizes cost as a factor in the development decision-making process is a final requirement. http://www. driving up material and labor costs in manufacturing. The key is to emphasize management of product costs during development. For example. Development personnel must operate as entrepreneurs in making hard decisions about the product and process design to achieve target costs. Test engineering may try to minimize its non-recurring development budgets and capital expenditures resulting in a less automated test process and higher recurring test costs for production verification. Product development teams provide the organizational mechanism to bring the various disciplines together to optimize product costs from an enterprise perspective.
) • The following quotations have been taken from a state-of-the-art review about target costing. • Product management must widen to incorporate both physical and service attributes measured in terms of customer value. • Product profitability must be assessed and planned in the context of a comprehensive life cycle and the relationship of a broad market value chain. cost management and cost control instruments which are aimed primarily at the early stages of product and process design in order to influence product cost structures resulting from the market-derived requirements. CAM-I has launched an extensive study labeled as target cost management (TCM). Target costing is a cost management concept that has been developed and practiced in Japanese companies since the 1970s and has been described in English mainly by Japanese authors. Target costing is built on a comprehensive set of cost planning. The CAM-I study group made the following conclusions concerning the major changes needed: An overall management system is required to set the targets and to channel the decisions of all those involved in product definition and development towards wider corporate goals. (CAM-I TCM Study Group statements 1994. • Cost management must shift its focus from accounting for the sake of accounting to enable expenditures to be used as a planning tool for creative product and process design. The target .Target cost management CAM-I (Consortium for Advanced Manufacturing – International) was established 1972 as an international non-profit-organization to carry out research and scholarship on management and manufacturing technology systems.
The sales target is calculated using the retail price Sa = Us * Qs where Us is the target retail price and . Reducing cost through continuous improvement. Target costing. Thus. as it has been developed in Japan. they talk about cost planning and cost control. Estimated costs depend on the managers’ past experience or intuition (Makido 1992). i. (Horváth 1993. the use of target costing has a long tradition at Toyota. while actual costs are calculated after production. Predetermined costs are divided into standard costs and estimated costs. Standard costs depend on statistical data and are utilized as an index for cost management. the lifetime target profit Ps of a new model (e.) For example. Predetermined costs are the expected measures of the cost before production. Celica) is calculated as follows: Ps = P% * Sa where P% is the profit ratio of sales and Sa is the target sales. is becoming relatively less important. “cost kaizen”. was invented by Toyota in 1965.) Japanese management accounting uses classification of predetermined and actual costs. influencing product costs during the design phase and keeping the running costs as low as possible.costing process requires the cost orients coordination of all product related functions. At Toyota.e. because the efforts made throughout the company will inevitably lead to fewer opportunities to cut costs. (Tanaka T 1993.g.
The phases are outlines below: STEP1: Planning Summarize the new product plan in a document that clarifies the design requirements: 1. Schedule the product’s design. 2. Design the basic product concept under the target cost. Frame a general drawing under the target cost. basic design and manufacturing preparation. Therefore. concept design. Outline the product’s concept and mission. Define product target cost. The system consists of five stages: planning. manufacturing and marketing. 2. Generate primary specifications for the product’s performance and design. selling price and volume. 4. STEP3: Basic design Make a general drawing of the product based on the previous steps: 1. 4. Assign target cost to the top and middle functions of each functional area or main component of the new product. .Qs is the target production volume over the product’s life. Formulate the main functional areas. 3. Use a rough cost estimate to ascertain whether the basic product concept has been designed to fit the target cost. 1. the present cost control system is focused on the design phase. Assign the target cost to the functional area of the new product. 2. STEP2: Concept design Formulate the basic concept of the new product based on the design requirements mentioned in step 1. Tanaka M (1989) claims that 80-90% of the life cycle cost is determined at the design phase of the product. 3.
type and jig under the target cost. Use a rough estimate to ascertain whether the general drawing has been designed to fit the target cost. Xerox is mentioned as one the well-known practitioners of systematic proactive cost planning.3. The design of the manufacturing process. STEP4: Detailed design Write the product’s manufacturing specifications based on: 1. The management believed that the loss was related to the market price rather than their own manufacturing. 2. (Tanaka M 1989. STEP5: Manufacturing preparation Write the product’s manufacturing specifications based on: 1. (Boer & Ettlie 1999. The detailed manufacturing specifications under the target cost. The detailed cost estimate used to ascertain whether the manufacturing preparations for the product are accomplished within the target cost. A detailed cost estimate to ascertain whether the product’s manufacturing specifications have been designed to fit the target cost. of which 77 showed an orientation towards market-driven cost control. The standard cost of $2900 per ton was thought to be based on a solid analysis and was taken for granted. .) According to Shank & Fisher (1999).) Boer and Ettlie (1999) report a case where a car manufacturer could have prevented a $300 million mistake by using proactive target costing. The situation of Montclair Mill seemed gloomy: The mill was making $700 loss per every ton of paper sold. target costing seems to be applied mostly at the early stages of product development. 2. but the case of Montclair Paper Mill shows how the target costing principle can be applied at a later stage of the product life cycle. The survey was conducted among the top-performing US R&D units and resulted in 126 questionnaires.
