Target Costing

OUTLINE
Origin
Definition
Main Concept & Application
Related Concepts
Process
Advantages
Disadvantages
Illustrative Models
Target Costing 2

TARGET COSTING
Target Costing 3
Target
Price
Target
Profit
Target
Cost
Let us explore, how it works?

COST
COMPETITIVENESS
Target Costing 4
Achieving a Target Cost
over the entire lifecycle of a product to compete for the
best price in a market.

TARGET COSTING
Target Costing 5
A customer-centric
costing system that bases all cost workings for a product
from its market price. The purpose is to reduce cost of a
product as low as possible to arrive at a price that would be
either equal to or less than that of competitors’ product
while delivering the same functionality.

ORIGIN
Target Costing originated from Japan in 1960s as a direct consequence of increasing
influence of western products in Asian markets. Western products were superior in
quality and reasonable in prices. Japanese companies struggled hard due to shortage of
resources for development of such products that could compete western products in
quality, cost and productivity. They constituted teams of cross-functional technicians
to find out products that could compete in cost, quality and productivity. These teams
examined production processes minutely. Their aim was to increase the degree of
integration between up-stream and down-stream activities of a company’s operations.
Target Costing originated out of these examinations. Finally, such designs of products
were found that could beat competitors’ products in cost, quality and productivity. They
achieved this goal by using several tools from different disciplines, such as engineering,
production, marketing, design and management & cost accounting.
The tools used by them included the following: Value Analysis, Value Engineering,
Functional Analysis, Kaizen Costing, Lifecycle Costing, market analysis tools,
managerial accounting tools, production methods, etc., etc.
Target Costing enabled Japanese companies to have effective and efficient designing
and product development departments.
Now, Target Costing is used across the world today for achieving cost-competitiveness.
Target Costing 6

COSTING SYSTEM
 Improves the understanding of the costs of products and services,
where issues are identified at the design development stage of a
product so that a corrective action can be taken for cost-efficiency.
 Brings a focus on the final users of a service or product.
 Is multidisciplinary and involves cross-functional team of
technicians in the cost management and encourages them to take
responsibility for cost-competitive design of a product.
 Provides a framework which encourages a focus on the wider
supply chain, in effect a whole systems approach.
 Can be used by service organizations to look at the impact which
new services have on the existing ones.
 Develops specific and real targets which ensure satisfactory
financial performance.
 Highlights other problems in areas such as purchasing which affect
the cost of the product or service.
Target Costing 7

DEFINITION
According to CIMA Official Terminology a target cost is,
“a product cost estimate derived by subtracting a
desired profit margin from a competitive market
price.”
Target costing is a formal system that attempts to achieve a target cost.
Target costing is just not costing system or cost management technique but
this is a complete business management philosophy that is purely market-
oriented.
Target Costing (TC) is a
“structured system for achieving a target cost at
which a proposed product with its specific
functionality must be produced to generate a target
profit at its target selling price.”
Target Costing 8

OBJECTIVE
• Reducing cost of a product
equal to that of competitors’
product at design stage to
enable the company to stay
competitive in the market in
terms of price and product
features.
• TC is a market-driven costing
system for developing a
product that is primarily and
effectively used for cost
planning and controlling at
allowable levels throughout the
lifecycle of a product.
Target Costing 9

PROCESS
Target Costing 10
It is an iterative process which is used by a design
development team, the process continues to change design
of a given product until the cost of a product is either
lowered or becomes equal to target cost while maintaining
the required level of functionality.
Management benchmarks a product from a market and launches its own
campaign to create a similar product from its own manufacturing
facilities/resources at the same cost and with the same design and features.
To achieve this purpose, a team of cross-functional technicians (engineering,
production, marketing, design, management accounting departments) is
constituted.
The purpose behind achieving target cost is to beat competitive products and to
ensure required market share and profitability. If the product under design is
delivering same value as that of competitors’ products and has lesser or equal
cost, then, the product has competitiveness in the market, otherwise, the product
may be failed in the market.

UTILIZATION
Target Costing 11
TC is being used invariably across the world today, as a tool for cost
management, to secure required market share and to achieve desired
profit levels.
 More than 80% companies in Japan that are in assembly line business,
employ TC as a tool or technique to manage their cost.
 More than 60% companies in Japan that are in processing industry, use TC
as a cost management technique.
Here are given the names of few reputed companies that are using TC as a
mechanism for cost management:
Boeing, Eastman Kodak, Honda, Daimler, Chrysler,
Caterpillar, GE, GM, Toyota, Nissan, Sony, Mitsubishi,
Ford, Motorola, etc., etc.
CAVEAT
It is learned through experience that TC is best suited for industries that have
non-customized and high volume products.

