TC-© 2011 Baba 1

Target costing (TC)• Definition of Target Costing– “ a structured approach to determining the cost at

which proposed product with specific functionality & quality must be produced, to generate desired level of profitability at its anticipated selling price.

• Mechanism for determining selling prices.• It is a cost management tool.• More inclusive approach. There are advantages in combining

employees from strategy, planning, marketing, engineering, finance & production.

• TC Shifts definition of costs from short run to long run.• TC provides a way to link profit planning, feasibility, market surveys,

value analysis, strategic accounting, budgetary control & financial management.

• TATA Nano Rs. 1 ,00,000. – is a typical example for target costing.

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Target costing • Customer oriented approach.• Suppliers are included in the design team, they can suggest

standard parts/alternative parts instead of custom-design parts which will reduce the product cost.

• Used by Japanese companies (more than 80% in assembly industries & more than 60% of companies in processing industry and recently adopted by Europe and the USA.

• A range of specialized tools , including functional analysis, value engineering, value analysis, concurrent engineering were introduced to support TC.

• TC is most useful in situations where majority f product costs are locked in during product design stage. This is the case for most manufactured products, but a few services.

• TC results in less value in the production of raw materials such as chemicals.

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Main features of Target Costing System (TCS)• TCS is viewed integral part of design & introduction to new product, it is part

of whole management process rather than simply a tool for cost reduction. Target profit margin is derived from the company’s long term business plan.

• Market driven-target SP is decide very often decided on the basis competitor’s SP.

• Integral to setting target selling price is the establishment of target production volume, given the relationship between price & volume.

• Embodied in TCS is the process of determining cost reduction target- the difference between current cost & target cost indicates required reduction that is needed.

• A degree of judgment is needed where allowable costs & Target cost differ.• The activities to meet T.Cost objective continue through design stage up until

point where new product goes into production, typically total target is broken down into its various components -each component is studies & opportunities for cost reduction are identified (value engineering & value analysis). There is also an ongoing continuous improvement program, known as Kaizen costing.

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What is required?

• Team approach• Team members include: 1.designers 2. engineers 3.

Purchasing 4. manufacturing 5. marketing 6. management accounting personnel

• The discipline of a team approach ensures that no particular group is able to impose functional preferences.

• Aim During product design process is that elimination of product functions that add costs which do not increase market price.

TC-© 2011 Baba

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Target Costing -Advantages• Advantages of TC– It reinforces top to bottom commitment.– Creates competitive future with market driven

management for designing & manufacturing products.

– It uses management control systems to support & reinforce manufacturing strategies.

– Cost economies and strategies are thought of right at the designing stage,

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Problems with TC– Development process can be lengthened to a considerable

extent ,since design team may need a number of iteration.– Large amount of cost cutting can result in finger pointing in

various parts of the company.– Having representative from a number of departments on the

design team can some times make it more difficult to reach consensus.

• Above problems can be solved by choosing s strong team manager with exceptional knowledge of design process, good interpersonal skills & commitment to staying within both time & cost budget for design project.

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Implementing TC system

Procedures: 1. Create charter2. Obtain a management sponsor.3. Obtain budget.4. Assign a strong tem manager.5. Enroll full time participants.6. Use project management tools.

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Stages of target costing1. Customer requirements- gathering Market information -Market research to find

the customer’s perceived value-tear down analysis-examining the competitors’ products-dismantling of the competitor's product use value engineering. Documenting customer requirements(product characteristics, competitors’ performance comparison, customers’ rating, comparisons).

2. Comparing Competitors Products-How customers differentiate the product from the competitors; published performance data, government data industry journals commercially available data bases, specifications, brochures, customers’ inputs, comparative test data, annual reports, reverse engineering (Reverse Engineering determines design characteristics, provide information about competitor’s material, processes, techniques, engineering, specifications etc.)

3. Cost structure analysis, best practice model and benchmarking. Choose a product design that assures targeted profit& cost for each component in total.

4. Target profit margin depends on planned return on investment and fix % of profits on sales

5. Decomposed into a target profit for each product.6. Deduct the target profit from target price.7. Compare with the predicted actual cost. 8. If predicted cost>target cost then efforts are made to close the gap.9. Continuous improvement-Kaizen

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Stages of target costing

• Target Cost = Competitor’s price-Desired Profit• Market based price starts with Target Price (TP); TP is

estimated piece for a product or service that potential competitor will pay.

• TC is maximum allowable cost & is specified by reference to successive stages in product life cycle.

• Market orientation of TC-– Keeps track of external market information-TC is driven by external

marketing forces and factors– Internal cost planning process.– TC is not a day today planning tool, it is to be achieved at design

stage

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If target costs not achieved ?

• Product should not be launched• Design teams should not be allowed to

achieve target cost by eliminating desirable product functions.

• Design teams use tear-down analysis• Value engineering is to achieve the target cost.

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Value Engineering (VE) &Value analysis (VA)• Objectives of VE & VA is to reduce costs & achieve quality level that satisfies -

improvement in product design, changes in material specifications, modification in process methods.

• VE involves searching for opportunities to modify design of each component or part of product to reduce cost, but without reducing functionality or quality.

• VA entails studying the activities that are involved in producing product to detect non-value-adding activities that may be eliminated or minimized to save costs but without reducing the functionality or quality of product. VA is systematic evaluation of all aspects of the value chain.

• To implement VE, managers distinguish between value added activities & costs from non value added activities & their costs.(value added cost is that cost which if eliminated would reduce actual or perceived value or utility-usefulness)-One of the goals of VE is to reduce & possibly eliminate non-value added costs & increase efficiency of value added activities.

• Non value added cost –(producing defective products, rework, machine breakdown).• Gray areas-supervision, production control, ordering, receiving• VA is used in TC to reduce costs by analyzing trade offs between different types of

product functionality (-features) & total product costs• An important first step on VA is to perform consumer analysis (Critical Consumer

Preference) during design stage• .

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Value Engineering (VE)• Here are some of the issues that are dealt with during VE

review1. Can we eliminate functions from production process?2. Can we eliminate some durability or reliability?3. Can we minimize the design.4. Can we assign the product better for the manufacturing

process ?5. Can we substitute parts ?6. Can we combine steps?7. Is there a better way ?

• Another approach to VE is to call on the services of a company’s supplier’s t0 assist in the cost reduction efforts.

• Another cost reduction approach is to allocate cost reduction based on presence of certain product feature in product design.

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Kaizen costing• This is Japanese term for a number of cost reduction steps that can be

used subsequent to issuing new product design to factory floor.• It is a mechanism for reducing and managing costs.• Improvement to the process rather than applied during design stage.

Constantly refining the process & there by stripping out extra costs.• The cost reductions from Kaizen Costing is much smaller than VE but are

still worth it.• Cost reduction through the increased efficiency of the production

process.• To reduce the cost of components and the products by a pre-specified

amount.• To reduce or eliminate waste in the production process.• It is heavily on empowerment of employees• Workers are given more responsibilities to improve the processes and

reduce costs.

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Methods of establishing TC

• Methods of establishing TC– Subtraction Method

• TC = Targeted Price - Targeted Profit

• Targeted PROFIT– Addition Method – the traditional costing Targeted Profit

• % of sales• % of costs-

– % of Total costs– % of Manufacturing Costs– % of Prime Costs – % Of ABC

– %ROI

TC-© 2011 Baba