CMA FINAL (G3) – SCM

SCM- DEC 2020- Target costing or Price-led costing or Pull costing

Akio Morita, one of the promoters of SONY, is credited with this approach, which is a scientific and
structured methodology to establish a cost target at which, a product with a specific functionality
and quality, must be produced, to generate the desired level of profit. It is a cost estimate derived by
subtracting the desired profit margin from the competitive market price.

It is a cost and profit managem3nt tool for optimizing the overall cost of a product over its entire life
cycle.

The major steps are:

1) Ascertain customer requirements ( product characteristics, price, performance,etc)

2) Competitor analysis ( products and practices) (reverse Engineering or tear down
approach)
3) Establish the market price to achieve the target volume
4) Establish the target profit or ROI and work out the target cost
5) Form a cross-functional team to be responsible for the exercise
6) Concept design( main functions)
7) Basic design ( general arrangement drawings and part list)
8) Detailed design (manufacturing specifications for the parts)
9) Prepare a cost estimate and identify cost gap based on the target cost
10) Explore ways and means of bridging the cost gap
11) Finalise the achievable target cost.

The main benefits are:

(a) Customer focus is ensured

(b) Costs are reduced before they are locked in ( basis for 70 to 80% of the costs are
decided during the design stage)
(c) The design specification and production specification are controlled with Value Analysis.
(d) Inefficiencies and corrupt practices come to light and can be eliminated.

Problem 1 : A Co manufactures and sells 8000 units of its product. Full unit cost is Rs 110. The price
has been fixed to earn 25% return on the investment of Rs 8 lakhs. Find (a) unit selling price (b)
mark-up as % on full cost (c ) UVC if the above USP has mark-up of 50% on variable cost (d) If the
USP is increased to Rs 140, the volume would drop to 7000. Do you advise this change? (e) if the
investment is reduced to Rs 7 lakhs and the price is to be reduced to Rs 130, to sell 8000 units, what
should be the target unit cost with the same ROI of 25% ?

Problem 2 : A Co is currently selling 1,20,000 units of its product A at Rs 900 per unit.The main
competitor is expected to reduce price by 10%. The Co wishes to cut its price by 12% to preempt the
competitor’s expected move. The sales volume is expected to increase to 1,70,000 units. The
following data have been compiled:

Existing Expected

Unit Direct material cost (Rs) 300 280

Unit direct labour cost (Rs) 50 45

Unit direct machine cost(Rs) 60 50

Manufacturing OH
CMA FINAL (G3) – SCM

No of orders (Rs 70 per order) 20,000 19,200

Testing hours(Rs 3 per hour) 3,20,000 2,50,000

Rework units (Rs 80 per unit) 10,000 12,000

Other operational fixed costs based on the expected volume:

Unit R & D cost (Rs) 40

Unit marketing & service cost(Rs) 120

Find the unit and total current and target costs and the current and target profit.

Solution:

Per unit Total

Current Target current target

Sales (units) 1,20,000 1,70,000

USP ( Rs) 900 792 ---- ------

Sales revenue (Rs L) ------ ----- 1,080 .00 1,346y.40

Direct material cost

Direct labour cost (Rs L)

Direct machine cost

Ordering cost

20,000 x 70/1,20,000 Rs 11.67 ---- Rs 14.00 L -----

----- ----------

Testing cost

3 x 3,20,000/1,20,000 Rs 8.00 ----- Rs 9.60 L ------

----- --------

Rework cost

80 x 10,000/120,000 Rs 8.67 ----- Rs 8.00 L

----- ------

Total cost Rs Rs Rs L Rs L

Gross margin Rs Rs Rs L Rs L

R&D Rs Rs Rs 68.00L Rs 68.00L

Marketing & Services cost Rs Rs Rs 204.00L Rs 204.00L

Total cost Rs Rs Rs L Rs L
CMA FINAL (G3) – SCM

Operating profit Rs Rs Rs L Rs L