TARGET COSTING
Target costing is the process of determining the maximum
allowable cost for a new product and then developing a
prototype that can be profitably made for that maximum
target cost figure.
The target cost for a product is calculated by starting with
the product's anticipated selling price and then deducting
the desired profit.
TARGET COST = ANTICIPATED SELLING PRICE – DESIRED PROFIT
Value engineering is used in target costing to reduce product
cost by analyzing the tradeoffs between different types of
product functionality and total product cost.
An important first step in value engineering is to perform a
consumer analysis during the design stage of the new or revised
product.
TARGET
COSTING
The type of value engineering used depends on the product's
• Changes are made to
features.
• Frequent new models
or updates to the
product.
• E.g.
automobiles,
computer software,
cameras audio/video
equipment.
GROUP 2
GROUP 1
functionality.
• Changes are made to
product.
• Functionality must
be designed into the
product.
• E.g.construction
equipment(truck),
specialized medical
equipment
Functional analysis a process of examining the
performance and cost of each major function or feature of
the product.
Objective: An overall desired level of performance
achievement for each function is obtained while keeping
the cost of all functions below the target cost.
Benchmarking is often used at this step to determine
which features give the firm a competitive advantage.
Design analysis - The design team prepares several possible
designs of the product each having similar features with
different levels of performance and different costs.
Benchmarking and value chain analysis help guide the
design team in preparing designs that are both low cost and
competitive.
The design team works with cost management personnel to
select the one design that best meets customer preferences
while not exceeding the target cost.
FIRM/
INDUSTRY
FUNCTIONALITY
COST REDUCTION APPROACH
STRATEGY
Olympus/
Increasing rapidly; is Target costing using value engineering; Heavy focus on managing
Cameras
designed in.
the concept of distinctive functionality for functionality
the
price
point,
plus
supportive
functionality.
Nissan/Auto
Increasing
rapidly; Value engineering by product and by each Prices are set by desired
easy to add or delete component of each product; then increase customer’s
functionality.
price or reduce functionality
expectations
about functionality; the
target cost is used to find
savings, especially from
suppliers.
Komatsu/
Static;
Construction
designed in.
Equipment
must
be Design analysis to determine alternative Primary focus is on cost
designs. Functional analysis to develop control
rather
than
cost/functionality trade-offs. Productivity redesign or functionality
programs to reduce the remaining costs.
analysis.
Group technology is a method of identifying similarities in
the parts of products a firm manufactures so the same parts can
be used in two or more products thereby reducing costs.
Large manufacturers of diverse product lines e.g. automobile
industry, use group technology in this way.
ABC is particularly useful for helping product designers
purchasing managers manufacturing managers and marketing
managers work together with a common understanding of the
costs of different features and options.
Target costing was developed in recognition of two
important characteristics of markets and costs .
MARKETS:
• Companies have less control over price than they would
like to think.
• The market (i.e., supply and demand) determines prices.
• So, anticipated market price is taken in target costing .
COST:
• Most of the cost of a product is determined in the design stage (not
during production).
• The opportunities to reduce cost come from designing the product
so that it is
 Simple to make,
 Uses inexpensive parts, and
 Is robust and reliable.
The difference between target costing and other approaches
to product development is profound. Instead of designing the
product and then finding out how much it costs, the target
cost is set first and then the product is designed so that the
target cost is attained. TARGET
COSTING
Handy Appliance Co. feels that there is a market niche for
a hand mixer with certain new features.
The marketing department believes that a price of $30
would be about right for the new mixer.
At that price, it is estimated that 40,000 of new mixers
could be sold annually.
An investment of $2,000,000 would be required to
design, develop, and produce.
The company desires a 15% return on investment (ROI).
Given these data, the target cost to manufacture, sell, distribute, and
service one mixer is $22.50 as calculated hereafter
Projected sales
(40,000 mixers*$30 per mixer )
Less desired profit
(15%*$2,000,000)
Target cost for 40,000 mixers
Target cost per mixer
($9,00,000 / 40,000 mixers)
$1,200,000
$300,000
$9,00,000
$22.50
Health Products International Inc. (HPI) is conducting a value
engineering project by making a target costing analysis of a major
product - a hearing aid.
Second-generation hearing aid (HPI – 2) for $ 750 (cost of $ 650)
Has obtained 30 percent of this market worldwide at a profit of
$100 per aid.
Competitor recently introduced a new third generation hearing aid @
the price to $1200.
HPI must meet the new lower price and maintain its current rate of
profit ($100 per unit) by redesigning the hearing aid and/or the
manufacturing process.
The target cost for the new aid is
A reduction in cost of $150 ($650-$500) from the current
model.
OLD ($)
NEW ($)
S.P.
750
600
Profit
100
100
TARGET COST
650
500
ALTERNATIVES
Alternative A
Alternative B
Alternative C
(-)Reduce R&D: $50
Replace –
(-) The microphone unit
with
one
of
nearly
equivalent sensitivity: $30
(-)Toggle power switch
with slide switch: $30
(-)Current
inspection
procedure
with
an
integrated quality review
process at each assemble
station: $40
Replace –
(-)Amplifier unit with one
having slightly less power,
not expected to be a
noticeable difference:$ 50
(-) Microphone unit: $30
(-) Toggle power switch
with slide switch: $ 30
(-)
Current
inspection
procedure : $ 40
(+)Increase R&D to 3G:
$40
$150
Replace –
(-)Amplifier unit: : $ 50
(-)Microphone unit: $30
(-)Toggle power switch with
slide switch: $ 30
(-)Current
inspection
procedure : $ 40
(-)Plastic earpiece material
with material of
lower
quality: $20
(-)Renegotiate
contract
with supplier of plastic
casing:$ 20
$150
$150
The U.S. Auto Companies – General Motors, Ford, and
Daimler Chrysler
The Japanese Auto Companies - Toyota, Nissan, Honda,
Mitsubishi etc.
General Electric
Motorola
NASA
Sony
The U.S. Military
Provide for the members of the design team a running series of cost
estimates based on
•
Initial design sketch,
•
Activities based costing reviews of production process, and
•
Best guess costing information from suppliers based on estimated production
volumes.
Take responsibility for any capital budgeting requests generated by the
design team.
Answer to any questions from finance staff regarding issues or
uncertainties in the capital budgeting approach.
Bridging the gap between the current cost of product development and
design and the target cost .
Proactive approach to cost management.
Orients organizations towards customers.
Breaks down barriers between departments.
Minimize non value-added activities.
Reduced time to market.
Encourages selection of lowest cost value added activities.
Implementation enhances employee awareness and Foster
partnerships with suppliers.
Requires many meetings for coordination.
Its implementation requires willingness to cooperate.
Effective
implementation
and
use
requires
the
development of detailed cost data.
May reduce the quality of products due to the use of cheep
components which may be of inferior quality.
MANAGERIAL
IMPLICATIONS
OF TARGET COSTING
Author(s): Marilyn M. Helms, Lawrence P.
Ettkin, Joe T. Baxter, and Matthew W. Gordon
Target costing may serve as a solution when developing new products,
minimizing costs through the optimal use of all resources along the
entire supply chain .
Originating in Japan, target costing is used in over 80 percent of
Japanese assembly companies (Kroli, 1997) and by 100 percent of
Japanese car manufacturers (Boer and Ettiie, 1999).
Target costing involves :
Selecting and Involving Suppliers
Design Modifications
Outsourcing
Involvement and Continuous Improvement
RESEARCH
INDUSTRY
Cooper and Slagmulder, 1997;
Automotive sector
Knott, 1996; and Tanaka, 1993
COMPANIES
FINDINGS
Toyota,
Nissan,
Sony,
Matsushia,
Daihatsu,
Canon, Olympus Optical,
and Komatsu
Non-Japanese companies –
Mercedes,
Goodyear,
Rockwell,
Texas
Instrument,
DaimlerChrysier, and the
North Sea oil industry
-



