TARGET COSTING: Delighting Your Customers While Making a Profit
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: 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.
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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.
and any uncontrollable corporate allocations. If the company is responding to a request for proposal/quotation. competition and competitive price response. business and market penetration strategy. 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. and elasticity of demand. a worksheet (see example below) is used to calculate the target cost by subtracting the standard profit margin.
. Department of Defense and to the price-to-win philosophy used by a number of companies pursuing contracts involving development under contract. Once the target price is established. 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. Establish a market-driven target price. A target price needs to be established based upon market factors such as the company position in the market place (market share). The target costing concept is similar to the cost as an independent variable (CAIV) approach used by the U. If a bid includes non-recurring development costs. 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. Determine the target cost.
3. 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. 1. the target price is based on analysis of the price to win considering customer affordability and competitive analysis. warranty reserves.
2. targeted market niche or price point. these are also subtracted.S. Re-orient culture and attitudes.
The greatest opportunity to control a product's costs is through proper setting of requirements or specifications.
. Responsibilities to support target costing need to be clearly defined. This process needs to be based on early and proactive consideration of target costs and incorporate tools and methodologies described subsequently.
5. fabrication processes. as well as track changing estimates against target cost over the development cycle. These opportunities can be achieved when there is outof-the-box or creative consideration of alternatives coupled with structured analysis and decision-making methods. purchasing. Further. Brainstorm and analyze alternatives. compare alternatives. A target cost worksheet can be used to capture the various elements of product cost. Establish a target costing process and a team-based organization. these models are based on parametric estimating or analogy techniques. a teambased organization is required that integrates essential disciplines such as marketing. and assembly process and need to be validated to insure reasonable accuracy. Product cost models and cost tables provide the tools to evaluate the implications of concept and design alternatives. In the early stages of development. Before the target cost is finalized. Balance target cost with requirements. 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. A well-defined process is required that integrates activities and tasks to support to support target costing. This requires a careful understanding of the voice of the customer. engineering. and finance. The models need to be comprehensive to address all of the proposed materials. Establish product cost models to support decision-making. it must be
considered in conjunction with product requirements. and use of techniques such as quality function deployment to help make these tradeoff's among various product requirements including target cost. these models are based on industrial engineering or bottom-up estimating techniques.
7. use of conjoint analysis to understand the value that customers place on particular product capabilities. Further on in the development cycle as the product and process become more defined.4. manufacturing.
modularity and part standardization. databases. procedures.
10. Current estimated costs need to be tracked against target cost throughout development and the rate of closure monitored. The enterprise must examine these costs. Since a significant portion of a product's costs (typically 30-50%) are indirect. But in addition to these steps. 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. 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. Measure results and maintain management focus. training. Use tools to reduce costs. and supporting analytic tools. allow their avoidance. design for inspection and test.
http://www. Use of tools and methodologies related to design for
manufacturability and assembly. these costs must also be addressed. re-engineer indirect business processes. These methodologies will consist of guidelines. 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.com/target.html
. as a result. and minimize non-valueadded costs.npd-solutions.8. and value analysis or function analysis.
assessing customer affordability requirements. understanding cost drivers. to support analysis of concept alternatives. Indirect costs are the second most significant cost element. 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. These objectives must then be communicated to the rest of the organization. and analyzing volumecost relationships.
2. and establish an activity-based costing system to better support decision-making. Product cost models and/or cost tables are required to evaluate concept and design alternatives and support decision-making. work with key suppliers to establish a Target Costing program. and facilitate the use of these practices on a development project. We can help in establishing metrics and determining baseline performance. determining elasticity of demand. Supplier involvement in a Target Costing program is critical since typically 50-70% of product costs are materials. Parametric cost models are needed in the early stages of a development program to develop a proposal or establish a business case. We can provide value analysis training and design for manufacturability training.
6. Our Target Costing training can provide an understanding of the concepts and essential elements of a Target Costing approach.
8. We can work with the team to facilitate their use of Target Costing practices. Achieving Target Cost / Design-to-Cost Objectives. We can assist with business process reengineering indirect activities.
4. can help with the following eight-step approach: 1. provide Target Costing training to suppliers. validating and establishing these cost models and cost tables and define a process for their use.
. We can review the current development process and define the changes and additional activities to establish a Target Costing Process. The concepts of target costing that form the basis for our consulting process are described in a paper titled. eliminate non-value-added activities. We can help organize the data gathering. DRM Associates. We can help define roles and responsibilities to support Target Costing and provide TeamBuilding training or Team Launch training as required. A team-based organization needs to be established to support development. the associated costs. building. 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. We can work with the materials organization to help structure a supplier involvement program based on Target Costing. and perform trade studies. a leading consulting organization specializing in product development.
