Practice & implementation of Target Costing – Bangladesh Perspective

View with Images & Charts.

“Practice & implementation of Target Costing – Bangladesh Perspective”

Executive Summary

Today fast changing business environment makes urgent necessity of product innovation and strategic management awareness, keys to companies’ competitiveness, long-term strategy implementation and survival. Firms can no longer produce and market huge amounts of standard products with a relatively stable market and technological climate. The business management has to grapple with unstable, rapidly changing markets and technologies in order to run their organizations and be able to sell products. To implement market-driven cost management policies across the organization, measurement and cost control systems must be designed to motivate the desired consumer-oriented behavior. Thus, strategies that determine the direction of product innovation have become more crucial to corporate management today than ever before. In this situation therefore, Target Costing technique has been identified as the system, which will help managers push forward this badly needed strategy. The increasing popularity of the technique as opposed to “cost plus”, has influenced my study in this thesis. Use of the Target Costing technique is high among manufacturers and cost reduction is among their main motive for adopting the technique.

In today’s intensely competitive and highly volatile business environment, consistent development of low cost and high quality products meeting the functionality requirements is a key to a company’s survival. Companies continuously strive to reduce the costs while still producing quality products to stay ahead in the competition. Many companies have turned to target costing to achieve the objective. Target costing is a structured approach to determine the cost at which a proposed product meeting the quality and functionality requirements must be produced in order to generate the desired profits. It subtracts the desired profit margin from the company’s selling price to establish the manufacturing cost of the product.

Target costing is a widely used technique for cost management during product development. Despite target costing strategic intuitiveness, its operational during product development requires careful decomposition of a product’s constituent cost elements. The main objective of this thesis is to describe an experience developing early-stage cost parameters for a specific product development process effort for manufacturing company by proposing and applying a Target Costing technique. One secondary objective is to provide a model to operational “Target Costing technique” by breaking down cost targets into product parts, features and common elements, focusing on creating parameters for cost control during product development.

Target costing is a strategic weapon that is being increasingly adopted by a number of leading firms across the world. Despite a proven record of success, many managers often underestimate the power of target costing as a serious competitive tool. When they read the word “costing,” they naturally assume that it is a topic for their finance or accounting staff. They miss the fact that target costing is really a systematic profit planning process. Rather than the inward orientation of traditional cost methods, Target costing is externally focused taking its cue from the market and customers. It is market-driven costing that develops new products that meet customer price and quality requirements as opposed to cost-driven development of products that are then pushed on to customers in the hope that they will buy the products.

This thesis explains the use of target costing as a strategic profit planning and cost management tool. This will identify its key principles, contrast it with traditional cost management tools, show the critical steps in the process, and demonstrate its functioning in practice.

Chapter 1 provides a review and analysis of the study on target costing and provides a background expression of the study. Define what is the objective of the study is & the methodology used to conduct the survey to prepare the thesis. Define the limitation hindrances to make the thesis are.

Chapter 2 provides a complete literature review of the study on target costing, that covered the following topics- history & background of target costing, principles of target costing that consider as a foundations, process of target costing and process for new product development, characteristics of target costing also advantage & disadvantage of target costing.

Chapter 3 mention the role of target costing in an organization which implies the strategic mean of target costing & need for target costing various Bangladeshi companies. This chapter expresses the target costing approach & various pricing approach and element that influence the target costing technique. This chapter also mentions that how to established target costing various companies & how to attain this technique.

Chapter 4 shows an analysis on the practice & prospect of target costing in Bangladesh, by conducting survey, to various companies & professional accountants. Study data put by appropriate coding into SPSS and derive the findings.

Chapter 5 provides finding of the study that is found from the previous analysis covered various essential issues & recommend the action should take to established the thesis topic- “Practice & implementation of Target Costing – Bangladesh Perspective”

Introductory Section

1.01 Introduction of the Report:-

The most important feature of any company is its ability to stay ahead of the competition. In the midst of a plethora of products and choices for the customer, it becomes increasingly important for any company to make its products better, faster, cheaper and more innovatively. Increasing the efficiency of products has the two aspects of cost and functionality attached to it. An efficient designing technique takes the cost and functionality aspects into consideration during the early stages of product design. Such an approach provides us with the chance to concentrate our design efforts on important features and at the same time reduce the costs incurred on less important features. Target costing is like a planning tool that helps us to identify the features to be improved and helps us in setting targets for designing and cost reduction.

