Target Costing

Definition

Target costing is a strategic cost management technique used to determine the maximum allowable cost for a product or service based on its expected market price and desired profit margin. It involves working backward from the target selling price to establish cost targets that must be met in order to achieve profitability goals.

5 Must Know Facts For Your Next Test

1. Target costing is particularly useful in highly competitive markets where price is a key factor in customer decision-making.
2. The target costing process involves setting a target price based on market research, then working backward to determine the maximum allowable cost to achieve the desired profit margin.
3. Value engineering is often used in conjunction with target costing to identify opportunities to reduce costs without compromising product functionality or quality.
4. Kaizen costing is a complementary approach that focuses on continuous cost reduction through small, incremental improvements throughout the product's lifecycle.
5. Effective target costing requires close collaboration between cross-functional teams, including marketing, engineering, and finance, to ensure that cost targets are achievable and aligned with the organization's strategic objectives.

Review Questions

• Explain how target costing is used to establish pricing for a new product or service.
  • In the target costing approach, the starting point is the expected market price for the product or service, based on customer research and competitive analysis. The organization then works backward to determine the maximum allowable cost, which is the difference between the target price and the desired profit margin. This cost target becomes the benchmark for the design, engineering, and production teams to develop the product or service in a way that meets the cost objective while still delivering the desired functionality and quality.
• Describe how value engineering can be used in conjunction with target costing to optimize product costs.
  • Value engineering is a complementary technique that can be used alongside target costing to identify opportunities to reduce costs without compromising the product's functionality or quality. By systematically analyzing the product's design, materials, and production processes, the value engineering team can suggest alternatives that maintain or even enhance the product's value to the customer while lowering the overall cost. This collaborative approach between the target costing and value engineering teams helps ensure that the organization can meet its cost targets and achieve the desired profit margins.
• Evaluate the role of cross-functional collaboration in the successful implementation of a target costing strategy.
  • Effective target costing requires close collaboration between multiple departments within an organization, including marketing, engineering, and finance. Marketing professionals provide insights into customer needs and preferences, as well as competitive pricing data, to help set the target price. Engineering teams then work to design and engineer the product or service in a way that meets the cost targets while maintaining quality and functionality. Finance professionals provide financial analysis and cost modeling to ensure the cost targets are achievable and aligned with the organization's strategic objectives. By bringing these diverse perspectives together, the organization can develop a comprehensive target costing strategy that balances customer value, cost control, and profitability.

Related terms

Cost Reduction: The process of identifying and implementing ways to lower the costs associated with producing a product or delivering a service.

Value Engineering: A systematic approach to improving the value of a product or service by enhancing its functionality while minimizing costs.

Kaizen Costing: A continuous improvement process that focuses on gradually reducing the cost of a product or service over time through small, incremental changes.