TARGET COSTING

Prof. A.K.Mishra
 Strategic Tools for Mgt Accountant
Developed Strategic Cost Mgt Emerging Applications
Applications
• Activity Based Methods
• Enterprise Risk Mgt
• Target Costing
• Non-financial Performance
• Capacity Mgt
Measurement
• Asset Mgt
• Strategy Planning & Execution
• Process Mgt
• • Customer Lifetime Value
Extended Enterprise
• Lean Enterprise • Resource Consumption
• Theory of Constraints Accounting

Strategic Tools for Management

Draft Accounting
 Two Approaches to Pricing
• 1. Cost-Based
Pricing Rs
Rs
• 2. Target Costing
and Pricing
Comparing Traditional Cost Reduction
to Target Costing
• Under traditional costing, the profit margin is
the result of the difference between the
expected selling price and the estimated
production cost.
• Pt = St – Ct
• The cost-plus method is another traditional
approach.
Comparing Traditional Cost Reduction
to Target Costing
• Under the cost-plus method the selling price is
the sum of the expected product cost and the
expected profit margin.
• Scp = Ccp + Pcp
 Comparing Traditional Cost Reduction
to Target Costing
• Target costing is a method of determining the cost
of a product or service based on the price (target
price) that customers are willing to pay.
• The target cost is the difference between the
target selling price and the target profit margin.
• Ctc = Stc – Ptc
Example: Current product specifications and the targeted market share call for
a sales price of Rs250,000. The required profit is Rs50,000 per unit.
The target cost is computed as follows:

Rs250,000 – Rs50,000 = Rs200,000

This is also referred to as price-driven costing.

 Rationale of Target Costing
 In a highly competitive market:
Price is largely determined by supply and demand
 Must control costs to earn a profit
 Target cost - cost that provides the desired profit on
a product when the seller does not have control over
the product’s price

7
 Target Costing- Example
••Handy
Handy Appliance
Appliance feels
feels there
there is
is aa niche
niche for
for aa hand
hand mixer
mixer
with
with certain
certain features.
features.
••Marketing
Marketing Department
Department believes
believes that
that price
price of
of Rs30
Rs30
would
would be
be right
right and
and that
that about
about 40,000
40,000 mixers
mixers could
could be
be
sold.
sold.
••Rs2,000,000
Rs2,000,000 invest
invest required
required to
to gear
gear up
up for
for production.
production.
••Company
Company requires
requires aa 15
15 percent
percent ROI
ROI on
on invested
invested funds.
funds.
Determine
Determine the
the target
target cost.
cost.
 Target Costing
Projected sales (40,000 units × 30) 1,200,000
Desired profit (2,000,000 × 15%) 300,000
Target cost for 40,000 mixers 900,000

Target cost per mixer (900,000 ÷ 40,000) 23

Each functional area within Handy Appliance would

be responsible for keeping its actual costs within the
target established for that area.
Comparing Traditional Cost Reduction
to Target Costing
 Target Cost Concept

Present Future
 Target Costing

Price led Cross-functional

costing teams

Key
Life-cycle principles Value-chain
costs of target orientation
costing

Focus on Focus on
process product
design Focus design
on the
customer
 Market research
Market Share Objective Target Selling Price determines price at
which a new product will
Select segment to sell. Customer willing to
compete, e.g. luxury or pay (supply & demand)
Target Profit
economy goods
(Target S.P-Desired Profit )
Includes all product & Management computes
period cost to make & a manufacturing cost that
Target Cost will provide an acceptable
market the product
profit margin based on
target price
Product Functionality Product and Process Design
Engineers and cost analysts design
a product that can be made for the NO
allowable cost to make profit Target Cost Met Redesign product and
when sold at target price techniques to achieve
(concurrent design & engineering) YES
target. (continuous
Produce Profit improvement)
Value engineering used
•Quality of material Target costing focuses a company’s cost
•Number of parts
reduction efforts in the product
•Change components
•Change methods design stage of production.
 price led
 customer focused
Target-  designed centered and Assign portion of total target
Costing  cross functional. costs to marketing, engineering,
Model and manufacturing departmt.
 TARGET COSTING-CUSTOMER REQUIREMENTS

• UNDERSTANDING CUSTOMER REQUIREMENTS BY

GATHERING MARKET INFORMATION RELATING TO
CUSTOMER EXPECTATIONS ABOUT:
-PRICE
-QUALITY
-DELIVERY
-SERVICE
-TECHNOLOGY&
PRODUCT PERFORMANCE
 Tata motors developed ‘Nano’its small
car with a target price
Purpose

Price

Product
People
Path breaking ideas, Promotion
conceived and implemented
in one or more of the 7 Ps, Place/Reach
leading to INNOVATION.
Process
Tata Nano – Perfect Case of Target Costing
• Tata Nano idea struck in the mind of
Purpose Chairman when he saw a family of four (a
man, his wife and two kids) riding on a
scooter on a rainy day.

• He felt that there was an unfulfilled need

of safe, affordable and an all weather
alternative.
Purpose from which the concept
emanated, which stresses upon the fact
that agility and understanding the unstated/
unfulfilled need of customers is the most
important source of innovation.
Tata Nano – Perfect Case of Target Costing
• Price got fixed at Rs 1 lakh without
Price compromising
– Aesthetics
– Value to customer
– Safety & environment requirements

• Normally bikes cost about 50,000 Indian Rupees

(1,250 USD).

• The cheapest car in the market was Maruti 800

which costed about 2Lakhs

It was said that “The People’s Car”

was impossible to produce. Tata just
proved the naysayers wrong. The
Tata Nano is the cheapest car in the
Tata Nano – Perfect Case of Target Costing
• Product design was choked because of the
Price (contd) price target.
• Hence the setting the price as target triggered
a series of innovation which involved:
– Target Cost approach – which involved breaking
down the cost targets to sub-system and then to
component level.

– Suppliers were challenged with the stringent cost

Target price itself target given to them, but they accepted the same
became the source of and the result is in front of you.
innovation, as the big
names in the industry
just rubbished it as false
claims
Tata Nano – Perfect Case of Target Costing
Product with Target – Target Cost approach with cost savings
Cost Approach – Smaller size of car & component (material
cost savings)
– Material substitution (e.g. engineering
plastics)
– Simplified component & design
– Simplified manufacturing process
Tata Motors created
breakthrough product
changing the market
dynamics and helped in
providing a new
customer experience.
Tata Nano – Perfect Case of Target Costing
Product with Target – Target Cost approach with cost savings
Cost Approach

Target price itself

became the source of
innovation, as the big
names in the industry
just rubbished it as false
claims
Tata Nano – Perfect Case of Target Costing
Product with Target • 2 cylinder engine (conventionally
Cost Approach there are 3-4 cylinder engines)
• Number of components such as
spark plugs, piston rings, injector &
engine plug were reduced

Company chairman Ratan Tata

said the car was a result of
radical changes, reinvention of
the manner in which a car is
produced.

Tata Nano is equipped with small rear

mounted low powered engine of 623cc,
2-cylinder, multi point fuel injection
patrol engine to reduce overall cost
Tata Nano – Perfect Case of Target Costing
Product with Target • Engine packaged on the rear side.
Cost Approach
Rear-engined layout is chosen
to save power steering and
ease safety costs...
Tata Nano is equipped with small rear
mounted low powered engine of 623cc,
2-cylinder, multi point fuel injection
patrol engine to reduce overall cost
• Resulted in spacious interior space at
front end helped Nano to pass cash
protection regulations
• Reduced length reduced amount of
required steel & engineering works
• Reduction in cost of equal speed
joint, steering system and drive shaft
joints (removed)
• Weight reduction to 48:58 at front
wheels eliminated power steering
The rear engine and front drive
reduce the transmission load and
cost.
Tata Nano – Perfect Case of Target Costing
Inspired by Indian Reduced
Product with Target auto rickshaws Manufacturing Cost
Cost Approach
Radical Decision in
form of innovation to
cut cost
Used only one wiper
(in centre) sweeping
from end to end
Identical handles
& mechanisms
for left and right
side doors

Door handle had

70 percent less
parts than one of
the cheapest
European cars.

