Examples of Target Costing | Cost Accounting

The following points highlight the two main examples of target costing. The examples are: 1. Tata
Rs 0.1-Million Car 2. Tata Rs 0.1-Million Car- Potential Competition.

Example # 1. Tata Rs 0.1-Million Car:

On 11 March 2003 Business Standard reported the following:

Ratan Tata, chairman of India’s second-largest and longest-established conglomerate, said, he is

pressing ahead with a project to bring to market a $2,000 car (Rs 1 lakh), which he believes could
revolutionize personal transport in India and some other Asian countries.

He conceived the idea several years ago- to use components from the region’s large scooter and
motorcycle industries to create a basic four-seater, four-door car to which the region’s millions of
scooter and motorcycle riders, plus 3-wheeler users could aspire. (Emphasis added)

‘It is my dream to make the car a reality within the five years I remain as Tata chairman,’ said Tata.
The project has become more ambitious as it has entered trial engineering phases—most notably
with the cutting of the target retail price by one-third from the originally envisaged $3,000. Total
material costs for the vehicle are claimed to have already been pared down towards the $1,200
mark. (Emphasis added)

The vehicle might not be acceptable to Western consumers but ‘it would not need to be a poor
substitute for a car,’ he said. ‘It will look like a car and have proper seating-stretched, canvas seats
would not, e.g., be acceptable. It would be all right for it to be a bit noisier than an ordinary car, but
it has to be both simple and safe. (Emphasis added)

Despite the projected price being less than half that of the cheapest car on the Indian market, a basic
Suzuki model, Tata said it was not unrealistic and would not need to be subsidised. The vehicles
would be produced primarily in kit form for assembly at several places around India, to create local
employment.

They have a potential market in other Asian countries such as Vietnam, Malaysia and Indonesia,
said Tata, in addition to bridging the gap for 2 million to 3 million Indians between powered two-
wheelers and cars. (Emphasis added)

The engine capacity of the car will be 667 cc of power, which is not much more than the 500 cc
powering Royal Enfield’s Machismo motor cycle. The car will be petrol driven. Diesel version may
follow within six months of the launch of the petrol driven car. The seating capacity will be four
(including the driver). It will comply with the emission and safety standards of the country in which
it will be introduced, including India. The company (Tata Motors) expects to sell 0.25 million cars
per annum and target sale of one million cars.

On 15 February 2006 DWS Review (dot) com reported the following:

However, the company has pointed out that it is not looking to strip down a traditional car, but
rather, ‘start with a clean sheet of paper for designing and conceptualizing this vehicle. It will not be
a stripped down version of a car, but there will also be nothing too fanciful about it.’ (Emphasis
added) In addition, the car would be made such that upgrades would be possible, indicating that
add-ons after the car has been sold would be possible.

According to sources, the project (code named Project X3) is aiming to become financially viable
by reducing inventory costs to zero or close to zero. The company is aiming to centralize the high-
volume parts production, and decentralize the final assembly. Ratan Tata said, in an interview to
McKinsey Quarterly, ‘We’re looking at small satellite units, with very low break-even points, where
some of the cars could be assembled, sold, and serviced.'(Emphasis added)

Chances of the Tata’s cheap car for the masses will depend significantly upon how well it is
marketed. Despite its low cost, a completely no-frills and staid car is unlikely to appeal to the
status-sensitive Indian consumer. An affordable car that meets safety standards but also looks
stylishly adorable is probably Tata’s best bet at cornering the market with its ‘people’s car’.
(Emphasis added)

In December 2007, a report says ‘Market analysts are expecting that upcoming car might become a
huge challenger to auto-rickshaw manufacturers as it would become a cheaper alternative to taxi
drivers’.

On 19 December 2007, Economic Times reported:

Talking on the potential of economics of this car, the top-notch scientist (R A Mashelkar, who is an
independent director on the board of Tata Motors) said- ‘It will create a paradigm shift in low-cost
transport and the whole world is looking forward to a car that efficiently runs 25 km on a litre of
petrol and offers international specifications. These kinds of fuel- efficient cars will be in demand as
pollution is on the rise, climates are changing and fossil fuels are running out. People are looking at
a new global eco-car and I have a feeling that this can be the new eco-car not only in the country
but elsewhere—in other countries. I feel a sense of pride that it will be manufactured in India.’