During 18 moths. He emphasizes the strategic value of target costing in managing the company’s future profits. Fiber cost: 60% cost reduction. Paper machine cost: Yield from 47% -> 75%. 4. these produced the desired level of costing and a dramatic turnaround in the mind set. . Together. and the continuous improvement seemed to gain even more. Dye costs: material savings of $250 per ton incorporated in the yield improvement at the paper machine resulted in an amazing $769 reduction per ton. four major reductions were accomplished: 1. the cost dropped to $240.) Cooper & Slagmulder (1999) gives a comprehensive review of the application of target costing. 2. and after ta cost-driven analysis. the target costing discipline has been structured into three sections.The implementation of target costing was introduced with a new target of $1162 per ton. The management accepted the challenge. Conversion costs: Based on benchmarking. 3. 17. (Shank & Fisher 1999. which equals a 60% cost reduction. as illustrated in Fig. a reduction from $303 to $150 was challenged with the risk of possible outsourcing. According to their study of seven Japanese companies.
The Cardinal Rule controls the process in three ways: 1. the offsetting saving must be found somewhere else. 17) requires a highly disciplined approach. . The process starts from the left. 2. The company does not launch any product exceeding the target costs. The senior management tends to push down the product target costs as much as possible while the chief engineer must find the realistic limits in co-operation with the design teams and the suppliers. Three main elements of the target costing process (Cooper & Slagmulder 1999). Once these have been decided on. If the design does not reach the target costs. The role of the product chief engineer is remarkable in the fundamental decisions concerning product and component target costing. by setting the company’s long-term sales and profits objectives. Successful application of this process (Fig. the Cardinal Rule is applied to ensure that discipline is maintained throughout the design process. Each of the main phases must be balanced to avoid unrealistic target setting. and continues through the product level targets to component level target costing.Figure 17. The Cardinal Rule of target costing is: “The target cost must never be exceeded”.
fi/isbn9514264509/html/x1194. The design transfer to manufacturing must be well controlled to achieve the target cost. the early involvement of proactive product cost management has been highlighted as a major advantage of some leading Japanese companies in highly competitive markets. As a conclusion.3.html . http://herkules.oulu.
Target costing is a cost management concept that has been used very effectively by leading Japanese manufacturers. Consumers are demanding new and diversified products in short intervals. (CPA in Industry) by Lee.S. Changing Product Life and Requirement Product life cycles are getting shorter and shorter. the total cost of each product. quite often one or two years. In U. companies. The practice is effective in achieving the desired ROI or ROE. managers and accountants must heed the shareholders' needs for satisfactory shortterm profits. focus on product profitability. It is similar to the emerging concept of activity-based costing in that it relates profit to return on sales as opposed to return on investment. Due to factory automation. and easily understood if we look at the Big Three automakers' practice of raising prices whenever there is a restriction placed on Japanese imports. manufacturers have learned cost management should start up front at the initial stage to be effective and measure up to their foreign counterparts. producing. profit-driven outlook of most US manufacturing companies.Use target costing to improve your bottom-line. but it hurts the carmakers' ability to increase market share in sales volume. Born out of the market-driven philosophy. thereby allowing the company greater flexibility in production management and in production development. there is a limit to how much cost cutting companies can do in the manufacturing stage. Control Costs Early Target costing. is primarily used and most effective in the product development and design stage. A case example illustrates the technique. With a one-year product life. Most popular cost accounting methodologies. A new cost management concept has been developed and practiced by worldclass Japanese manufacturers to deal with the needs in the product development and design phase.S. marketing. costs of designing. Once the product is developed and designed. U. sometimes to less than one year in high-tech industries. which has allowed companies like Sony and Toyota to win a considerable share of their respective markets. target costing enables companies to attain low costs to ensure low prices that help maintain market share. target costing is based on the pricedown. market-driven perspective rather than on the short-term. This focus on meeting the shareholders' short-term needs has been well documented. cost-down strategy. An increased . No matter how effective the cost accounting methodology may be. John Yee Abstract. and delivering products dictate the mode of competition. which emphasize cost control in the manufacturing phase of the product life cycle. What all these changes mean is the traditional standard costing systems. based on allocation routines. Accountants usually measure. It is based on a long-term. robots and computer-controlled manufacturing systems are replacing the conventional production lines. measured by ROI or ROE. are no longer effective. It is also a very effective foundation for building long-term quality improvement initiatives. although its concept is used throughout the product life cycle. including the emerging activity-based costing. With its emphasis on market position and product leadership. controlling costs in the manufacturing phase simply doesn't accomplish much.