Building up from the bare minimum enabled the

engineers to achieve their cost (and price)
targets without compromising the essential
functions of the car.
Tata Nano – Perfect Case of Target Costing
One side view mirror, Non adjustable seats,

Used simple motor cycle speedometre

Instrument cluster in middle of dashboard

Hollow steering shafts reduced further costs
and weight.

No radio but slot used for storage which cut

major cost but added value to customer

The final choice was a conventional looking seat

with a structure made of metal and the headrest
integrated with the seat to save on costs.
Tata Nano – Perfect Case of Target Costing

MRF, a leading tyre manufacturer,

redesigned the tyre to bear extra
weight on the rear wheels.

The final design is called stylein- steel

Interior space maximized wheels - a concept that looks like alloy
by pushing wheels to the but is made of pressed steel; and the
corners cost is almost the same as a normal
steel wheel.
Tata Nano – Perfect Case of Target Costing
Product with Target • Acquisition of 37 patents by Tata
Cost Approach • Meets all current regulatory
requirements meeting Euro IV standard
• All sheet metal body
• Safety features
– Crumple zones
– Intrusion resistant doors
Tata Motors created
breakthrough product – Seat belts & anchorages
changing the market – Rear tail glass bonded to its body
dynamics and helped in
providing a new
customer experience.
Radical Decision in
form of innovation to
cut cost
Tata Nano – Perfect Case of Target Costing
• Sufficient Space inside to accommodate 5 persons
Product comfortably.
(contd)
• 4 door, 30 hp, 624 cc engine, 4 speed manual
transmission, disk/drum break set up

• Highly fuel efficient (20 kmpl)

• Exceeds the current Safety requirements

• Complies with the current emission requirements.

Product created was (Euro IV)
very contemporary

Radical Decision in
form of innovation to
cut cost
Tata Nano – Perfect Case of Target Costing
People
• Designed by team of 500 young engineers
– WEST >1000

• Team worked cross functionally with other

teams to maximise chances of finding
Cross Functional ways to keep cost low
Team

Putting them into • Created separate unit isolated from rest of

challenging
assignments & giving
company
them International
exposure
Tata Nano – Perfect Case of Target Costing
People • Suppliers also took on the target cost
challenge for the Nano
(contd)
– Bosch came through by adopting the motor cycle
starter motor to save weight & by finding a way to
trim several ounces from the generator

– Delphi developed the low cost centrally maintained

instrument cluster with just a speedometer,
Suppliers were odometer and turn indicator signals. It also
challenged with the eliminated screws and replaced them simply with
stringent cost target
given to them, but
panels and parts that just snapped on firmly.
they accepted the
same
Tata Nano – Perfect Case of Target Costing
People • The main solution found to reduce costs is
(contd) how Tata Motors will buy the car
components.

• While car manufacturers usually buy 10 to

15% of the car parts from multiple
suppliers in a concurrential environment,
Suppliers were
challenged with the • Tata opened invitation to tender on the
stringent cost target
given to them, but web to buy up to 40-50% of the car parts.
they accepted the
same
Tata Nano – Perfect Case of Target Costing
People • Assembly kit developed for distributors
(contd)
• Stock completely knock down kit (CKD) of
car at warehouse & assemble them on
site

• Transporting in CKD condition less

Distributors were expensive than full car
Converted into
entrepreneurs for
reducing cost of
transportation
Tata Nano – Perfect Case of Target Costing
• Special portal developed which got 30
Promotion mill hit even before the launch of car

• After launch there were another 30 mill

hits in less than a month

• Received 2 lakh applications in beginning

Innovation lies in reaching the right

customers always and communicating
in a simple and effective manner.
Tata Nano – Perfect Case of Target Costing
• Booking facilitated through several banks
Place/Reach

• Insurance schemes co designed with

insurance companies

• Enhanced sales & service network for

better reach & service to customers

Conscious of the fact that demand for

such cars would be substantial from the
remotest corner of the country,
 Concerns About Target Costing
• What are some potential problems in
implementing target costing?
1.Conflict can arise between parties involved in
the process.
2.Employees may experience burnout due to
pressure.
3.Development time may increase.
4.Lack of understanding target costing concept