Mr Mashelkar said- ‘The way their engineers have been able to design it and style it to meet
specifications—it is absolutely incredible.

The story of the Tata Rs 0.1 -million car is quite fascinating. It is a very good example of target
costing approach. The idea was conceived much before the year 2003. The company had a clear
idea about the market segment of this product and also of the functionality and quality that will be
successful in that market segment.

Keeping in view the market pricing dynamics, the target price was established, and the development
and design team was given the mandate to design the car in a manner that it can be produced at the
target cost. It is not that innovation was required only in product design, but well thought out
manufacturing strategy was also formulated and target costs are given to component suppliers to
keep the cost low.

In response to a question, Mr Ravi Kant, MD, Tata Motors said:

I think costs have been kept under control on account of three factors. First, the design of the car
itself. Second, the kind of materials you use while ensuring the car is safe. Third, the various
incentives and tax breaks that we are availing of like any other manufacturer. I must also point out
that early vendor involvement in the designing of the car helped us to bring the cost down.
Without the collaboration efforts of our partners, suppliers and vendors, this would not have been
possible. So many people have come forward, including many well-known multinationals, who
have taken up this challenge of creating solutions for this car. They would guide us on ways to cut
costs while at the same time improving quality and performance.

In order to cut cost, the company plans to adopt the distributed manufacturing system. Under this, a
completely knocked down kit of the car will be built at three Tata- owned plants. The kit will then
be ferried to warehouses across the country, where they will be assembled by dealers.

The idea is that the dealer will have a warehousing terminal to house the semi-knocked down kits,
an assembly plant, and a sales office where a few vehicles will be displayed. As soon as customer
will place a firm order, the dealer will withdraw the kit from the warehouse, assemble it at his plant
and deliver it to the customer.

This is an innovation in the supply chain and distribution. The idea is similar to assembling home
furnishing at home with little help from the manufacturer. The system will be viable because the
company expects that each dealer will handle large volume.

The Tata Rs 0.1-million car story clearly brings out an important advantage of target costing—it
leads to innovation.

Example # 2. Tata Rs 0.1-Million Car- Potential Competition:

E.g., Financial Express on 26 March 26 2007 reported the following:

Fearing erosion in two-wheeler sales, once Ratan Tata’s dream Rs 1 -lakh car is launched, the
country’s second largest two-wheeler manufacturer Baja Auto is seriously considering entering the
passenger car market. Hero Honda, the country’s top bike maker has already said it would foray into
the four-wheeler market.

‘The JD power study says that it (Tata’s one lakh car) will affect the two-wheeler market. If that
happens, then we would also manufacture cars for the market,’ Bajaj Auto chairman Rahul Bajaj
said on the sidelines of the eighth annual convocation ceremony of Indian Institute of Management
(IIM), Indore. Bajaj Auto, which was earlier essentially a scooter manufacturer, shifted gears and
got into the motorcycle segment when the market preference moved to the latter from scooters.

Bajaj had earlier said it would launch a goods-carrier version of a light commercial vehicle in the
first half of 2009. It is also expected to a launch passenger carrier version a little later. The proposed
vehicle will be fitted with a 500—600 cc engine and will be available in diesel, petrol, and
compressed natural gas (CNG) versions.

International consultancy firm JD Power had said early this week that the Tatas’ people’s car would
severely affect the top-end motorcycle segment in which Bajaj is the market leader with Pulsar. Tata
Motor’s proposed car is likely to be launched in the third quarter of 2008.

The country’s largest car manufacturer Maruti Udyog Ltd’s (MUL) True Value initiative has already
dented the domestic high-end motorcycle market. Under True Value, Maruti dealers sell used car
certified by the company at a considerably lower price compared with a new one. Maruti sells
around 75,000 used cars a year under this initiative.

Kolkata-based Global Automobiles, which recently entered the two-wheeler market, has also tied up
with China’s Guangzhou Motors, to roll out a low-cost (sub Rs 1 lakh) car.
Tata Motors will be required to recover the cost from the first model and its variations.

Mr Ravi Kant, MD, Tata Motors, in his interview with the Business World said:

Now that people see that the car is a possibility, the thought is going to cross somebody’s mind—if
he can do it, why can’t I? I will not like to say anything about different competitors, apart from the
fact that we are quite conscious that people will come and, therefore, we will have a window of
opportunity for a few years. Hopefully, we have the first mover advantage.