target costing

Introduction Target Costing is a process of developing costs for a product (or

services) based on market driven considerations.

A method that allows firms to provide consumers with products that they want, at a price they can afford, and still earn desired financial returns.

Key Attributes

Price Led Costing

Customer Focus

Focus on design of products and processes

Life Cycle cost reduction

Value Chain involvement

Application

To start from the market and work back to production process, through design and development of product that customer needs at acceptable prices.

It is applied in the design and development stage.

Target Cost of a product = Target selling price less Target Profit

Value Engineering is a key to achieving target costs.

It is a systematic evaluation of all aspects of production and marketing that starts from R&D, Design of products, and distribution to customers, ending with customer service.

Target costing is widely used by Japanese and American Industries in automobiles (Toyota), Electronics (Panasonic), Information Technology (Apple).

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Target Costing Characteristics Contradicts the traditional approach: design product, determine cost,

set price

Intense customer focus

What do they want? How much will they pay for it?

Can we make a profit on it?

Want answers to these questions before committing to the project

Cost control from the beginning

70-90% of costs are committed to at the design stage

Focus on product and process design to engineer out costs from the beginning

Saves costly changes later on

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Target Costing Characteristics

Product, manufacturing process, delivery process designed simultaneously

Ensures features customers demand, but within acceptable cost parameters

Eliminates the temptation to add costly features

Customers may not value the added features

Forces consideration of manufacturability

Reduces the need for subsequent changes

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Target Costing Characteristics

Cost control at all phases of the product life cycle

Design

Production

Delivery/setup

Customer’s cost of ownership

Emphasizes future sales instead of current cost savings

Service and repair

Disposal and recycling

Traditional costing process model

Product RequirementProduct Requirement

Product Design and Development


Supplier Cost EstimatesSupplier Cost Estimates

ProductionProduction

Process Design & Product Cost Estimates

Process Design & Product Cost Estimates

Cost is too highCost is too high

Target costing process model

Market Research

Product Strategy and profit plan


Production and LogisticsProduction and Logistics

Competitive Strategy and Intelligence

Value Engineering

Voice of Customer Establish and Attain Target cost

SalesSales

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Target Costing Process

Two stage process

Establish the target cost

Market research

Product planning, concept development stages

Achieve the target cost

Value engineering, continuous improvement

Design stage

Continuous improvement in later stages

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Establishing the Target Cost

Determine the selling price

Must be acceptable to the customer

Must be able to withstand competition

Techniques

Existing price +/- value of features added or deleted

Consensus of focus group

Price predicted to achieve a desired market share

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Determine the product and its market

Who is the target market?

What do they want?

What do competitors offer?....Benchmarking

Introduce concept or prototype

Evolutionary or revolutionary?

Refine until it meets customer needs

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Determine the required profit

Return on sales

Desired return

Historical return for similar products

Industry average for similar products

Return on sales will fluctuate over the life of the product

Price and costs fluctuate

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Unit price, cost and profit are almost meaningless because they fluctuate

Life cycle totals are more meaningful

Total expected revenue throughout product life

- Total desired profit throughout product life

Total target cost

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Achieving the Target Cost

Must include the features the customer wants while maintaining cost at or below target

Want to meet the customers needs, but not exceed them

Eliminating desired features will result in an undesirable product

Adding unwanted features will increase cost

Failing to keep cost at or below target will result in unacceptable profits

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Rank customer requirements (exhibit 1)

What does the customer want?....Voice of Customer

How important is each function to the customer?

What do we and our competitors currently offer? Competitive evaluation (exhibit 1)

Do our current product features meet the customer needs?

Are the customers’ needs met, unmet or exceeded?

What can we learn from our competitors’ products?

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EXHIBIT 1CUSTOMER REQUIREMENT RANKINGS

Less More Raw % of Total

Customer Requirement Important Score Raw Score

1 2 3 4 5 1 2 3 4 5

Multiple speeds 4 4 14.8%

Horizontal oscillation 3 3 11.1%

Vertical oscillation 1 1 3.7%

Light weight 4 4 14.8%

Adjustable height 1 1 3.7%

Airflow capacity 4 4 14.8%

Quietness 5 5 18.5%

Compact size 3 3 11.1%

Looks nice 2 2 7.4%

Total 27 100%

Us

Competitor

Both

Important

Competitive

Comparison

Ranking

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Determine the cost gap between current cost and allowable cost

Current cost is based on

Currently used components

Current suppliers

Current manufacturing processes

Current distribution network

Etc.

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Achieving the Target Cost Decompose the cost gap (exhibit 2)

Life cycle decomposition Cost reduction goals are divided among the functions in

the product’s life cycle

Design/engineering

Manufacturing

Sales/distribution

Service/support

General administration

Etc.

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Achieving the Target Cost Value chain decomposition

Cost reduction targets are divided among internal and external activities

Internal costs

Labor, overhead, selling and administrative costs, etc.

External costs

Components and services acquired from suppliers, etc.

Often represent a large proportion of total cost

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EXHIBIT 2COST GAP BREAKDOWN BY LIFE CYCLE AND VALUE CHAIN

Life Cycle

Target Current Gap Target Current Gap Target Current Gap

Research and development 0.30$ 0.50$ 0.20$ 0.30$ 0.50$ 0.20$

Manufacturing 4.00 5.00 1.00 13.00$ 15.00$ 2.00$ 17.00 20.00 3.00

Marketing and distribution 1.50 2.00 0.50 4.50 5.00 0.50 6.00 7.00 1.00

Service and support 0.25 0.50 0.25 0.25 0.50 0.25

General administration 0.75 1.00 0.25 0.75 1.00 0.25

Total 6.80$ 9.00$ 2.20$ 17.50$ 20.00$ 2.50$ 24.30$ 29.00$ 4.70$

Internal Costs External Costs Total Costs

Value Chain

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Perform value engineering to design out costs without sacrificing needed features

Perform a cost analysis of major components and activities

List components or activities and their functions

Calculate a cost breakdown (exhibit 3)

Determine the current cost of each component or activity and convert to percentage of total cost

Costs include materials, labor, overhead, etc.

