Target costing

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Target Cost

A target cost is a cost estimate derived by subtracting a desired profit margin from a competitive market price.

Target Costing Process

  1. Target costing begins by specifying a product an organisation wishes to sell. Ideally only those features valued by customers will be included in the product design.

  2. The price at which the product can be sold at is then considered. 

    This will take into account the competitors’ products and the market conditions expected at the time that the product will be launched.

  3. From the above price a desired margin is deducted. 

    This leaves the cost target. 

    An organisation will need to meet this target if their desired margin is to be met.

  4. Costs for the product are then calculated and compared to the cost target mentioned above.

  5. If it appears that this cost cannot be achieved, then the difference (shortfall) is called a cost gap. 

    This gap would have to be closed, by some form of cost reduction, if the desired margin is to be achieved.

Target Cost Gap

Where a gap exists between the current estimated cost levels and the target cost, it is essential that this gap be closed. 

Efforts to close a target cost gap are most likely to be successful at the design stage. 

It is far easier to ‘design out’ cost during the pre-production phase than to ‘control out’ cost during the production phase.

Ways to reduce a cost gap

  1. Review the product’s features.

  2. Remove features that add to cost but do not significantly add value to the product when viewed by the customer.

  3. Team approach - The company should bring together members of the marketing, design, assembly and distribution teams to allow discussion of methods to reduce costs.

    Open discussion and brainstorming are useful approaches here.

  4. Review the whole supplier chain - each step in the supply chain should be reviewed, possibly with the aid of staff questionnaires, to identify areas of likely cost savings. 

    For example, the questionnaire might ask ‘are there more than five potential suppliers for this component?’ Clearly a ‘yes’ response to this question will mean that there is the potential for tendering or price competition.

  5. Reduce waste or idle time that might exist. 

    Where possible, standardised components should be used in the design. 

    Productivity gains may be possible by changing working practices or by de-skilling the process. 

    Automation is increasingly common in assembly and manufacturing.

These techniques are known as value-engineering.

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