5. other requirements. considering trade-offs in costs vs.Meeting customer affordability requirements is critical to a successful product. help establish DFM guidelines. and the DFM principles to reduce costs. Value analysis and design for manufacturability are two primary methods to provide focus on functions of value to the customer. define a process for the application of value analysis and DFM.
7. We can help in selecting. guide this analysis. We can then develop and conduct training to deploy this process to the organization. Initiation of a Target Costing program begins with management understanding and
commitment. and develop pricing programs. target costing is key to a successful product. Target costs must be established based on analyzing market niches.
3. Since typically 80% of product costs are committed based a decisions during concept development.
Monitoring of Target Costing results is key to a successful program. Similarly. http://www. Decisions made after the product moves into production account for another ten to fifteen percent of the product's costs. the problem is that it is too late and too little. e. over time. DEFINITION OF TERMS The following definition of terms will provide a common basis for discussion:
.. In either case. sales and marketing.com/targetcons. Cost will become a more important factor in the acquisition of a product in two situations. a customer's internal economics or financial resource limitations may shift the acquisition decision toward affordability as a more dominant factor.g. First. 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. and quality. When a company faces a profitability problem and undertakes a cost reduction program. and product distribution activities and policies account for another ten to fifteen percent of the product's cost. customers or users of a product will demand more and more. more performance at less cost. And . is determined by decisions made from conception through product development cycle. it will typically reduce research and development expenditures and focus on postdevelopment activities such as production. A large percentage of the product's ultimate acquisition or life cycle costs. relatively little latitude exists to reduce the cost of a product. as the technology or aesthetics of a product matures or stabilizes and the competitive playing field levels. performance. The management of product cost begins with the conception of a new product.9. aesthetics.
establish Target Costing tracking systems.npd-solutions. develop design review guidelines. a successful product supplier must focus more attention on managing product cost. Once the design of the product has been established. The importance of these factors will vary from product to product and market to market. and insure appropriate management focus to a Target Costing program.html
ACHIEVING TARGET COSTS/ DESIGN TO COST OBJECTIVES INTRODUCTION A competitive product must address factors such as cost. While not suggesting that these are inappropriate steps to take. and general and administrative expenditures. typically seventy to eighty percent. sales. schedule or time-to-market. We can help 10. Most of the cost structure in a company has been locked into place with the design decisions made about the company's products. Second. decisions made about general and administrative. competition is increasingly based on cost or price.
There may not be a rigorous planning and budgeting process for development projects. product cost or life cycle cost considerations are an afterthought. 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. Costs are tallied up and used as the basis for determining the product's price. cost is a more important factor. Stability and management of requirements to balance requirements with affordability and to avoid creeping elegance. The primary focus is on product performance. This may occur before or after the product has been released to production. Budgets are established without buy-in from development personnel resulting in budget overruns. In other companies. 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. but this emphasis is not acted upon until late in the development cycle. Companies may get by with this approach in some markets and with some products in the short term. design changes are made to varying degrees to reduce costs. Projected costs of production are estimated based on drawings and accumulated from quotes and manufacturing estimates. 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.
. In some organizations. Commitment by development personnel to development budgets and target costs. If these projected costs are too high relative to competitive conditions or customers requirements. aesthetics. Establishment and allocation of target costs down to a level of the hardware where costs can be effectively managed. The result is extended development cycles and added development cost with these design iterations. or technology. development costs receive relatively little attention as well. 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. but ultimately competition will catch up and the product will no longer be competitive.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.
These targets should be developed based on pricing formulas and strategies and consideration of price elasticity. or when they are exposed to competitor's product pricing in the market place. Active consideration of costs during development as an important design parameter appropriately weighted with other decision parameters. Based on this awareness of customer affordability or design to cost requirements. nonrecurring development costs will be lower. 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. Everyday customers buy products with functions. 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. This suggests a
. In an environment where development cost is significant relative to total recurring production costs. Use of value analysis / function analysis and its derivatives (e. marketing. 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. cost targets should be formally established.g. Access to cost data to support this process and empower development team members. If product is an evolutionary step with minimal development risk. parts and subsystems. Product cost models and life cycle cost models to project costs early in the development cycle to support decision-making. A keener awareness of design to cost requirements is needed. The use of standard parts and modules from other existing products will also lower non-recurring development costs.
