Target Costing

Target costing is an integrated approach to determine product features, product price, product cost and product design that helps ensure a company will earn reasonable profit on new products.

Target cost is the cost of resources that should be consumed to create a product that can be sold at a target price.

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Target Costing Process A target price is the estimated price for a product/service that potential customers will pay. Target Cost = Target price Profit margin. Target Price Target price is the estimated price for a product/service that potential customers will pay. Target Operating Income Per Unit Target operating income per unit is the operating income that a company aims to earn per unit of a product/service sold. Target Cost Per Unit Target cost per unit is the estimated long-run cost per unit of a product/service that enables the company to achieves its target operating income per unit when selling at the target price.

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Four components of target costing process (1) Planning and market analysis (2) Development (3) Production design (4) Production and continuous improvement.

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Target Costing Process

Establishing Target Price

Attaining Target Cost

Concept development
Concept development Profit margin Target Cost

Production design and value engineering

Planning and market analysis

Production and continuous improvement

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Target Costing Illustrated We illustrate the step-wise target pricing and target costing below. Assume HCL Ltd. manufactures two brands of personnel computers (PCs): Deskpoint and Provalue. Deskpoint is HLLs top-of-the-line product, a Pentium 4 chip-based PC. Provalue is a less powerful Pentium chip-based machine. The HLL currently produces 1,50,000 units of Provalue. The per unit sale price of Provalue is Rs 10,000. The full cost of Provalue is Rs 1,35,00,00,000 consisting of manufacturing cost of Rs 102,00,00,000 and operating cost of Rs 33,00,00,000. Step 1: Develop a Product That Satisfies Needs of Potential Customers Marketing research indicates that customers do not value Provalues extra features such as special audio features and designs that accommodate upgrades that can make the PC run faster and perform calculations more quickly. They want HLL to redesign Provalue into a no-frills PC and sell it at a much lower price. The HLL is, accordingly, planning design modification for Provalue. Step 2: Choose a Target Price The HLL expects its competitors to lower the price of PCs that compete against Provalue by 15 per cent. The management of HLL wants to respond aggressively by reducing Provalues price by 20 per cent from Rs 10,000 to Rs 8,000 per unit. At this lower price, marketing manager of HLL forecasts an increase in annual sales from 1,50,000 to 2,00,000 units.
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Step 3: Derive a Target Cost Per Unit (Target Price Target Operating Income) The management of HLL wants a 10 per cent target operating income on sales revenues. Total target revenues = Rs 8,000 per unit 2,00,000 units = Rs 160,00,00,000. Total target operating income = 0.10 Rs 160,00,00,000 = Rs 16,00,00,000 Target operating income per unit = Rs 16,00,00,000 2,00,000 units = Rs 800 per unit Target cost per unit = Target price per unit Target operating income per unit = Rs 8,000 Rs 800 = Rs 7,200 Total full costs of Provalue = Rs 135,00,00,000 Current full per unit cost of Provalue = Rs 1,35,00,00,000 1,50,000 units = Rs 9,000 per unit The target cost value of Provalue of Rs 7,200 is well below its existing Rs 9,000 unit cost. The HLLs goal is to reduce its unit cost by Rs 1,800. The cost reduction efforts should be extended to all parts of the chain value from R&D to customer service including seeking lower prices from suppliers of materials and components. Step 4: Perform Value Engineering to Achieve Target Cost Value engineering is a systematic evaluation of all aspects of value chain business functions with the objective of reducing costs while satisfying customer needs. It can result in improvements in product design, changes in materials specifications and modification in process methods.
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