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EXHIBIT 3COMPONENT COST BREAKDOWN

Percent of

Component Function Cost total cost

Motor Turns blade 8$ 40%

Transmission Provides oscillation capabilities 4 20%

Speed control/switch Controls blade speed 3 15%

Body Houses motor, transmission, speed control 2 10%

Blade Moves air 1 5%

Blade guard Protects blade from contacting objects 2 10%

Total 20$ 100%

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Achieving the Target Cost Relate the components to customer requirements

(exhibit 4)

Develop Quality-Function-Deployment matrix

Indicates which components have the greatest impact on customer requirements

Develop a functional ranking (exhibit 5)

Indicates the importance of each component to the customer

Based on the component’s contribution to providing the desired functions

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EXHIBIT 4QUALITY-FUNCTION-DEPLOYMENT (QFD) MATRIX

Speed Blade

Motor Transmission control Body Blade guard

Multiple speeds

Horizontal oscillation

Vertical oscillation

Light weight

Adjustable height

Airflow capacity

Quietness

Compact size

Looks nice

Strong correlationModerate correlationWeak correlation

Components

Customer Requirements

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EXHIBIT 5COMPONENT CONTRIBUTION TO CUSTOMER REQUIREMENTS

Customer Requirements Speed Blade

Motor Transmission control Body Blade guard

Multiple speeds 40 X 14.8 = 5.92 60 X 14.8 = 8.88

Horizontal oscillation 80 X 11.1 = 8.88 20 X 11.1 = 2.22

Vertical oscillation 80 X 3.7 = 2.96 20 X 3.7 = 0.74

Light weight 70 X 14.8 = 10.36 10 X 14.8 = 1.48 20 X 14.8 = 2.96

Adjustable height 100 X 3.7 = 3.70

Airflow capacity 50 X 14.8 = 7.40 50 X 14.8 = 7.40

Quietness 40 X 18.5 = 7.40 60 X 18.5 = 11.10

Compact size 5 X 11.1 =0.56 5 X 11.1 =0.56 30 X 11.1 =3.33 30 X 11.1 =3.33 30 X 11.1 =3.33

Looks nice 50 X 7.4 = 3.70 50 X 7.4 = 3.70

Total contribution percentage 31.64% 13.88% 8.88% 16.65% 21.83% 7.03%

Components

Contribution weight assigned to the component * importance to the customer (exhibit 1)

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Identify components for cost reduction Calculate a value index for each major component

(exhibit 6)

Component cost as a percentage of total cost divided by the component’s relative importance to the customer

Index greater than 1

Disproportionately high cost in relation to its importance

Implies cost reduction should be considered

Do not manage by the numbers alone

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EXHIBIT 6CALCULATION OF VALUE INDICES FOR COMPONENTS

Percent of ContributionComponent Total Cost Percentage Value Action

(Exhibit 3) (Exhibit 5) Index ImpliedMotor 40% 31.64% 1.26 Reduce costTransmission 20% 13.88% 1.44 Reduce costSpeed control 15% 8.88% 1.69 Reduce costBody 10% 16.65% 0.60 ImproveBlade 5% 21.83% 0.23 Improveblade guard 10% 7.03% 1.42 Reduce cost

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Generate cost reduction ideas

Eliminate over-engineering

Eliminate, replace, combine, rearrange

Seek ways to accomplish the goal at less cost

Consider the process as well as the product

More efficient manufacturing processes

Better logistics

Etc.

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Test the ideas

Will they be effective?

Are they technologically feasible?

Is there a domino effect?

Construct a component interaction matrix (exhibit 7)

Do activities interact?

Estimate the achievable costs

Use activity-based costing, cost tables, etc.

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EXHIBIT 7COMPONENT INTERACTION MATRIX

Speed BladeComponent Motor Transmission control Body Blade guard

Motor X XTransmission X XSpeed control XBody X X X XBlade XBlade guard X X

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Make the Decision

Achievetargetcost?

Closeenough?

Release designfor production

Abortproject

Repeatvalueengr.?

Value engineering

Yes

No

Yes

No

No

Yes

Begin

CASE STUDY: Tata Nano

To develop a product for people who want to move from 2 wheeler to 4 wheeler in affordable price.

Car to cost within a price range of Rs 1,00,000.

Car to be developed with low cost, safety, low on emissions and fuel efficient.

To be a truly people’s car.

Car to be developed on three main factors.

Cost

Safety

Regulatory requirement

Product development (Target costing)

Just one wind shield wiper

Just one wind shield wiper

Plastic panel designed to eliminate need of

screws

Plastic panel designed to eliminate need of

screws

Seats with integrated head rest

Seats with integrated head rest

Use of aluminum engines to reduce weight and cost.

Use of aluminum engines to reduce weight and cost.

No radio, No AC, No side mirrors

No radio, No AC, No side mirrors

Material Substitution (i.e. Engineering

Plastics)

Material Substitution (i.e. Engineering

Plastics)

Use of Plastic and adhesive rather than Welding and metal

body.

Use of Plastic and adhesive rather than Welding and metal

body.

target costing

Documents

target market

target costs

target costdetermine

target costvalue engineering

target profitvalue engineering

design of products

development of product

design stagefocus