TARGET COSTING AS A FOUNDATION Executive management. features and performance in excess of their needs and wonder how much is money is wasted on these unneeded capabilities. and development team personnel all need to have an understanding of customer affordability constraints or competitive market place requirements. program/product managers. 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. the top-level target cost will need to be allocated to lower level subsystems or modules. Prices and target costs will also have to consider projected production volumes and amortization of nonrecurring development costs. 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. and Continuous improvement through value engineering to improve product value over the longer term..• • • • • • • • • •
An understanding of the product's cost drivers and consideration of cost drivers in establishing product specifications and in focusing attention on cost reduction. Application of design for manufacturability principles as a key cost reduction tactic. This will establish a measurable objective for a product development team where multiple teams are involved in a development project.
As the organization proceeds through the design of both product and process. 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. 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. at best. Data will need to be gathered as a basis for creating or extending the product cost model for the new process(es). these goals should be accepted by the team as achievable. the targets and budgets should be carefully reviewed with the team members to insure they understand these cost objectives and the assumptions behind them. Early in the development cycle. 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. and critical parameter tolerances. a system integration team. product/part characteristics. new manufacturing processes will need to be considered. Ad-hoc cost studies or trade studies may be prepared for significant issues. they will begin exploring alternatives as part of the design process. The model will be implicitly based on assumptions about existing processes and process relationships to types of materials. a different type of product cost model will be used that will consider the specific manufacturing processes. a sense of commitment to these budgets or targets develops. On occasion. Later in the development cycle. While competition will generally dictate that stretch goals be established. The model will be driven by general design parameters. 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. If it is determined after extensive evaluation that the product requirements cannot be achieved at the target cost. This type of model will be built around existing processes where relatively good historical cost data should exist. COST MODELS AND COST DATA Once a team has a set of requirements and a cost target established.g. sizes and tolerance requirements. If the budgets or targets are established by someone outside the product development team (e. When empowered product development teams actually develop these budgets and targets.strategy of not letting product and process technology application get too far ahead of customer affordability requirements. or a project engineer). the product cost model will be based primarily on characteristics of the product design with relatively little consideration of the actual manufacturing process. the requirements and targets will need to be re-evaluated and modified. but tools to regularly support this process are lacking. by a product or program manager.. they will tend to evaluate a product concept primarily based on its performance merits and. a management team. Information to support this model development can be obtained from
. secondarily consider a subjective estimate of the relative costs of the design alternatives. In the absence of other information.
The focus is on accumulating and tracking estimated material. casting. Cost data will also need to be obtained for many purchased parts and sub-assemblies. and costs as part of their capabilities. A company's initial attempt with a product cost model may utilize a spreadsheet program or a bill of material cost roll-up capability. This information may be available in the form of catalog prices or supplier quotations. These individual packages or modules will be oriented toward a limited part or product domain. Parametric techniques would take general characteristics about the product such as size. etc. printed circuit boards. and manufacturing engineers. cost models and
. a more sophisticated product cost model should be developed that will project costs based on the characteristics of parts and the overall product design. 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 cost model would be based on parametric or analogy techniques. 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. Over time. part and assembly costs. facility engineers. weight. several different costing tools may be used by an organization. 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. As the development cycle moves into the product design phase. to support cost projections much earlier in the development cycle. In the early stages of product development. sheet metal.. This type of cost model might be based on commercially available design for manufacturability (DFM) or design for assembly (DFA) software packages. However. and use these parameters to develop a general cost estimate. Over the course of the development cycle. 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.equipment suppliers. These systems typically generate an estimate of fabrication or assembly labor time and costs or machine cycle time. 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.. 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. manual or automated assembly. etc. In addition.g. number of functions. Multiple modules will typically be needed to support overall product cost modeling. In addition. 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. injection molding. e. other users of this manufacturing process.
life cycle costs may need to be considered as the basis for making design decisions. Typical data required will be labor rates. historical data related to operations.g. the quality of the cost data will improve. direct labor is becoming an insignificant cost component in many products. This data needs to be made available to support cost modeling. This will add to the complexity of a cost model. learning curves. and disposal costs. and operation. Costs will be more closely based on the consumption of resources and the aberrations associated with allocating indirect costs will diminish. part. efficiencies. training. historical and projected parts costs. Some companies try to restrict access to cost data to prevent this information leaking out to competitors. maintenance costs.. However. reliability and maintenance often is needed. Traditional approaches to allocating overhead or burden costs generally based on direct labor. While these costs can be modeled. Further. Once the product design is essentially complete. All of this has led to distortion of overhead cost allocations and inappropriate design and sourcing decisions.DFM/DFA tools as just described would be used. there is frequently a lack of understanding of sunk costs and fixed versus variable indirect costs. fuel or energy consumption.). These estimates would be more refined since more is known about the design of the product and its cost drivers. assembly. These costing tools are illustrated below. To support the operation of these cost models. Finally. overhead rates. Data will need to be gathered on operating costs (e. cost data will need to be readily accessed. cost accounting systems would collect costs by product. facilities. This restricted access undermines a design to cost methodology and empowerment of the product development teams. 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. manpower. 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.
