Critical Review of

“Develop Profitable New Products with Target Costing”

Submitted to:

Prof. Kaushik Bhattacharya

IIM Lucknow Noida Campus

Submitted by:

Group No. 2

Bhawna B (IPMX12062)
Krishnan V (IPMX 12072)
Paritosh K (IPMX 12082)
Saikrishna Teja (IPMX
12092) Vivek S (IPMX
12102)

INDIAN INSTITUTE OF MANAGEMENT LUCKNOW (NOIDA

CAMPUS)
Executive Summary:
Organizations today are in a constant pressure to develop products that deliver quality and
functionality which customers demand at a price that they are willing to pay. The real challenge
however is to deliver these products without compromising on profits. Therefore, organizations
are forced to come up with defence mechanisms that protect their interests of staying competitive,
meeting customer expectation and meeting targeted profits. One such defence mechanism is called
‘Target Costing’. Target Costing as defined in the article is “primarily a technique to strategically
manage a company’s future profits.”

Target Costing can be largely split into three sections:

a) Market-driven costing: It is done at the time of conceptualization of the product to identify

the exact offering and the accurate price the consumer would be willing to pay. It consists of
two tasks - setting long-term sales and profit objectives for the company and structuring product
lines to achieve maximum profitability.

b) Product-level target costing: It involves establishing product-level target costs without

sacrificing functionality and quality primarily through techniques like value engineering.

c) Component-level target costing: It includes decomposing the product-level target cost to the
major functions, set component-level target costs and managing suppliers.

The Process of Target Costing:

Usually, as part of regular costing processes, the cost is estimated by the various product
development steps. However, ‘target costing’ makes cost an input to the product development
process, not an outcome of it.
a) Identifying a market price of the product that the consumer would be willing to pay b)
Defining a desired profit to be made on the product across the product life-cycle and c)
Computing the target cost of the product by the formula:
○ Allowable Cost = Target Price - Desired Profit
○ Target Cost Reduction Objective = Current Cost – Allowable Cost
○ Product level Target Cost = Current Cost – Target Cost Reduction Objective
○ Strategic Cost Reduction Objective = Product Level Target Cost – Allowable Cost

It is important to note that the above mentioned ‘Current Cost’ is an iterative number and is
finalized only on achieving the ‘Allowable Cost’.
Article applicability in ‘Olympus Optical Company’ in Japanese Context:
An example of successful implementation of ‘Target Costing’ is that of ‘Olympus Optical
Company’, a producer of SLR Cameras. The example has been particularly mentioned in the
article as well. After market analysis, the target selling price and allowable costs were
determined. In order to reduce the production costs, the company lowered the cost of purchased
parts. The company reduced the number of parts to eliminate labour extensive process.
Expensive metal and glass parts were replaced with cheaper and durable plastic parts. Since the
complexity of the product is low, the resources used for production became optimal and the
overall product development cycle became less time consuming. Thus, target pricing proved to
be very profitable for Olympus.
Concept Limitations:
a) The concept of ‘Target costing’ depends heavily on the ‘Market Analysis’ & ‘Market
Driven Costing’ phase making it vulnerable to the disruptions (like technology
disruptions) that are very likely in the current market scenario.
b) The ‘Target Costing’ concept is difficult to applicable in the service industry.
c) Due to the numerous steps and iterations, the time consumed to implement ‘Target
Costing’ is very large.
d) In case the market is disrupted by a competitor who aggressively brings down the price,
the production department is likely to face undue pressure. In such cases, there is a high
likelihood of using cheaper materials / technology. Such drastic & hasty steps affect the
organization in the longer run.
e) The success of ‘target costing’ methodology is based on the assurance of continuous
supply of components from suppliers. However, the constant cost pressure on component
manufacturers is likely to make the whole business proposition unviable to them. This
would put the project at risk.

Conclusion:
Target costing disciplines the firm to manage costs in a structured way. This is a customer centric
approach, which helps the companies to develop products without compromising customer
expectations and firm’s profit. However, the limitations of the technique to apply to service
sector and to adapt to the changing market conditions would reduce the scope of the technique.
Therefore, future research is required to estimate factors such as heterogeneity of the service,
dynamic variation in market etc., which effect the success of Target costing implementation. It is
hoped that the future research will circumvent all the limitations to enable the successful
implementation of Target costing across diverse industries.
References
https://shop.sloanreview.mit.edu/store/develop-profitable-new-products-with-target-costing
http://managerial-accounting.blogspot.in/2012/09/problems-of-target-costing-in.html
https://www.academia.edu/34874152/TARGET_COSTING_COST_MANAGEMENT_AND_PRO
FIT_ENHANCEMENT
https://repositorio.iscte-iul.pt/bitstream/10071/9826/1/publisher_version_467_2005_1_PB.pdf
https://lawaspect.com/target-costing-nissan-vs-olympus/