Target Costing is often presented as one of the strategic cost management accounting approaches better suited to strengthen a company’s competitiveness in meeting today’s business challenges. Target Costing is an “open system” which links external and internal factors from the inception. The activities to optimize the key success factors of a product are carried out mainly at the development and design phases, involving a multi-functional team of a company’s participating functions as well as other members of the value-chain, mainly the suppliers. Since Target Costing has begun to be adopted and implemented by business organizations operating in other business environments than its original one, it can be assumed that something new about the approach can be learned by exploring what is happening in other business contexts. Aim of this thesis is to investigate the core components of target costing that’s executed in Bangladesh, how its principles will apply in the firms of Bangladesh for rapid expansion.

1.02 Background of the Report:-

Globalization or Free market economy is now world’s major challenge to every business industry. Recent business world as well as Bangladesh faces highly economic recession, with this situation the present economy of Bangladesh demands immediate development of business technique, tools and proper decision making policy. This report has been prepared in the light of emerging management accounting technique “Practice & implementation of Target Costing – Bangladesh Perspective” as a part of the fulfillment of thesis program required for the completion of the BBA program Major in Accounting under the Faculty of Business Administration of Stamford University Bangladesh.

This thesis report is a mandatory requirement of my BBA program, and prepared by supervision of thesis supervisor. The report was prepared under the supervision of Asif Mahbub Karim, Assistant Professor, Faculty of Business Administration, Stamford University of Bangladesh. The thesis supervisor authorized me to submit the report of “Practice & implementation of Target Costing – Bangladesh Perspective”

1.03 Objective of the Study:-

With aim of completion the BBA program, the objective of this study is dividing in two categories- General Objective & Specific Objective. The General objective of the report is to express the gather knowledge by conducting study about Target Costing, also this management accounting techniques functional activities & performance in various industries in Bangladesh.

The Specific objective of this thesis is: –

To understanding the meaning and importance of target costing. To understand how target costing can be applied in an organization. To know how to manage the target costs. To know the factors that influence target cost and its merits and drawbacks.

To investigate and assess how target costing can be used as an efficient cost management tool for managers and as such be an effective planning strategy in this changing business world and Bangladesh, it has been observed that more than 80% of major manufacturing of world business as well as of other levels of production have used target costing.

To diagnose the core concept of target costing and, attempt to provide some understanding that might explain the degree of reliability of the system. Some of the shortcomings of the system will be identified and how they can be overcome.

To investigate that Target costing is being used by various firms as a strategic cost management method, if so, the intensity of its application and the prospect in Bangladesh.

1.04 Scope of the Study:-

Investigative study method is used in writing this report. This study method was significant for me because before this study I have not enough understanding to proceed with such type of research project also on this topic.

This study is characterized by flexibility and resourcefulness with respect to the methods, formal research method employed by investigating various business industries in Bangladesh and obtaining information by asking question to qualified personnel.

The study involves structured questionnaire, large sample and probability sampling plans. Under the study once a new idea or insight is discovered, they may shift their exploration in that direction. Observation method is used to complete this qualitative research.

Finally the purpose of this study is to determine whether target costing is used by the Bangladeshi manufacturing companies and whether those companies using the technique apply the principles of the target costing application process in their customer expectation, profit margin, cost and price determination, cost reduction and management operations.

1.05 Methodology of the Study:-

In order to make the Report more meaningful and presentable, two sources of data and information have been used widely- Primary Data & Secondary Data. Both primary and secondary data sources were used to generate the report.

Primary Data Sources Secondary Data Sources
Conversation with the accounting professional Published article and manuals on Target Costing
Observing various organizational procedures Periodicals published by ICAB & ICMAB
Relevant field study as supervisor concerned Various books, articles, compilations etc.
Information through interviews with respective personnel From newspapers and internet

Table 1:- Methodology of the Study

To successfully finish the project certain methodology has been followed to cover the followings: –

o The Preparation of the Survey structure & Selection of the Sample

o The Data Gathering Technique

The Preparation of the Survey structure & Selection of the Sample size

The data used in the study consist of the information gathered via the survey applied to the various department executives from the companies selected and the qualified personnel by the simple casual method. In my study, the default sample size was 20. In the case of control and random designs, I used 10 cases control for the user of TC & 10 for random, whose hypothesis were then estimated.

The Data Gathering Technique

Considering the relevant literature and study about the topic subject in the direction of the purpose and scope of the study, the questionnaire form is formed in three sections.

