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Target CostingTarget Costing

Target cost is the cost of resources that should beconsumed to create a product that can be

sold at a target price.

Target costing is an integrated approach to determine

product features, product price, product cost and

product design that helps ensure a company

will earn reasonable profit onnew products.

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Target Costing Process

A target price is the estimated price for a product/service that potential

customers will pay.

Target Cost = Target price Profit margin.

Target Price

Target price is the estimated price for a product/service that potential

customers will pay.

Target Operating Income Per Unit

Target operating income per unit is the operating income that a company aims

to earn per unit of a product/service sold.

Target Cost Per Unit

Target cost per unit is the estimated long-run cost per unit of a

product/service that enables the company to achieves its target operating

income per unit when selling at the target price.

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Four components of target costing process(1) Planning and market analysis

(2) Development

(3) Production design(4) Production and continuous improvement.

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Establishing

Target Price

Concept

development

Planning and

market

analysis

Attaining Target

Cost

Production design

and

value engineering

Production and

continuous

improvement

Concept

development

Profit

margin

Target

Cost

Target Costing Process

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Target Costing Illustrated

We illustrate the step-wise target pricing and target costing below.

Assume HCL Ltd. manufactures two brands of personnel computers (PCs):Deskpoint and Provalue. Deskpoint is HLLs top-of-the-line product, a Pentium 4chip-based PC. Provalue is a less powerful Pentium chip-based machine. TheHLL currently produces 1,50,000 units of Provalue. The per unit sale price ofProvalue is Rs 10,000. The full cost of Provalue is Rs 1,35,00,00,000 consisting ofmanufacturing cost of Rs 102,00,00,000 and operating cost of Rs 33,00,00,000.

Step 1: Develop a Product That Satisfies Needs of Potential Customers

Marketing research indicates that customers do not value Provalues extrafeatures such as special audio features and designs that accommodate upgradesthat can make the PC run faster and perform calculations more quickly. Theywant HLL to redesign Provalue into a no-frills PC and sell it at a much lowerprice. The HLL is, accordingly, planning design modification for Provalue.

Step 2: Choose a Target PriceThe HLL expects its competitors to lower the price of PCs that compete againstProvalue by 15 per cent. The management of HLL wants to respond aggressivelyby reducing Provalues price by 20 per cent from Rs 10,000 to Rs 8,000 per unit.At this lower price, marketing manager of HLL forecasts an increase in annualsales from 1,50,000 to 2,00,000 units.

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Step 3: Derive a Target Cost Per Unit (Target Price Target Operating Income)

The management of HLL wants a 10 per cent target operating income on salesrevenues.

Total target revenues = Rs 8,000 per unit 2,00,000 units = Rs 160,00,00,000.

Total target operating income = 0.10 Rs 160,00,00,000 = Rs 16,00,00,000

Target operating income per unit = Rs 16,00,00,000 2,00,000 units = Rs 800 perunit

Target cost per unit = Target price per unit Target operating income per unit = Rs8,000 Rs 800 = Rs 7,200

Total full costs of Provalue = Rs 135,00,00,000

Current full per unit cost of Provalue = Rs 1,35,00,00,000 1,50,000 units = Rs 9,000per unit

The target cost value of Provalue of Rs 7,200 is well below its existing Rs 9,000 unitcost. The HLLs goal is to reduce its unit cost by Rs 1,800. The cost reductionefforts should be extended to all parts of the chain value from R&D to customerservice including seeking lower prices from suppliers of materials and

components.

Step 4: Perform Value Engineering to Achieve Target Cost

Value engineering is a systematic evaluation of all aspects of value chain businessfunctions with the objective of reducing costs while satisfying customer needs. Itcan result in improvements in product design, changes in materials specificationsand modification in process methods.