These costing tools should have a consistent basis for accounting for costs and a consistent set of rates. 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. As companies move toward activitybased costing. and escalation projections for labor and materials. In addition.
. as the product moves into production. In some cases. etc.
com/dtc. And the quality of information and the cost models must be continually improved and refined. This increased focus on product or life cycle costs will lead to significantly reduced costs and more satisfied customers.DECISION-MAKING In the absence of product cost models and product development teams. Product development teams provide the organizational mechanism to bring the various disciplines together to optimize product costs from an enterprise perspective. product cost management must begin with the start of product development. 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. 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. The key is to emphasize management of product costs during development. Cost models must be provided to support decision-making early in the development cycle. each functional organization will make decisions from their own perspective. not merely accumulating costs as designs are completed. trying to manage the elements of cost that they are responsible for.html
. http://www.npd-solutions. A company operating philosophy that emphasizes cost as a factor in the development decision-making process is a final requirement. Cost models provide the means for the team to objectively consider the implications of various development decisions. Decisions to minimize tooling capital expenditures may also have the same effect in manufacturing costs. 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. Target costs must be established at the start and used to guide decision-making. For example. driving up material and labor costs in manufacturing. Development personnel must operate as entrepreneurs in making hard decisions about the product and process design to achieve target costs. These costs projections will aid decisions about the design of the manufacturing process as well. Product development personnel must understand competitive pricing or customer affordability requirements. SUMMARY Since the decisions made during the product development cycle account for seventy to eighty percent of product costs. decisions to minimize nonrecurring design engineering expenditures may result in a less producible product.
Product profitability must be assessed and planned in the context of a comprehensive life cycle and the relationship of a broad market value chain.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. (CAM-I TCM Study Group statements 1994. The target costing process requires the cost orients
. Target costing is built on a comprehensive set of cost planning.)
The following quotations have been taken from a state-of-the-art review about target costing. 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. 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). Product management must widen to incorporate both physical and service attributes measured in terms of customer value. 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. 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.
while actual costs are calculated after production. Standard costs depend on statistical data and are utilized as an index for cost management.e. because the efforts made throughout the company will inevitably lead to fewer opportunities to cut costs. At Toyota. Celica) is calculated as follows: Ps = P% * Sa where P% is the profit ratio of sales and Sa is the target sales. i. is becoming relatively less important. (Horváth 1993. influencing product costs during the design phase and keeping the running costs as low as possible. as it has been developed in Japan. the use of target costing has a long tradition at Toyota. Thus. was invented by Toyota in 1965. Predetermined costs are the expected measures of the cost before production. Reducing cost through continuous improvement.coordination of all product related functions. (Tanaka T 1993.g. Target costing. the lifetime target profit Ps of a new model (e.) For example. “cost kaizen”. Predetermined costs are divided into standard costs and estimated costs. The sales target is calculated using the retail price Sa = Us * Qs where Us is the target retail price and
. they talk about cost planning and cost control. Estimated costs depend on the managers’ past experience or intuition (Makido 1992).) Japanese management accounting uses classification of predetermined and actual costs.
1. 2. basic design and manufacturing preparation. Assign target cost to the top and middle functions of each functional area or main component of the new product. The system consists of five stages: planning. manufacturing and marketing. Assign the target cost to the functional area of the new product. Use a rough cost estimate to ascertain whether the basic product concept has been designed to fit the target cost. 3. 2. Frame a general drawing under the target cost. Schedule the product’s design. STEP3: Basic design Make a general drawing of the product based on the previous steps: 1.