The first section consists of personal information of the respondents such as names, titles and positions.

The second section of the questionnaire consists of questions regarding general information about the company such as industry; manufacturing method and the personnel questions aimed at detection of the level of current applications in terms of the basic principles and applications of target costing.

The third section is discussed in this study consists of questions related to the analysis of the companies which use target costing or a similar application in Bangladesh, in terms of the benefits those companies obtain and the factors affecting the success of target costing. SPSS-11.5 (Statistical Package for Social Sciences) was used for the analysis of data obtained from the questionnaire.

1.06 Limitation of the Study:-

On the way of my study, I have faced some problems that termed as the limitations of the study. In all respect following limitation and weakness remain within which I failed to escape by any means. These are follows:

Budgeted time limitation: – It was one of the main constraints that hindered to cover all aspects of the study.

Confidentiality of data: – Because of some divisional and confidential problem, I could not get enough information. Every organization has their own secrecy that is not revealed to others. While collecting data some company personnel did not disclose enough information for the sake of confidentiality of the organization.

Data Insufficiency: – Especially there is a lack of information about the determination of the companies applying target costing method and the level of target costing applications in these companies. Sufficient books, publications, fact and figure are not available. These constrains narrowed the scope of accurate analysis. If these limitations had not been there, the report would have been more useful and attractive.

Literature Survey

2.01 Introduction: –

The literature about target costing deals more with the concepts of target costing than with its practical application. Literature describes the concept of target costing and various techniques used in target costing.

The definitions of target costing are many, but they all focus on the same point of cost reduction. However, definitions vary in the scope of cost reduction. Some definitions take the overall product life cycle into consideration while some consider particular functions or just product development, along with some important definitions of target costing are mentioned as follows:

Target costing is a set of management methods and tools used to drive the cost and activity goals in design and planning for new products, to supply a basis for control in the subsequent operations phase, and to ensure that those products reach given life cycle profitability targets.

Target costing has been defined in by listing all stages of product life cycle, while Cooper and Slagmulder defined target costing in Target Costing and Value Engineering by placing emphasis on the aspects of cost, quality and functionality as follows:

Target costing is a structured approach to determine the life cycle cost at which a proposed product with specified functionality and quality must be produced to generate the desired level of profitability over its life cycle when sold at its anticipated selling price.

Different aspects of target costing including those of interest to management are detailed in. The following are the key messages sent by target costing according to:

1. Target costing takes place within the strategic planning and product development cycles of a firm. Product design goes through this development cycle in a recursive, rather than in a linear fashion.

2. The first phase of target costing is the establishment phase. The focus here is on defining a product concept and setting allowable cost targets for a product or a family of products.

3. The second phase of target costing is the attainment phase. This phase transforms the allowable target costs into achievable target costs.

4. The establishment and attainment phases of target costing occur at different points in the product development cycle. Different organizational processes play primary and secondary roles in these two phases.

5. Many other business processes support target costing, and the success of target costing depends on these other processes being performed effectively within an organization.

The literature review of target costing shows us that the concept of target costing and the tools used for its implementation are described in detail. Several companies where target costing is used are mentioned, but specific details about product designing and cost reduction are not available in literature review. The later chapter will explains target costing and discusses the issues of implementation.

2.02 History of Target Costing:-

Target costing originated in Japan in the 1960s. As it did with quality, Japanese industry took a simple American idea called value engineering and transformed it into a dynamic cost reduction and profit-planning system. Value engineering originated at General Electric during World War II. It was an organized engineering approach to determining how to produce products in the face of parts’ shortages. The practice instituted to design products that could do more with fewer parts. Later it became an organized effort to examine how to provide the needed features or functions in a product at the lowest possible cost. Japanese industry expanded the basic concepts of value engineering into the target-costing process. Today more than 80 percent of all assembly industries in Japan, such as automobiles, electronics, consumer appliances, and machine tools and dyes, use target costing. Naturally, some of the best practitioners of target costing are leading Japanese companies such as Toyota, Nissan, Sony, Nippon Denso, Daihatsu, Cannon, NEC, Olympus, and many others.

In the United States, target costing has been used only since the late 1980s. The loss of market share to Japanese companies, as in Chrysler’s case, has been a major motivation for adopting target costing. Adoption of target costing in the United States remains slow for several reasons, some managers fail to appreciate its strategic importance. Others mistake it for a narrow cost reduction technique and confuse the simplicity of its ideas for a simplistic process. