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TARGET COSTING
Prof. A.K.Mishra
DraftStrategic Tools for Management Accounting
Developed Strategic Cost Mgt Applications
• Activity Based Methods• Target Costing• Capacity Mgt• Asset Mgt• Process Mgt• Extended Enterprise• Lean Enterprise• Theory of Constraints
Emerging Applications
• Enterprise Risk Mgt• Non-financial Performance
Measurement• Strategy Planning & Execution• Customer Lifetime Value• Resource Consumption
Accounting
Strategic Tools for Mgt Accountant
Two Approaches to Pricing
• 1. Cost-Based Pricing
• 2. Target Costing and Pricing
RsRs
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 – PtcExample: 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.
7
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
Target Costing- Example
•Handy Appliance feels there is a niche for a hand mixer with certain features.
•Marketing Department believes that price of Rs30 would be right and that about 40,000 mixers could be sold.
•Rs2,000,000 invest required to gear up for production.
•Company requires a 15 percent ROI on invested funds.
Determine the target cost.
•Handy Appliance feels there is a niche for a hand mixer with certain features.
•Marketing Department believes that price of Rs30 would be right and that about 40,000 mixers could be sold.
•Rs2,000,000 invest required to gear up for production.
•Company requires a 15 percent ROI on invested funds.
Determine the target cost.
Target Costing
Projected sales (40,000 units × 30) 1,200,000Desired 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 CostingTarget Costing
Keyprinciplesof targetcosting
Price led costing
Focuson the customer
Focus onproductdesign
Focus onprocessdesign
Cross-functionalteams
Life-cyclecosts
Value-chainorientation
Target CostTarget Cost
Target Selling PriceTarget Selling PriceMarket Share ObjectiveMarket Share Objective
Target ProfitTarget Profit
Product and Process DesignProduct and Process Design
NO
Produce ProfitProduce Profit
YES
Target-Costing Model
Market research determines price at which a new product will sell. Customer willing to pay (supply & demand)
(Target S.P-Desired Profit ) Management computesa manufacturing cost thatwill provide an acceptableprofit margin based on target price
Engineers and cost analysts design a product that can be made for the allowable cost to make profit when sold at target price (concurrent design & engineering)
Value engineering used•Quality of material•Number of parts•Change components•Change methods
Target Cost MetTarget Cost Met
Product FunctionalityProduct Functionality
Redesign product and techniques to achieve target. (continuous improvement)
Select segment to compete, e.g. luxury or economy goods
Target costing focuses a company’s cost reduction efforts in the product design stage of production. price led customer focused designed centered and cross functional.
Assign portion of total target costs to marketing, engineering, and manufacturing departmt.
Includes all product & period cost to make & market the product
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
PurposePurpose
ProcessProcess
Place/ReachPlace/Reach
PromotionPromotion
PeoplePeople
ProductProduct
PricePrice
Path breaking ideas, conceived and implemented in one or more of the 7 Ps, leading to INNOVATION.
• Tata Nano idea struck in the mind of 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.
Tata Nano – Perfect Case of Target Costing
PurposePurpose
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.
• Price got fixed at Rs 1 lakh without 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
PricePrice
Tata Nano – Perfect Case of Target Costing
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 World!!
Tata Nano – Perfect Case of Target Costing• Product design was choked because of the
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 given to them, but they accepted the same and the result is in front of you.
Price Price (contd)(contd)
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– Target Cost approach with cost savings– Smaller size of car & component (material
cost savings)– Material substitution (e.g. engineering
plastics)– Simplified component & design – Simplified manufacturing process
Product with Target Product with Target Cost ApproachCost Approach
Tata Motors created breakthrough product changing the market dynamics and helped in providing a new customer experience.
Tata Nano – Perfect Case of Target Costing– Target Cost approach with cost savings
Target price itself became the source of innovation, as the big names in the industry just rubbished it as false claims
Product with Target Product with Target Cost ApproachCost Approach
Tata Nano – Perfect Case of Target Costing
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
• 2 cylinder engine (conventionally there are 3-4 cylinder engines)
• Number of components such as spark plugs, piston rings, injector & engine plug were reduced
Product with Target Product with Target Cost ApproachCost Approach
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 – Perfect Case of Target Costing
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
• Engine packaged on the rear side.• 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
Product with Target Product with Target Cost ApproachCost Approach
Rear-engined layout is chosen to save power steering and ease safety costs...