APPLICABILITY
TC is the most effective system for planning,
controlling and monitoring of cost for new products
at each stage of their life cycle.
HOWEVER
It can also be used for existing stream of products.
Why TC is effective for new products?
It is noted through studies, 70% to 80% cost is
planned and committed at design stages. If all focus is
placed on cost-cutting at design stages then cost is
managed according to the plans efficiently and
effectively.
Target Costing 12

COMMITTED COST
Target Costing 13
Committed costs refers to the costs that management agrees to incur for
product development through all stages of the life cycle. Studies have
suggested, about 70% to 80% of manufacturing cost is committed at
design stages of a product. TC focus all attention at cost components
(materials, labor & overheads) at design stages. For example, it is
decided at product design stages, what type of materials to be used and
from where they can be acquired? What alternatives are available for
those materials in the market? How many suppliers for the materials are
available in the market?
Which supplier will provide the required quality materials at required
quantities at a given point in time at an allowable cost?
Suppliers are also involved at design stages to provide cost effective
solutions. For instance, suppliers can help in reducing cost by suggesting
alternative parts or components at the lowest cost for a desired level of
functionality.
Similar decisions are made for labor and overhead costs.

COST ACCUMULATION
The cost of a product is accumulated at different stages in the lifecycle of
a product. A lifecycle of a product starts from concept stage and ends
with recycling or decomposing of a product. Therefore, TC aims to
control cost at each stage in order to achieve overall target cost of a
product.
Following are the costs that are normally incurred at each stage of
lifecycle of a product:
1. Design ----------- Concept development, design, tooling, proto-
type
2. Manufacture ----------------- incurring direct cost of materials,
labor and indirect costs (materials, labor and other overheads)
3. Operations ------------- Warehousing, Distributing, Selling,
Admin, loading and unloading costs, local taxes, advertising,
warranty, etc.
4. End/retire --------------- Recycling, disposal cost, decomposing
cost
Target Costing 14

ALLOWABLE COST
COMPARED W. TARGET COST
Allowable Cost is the maximum cost that can be
incurred on the development of a product
WHEREAS
Target Cost is the estimated cost over the entire
life cycle that management incurs to develop a
product with required level of functionality to
achieve target profit at a target price.
CAVEAT
If the target cost cannot be achieved then the product should
not be launched. Further, design team must not be allowed to
achieve target cost by eliminating desirable product functions
or features. As the product would stand weaker against the
competition in the market if desired features are compromised.
Target Costing 15

RELATED CONCEPTS
 Target Pricing
 Cost-Plus Pricing
 Absorption Costing
 ABC Costing
 Life Cycle Costing
 Kaizen Costing
 Value Analysis
 Value Engineering
 Functional Analysis
CAVEAT
TC is just not a cost work-out technique but it is a complete business management
philosophy. We, hereby, mention in brief, as to how, each of the above mentioned tools is
related to TC.
Target Costing 16

COMPARISON
TARGET PRICING
1. Competitors’ prices are considered for
setting prices
2. Price determines cost of a product
3. Design is primary focus for reducing
cost
4. Cross functional team of technicians
participate in cost management
5. Suppliers are involved at design
stages
6. Involve value chain in cost planning
Important Note
Price setting procedure for a product under Target Pricing is
exactly reverse to that of Cost-Plus Pricing.
COST-PLUS PRICING
1. A certain amount of profit is added to
cost to arrive at a price
2. Cost determines price of a product
3. Focus is on meeting budgeted cost,
reducing production losses and
wastages
4. Cost and Management Accountants
work out cost of products and suggest
cost reductions
5. Suppliers are involved at production
stage
6. There is no consideration for value
chain at cost planning stage
Target Costing 17

DIFFERENTIATED
Target Costing 18
1: Design a
product
2: Determine
product costs
3: Set price
based on cost
4: Convince
customers about
product value
Cost-based Pricing
1: Check-out
customer needs
and value
perceptions
2: Set target
price to match
customer
perceived value
3: Determine
target cost
4: Design
product within
target cost
Target Pricing /Value Based Pricing

PROCESS FLOW CHART
Target Costing 19
Target
Price
Target
Cost
Target Disposal
Cost
Target
Warrantee Cost
Target Selling
& Admin Cost
Target
Production
Cost
Target Design
Cost (RD&E)
Review and
examine all
Target
Cost
Elements
regularly
and let them
not exceed
their
allowed
levels

