Target costing should be viewed as an integral part of a strategic profit management system.
The initial consideration in target costing is the determination of an estimate of the selling price for a new product which will enable a firm to capture its required share of the market. Then it is necessary to reduce this figure to reflect the firm’s desired level of profit, having regard to the rate of return required on new capital investment and working capital requirements.
The deduction of required profit from the proposed selling price will produce a target price that must be met in order to ensure that the desired rate of return is obtained.
Thus the main theme that underpins target costing can be seen to be 'what should a product cost in order to achieve the desired level of return’.
Target costing will necessitate comparison of current estimated cost levels against the target level which must be achieved if the desired levels of profitability, and hence return on investment, are to be achieved. Thus where a gap exists between the current estimated cost levels and the target cost, it is essential that this gap be closed.
Example:
The Marketing Director of Company A has estimated that sales volume amounting to 5% of the total market size can be achieved in year 1 if a selling price of £80 per unit is maintained throughout the year. The board of directors are in agreement that they wish to maintain a 5% share by volume, of the total market size in each of years 2–4.
The management of Company A should be cognisant of the fact that it is far easier to ‘design out’ cost during the pre-production phase than to ‘control out’ cost during the production phase. Thus cost reduction at this stage of a product’s life cycle is of critical significance to business success. A number of techniques may be employed in order to help in the achievement and maintenance of the desired level of target cost. Attention should be focused upon the identification of value added and non-value added activities with the aim of the elimination of the latter. The product should be developed in an atmosphere of ‘continuous improvement’. In this regard, Total Quality techniques such as the use of Quality circles may be used in attempting to find ways of achieving reductions in product cost.
Value engineering techniques can be used to evaluate necessary product features such as the quality of materials used. It is essential that a collaborative approach is used by the management of Company A and that all interested parties such as suppliers and customers are closely involved in order to engineer product enhancements at reduced cost.
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Showing posts with label Target Costing. Show all posts
Showing posts with label Target Costing. Show all posts
Tuesday, October 18, 2011
Sunday, June 26, 2011
Explain "Target Costing" and how it may be applied
Target Costing (TC) is technique that focuses on managing costs during a product’s planning and design phase. TC is a customer-oriented approach.
Target costing (TC) is an approach aimed at reducing the life cycle costs of new products while ensuring quality, reliability and other customer requirements, by examining all possible ideas for cost reduction at the product planning, research and development and the prototyping phases of production. It is not just a cost reduction technique but is part of a comprehensive strategic profit management system.
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Target Cost-Setting Process
Develop a product concept and then determine the price that customers are willing to pay for it to achieve the desired market share.
A target or desired profit margin is deducted to get a target cost for the product. The target profit margin can be based on a required return on the new investment or profit as a percentage of sales.
If the estimated actual cost of the product exceeds the target cost, value engineering and value analysis and continuous improvement will be used to close the cost gap.
It is important that target costing is supported by an accurate costing system using appropriate cause-and-effect cost drivers for cost assignment.
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Target costing (TC) is an approach aimed at reducing the life cycle costs of new products while ensuring quality, reliability and other customer requirements, by examining all possible ideas for cost reduction at the product planning, research and development and the prototyping phases of production. It is not just a cost reduction technique but is part of a comprehensive strategic profit management system.
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Target Cost-Setting Process
Develop a product concept and then determine the price that customers are willing to pay for it to achieve the desired market share.
A target or desired profit margin is deducted to get a target cost for the product. The target profit margin can be based on a required return on the new investment or profit as a percentage of sales.
If the estimated actual cost of the product exceeds the target cost, value engineering and value analysis and continuous improvement will be used to close the cost gap.
It is important that target costing is supported by an accurate costing system using appropriate cause-and-effect cost drivers for cost assignment.
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Friday, December 4, 2009
Target Costing (II)
Very often the management may decide to go ahead and manufacture a product whose target cost is well below the currently attainable cost (so that there is a cost gap).
To attain the Target cost, management will set benchmarks for improvement towards the target costs, by specified dates.
Options available to reduce costs:
(a) Training staff in more efficient techniques
(b) Using cheaper staff
(c) Acquiring new, more efficient technology
(d) Cutting out non-value-added activities
Cost savings must be actively sought and made continuously. Value analysis will be used to reduce costs if and when targets are missed.
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The following comments appeared in an article in the Financial Times
Mercedes-Benz, one of the world’s most prestigious and tradition-laden carmakers, has taken its time to wake up to the daunting dimensions of the challenges it faces in the rapidly-changing world car market of the 1990s.
The company has accepted that radical changes in the world car market mean that Mercedes-Benz will no longer be able to demand premium prices for its products based on an image of effortless superiority and a content of the ultimate in automotive engineering.
Instead of developing the ultimate car and then charging a correspondingly sky-high price as in the past, Mercedes-Benz is taking the dramatic and radical step of moving to target pricing. It will decide what the customer is willing to pay in a particular product category – priced against its competitors – it will add its profit margin and then the real work will begin to cost every part and component to bring in the vehicle at the target price.
The following extracts are from an article which appeared three months later.
The marketing motto for the Mercedes-Benz compact C-class is that it offers customers more car for their money.