In companies where target costing is used. The target profit for each period is determined for each of the new and existing product portfolios.nigh impossible. rather than ROI. "How much does the product cost?" This question follows a new product design into the cost accounting department. high-price product. Calculating the profitability of each of those products in ROI is well. In the meantime. This link allows the company to focus on profit and product in an integrated strategy. high-price. there seems to be a different culture and attitude. * The Strategic Reason. The desired profit is determined based on the company's desired return on sales (ROS). manufacturers need to focus on the profitability of portfolios of related products and the role each product plays for the product group. The first is technical. labor costs. The profitability of each group of related products is the focus. This is in direct contrast to a typical U. manufacturer's practice. which is based on the current standards of materials. the second is strategic: * The Technical Reason. They place more emphasis on their relative position in the market and product leadership. Now. In the fastchanging market of today. cost management must start (and done substantially) at the design stage.market share would give them a buffer in the future if they choose to sacrifice sales volume to increase revenue and longterm profit. depending on what stage the product is in its life cycle and what leadership role the product can play in acquiring a new segment of the market. There are two primary reasons for using ROS. intensive studies of competitors' parts are done. and other manufacturing overhead costs under the current production standards. usually impossible in the short run. which does not discriminate against high-quality. and overhead. Target costing derives its bases from the company-wide profit plan. After motivational considerations have been made.S. The desired profit margins are traded between products in the same group. manufacturers need a variety of products in low volumes to survive. This is a target which is very hard to attain. "What should the new product cost?" It is not. This departmentalized policy formulation of a typical U. the desired profit is subtracted to yield the allowable cost. the struggle begins.S. This allowable cost is top management's dream. the gap between allowable cost and estimated cost is reviewed on various dimensions. which estimates the new product costs based on the prices of purchased materials and parts. tends to discriminate against developing a new high-quality. The target cost is then established as an attainable target which will motivate all personnel to achieve. high-margin products that require high costs. Connect with Profit Planning Target costing is very closely linked with the company's long-term profit and product planning process. in which the question persists. The allowable cost is compared to the estimated cost. The marketing department then addresses the issue of whether they can sell the new product. Setting the Target Costs The main theme in the entire target costing practice is. . ROS provides a better measure. which focuses on cost. For this. labor. Since more than 80% of product cost is already determined by the time product design and processing is complete. In the implementation of long-term strategies. company. rather than the profitability of individual products. "What does it cost?" Wben the target sales price is established based on market research.
and fine line class. and was not intended to be. A short payback period is usually assumed in planning and evaluating target costs. Negotiations also take place among design. the desired return on this offer is $120. SInce PCBM's usual return on sales (ROS) rate is 25 percent. linked to corporate profit planning. number of images per panel. nevertheless.000. Post. PCBM. however. and compromises are made in their efforts to get within the target cost range. A Case Example The following short case example is used to illustrate the process of determining target costs using production and cost figures. and other departments in the company. and target costs as they are practiced In Japan. GE's activity analysis was not. Production engineers determine standards for material and part usage. The process of VE consists of describing the functions of each product. and quantifying the components of those functions. investigations follow. number of holes. The fundamental mechanism Japanese manufacturers use to achieve target cost. is value engineering (VE). labor consumption. which is measured by the relationship between the functions performed by products and services and the costs incurred. and service. calculated as follows: . target profit. If targets have not been achieved. marketing. As soon as the above-mentioned standards are established. Value Engineering The idea behind VE is very similar to activity analysis which was first developed and used by General Electric. The struggle to achieve the target costs takes place in and outside the company. These standards are also used as a database for material requirements planning (MRP). a Silicon Valley PCB manufacturer. VE is a mechanism Japanese manufacturers use to enhance the value of products and services. In the design phase.. hole size. part.000 units of a multi-layer panel product by an electronic product manufacturer. Some are geared toward process improvement while others are focused on satisfying the needs of customers. Post-Audit of Target Costing Performance The short life cycles of manufactured goods in today's market require manufacturers to recover investment in a short time. stack height. etc. post plate drill. a printed circuit board (PCB) manufacturer's VE activities for the drilling operation include panel size. For example. cost management people help engineering planners and designers decompose the target cost into each cost element according to their relations to detailed production functions.Achieving The Target Costs At this point. management science techniques are employed on the many aspects of the drilling operation to improve upon the current method. is offered $48 per unit for 10. laminate thickness. which become the basic cost data for financial accounting purposes. The functions are defined by different companies in different ways.audit of target costing performance is done on a regular basis to examine the degree to which targets have been achieved. engineering. purchasing people negotiate with outside suppliers as to the prices of purchased materials and parts. lot size and frequency.