Nicolini,
Tomkins,
Holti,
Construction sector
Oldman, and Smalley (2000)
-


Ellram (2000)
Semiconductor, automotive,
and electronic equipment
industry
,
computer
peripheral,
consumer
products, and aerospace
original equipment


-


Value engineering or analysis,
Design for manufacturing,
Effective
organizational
structures,
Streamlined
development
processes,
Actively engaging the supply
chain
Reducing costs,
Understanding the supplier's
cost structures,
Improving
internal
cost
management.
Improving cost monitoring, and
increasing cost accountability.
RESEARCH
INDUSTRY
Swenson, Ansari,
Dell, and Kim
Airlines
(2003)
COMPANIES
FINDINGS
Shared target costing
principles included:
 Price-led costing,
Boeing, Caterpillar,  A customer design focus,
DaimlerChrysier, and  Cross
functional
&
Continental Teves
value-chain involvement
and
 Life-cycle orientation to
price and costs.
Eastman-Kodak,
Micrus
Banham, 2000
Semiconductors,
Transportation
and
Honda of America, Cross-functional
heavy
equipment
involvement
of
design,
and Boeing
industries, the
marketing, procurement,
Entire auto industry,
logistics, and finance on
electronics,
oil, IBM's
Information
talking with the customer
Chen and Chung, Pharmaceuticals
Product Division spin
2002
off
of
Lexmark
International
Lack of
Understanding
or Relevance
Team and CrossFunctional
Barriers
Production Detail
Irrelevance or
Fear of the
Effects
MIS and
Accounting Cost
Data Limitations
Research at the University of Birmingham (UK) found that if the
design team has difficulty meeting a target cost, a systematic approach
can be taken.
•
First, it may be important to review the target cost to determine if the
cost can be raised or if margins can be reduced.
•
The next step is to review the manufacturing process for a possible
modification or relaxation of product functionality requirements.
•
It may be useful to make improvements in the machinery tooling to
meet target costs.
•
Another avenue is to reduce supplier costs.
•
The last alterative may be abandoning the project.