The rear engine and front drive reduce the transmission load and cost.
Tata Nano – Perfect Case of Target CostingReduced Reduced
Manufacturing CostManufacturing Cost
Used only one wiper (in centre) sweeping from end to end
Inspired by Indian auto rickshaws
Building up from the bare minimum enabled the engineers to achieve their cost (and price) targets without compromising the essential functions of the car.
Radical Decision in Radical Decision in form of innovation to form of innovation to
cut costcut cost
Product with Target Product with Target Cost ApproachCost Approach
Identical handles & mechanisms for left and right side doors
Door handle had 70 percent less parts than one of the cheapest European cars.
Tata Nano – Perfect Case of Target Costing
Instrument cluster in middle of dashboard
One side view mirror, Non adjustable seats,
No radio but slot used for storage which cut major cost but added value to customer
Used simple motor cycle speedometre
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.
Hollow steering shafts reduced further costs and weight.
Tata Nano – Perfect Case of Target Costing
The final design is called stylein- steel wheels - a concept that looks like alloy but is made of pressed steel; and the cost is almost the same as a normal steel wheel.
Interior space maximized by pushing wheels to the corners
MRF, a leading tyre manufacturer, redesigned the tyre to bear extra weight on the rear wheels.
• Acquisition of 37 patents by Tata• Meets all current regulatory
requirements meeting Euro IV standard• All sheet metal body• Safety features
– Crumple zones– Intrusion resistant doors– Seat belts & anchorages– Rear tail glass bonded to its body
Tata Nano – Perfect Case of Target Costing
Tata Motors created breakthrough product changing the market dynamics and helped in providing a new customer experience.
Radical Decision in Radical Decision in form of innovation to form of innovation to
cut costcut cost
Product with Target Product with Target Cost ApproachCost Approach
• Sufficient Space inside to accommodate 5 persons comfortably.
• 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. (Euro IV)
Tata Nano – Perfect Case of Target Costing
Product Product (contd)(contd)
Product created was very contemporary
Radical Decision in Radical Decision in form of innovation to form of innovation to
cut costcut cost
Tata Nano – Perfect Case of Target Costing
• Designed by team of 500 young engineers– WEST >1000
• Team worked cross functionally with other teams to maximise chances of finding ways to keep cost low
• Created separate unit isolated from rest of company
Cross Functional Cross Functional TeamTeam
PeoplePeople
Putting them into challenging assignments & giving them Internationalexposure
Tata Nano – Perfect Case of Target Costing• Suppliers also took on the target cost
challenge for the Nano
– 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, odometer and turn indicator signals. It also eliminated screws and replaced them simply with panels and parts that just snapped on firmly.
People People (contd)(contd)
Suppliers were challenged with the stringent cost target given to them, but they accepted the same
Tata Nano – Perfect Case of Target Costing• The main solution found to reduce costs
is 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,
• Tata opened invitation to tender on the web to buy up to 40-50% of the car parts.
People People (contd)(contd)
Suppliers were challenged with the stringent cost target given to them, but they accepted the same
Tata Nano – Perfect Case of Target Costing• Assembly kit developed for distributors
• Stock completely knock down kit (CKD) of car at warehouse & assemble them on site
• Transporting in CKD condition less expensive than full car
People People (contd)(contd)
Distributors were Converted into entrepreneurs for reducing cost of transportation
• Special portal developed which got 30 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
PromotionPromotion
Tata Nano – Perfect Case of Target Costing
Innovation lies in reaching the right customers always and communicating in a simple and effective manner.
• Booking facilitated through several banks
• Insurance schemes co designed with insurance companies
• Enhanced sales & service network for better reach & service to customers
Place/ReachPlace/Reach
Tata Nano – Perfect Case of Target Costing
Conscious of the fact that demand for such cars would be substantial from theremotest 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
