Target costing
Encyclopedia
Target costing is a pricing
method used by firms. It is defined as "a cost management tool for reducing the overall cost of a product over its entire life-cycle with the help of production, engineering, research and design". A target cost is the maximum amount of cost that can be incurred on a product and with it the firm can still earn the required profit margin
from that product at a particular selling price.
In the traditional cost-plus pricing
method materials, labor and overhead costs are measured and a desired profit is added to determine the selling price.
A lengthy but complete definition is "Target Costing is a disciplined process for determining and achieving a full-stream cost at which a proposed product with specified functionality, performance, and quality must be produced in order to generate the desired profitability at the product’s anticipated selling price over a specified period of time in the future."
This definition encompasses the principal concepts: products should be based on an accurate assessment of the wants and needs of customers in different market segments, and cost targets should be what result after a sustainable profit margin is subtracted from what customers are willing to pay at the time of product introduction and afterwards. These concepts are supported by the four basic steps of Target Costing:
(1) Define the Product
(2) Set the Price and Cost Targets
(3) Achieve the Targets
(4) Maintain Competitive Costs.
To compete effectively, organizations must continually redesign their products (or services) in order to shorten product life cycles. The planning, development and design stage of a product is therefore critical to an organization's cost management process. Considering possible cost reduction at this stage of a product's life cycle (rather than during the production process) is now one of the most important issues facing management accountants in industry.
Here are some examples of decisions made at the design stage which impact on the cost of a product.
Japanese companies have developed target costing as a response to the problem of controlling and reducing costs over the product life cycle.
Pricing
Pricing is the process of determining what a company will receive in exchange for its products. Pricing factors are manufacturing cost, market place, competition, market condition, and quality of product. Pricing is also a key variable in microeconomic price allocation theory. Pricing is a...
method used by firms. It is defined as "a cost management tool for reducing the overall cost of a product over its entire life-cycle with the help of production, engineering, research and design". A target cost is the maximum amount of cost that can be incurred on a product and with it the firm can still earn the required profit margin
Profit margin
Profit margin, net margin, net profit margin or net profit ratio all refer to a measure of profitability. It is calculated by finding the net profit as a percentage of the revenue.Net profit Margin = x100...
from that product at a particular selling price.
In the traditional cost-plus pricing
Cost-plus pricing
Cost-plus pricing is a pricing method used by companies to maximize their profits.The firms accomplish their objective of profit maximization by increasing their production until marginal revenue equals marginal cost, and then charging a price which is determined by the demand curve. However, in...
method materials, labor and overhead costs are measured and a desired profit is added to determine the selling price.
What is target costing?
Target costing involves setting a target cost by subtracting a desired profit margin from a competitive market price.A lengthy but complete definition is "Target Costing is a disciplined process for determining and achieving a full-stream cost at which a proposed product with specified functionality, performance, and quality must be produced in order to generate the desired profitability at the product’s anticipated selling price over a specified period of time in the future."
This definition encompasses the principal concepts: products should be based on an accurate assessment of the wants and needs of customers in different market segments, and cost targets should be what result after a sustainable profit margin is subtracted from what customers are willing to pay at the time of product introduction and afterwards. These concepts are supported by the four basic steps of Target Costing:
(1) Define the Product
(2) Set the Price and Cost Targets
(3) Achieve the Targets
(4) Maintain Competitive Costs.
To compete effectively, organizations must continually redesign their products (or services) in order to shorten product life cycles. The planning, development and design stage of a product is therefore critical to an organization's cost management process. Considering possible cost reduction at this stage of a product's life cycle (rather than during the production process) is now one of the most important issues facing management accountants in industry.
Here are some examples of decisions made at the design stage which impact on the cost of a product.
- The number of different components
- Whether the components are standard or not
- The ease of changing over tools
Japanese companies have developed target costing as a response to the problem of controlling and reducing costs over the product life cycle.