Target costing has recently received considerable attention. Computer-Aided Manufacturing – International defines target cost as & quota market-based cost that is calculated using a sales price necessary to capture a predetermined market share.” In competitive industries, a unit sales price would be established independent of the initial product cost. If the target cost is below the initial forecast of the product cost, the company drives the unit cost down over a designed period to compete. Target cost = Sales price (for the target market share) – Desired profit Japanese cost management is known to be guided by the concept of target cost. It’s the decision of the Management regarding the product that is to be designed, what a product should cost, based on marketing (rather than manufacturing) factors.
The following write-up on target costing for the Sony Walkman describes the target costing approach. The target costing philosophy leads to a market-driven approach to accounting. Target costs are conceptually different from standard costs. Standard costs are predetermined costs built up from an internal analysis by industrial engineers. Target costs are based on external analysis of markets and competitors. Several Japanese firms are known to compute two separate variances, one comparing actual costs with target costs and other comparing actual costs with standard costs. Target costing is a tool for reducing the costs of existing products. It is impossible that the design, manufacturing, and engineering groups will lead to optimal, cost-efficient process at the beginning of production. The search for better, less expensive products should continue in the framework of continuous improvement.
- The ABC technique can be useful as a tool for target costing of existing products. ABC assists in identifying non-value-added activities and can be used to develop scenarios on how to minimize them. Target costing at the activity level makes opportunities for cost reduction highly visible.
- Target costing is also strongly linked to consumer requirements and tries to identify the features such as performance specifications, services, warranties, and delivery consumers want products to provide. These consumers may also be questioned about which features they prefer in products, and how much they are worth to them. The surveys on preferable features and value of these features help management do a cost-benefit analysis on different features of a product and then try to reduce costs on features that are not ranked highly.
- Target costing also provides incentives to move toward less expensive means of production, as well as production techniques that provide a more even flow of goods. JIT provides an environment where there is better monitoring of costs and product quality as well as access to ideas for continuous improvement and better production strategies.