LAGUNA STATE POLYTECHNIC UNIVERSITY

Target Costing
GROUP 5
DEFINITION
Target costing is a management method that helps
a company choose pricing depending on external
factors. These factors include competition, the
presence of switching costs for the customer,
similar products, and more.
The presence of such factors leaves
management with little or no control over the
selling price.
It is a strategic management process for reducing
costs at the early stages of product plan­ning and
design. Target costing begins with identifying
customer needs and calculating an acceptable
target sales price for the product.
In simple words, the target costing is estimating
the cost of a product by subtracting a profit
margin that the company wants from the
competitive market price of the product.

Target Cost =
Expected selling price – Desired profit
Key Principles of
Target Costing:
 1. Price-Led Costing:
Target costing sets the target cost by first
determining the price at which a product can be sold
in the marketplace. Subtracting the target profit
margin from this target price yields the target cost,
that is, the cost at which the product must be
manufactured.
Notice that in a target costing approach, the
price is set first, and then the target product
cost is determined. This is opposite from the
order in which the product cost and selling
price are determined under traditional cost-
plus pricing.
 2. Focus on the Customer:
To be successful at target costing,
management must listen to the company’s
customers. What products do they want?
What features are important? How much are
they willing to pay for a certain level of
product quality?
 Management needs to aggressively seek
customer feedback, and then products must
be designed to satisfy customer demand and
be sold at a price they are willing to pay. In
short, the target costing approach is market
driven.
 3. Focus on Product Design:
Design engineering is a key element in target
costing. Engineers must design a product
from the ground up so that it can be
produced at its target cost.
This design activity includes specifying the
raw materials and components to be used as
well as the labour, machinery, and other
elements of the production process. In
short, a product must be designed for
manufacturability.
 4. Focus on Process Design:
Every aspect of the production process must
be examined to make sure that the product is
produced as efficiently as possible.
 The use of touch labour, technology, global
sourcing in procurement and every aspect of
the production process must be designed
with the product’s target cost in mind.
 5. Cross-Functional Teams:
Manufacturing a product at or below its target cost
requires the involvement of people from many
different functions in an organisation: market research,
sales, design engineering, procurement, production
engineering, production scheduling, material handling
and cost management.
 Individuals from all these diverse areas of
expertise can make key contributions to the target
costing process. Moreover, a cross-functional
team is not a set of specialists who contribute
their expertise and then leave; they are
responsible for the entire product.
 6. Life-Cycle Costs
In specifying a product’s target cost, analysts
must be careful to incorporate all of the product’s
life-cycle costs. These include the costs of
product planning and concept design, preliminary
design, detailed design and testing, production,
distribution and customer service.
 Traditional cost-accounting systems have
tended to focus only on the production phase
and have not paid enough attention to the
product’s other life-cycle costs.
 7. Value-Chain Orientation:
Sometimes the projected cost of a new product is
above the target cost. Then efforts are made to
eliminate non-value-added costs to bring the projected
cost down. In some cases, a close look at the
company’s entire value chain can help managers
identify opportunities for cost reduction.
 Target costing is a common practice in Japan
where markets are extremely competitive. The
market determines the price of products and there
is a little opportunity for the individual organisa­
tions to set prices. Therefore, controlling cost is
extremely important.
RELATIONSHIP OF
TARGET COSTING AND
ACTIVITY-BASED
COSTING
 Relationship

Target costing is related to the

activity-based costing on three
points. (Horvath,1993, s.12-13)
 First

Determining the estimated cost.

 Activities that are used on the
indirect areas depending on the
product, can be analized by original
activity costs.
 Second

Activity-based costing can determine the

cost drive of the product planning and the
design offer.
 Subjects such as product diversification,
usage of standard parts, chain of distribution,
purchasing and production, has to be
compatible with market requirements.
While target costing provides information for
market requirements and cost goals, activity-
based costing can present cost structures of
design alternatives.
 Third

Activity-based costing can be used as a tool for

achieving target cost.
Activity-based costing which identifies the activities required

to realize specific product functions and related to this,

determines the cost allocation keys, assists to determine the

optimal value area by transferring activity costs to product

functions.
In addition to that, cost allocation key information
can present the conditions of the activities required
to be reorganized for cost reduction operation.
Target Costing
Process
 1. Conducting Market Research

The company should determine the customer wants

precisely through conducting marketing research. A new
product can be designed or make changes in the existing
product on the basis of the customers expectations and
perceptions.
 2. Identify the Nature of Market

The market information can be collected in such a way

that what type of products are available in the market, the
level of competition prevailing, the number of
competitors and the price at which the existing products
are available.
 Besides, the company should find out the
affordable price of the customers. If so, the target
costing is followed
 3. Translation of Customers
Requirements into Product Features
The preference of one customer differs from another.
These preferences are collectively called as customers
requirements. Now, the bundle of preferences are
bringing into a tangible thing i.e. product.
4. Development of a Product Design

By considering the engineering analysis of market

forces, customer needs, relevant technology, competitors
models, product configuration and performance features,
design alternatives, process capabilities,
 5. Determine the Price, Margin and Cost

Target selling price is determined on the basis

of market survey, at which the product can be
sold.
The standard margin is also included in the target
selling price. If so, it is possible to determine the
target cost
Target Cost =
Target Selling Price – Target Profit
 6. Conducting Value Engineering Process

The company can conduct value engineering

process to reach target cost. It is a well known
fact that the difference between target selling
price and the target profit is target cost.
The target selling price cannot be changed at
any cost; Hence, it is a duty on the part of
company is that takes necessary steps to reach
the target cost.
 7. Improve the Design to Reach Target
Cost
The company starts a minor trial production. Such
a production ensures all product performances,
target cost and target profit margin also. The trial
production comes to an end whenever the product
design matches the target cost.
 8. Approval of Top Management
A detail report is presented before the top
management for getting approval. The report
contains the production process, elements of cost
involved with the level of costs to be incurred and
design of the specified product. A formal approval
is given for starting commercial production.
 9. Maintenance of Accounts

A separate accounting records are to be maintained for

each product design. It is possible to verify whether the
total expenses exceed the target cost. If the expenses
are not controllable at any time, the product design will
be changed. Hence, the maintenance of separate set of
books are highly required under target costing process.
 10. Implement the Target Costing

The company can get the information regarding the

expenses incurred for each design separately. A
continuous watching is essential to bring the total
cost within the target cost.
 Market-Driven Target Costing
In this phase, Selling Price is determined by analyzing the

entire industry value chain and all functions of the firm.

The focus of this costing phase is on analyzing market

conditions and determining the company’s Profit Margin

in order to identify the “Allowable Cost” of a product.

 In this phase, the desired profit level is set on the
basis of firm’s strategy and financial goals, and is
deducted from Selling Price to obtain Allowable
costs. Intensity of competition, nature of customers,
similar product introduction by competitors, and
level of customer sophistication are the key factors
influencing Market-driven Target Costing.
 Product-Level Target Costing

In this phase, Allowable Cost only gives a ball-park figure

of cost saving to be achieved. It has to be translated into
Achievable Target Cost. This type of costing concentrates
on designing products that satisfy the company’s customers
at the Allowable Cost. The cardinal rule of Product-level
Target Costing is to never exceed the Target Cost.
 The objective of this Target Costing phase is to create
intense but realistic pressure on the product designers to
reduce costs. Product Strategy (number of products in the
line, frequency of redesign, degree of innovation) and
product characteristics (complexity, magnitude of up-front
investments, and duration of product development) are the
key factors affecting Product-level Target Costing.
 Component- Level Target Costing

The Component-level Target Costing settles the price at

which a firm is willing to purchase the externally-acquired
components being used in its product. This phase involves a
cross-functional team that is tasked to reduce costs across
all functions such as designing, purchasing, manufacturing,
marketing, and other activities.
The components cost history serves as the starting point for
estimating the new component-level target costs alongside
optimal selection of suppliers. A supplier-focused strategy
is the key factor that influences Component-level Target
Costing.
 Target Costing

Advantages
&
Limitations
 ✓ Positive Impact on
Profitability
Target costing has positive
Advantages impact on profitability of the
organisation, throughout the
life cycle of every product.
 ✓ Company Competitive
Future
This costing helps to create
the competitive future of any
Advantages company as the product is
designed and manufactured
as per requirements of the
market.
 ✓ Top to Bottom
Commitment
It reinforces top to bottom
Advantages commitment to process and
product innovation and is
aimed at identifying issues.
 ✓ Valuable Edition to Life
Cycle

Advantages This costing can be used as

a valuable addition to the life
cycle products.
 ✓ Lack of Consensus
It is very difficult to reach to a
consensus on the proper
Limitation design of the product, because
the opinion of the design team
members may vary.
 ✓ Lengthy and Time
Consuming
This system is lengthy and time
Limitation consuming process. This delay
may lead to serious cost over
runs.
 ✓ Cost Cutting
A large amount of mandatory
cost cutting may result in finger
printing in many parts of the
Limitation company. It may bring savings
in one part, while there may be
cost reduction in some other
parts.
 Reducing cost
may sometime
Limitation hurt employee's
morale.
 The project team has
to work tirelessly to
Limitation meet the target cost.
Thank You!
Group 5
Onet M. Bautista
Hynes S. Religioso
Alaiza Joy H. Plantilla
Rodelyn L. Toquero