PRICE-TAKER FIRM
Every firm is a price-taker firm under conditions of a perfectly competitive
market. There are numerous firms in the market that are producing identical
products in a given price range. This is why, a single firm cannot dictate its price
in a perfectly competitive market. However, in a monopoly or monopolistic
competition, a firm can dictate price or a small number of firms can dictate the
price, as the products offered by them don’t have perfect substitutes in the
market.
Other conditions that are present in a perfectly competitive market are given as
under:
 All companies are selling identical products, therefore, perfect substitutes
exist for the products offered by them
 There are no barriers for entry or exit in the market for companies
 Every company has relatively small share
 Buyers and sellers have full information about the market, prices and
products offered there
CAVEAT
Adopting Target Pricing is mandatory for a firm/company that is working under
conditions of perfectly competitive market. Otherwise, competitive pressures will
throw the firm out of the market one day.Target Costing 20

LIFECYCLE COSTING
• Lifecycle Costing (LCC) refers to
a process of identifying and
recording all costs that are incurred
over the entire lifecycle of a
product. LCC includes cost
incurred before production of the
product till cost incurred for
disposal of the product.
• TC attempts to achieve reduction of
Lifecycle Costs of a new product
by examining all stages for cost-
reduction at R&D, production and
disposal stage a product. TC is just
not a costing system but a
comprehensive profit planning tool
for a product over the entire
lifecycle.
Target Costing 21
Analysis of Lifecycle Costs

KAIZEN COSTING
Target Costing 22
Kaizen Costing (KC) refers to a process of cost improvement through small
incremental amounts rather than through large innovations. KC continues
throughout the manufacturing process. In TC, the main purpose is
achieving target cost over the lifecycle of a product. After the design is
finalized, the production starts, KC focuses on eliminating costs during
production processes. KC achieves this purpose by reducing unnecessary
cost during manufacturing processes. KC achieves cost reductions through
increased efficiencies during production processes. Every employee is
required to produce cost efficiencies in production processes. KC goals for
cost reduction are given to each employee on monthly or yearly basis.
Actual results are compared with KC goals. The actual results achieved are
made base for new KC goals for each employee. In this way, KC,
continuously improves cost at production stage. Since, TC requires cost
efficiencies during the entire lifecycle of a product, therefore, the same
objective is followed during production through application of KC.

HOW TC WORKS?
1. Market Survey and Research is conducted about the price and features
(functions and characteristics) of a product that is to be benchmarked by a
management.
2. Preparing feasibility around Target Price, Target Profit and Target
Cost.
3. The primary focus is on the product design that could match target cost.
Product design is changed time and again to reduce cost. This process is
repeated till the time target cost is achieved by a design.
The following tools are used at this stage: Value Analysis, Value
Engineering, Functional Analysis etc., etc.
4. Working out cost for each stage of a product’s lifecycle. This would help
in achieving overall target.
5. Implementing KC for continuous improvement in cost of a product during
remaining stages of the life cycle of a product.
Target Costing 23

PRODUCT DEVELOPMENT
Target Costing 24
Product
Design &
Development
Product
Concept
&
Feasibility
Product
Strategy
& Profit
Plans
Competitive
Strategy
Market
Research
Competitive
Intelligence
Production
Attain Target
Establish Target

RELATED CONCEPTS
Target Costing 25
 VALUE ANALYSIS
A systematic analysis that identifies and selects the best value alternatives
or designs, materials, processes, and systems.
 VALUE ENGINEERING
Value Analysis (VA) is used for existing products whereas Value Engineering (VE) is
used for new products at the design stages. Both Value Management Techniques
(VMTs) have same purpose of reducing cost without any compromising on the quality
of a product.
VE is an organized effort directed at analyzing the functions of the various
components for the purpose of achieving these functions at the lowest overall cost
without reductions in required performance, reliability, maintainability, quality, safety,
recyclability, and usability.. The relationship between VE and TC is: Once a target
cost has been set, the organization must determine target costs for each component in
a product. VE is used to examine the design of each component of a product to
determine whether it is possible to reduce costs while maintaining functionality and
performance.
 FUNCTIONALANALYSIS
Functional Analysis (FA) refers to the relationships between product functions, their
perceived value to customers and their cost to provision.

