Target Costing

Definition :

process for ensuring that a product launched with specified functionality, quality and sales price can be produced at a life-cycle cost that generates satisfactory level of profitability

(Cooper and Slagmurder, 1997).


Toyota determined that before a new product is introduced into the market, it must be able to be produced at a cost that will make it profitable when sold at a price acceptable to customers. The acceptable selling price to the marketplace determines the acceptable cost of producing the product.

Target Costing Encourages Design for Production

In the absence of a target costing approach, design engineers are apt to focus on incorporating leading-edge technology and the maximum number of features in a product. Target costing keeps the customer's function, quality, and price requirements in the forefront at all times. If customers do not want leading-edge technology (which could be expensive and untested) and several product features, they will resist paying for them. Focusing on achieving a target cost keeps design engineers tuned in to the final customer.

Left on their own, design engineers might believe that their job ends when they design a product that meets the customer's functional requirements. The tendency is to simply pass on the design to manufacturing and let manufacturing determine how best to produce the product. Further down the line, if the product needs servicing, it becomes the service department's responsibility to determine how best to service the product. A target costing approach forces design engineers to explicitly consider the costs of manufacturing and servicing a product while it is being designed. This is known as design for manufacture.

Minor changes in design that do not affect the product's functioning can often produce dramatic savings in manufacturing and servicing costs. Examples of design for manufacture include the following:

• Using molded plastic parts to avoid assembling several small parts.

• Designing two parts that must be fit together so that joining them in the correct manner is obvious to assembly workers.
• Placing an access panel in the side of an appliance so service personnel can make repairs quickly.
• Using standard-size parts to reduce inventory requirements, to reduce the possibility of assembly personnel inserting the incorrect part, and to simplify the job of service personnel.
• Ensuring that tolerance requirements for parts that must fit together can be met with available equipment.
• Using manufacturing procedures that are common to other products.

Pros and cons
Prons
Takes proactive approach to cost management.
Orients organization toward customer.
Breaks down barriers between departments.
Enhances employee awareness and empowerment.
Fosters partnerships with suppliers.
Minimizes non-value-added activities.
Encourages selection of lowest-cost value-added activities.
Reduces time to market. Cons

Cons
To be effective, requires the development of detailed cost data.
Requires willingness to cooperate.
Requires many meetings for coordination.