It is the first practical example of a group’s new pricing policy. The range embodies a principle new to Mercedes which states that before any work starts, a new product will be priced according to what the market will bear and what the company considers an acceptable profit. Then each component and manufacturing process will be costed to ensure the final product is delivered at the target price.
Under the old system of building the car, adding up the costs and then fixing a price, the C-class would have been between 15 percent and 20 percent dearer than the 10-year-old outgoing 190 series, Mr Vohnringer said.
Explaining the practical workings of the new system, he explained that project groups for each component and construction process were instructed without exception to increase productivity by between 15 and 25 per cent. And they had to reach their targets in record time.
One result was that development time on the new models was cut to 40 months, about a third less than usual. But the most important effect, according to Mr Vohnringer, has been to reduce the company’s cost disadvantages vis-à-vis Japanese competitors in this class from 35 percent to only 15 percent.
(source: BPP Learning Media)
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To attain the Target cost, management will set benchmarks for improvement towards the target costs, by specified dates.
Options available to reduce costs:
(a) Training staff in more efficient techniques
(b) Using cheaper staff
(c) Acquiring new, more efficient technology
(d) Cutting out non-value-added activities
Cost savings must be actively sought and made continuously. Value analysis will be used to reduce costs if and when targets are missed.
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The following comments appeared in an article in the Financial Times
Mercedes-Benz, one of the world’s most prestigious and tradition-laden carmakers, has taken its time to wake up to the daunting dimensions of the challenges it faces in the rapidly-changing world car market of the 1990s.
The company has accepted that radical changes in the world car market mean that Mercedes-Benz will no longer be able to demand premium prices for its products based on an image of effortless superiority and a content of the ultimate in automotive engineering.
Instead of developing the ultimate car and then charging a correspondingly sky-high price as in the past, Mercedes-Benz is taking the dramatic and radical step of moving to target pricing. It will decide what the customer is willing to pay in a particular product category – priced against its competitors – it will add its profit margin and then the real work will begin to cost every part and component to bring in the vehicle at the target price.
The following extracts are from an article which appeared three months later.
The marketing motto for the Mercedes-Benz compact C-class is that it offers customers more car for their money.
It is the first practical example of a group’s new pricing policy. The range embodies a principle new to Mercedes which states that before any work starts, a new product will be priced according to what the market will bear and what the company considers an acceptable profit. Then each component and manufacturing process will be costed to ensure the final product is delivered at the target price.
Under the old system of building the car, adding up the costs and then fixing a price, the C-class would have been between 15 percent and 20 percent dearer than the 10-year-old outgoing 190 series, Mr Vohnringer said.
Explaining the practical workings of the new system, he explained that project groups for each component and construction process were instructed without exception to increase productivity by between 15 and 25 per cent. And they had to reach their targets in record time.
One result was that development time on the new models was cut to 40 months, about a third less than usual. But the most important effect, according to Mr Vohnringer, has been to reduce the company’s cost disadvantages vis-à-vis Japanese competitors in this class from 35 percent to only 15 percent.
(source: BPP Learning Media)
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Target Costing Explained
Target Cost is an estimate of a product cost which is derived by subtracting a desired profit margin from a competitive market price.
Target costing is a pro-active cost control system. Techniques such as value analysis are used to change production methods and/or reduce expected costs so that the target cost is met.
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Target cost management:
• It is effective in managing costs in new product design and development stages.
• It also enables the production cost of a proposed product to be identified so that when sold it generates the desired profit level.
• It also plays a useful role in enabling enterprise to set and support the attainment of cost levels.
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Target costing requires managers to change the way they think about the relationship between cost, price and profit.
(a) Traditional approach is to develop a product, determine the expected standard production cost of that product and then set a selling price (probably based on cost) with a resulting profit or loss. Costs are controlled through variance analysis at monthly intervals.
(b) The target costing approach is to develop a product concept and the primary specifications for performance and design and then to determine the price the customers would be willing to pay for that concept. The desired profit margin is deducted from the price leaving a figure that represents total cost.
This is the target cost and the product must be capable of being produced for this amount otherwise the product will not be manufactured.
During the product’s life target cost will constantly be reduced so that the price can fall. Continuous cost reduction techniques must therefore be employed.
(source : BPP Learning Media)
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Target costing is a pro-active cost control system. Techniques such as value analysis are used to change production methods and/or reduce expected costs so that the target cost is met.
*********************
Target cost management:
• It is effective in managing costs in new product design and development stages.
• It also enables the production cost of a proposed product to be identified so that when sold it generates the desired profit level.
• It also plays a useful role in enabling enterprise to set and support the attainment of cost levels.
************************
Target costing requires managers to change the way they think about the relationship between cost, price and profit.
(a) Traditional approach is to develop a product, determine the expected standard production cost of that product and then set a selling price (probably based on cost) with a resulting profit or loss. Costs are controlled through variance analysis at monthly intervals.
(b) The target costing approach is to develop a product concept and the primary specifications for performance and design and then to determine the price the customers would be willing to pay for that concept. The desired profit margin is deducted from the price leaving a figure that represents total cost.
This is the target cost and the product must be capable of being produced for this amount otherwise the product will not be manufactured.
During the product’s life target cost will constantly be reduced so that the price can fall. Continuous cost reduction techniques must therefore be employed.
(source : BPP Learning Media)
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