Target costing is defined as a cost management tool for reducing the overall cost of a product over its product life cycle.  Management utilizes this pricing technique to meet both the demands of its customers as well as company profit goals. 

Target costing is particularly popular among Japanese firms such as Toyota, Nissan, Toshiba and Daihatsu Motor in various industries such as automobile manufacturing, electronics, machine tooling, and precision machine manufacturing.  As Japanese tastes became more diverse, assembly-oriented production grew in popularity.  This growing demand for a diverse range of products shortened product life cycles.  With shorter product life cycles more focus is placed on the costs occurring at each phase (development, planning and design.)  

Compared to traditional standard costing approaches in which an estimate of product, general administrative, marketing, and distribution costs is taken into consideration, target costing takes on a more proactive approach to pricing.  Traditional costing determines cost based on the design of goods, adds a markup and establishes a price.  In comparison, the marketplace directs target costing by first setting a selling price, then subtracting target income and finally reaching a cost.

Traditionally, a cost figure is obtained, implemented and once found to be poorly configured, sent back to management and engineers for reworking of production processes and cutting of costs.  In comparison, target costing utilizes costing information and focuses on the best possible price up front, preventing wasted time on after-the-fact discussions concerning design and re-engineering of the product. 

The decision making process involves a cross functional team, in which employees from various departments (Production, Engineering, R&D, Marketing, and Accounting) are given the responsibility of determining an acceptable market price and corresponding Return on Sales, as well as a feasible cost in which a given item may be produced.  In order to minimize costs, team members focus on eliminating non-value-added costs of the process, improving product design and modifying process methods.

Target costing, in particular, emphasizes the reduction of costs during the planning and design stage of the product life cycle since the majority of product cost is determined at this stage.  In comparison to traditional product costing methods, target costing allocates more of the total cost to the development stage, simultaneously reducing costs during the production stage.  A number of cost-engineering techniques are used in the cost reduction process.   Just-in-Time, Total Quality Control, Material Requirements Planning and Value Engineering are among such methods promoted by target costing.

With the increased popularity of assembly-oriented industries, Economic Order Quantity analysis, a traditional means of keeping certain amounts of inventory on hand, became less useful.  Instead, many firms, realizing the dangers of housing high inventory, turned to Just-In-Time and Material Requirements Planning.  JIT and MRP provided a great advantage to these companies that manufacture high variety, low-volume products.

Value engineering involves the design of a product after gathering input from employees and from various departments within a company, each offering a different perspective on possible cost minimization tactics. Value engineering considers all aspects of the value chain and frequently involves individuals outside of the company such as suppliers in order to reach a decision that encompasses the most successful combination of price and quality.   

Total Quality Control is a Japanese process that initially developed in the United States as a method of Quality Control. Inspection is the main issue that distinguishes between the two.  TQC incorporates QC (inspection) activities throughout a company, rather than in isolation within specific departments.

Initially a project is either accepted or rejected based on marketability and cost and profit data.  Once a project is accepted, the engineering department constructs an engineering development plan.  This plan considers all aspects of product cost up-front.  Target profit is then subtracted from expected sales to reach an estimate of allowable cost. In order to successfully reach this allowable cost, a great deal of effort is required from each department to tighten overall cost.  Individual processes are evaluated in order to direct efforts toward the most valuable and feasible cost saving areas.    

The prevalence of assembly-oriented products along with shortened product life cycles has contributed to the success of target costing.  Many firms have turned to target costing as a way of improving the price and quality of their products, creating a benefit in terms of a company’s profits as well as increased customer satisfaction.  Target costing adds value to the production process by eliminating non-value added activities, thus paving the way for decreased costs passed on to the consumer.  Target costing enables companies to ascertain a more realistic price as well as strengthen competition among firms to offer quality products at lower costs. 

Target Costing vs. Standard Costing

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