Target Costing 26
RELATED CONCEPTS
 ACTIVITY BASED COSTING
ABC is a cost attribution to cost units on the basis of benefit received from
indirect activities. (Cima Official Terminology)
 ABSORPTION COSTING
It reflects full cost pertaining to a product. It is also referred as Traditional Costing.
 CROSS-FUNCTIONAL TEAMS guide the target costing process. These
teams may include, for example, representatives from the organization’s design
engineering, manufacturing, management accounting, and marketing areas, as well as
representatives from among suppliers, customers, distributors, and waste disposers.
 SUPPLY CHAIN MANAGEMENT, which involves developing
cooperative, mutually beneficial long-term relations between buyers and suppliers,
plays a critical role in target costing when suppliers actively participate in resolving
cost reduction problems.
Important Note
When cost-plus pricing is used, the total cost of a product may be calculated either by Absorption
Costing or by Activity-Based Costing. ABC provides more accurate cost of a product due to more
accurate allocation of overheads.

DECISIONS
Following are a few typical decisions that are made by a
product design and development team for achieving a
Target Cost:
 Deciding about features/characteristics/functions of a product to
achieve the desired functionality
 The components or parts to be used in the product
 Identifying whether the components are standard or specialized
 The detail about production processes and sub-processes
 What components or parts are to be produced in-house and what
parts to be out-sourced?
 How outlook of a given product is impacting customer perception in
the market?
 Plan about cost incurrence for each stage of life cycle of a product
 The batch size of a product considered for manufacturing
Target Costing 27

COST WORK OUT--
STEP BY STEP
1. Establishing a target price in the context of latest offerings
from competitors in a market
2. Establishing target profit based on required profit, like ROI or
%age of sales or another base approved by a management
3. Determining target cost:
Target Cost = Target Price – Target Profit
4. Determining allowable cost
5. Determining cost gap
Cost-Gap = Allowable Cost – Target Cost
6. Finding ways and means to reduce Cost-Gap to nil to
achieve a Target Cost
Target Costing 28

REDUCING
COST-GAP TO NIL
Target Costing 29
Reducing cost-gap to nil is the biggest challenge for design
development team. They cannot compromise on the functionality of a
product that is benchmarked by their management, yet they have to
achieve target cost. Every product has its own unique development
scheme.
We here generalize few ways by which cost -gap is reduced to nil.
• Frequent changes in design until cost comes either equal to or less than the
target cost
• Using alternative materials or parts/components
• Using cost-effective labor
• Using standard components that are normally available in the market
rather than using specialized parts or components
• Using latest technology
• Removing all activities or processes that add no true value to the final
product

IMPLEMENTATION
CHALLENGES
Target Costing 30
Some of the potential problems in implementing a target costing system
from a behavioral point of view are:
 Conflicts that arise between parties involved in the target costing
process, (e.g., the conflict that arises between suppliers and the target
costing organization when too much pressure is placed on suppliers to
cut their costs),
 Burnout among employees, and
 Some employees (such as senior executives) reject the idea and do not
understand its value.

ADVANTAGES
 Managing cost to target levels for staying competitive in the market
 Market-driven production strategies ensure success in the market
 Allowing use of the latest technology at design stage helps for having
better design and superior product performance in a market.
 Assures best value for money to customers. Delivers optimal value
proposition to end-consumers
 Assures required market share
 Ensures max customer satisfaction
 Reduces development cycle of a product by reducing product-line
complexity
 Allows cross functional team of technicians to work together and
share their views freely for achieving a cost-effective design of a
product
 Provides cost control at all stages of life cycle of a product like design,
production/set-up, service/repair, disposal/recycling
Target Costing 31

DISADVANTAGES
 It takes more time than usual to achieve a design that meets all market
considerations pertaining to cost and allows a price that is acceptable in
the market. The iterative process of finding target cost is more time
consuming.
 Since team of cross-functional technicians is working together, it may
have behavioral issues because of different working background. In
traditional methods, only design department supposed to finalize the
design.
 Too much cost consciousness may hamper smooth functioning between
departments.
 Target costing is relatively difficult to apply in service industries due to
paucity of information and high level of specialties.
Target Costing 32

ILLUSTRATION # 1
Target Costing 33
Mega Electronics is planning to manufacture product X. The
selling price of product X is calculated at 640 dirhams per unit.
The company is planning to sell 2000 units/month at this price.
Target Profit is estimated at 15% of sales and expected cost per
unit is 575 dirhams.
Calculate Cost-Gap /unit for product X?
Solution
Target Profit = 15% x 640 = 96 dirhams per unit
Target Cost = 640 – 96 = 544 dirhams per unit
Cost-Gap = Expected Cost – Target Cost
Cost-Gap = 575 – 544 = 31 dirhams per unit
Note: The product design team is required to put more effort to
bring this cost-gap to nil.