material cost per panel of $19.000 for the offer. $36 x 10.desired return.000) for the offer is $40.75 . it was rather easy to demonstrate the cost impact of each component. which would reduce manufacturing costs.000) and the estimated cost ($400. it was decided that VE activities should be focused on reducing the defect rate and material handling and purchasing. which is adopted as the target cost reduction. $12. Various moves were analyzed to reduce the distances.000 for the offer. = $36 per unit. they were responsive to the request by PCBM for a review of the $48 price. Improvements on material handling were centered around reducing material moving distances between the point of receiving the deliveries and the point of usage. or $400. Desired return: 25% x $48 = $12 per unit. . The combined reduction in cost per unit of $3. which was estimated to reduce unit cost by $2. After long hours of careful evaluation by production supervisors.000 for the offer. Since the customer was satisfied with the quality of the product. two solder mask sides requested. and no tab plate edge. most of which looked too ambitious at first. the purchasing group of PCBM entered a long negotiation process with the suppliers. management asked the marketing team to review the $48 selling price. or $360.000. since sales price. five images per panel.000. Since PCBM had already designed and implemented an activity-based costing (ABC) system. panel size.000 units = $480. But.000 units is $36 per unit. Furthor Action After the successful execution of the target costing project. the suggestions were aggressively implemented by the processes and areas involved. Although this was still higher than the allowable cost of $360. a total of $30.000 by $10. estimated yield rate of 86%. $48. were made. Suggestions of possible improvement in performance by 30%. The result of these improvement activities was the reduction of another $1 per unit cost. The impact of accepting the offer on the production plan and the cost of total production for the period was also considered. board-width. The gap between the allowable cost ($360.000 started with VE activities. At the same time. and cost management people.Amount of the offer: $48 x 10. board length. The customer's representative tried to justify the fair level of the current price by pointing out that no tab plate edge was required. top management thought the efforts of those who were involved in reducing costs were substantial.000 = $120. PCBM's ABC system. brought the cost to $370. one component legend side.000.000 units = $360. The estimated cost is calculated by the cost management team as $40 per unit.000. process and product engineers. The allowable cost for this production of 10. since the new target costing-induced management plan had been accepted by all supervisors and managers of the plant. in order to persuade them to lower their prices. which had five process centers indicated the following costs of options: The cost of solder mask option: $1. The "struggle" to eliminate the gap of $40.000 for the offer.000. $12 x 10. A series of studies and analyses of material scraps and other types of defects were performed.80 The cost of component legend option: $0. The cost was estimated based on four layers requested.
htm . And target costing can be as effective in U. No cost was charged to their order for the tab plating option. Target costing. It is a disciplined approach to managing costs and improving processes and products.S. the ABC system already reflected that.nysscpa. as briefly illustrated here. which can provide necessary cost information for implementing target costing. as it has been in Japan. http://www. industry. is also very compatible with the emerging ABC. This helped PCBM earn credibility from the customer regarding the price quotes.Since the customer's PCB didn't require tab plating. The Real Weapon The real power of target costing is that it allows companies to successfully motivate employees and enforce cost management action plans.org/cpajournal/old/14979931. The customer finally agreed to consider a price increase in the near future.
Controllers who introduce target costing successfully into their organization may change how co-workers perceive financial types. Then they try to find piecemeal solutions for reducing the cost. The target costing process requires that the desired cost to manufacture a product be spelled out ahead of time.businessfinancemag. who has introduced pilot programs in target costing at his company. "For instance. because it encourages people with different functions to work on the same team to meet the collective target costing goals." says Keith Hallin. arrives at a price that works for the company as well as the customer. There's also the problem of changing workers' behavior.Avoiding the Pitfalls OBSTACLES What are the obstacles in target costing? It takes time and money to bring sweeping changes into an organization. is simple: In the long run your company will be better positioned to compete in the marketplace with target costing than without target costing. "Most American companies are working in silos. It also allows more people in the company to understand the company's objectives and how they are going to be achieved. target costing proponents say.com/magazine/archives/article. That makes it a more effective way to do business. not merely a dictum from senior management. http://www. it can improve customer satisfaction. Since target costing is customer-driven. senior manager of finance in the Boeing Commercial Airplane Group in Seattle. Why rock the boat if things are going well? The answer. and companies that have used target costing have indeed found that they reach their profit goals more effectively.html?articleID=4308&pg=2 . Target costing requires them to think beyond those traditional tasks and factor in the cost of the engineering. from a policeman or someone with a big stick to a valued partner working on everyone's behalf. engineers focus on the specifications of the product." American companies tend to build something and discover after it's produced that the price they need to charge to make a profit is too expensive for their customers. Target costing. ideally. to perform cross-functionally. Workers can understand that the reasons behind your cost objectives are directly related to gaining a competitive advantage.