. selling price and volume. Formulate the main functional areas. 2.Qs is the target production volume over the product’s life. Tanaka M (1989) claims that 80-90% of the life cycle cost is determined at the design phase of the product. Outline the product’s concept and mission. Design the basic product concept under the target cost. Define product target cost. concept design. The phases are outlines below: STEP1: Planning Summarize the new product plan in a document that clarifies the design requirements: 1. Use a rough estimate to ascertain whether the general drawing has been designed to fit the target cost. STEP2: Concept design Formulate the basic concept of the new product based on the design requirements mentioned in step 1. 3. 3. the present cost control system is focused on the design phase. 4. Therefore. 4. Generate primary specifications for the product’s performance and design.
. The survey was conducted among the top-performing US R&D units and resulted in 126 questionnaires. The design of the manufacturing process. The standard cost of $2900 per ton was thought to be based on a solid analysis and was taken for granted. (Tanaka M 1989. The detailed cost estimate used to ascertain whether the manufacturing preparations for the product are accomplished within the target cost. 2. 2. of which 77 showed an orientation towards market-driven cost control. The management believed that the loss was related to the market price rather than their own manufacturing.) According to Shank & Fisher (1999). Xerox is mentioned as one the well-known practitioners of systematic proactive cost planning. The detailed manufacturing specifications under the target cost. The situation of Montclair Mill seemed gloomy: The mill was making $700 loss per every ton of paper sold.STEP4: Detailed design Write the product’s manufacturing specifications based on: 1. type and jig under the target cost. A detailed cost estimate to ascertain whether the product’s manufacturing specifications have been designed to fit the target cost. 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 implementation of target costing was introduced with a new target of $1162 per ton. STEP5: Manufacturing preparation Write the product’s manufacturing specifications based on: 1. target costing seems to be applied mostly at the early stages of product development. (Boer & Ettlie 1999.) Boer and Ettlie (1999) report a case where a car manufacturer could have prevented a $300 million mistake by using proactive target costing.
which equals a 60% cost reduction. During 18 moths. as illustrated in Fig. the target costing discipline has been structured into three sections.
.) Cooper & Slagmulder (1999) gives a comprehensive review of the application of target costing. four major reductions were accomplished: 1. 3. 17. He emphasizes the strategic value of target costing in managing the company’s future profits. Paper machine cost: Yield from 47% -> 75%. and after ta cost-driven analysis. The management accepted the challenge. Together. the cost dropped to $240. these produced the desired level of costing and a dramatic turnaround in the mind set. 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. a reduction from $303 to $150 was challenged with the risk of possible outsourcing. 2. Fiber cost: 60% cost reduction. (Shank & Fisher 1999. and the continuous improvement seemed to gain even more. 4. Conversion costs: Based on benchmarking. According to their study of seven Japanese companies.
As a conclusion. 17) requires a highly disciplined approach. Each of the main phases must be balanced to avoid unrealistic target setting. The company does not launch any product exceeding the target costs. Successful application of this process (Fig. The process starts from the left. Once these have been decided on. by setting the company’s long-term sales and profits objectives.Figure 17. the Cardinal Rule is applied to ensure that discipline is maintained throughout the design process. and continues through the product level targets to component level target costing.fi/isbn9514264509/html/x1194. 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.oulu.html
. The Cardinal Rule controls the process in three ways: 1. the offsetting saving must be found somewhere else. The role of the product chief engineer is remarkable in the fundamental decisions concerning product and component target costing. the early involvement of proactive product cost management has been highlighted as a major advantage of some leading Japanese companies in highly competitive markets. The design transfer to manufacturing must be well controlled to achieve the target cost. 2. 3. The Cardinal Rule of target costing is: “The target cost must never be exceeded”.
http://herkules. If the design does not reach the target costs. Three main elements of the target costing process (Cooper & Slagmulder 1999).
managers and accountants must heed the shareholders' needs for satisfactory shortterm profits. costs of designing. U. Accountants usually measure. The practice is effective in achieving the desired ROI or ROE. It is also a very effective foundation for building long-term quality improvement initiatives. and easily understood if we look at the Big Three automakers' practice of raising prices whenever there is a restriction placed on Japanese imports. marketing. 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. Born out of the market-driven philosophy.Target costing is a cost management concept that has been used very
effectively by leading Japanese manufacturers. robots and computer-controlled manufacturing systems are replacing the conventional production lines. and delivering products dictate the mode of competition. Most popular cost accounting methodologies. measured by ROI or ROE. With its emphasis on market position and product leadership. based on allocation routines. 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. thereby allowing the company greater flexibility in production management and in production development. controlling costs in the manufacturing phase simply doesn't accomplish much.Use target costing to improve your bottom-line. What all these changes mean is the traditional standard costing systems. the total cost of each product. but it hurts the carmakers' ability to increase market share in sales volume. John Yee
Abstract.S. is primarily used and most effective in the product development and design stage. With a one-year product life. companies. profit-driven outlook of most US manufacturing companies. manufacturers have learned cost management should start up front at the initial stage to be effective and measure up to their foreign counterparts. Due to factory automation. quite often one or two years. are no longer effective. which emphasize cost control in the manufacturing phase of the product life cycle. This focus on meeting the shareholders' short-term needs has been well documented. producing.S. An increased
. A case example illustrates the technique.