Target Costing 34
ILLUSTRATION # 2
Alpha Pharmaceuticals is fixing Sale Price of product Y at 500 dirhams
per unit. The company is expecting a sale of 10,000 units per annum at
this price. Management has given approval for going ahead with this
price. The company’s ROI is estimated around 18% p.a. The company is
making an investment of 1,550,000 dirhams on launching of this product.
Calculate Target Cost per Unit?
Solution
Total Target Profit = 18% x 1,550,000 = 279,000 dirhams
Target Profit per Unit = 279,000/10,000 = 27.9 dirhams
Target Cost = 500 – 27.9 = 472.10 dirhams/unit

ILLUSTRATION # 3
Target Costing 35
Gamma Chemicals is planning to launch a product Z. Target Sale Price for this
product is calculated at 20 dirhams per unit. The company is expecting to capture
the required market share at this price. This is why, management has given green
signal for this price at the launching of this product. Target profit margin is 30%.
The estimated production cost per unit of this product is 16 dirhams per unit.
Calculate Cost-Gap for this product?
Solution
Target Profit per Unit = 30% x 20 = 6 dirhams
Target Cost per Unit = 20 – 6 = 14
Cost-Gap per Unit = 16 – 14 = 2 dirhams
Note: Product design team may have little more effort in bringing the cost-gap to
nil.

ILLUSTRATION # 4
Target Costing 36
Omaga Company is planning to extend its product line and is adding a new
product H. The product has a Target Price of 230 dirhams per unit. The price is an
average of all prices of all products that have similar features in the market.
Management is perceiving that the product will easily survive at this price in the
market. Target Profit of this product is estimated around 60 dirhams per unit.
Calculate Target Price for this product?
Solution
Target Price = Target Cost + Target Profit
Therefore,
Target Price = 230 + 60 = 290 dirhams per unit

ILLUSTRATION # 5
Target Costing 37
Zeta Textiles is using Cost-Plus Pricing for its products. They are launching a
new product RTY. The product has a cost of 1,000 dirhams per unit. The
markup on cost is 20%.
Calculate price per unit of the product by using cost-plus pricing method?
Solution
Price = Cost + (markup %age x Cost)
Price per unit of RTY = 1,000 + (20% x 1,000)
Price per Unit of RTY = 1,000 + 200 = 1,200 dirhams

ILLUSTRATION # 6
Target Costing 38
Description
Cost detail in each year of lifecycle
Year 1 Year 2 Year 3 Year 4
All amounts are in million of Dirhams
RD&E 550 - - -
Design - 650 - -
Production Cost 350 510 615
Marketing & Distribution Cost - 150 170 190
Disposal Cost - - - 125
A product Beta Complex is to be manufactured by Lambda Pharma
Laboratories (Pvt.) Ltd . The product has a lifecycle of 4 years. The costs in each
year are given below. Calculate the total lifecycle cost of this product?

SOLUTION
Target Costing 39
Description
Cost detail in each year of
lifecycle Total
Year 1 Year 2 Year 3 Year 4
All amounts are in million of Dirhams
RD&E 550 - - - 550
Design - 650 - - 650
Production Cost 350 510 565 1,425
Marketing & Distribution Cost - 150 170 190 510
Disposal Cost - - - 275 275
Total Lifecycle Cost of Beta Complex = 3,410

ABBREVIATIONS
Target Costing 40
Abbreviation Description
ABC Activity-Based Costing
CIMA Chartered Institute of Management Accountants - UK
FA Functional Analysis
GE General Electric
GM General Motors
KC Kaizen Costing
LCC Lifecycle Costing
R&D Research and Development
RD&E Research, Development and Engineering
ROI Return on Investment
TC Target Costing
VA Value Analysis
VE Value Engineering
VMTs Value Management Techniques

REFERENCES
Target Costing 41
 Management and Cost Accounting 6/e by Colin Drury
 Management Accounting 6/e by Atkinson
 Target Costing and Value Engineering by Robin Cooper & Regine Slagmulder
 Target Cost Management by Jim Rains
 A Practical Guide to Target Costing: Processes and Techniques by Frank
Robinson
 Japanese Target Costing: A Historical Perspective by Patrick Feil, Keun-Hyo
Yook, II-Woon Kim
 Cima Official Terminology

Ahmad Tariq Bhatti
FCMA, FPFA, MA (Economics), BSc
Dubai, United Arab Emirates
For Feedback & Queries
at.bhatty@gmail.com
Target Costing 42

Target Costing 43
The End of Presentation.

Target Costing

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