They are the type of customer you sell to and the type of product you make or service you offer. there are some things that will influence your target costing efforts no matter what type of business you're in or what your corporate culture is. But while every company uses target costing differently. . including senior management's objectives and your company's long-term profit objectives.PRODUCT AND CONSUMER INFLUENCESoduct and Customer Influences A number of factors influence target costing.
cost and time targets. 8. It may seem obvious to tie the cost of your product or service to the needs of your customers. Identify customers' real needs. 2. Become more competitive globally. 10. you may be able to: 1. Spend money where it will have the greatest impact. Match your firm's activities to your customers' requirements. 3. 5. Give co-workers a better understanding of cost objectives. 4. "In research-gathering . Transform your image of "policeman" into that of a valued partner working on everyone's behalf. something Boeing takes very seriously. That effort extends to researching customer needs. Increase customer satisfaction. 9. 7.10 Advantages of Target Costing If you are successful in implementing and maintaining an effective target costing system. 6. Achieve greater cost efficiencies. Determine an expected cost of manufacturing a product or providing a service. Allow co-workers to participate in setting quality. But target costing makes more of a defined effort to achieve this objective than traditional costing methods.
" says Hennessey. "Suppose you're an automaker and you've determined your customers want comfort." Uncovering customers' real needs can occasionally be . "Evaluate your product as it relates to enhancing customer comfort. the passengers. but how their customers. Dr. the car's suspension. we want to understand not only how our immediate customers [airplane purchasers and lessors] use our product. I ask how many people own one of our products. "Then I ask how many people have ever flown in one of our planes.. professor and chairwoman of the marketing department in the College of Business Administration and Economics at California State University." Target costing says you need to match your firm's activities to your customer's requirements. and everyone's hand goes up. use it as well. Enhance those things and reduce costs in areas that aren't as important to the customer. Although ours is a business-to-business company." says Boeing's Hallin. Judith E. Calif. the angle of the seat. Northridge. the upholstery. and no one raises their hand.seminars. perhaps by looking at the springs in the seat. Hennessey. offers an example.
it was successful. the target . they asked people what they wanted from a potato chip." says Hennessey. and initially. "When Procter & Gamble developed their Pringle's potato chip. don't give up. the longer your product development cycle from the design stage to the production stage. How does your product influence target cost? Generally. For instance. Procter & Gamble had missed taste as a customer need. the more difficult it may be to establish firm target costs early on.difficult even with a simple product. if your cycle is up to four years. But then customers found out that the product didn't taste very good. which is how long it typically takes at Boeing according to Hallin. If the process doesn't work the first time around." If in creating product functions that reflect what the customer wants your costs become too high to hit your target. try again." Hennessey says. and the answer uniformly was freshness. target costing needs many iterations to carry it through. "The product was launched in a vacuum-sealed can to maximize freshness. "Sometimes. Find other areas less important for customer satisfaction and try to reduce those costs. and even for the best of companies.
so a representative sample of allowable costs is taken and applied to all components. They have an allowable cost for each component function. program director for project redesign on all financial processes at Chrysler Corp. From these costs comes an updated target cost. in Auburn Hills." says George Millush. "We're very interested in target costing. the easier it is to implement target costing. It's usually impractical for a company with hundreds of design and production components to evaluate all of them. Mich. but it takes time to put the pieces in motion.cost you establish may need to be revised over the years. then the total allowable costs of all the functions for making the product are added to arrive at an expected cost of manufacturing the product. Companies with shorter product development cycles may find they can stick to their initial target cost more easily because they are not as susceptible to the changes that time can impose. "The simpler and more straightforward your product. and we're just in the infant stages here. Some companies with a long product development cycle take the process in incremental steps." .
com/magazine/archives/articl e.http://www.html?articleID=4308&pg=3 .businessfinancema g.
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