Changing Product Life and Requirement Product life cycles are getting shorter and shorter. Control Costs Early Target costing. target costing is based on the pricedown. It is based on a long-term. cost-down strategy. including the emerging activity-based costing. there is a limit to how much cost cutting companies can do in the manufacturing stage. although its concept is used throughout the product life cycle. In U. No matter how effective the cost accounting methodology may be. market-driven perspective rather than on the short-term. Consumers are demanding new and diversified products in short intervals. focus on product profitability. (CPA in Industry)
by Lee. target costing enables companies to attain low costs to ensure low prices that help maintain market share. which has allowed companies like Sony and Toyota to win a considerable share of their respective markets. sometimes to less than one year in high-tech industries. Once the product is developed and designed.
ROS provides a better measure. There are two primary reasons for using ROS. In the fastchanging market of today. Now. The desired profit margins are traded between products in the same group. The target cost is then established as an attainable target which will motivate all personnel to achieve. cost management must start (and done substantially) at the design stage. "How much does the product cost?" This question follows a new product design into the cost accounting department. 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. "What does it cost?" Wben the target sales price is established based on market research. This departmentalized policy formulation of a typical U. which is based on the current standards of materials. which does not discriminate against high-quality. the struggle begins. "What should the new product cost?" It is not. In companies where target costing is used. The allowable cost is compared to the estimated cost. After motivational considerations have been made. They place more emphasis on their relative position in the market and product leadership. This is in direct contrast to a typical U. * The Strategic Reason. The marketing department then addresses the issue of whether they can sell the new product. there seems to be a different culture and attitude. the gap between allowable cost and estimated cost is reviewed on various dimensions. Setting the Target Costs The main theme in the entire target costing practice is. 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. For this. high-price product.S. In the implementation of long-term strategies. company. labor. In the meantime. tends to discriminate against developing a new high-quality. This allowable cost is top management's dream. Calculating the profitability of each of those products in ROI is well. The profitability of each group of related products is the focus. labor costs. The desired profit is determined based on the company's desired return on sales (ROS). rather than ROI. manufacturers need a variety of products in low volumes to survive. The target profit for each period is determined for each of the new and existing product portfolios. Connect with Profit Planning Target costing is very closely linked with the company's long-term profit and product planning process. intensive studies of competitors' parts are done. manufacturer's practice. high-price. and other manufacturing overhead costs under the current production standards. and overhead.S. usually impossible in the short run.nigh impossible. This link allows the company to focus on profit and product in an integrated strategy. which estimates the new product costs based on the prices of purchased materials and parts. the second is strategic: * The Technical Reason. This is a target which is very hard to attain. rather than the profitability of individual products.
. Target costing derives its bases from the company-wide profit plan. which focuses on cost.market share would give them a buffer in the future if they choose to sacrifice sales volume to increase revenue and longterm profit. Since more than 80% of product cost is already determined by the time product design and processing is complete. in which the question persists. high-margin products that require high costs. the desired profit is subtracted to yield the allowable cost.
