Target Costing

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 on
new products.

Target cost is the cost of resources that should be

consumed to create a product that can be
sold at a target price.
 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.
 Four components of target costing process
(1) Planning and market analysis
(2) Development
(3) Production design
(4) Production and continuous improvement.
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 HLL’s top-of-the-line product, a system
with very good processer. Provalue is a less powerful chip-based machine. The
HLL currently produces 1,50,000 units of Provalue. The per unit sale price of
Provalue is Rs 10,000. The full cost of Provalue is Rs 1,35,00,00,000 consisting
of manufacturing 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 Provalue’s extra
features such as special audio features and designs that accommodate
upgrades that can make the PC run faster and perform calculations more
quickly. They want HLL to redesign Provalue into a no-frills PC and sell it at a
much lower price. The HLL is, accordingly, planning design modification for
Provalue.
Step 2: Choose a Target Price
The HLL expects its competitors to lower the price of PCs that compete against
Provalue by 15 per cent. The management of HLL wants to respond
aggressively by reducing Provalue’s 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 annual sales from 1,50,000 to 2,00,000 units.
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 sales
revenues.
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 per
unit
Target cost per unit = Target price per unit – Target operating income per unit =
Rs 8,000 – 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
9,000 per unit
The target cost value of Provalue of Rs 7,200 is well below its existing Rs 9,000
unit cost. The HLL’s goal is to reduce its unit cost by Rs 1,800. The cost reduction
efforts should be extended to all parts of the chain value – from R&D to customer
service 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
business functions with the objective of reducing costs while satisfying customer
needs. It can result in improvements in product design, changes in materials
specifications and modification in process methods.