and compromises are made in their efforts to get within the target cost range. Production engineers determine standards for material and part usage. etc. post plate drill. purchasing people negotiate with outside suppliers as to the prices of purchased materials and parts. target profit. engineering. In the design phase. These standards are also used as a database for material requirements planning (MRP). The process of VE consists of describing the functions of each product. Value Engineering The idea behind VE is very similar to activity analysis which was first developed and used by General Electric. which become the basic cost data for financial accounting purposes. PCBM. is value engineering (VE). A Case Example The following short case example is used to illustrate the process of determining target costs using production and cost figures. nevertheless. labor consumption.000 units of a multi-layer panel product by an electronic product manufacturer. investigations follow. hole size. Post. As soon as the above-mentioned standards are established. GE's activity analysis was not. laminate thickness.000. a Silicon Valley PCB manufacturer. lot size and frequency. the desired return on this offer is $120. marketing. If targets have not been achieved. number of holes. and fine line class. and target costs as they are practiced In Japan. cost management people help engineering planners and designers decompose the target cost into each cost element according to their relations to detailed production functions. is offered $48 per unit for 10.audit of target costing performance is done on a regular basis to examine the degree to which targets have been achieved. and quantifying the components of those functions. calculated as follows:
. which is measured by the relationship between the functions performed by products and services and the costs incurred. 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. and other departments in the company. linked to corporate profit planning. however.. number of images per panel. The functions are defined by different companies in different ways. a printed circuit board (PCB) manufacturer's VE activities for the drilling operation include panel size. The struggle to achieve the target costs takes place in and outside the company. management science techniques are employed on the many aspects of the drilling operation to improve upon the current method. The fundamental mechanism Japanese manufacturers use to achieve target cost. SInce PCBM's usual return on sales (ROS) rate is 25 percent. Negotiations also take place among design. part.Achieving The Target Costs At this point. and was not intended to be. VE is a mechanism Japanese manufacturers use to enhance the value of products and services. Some are geared toward process improvement while others are focused on satisfying the needs of customers. For example. A short payback period is usually assumed in planning and evaluating target costs. and service.
000. The gap between the allowable cost ($360. five images per panel. Desired return: 25% x $48 = $12 per unit. $12. which was estimated to reduce unit cost by $2. Since PCBM had already designed and implemented an activity-based costing (ABC) system.000 for the offer. Various moves were analyzed to reduce the distances. But.desired return.000.75
. The impact of accepting the offer on the production plan and the cost of total production for the period was also considered. management asked the marketing team to review the $48 selling price. in order to persuade them to lower their prices. it was rather easy to demonstrate the cost impact of each component. were made. Suggestions of possible improvement in performance by 30%. After long hours of careful evaluation by production supervisors. the suggestions were aggressively implemented by the processes and areas involved.000 units = $480. material cost per panel of $19. most of which looked too ambitious at first.80 The cost of component legend option: $0.Amount of the offer: $48 x 10. and cost management people.000 for the offer. and no tab plate edge. two solder mask sides requested.000. The "struggle" to eliminate the gap of $40. which had five process centers indicated the following costs of options: The cost of solder mask option: $1. since the new target costing-induced management plan had been accepted by all supervisors and managers of the plant. a total of $30. At the same time.000) for the offer is $40.000 units is $36 per unit. The result of these improvement activities was the reduction of another $1 per unit cost. The estimated cost is calculated by the cost management team as $40 per unit. process and product engineers.000) and the estimated cost ($400.000 for the offer. Furthor Action After the successful execution of the target costing project.000 by $10.000 = $120. they were responsive to the request by PCBM for a review of the $48 price. estimated yield rate of 86%. Since the customer was satisfied with the quality of the product. or $360. which is adopted as the target cost reduction. .000 started with VE activities. top management thought the efforts of those who were involved in reducing costs were substantial.000 units = $360. board-width. since sales price. The cost was estimated based on four layers requested. one component legend side.000. A series of studies and analyses of material scraps and other types of defects were performed. board length. $12 x 10. $48. it was decided that VE activities should be focused on reducing the defect rate and material handling and purchasing.000. = $36 per unit. Improvements on material handling were centered around reducing material moving distances between the point of receiving the deliveries and the point of usage. PCBM's ABC system. panel size. The customer's representative tried to justify the fair level of the current price by pointing out that no tab plate edge was required.000 for the offer. brought the cost to $370. which would reduce manufacturing costs. The allowable cost for this production of 10. the purchasing group of PCBM entered a long negotiation process with the suppliers. Although this was still higher than the allowable cost of $360. or $400. $36 x 10. The combined reduction in cost per unit of $3.
as it has been in Japan.Since the customer's PCB didn't require tab plating. is also very compatible with the emerging ABC.S. as briefly illustrated here. industry.org/cpajournal/old/14979931. And target costing can be as effective in U.
http://www. It is a disciplined approach to managing costs and improving processes and products.htm
. which can provide necessary cost information for implementing target costing.nysscpa. the ABC system already reflected that. This helped PCBM earn credibility from the customer regarding the price quotes. The Real Weapon The real power of target costing is that it allows companies to successfully motivate employees and enforce cost management action plans. No cost was charged to their order for the tab plating option. The customer finally agreed to consider a price increase in the near future. Target costing.
com/magazine/archives/article. 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. Target costing requires them to think beyond those traditional tasks and factor in the cost of the engineering. Target costing. it can improve customer satisfaction. It also allows more people in the company to understand the company's objectives and how they are going to be achieved. not merely a dictum from senior management.Avoiding the Pitfalls
What are the obstacles in target costing? It takes time and money to bring sweeping changes into an organization. "Most American companies are working in silos. arrives at a price that works for the company as well as the customer. Why rock the boat if things are going well? The answer. Workers can understand that the reasons behind your cost objectives are directly related to gaining a competitive advantage. to perform cross-functionally.
http://www. engineers focus on the specifications of the product.html?articleID=4308&pg=2
. target costing proponents say. Controllers who introduce target costing successfully into their organization may change how co-workers perceive financial types." says Keith Hallin. There's also the problem of changing workers' behavior. is simple: In the long run your company will be better positioned to compete in the marketplace with target costing than without target costing. from a policeman or someone with a big stick to a valued partner working on everyone's behalf. because it encourages people with different functions to work on the same team to meet the collective target costing goals. Since target costing is customer-driven." 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.businessfinancemag. and companies that have used target costing have indeed found that they reach their profit goals more effectively. That makes it a more effective way to do business. ideally. "For instance. senior manager of finance in the Boeing Commercial Airplane Group in Seattle. who has introduced pilot programs in target costing at his company.
. 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. They are the type of customer you sell to and the type of product you make or service you offer.PRODUCT AND CONSUMER INFLUENCESoduct
and Customer Influences
A number of factors influence target costing. including senior management's objectives and your company's long-term profit objectives.
Give co-workers a better understanding of cost objectives. 7. something Boeing takes very seriously. "In research-gathering
. But target costing makes more of a defined effort to achieve this objective than traditional costing methods. 5.10 Advantages of Target Costing
If you are successful in implementing and maintaining an effective target costing system. you may be able to: 1. Spend money where it will have the greatest impact. Transform your image of "policeman" into that of a valued partner working on everyone's behalf. Achieve greater cost efficiencies.
9. Increase customer satisfaction. 6. Become more competitive globally.
10. Match your firm's activities to your customers' requirements. 4. 8. Allow co-workers to participate in setting quality. Determine an expected cost of manufacturing a product or providing a service.
It may seem obvious to tie the cost of your product or service to the needs of your customers. Identify customers' real needs. cost and time targets.
2. 3. That effort extends to researching customer needs.
I ask how many people own one of our products. use it as well. Hennessey. "Then I ask how many people have ever flown in one of our planes. the upholstery. perhaps by looking at the springs in the seat. Enhance those things and reduce costs in areas that aren't as important to the customer. Judith E. Northridge. Calif. "Suppose you're an automaker and you've determined your customers want comfort." Target costing says you need to match your firm's activities to your customer's requirements.. and no one raises their hand. but how their customers. the passengers.seminars." says Boeing's Hallin. Although ours is a business-to-business company. the car's suspension." Uncovering customers' real needs can occasionally be
. and everyone's hand goes up. the angle of the seat. professor and chairwoman of the marketing department in the College of Business Administration and Economics at California State University. "Evaluate your product as it relates to enhancing customer comfort. offers an example. Dr." says Hennessey. we want to understand not only how our immediate customers [airplane purchasers and lessors] use our product.
try again. which is how long it typically takes at Boeing according to Hallin. Procter & Gamble had missed taste as a customer need. "Sometimes.difficult even with a simple product. the target
. if your cycle is up to four years. For instance. and the answer uniformly was freshness. Find other areas less important for customer satisfaction and try to reduce those costs. But then customers found out that the product didn't taste very good." Hennessey says. the longer your product development cycle from the design stage to the production stage. "The product was launched in a vacuum-sealed can to maximize freshness." says Hennessey. they asked people what they wanted from a potato chip. and even for the best of companies." If in creating product functions that reflect what the customer wants your costs become too high to hit your target. don't give up. How does your product influence target cost? Generally. "When Procter & Gamble developed their Pringle's potato chip. target costing needs many iterations to carry it through. If the process doesn't work the first time around. and initially. the more difficult it may be to establish firm target costs early on. it was successful.
"We're very interested in target costing."
. "The simpler and more straightforward your product. They have an allowable cost for each component function. so a representative sample of allowable costs is taken and applied to all components. Some companies with a long product development cycle take the process in incremental steps. and we're just in the infant stages here. the easier it is to implement target costing.cost you establish may need to be revised over the years. program director for project redesign on all financial processes at Chrysler Corp." says George Millush. Mich. From these costs comes an updated target cost. 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. but it takes time to put the pieces in motion. in Auburn Hills. 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. It's usually impractical for a company with hundreds of design and production components to evaluate all of them.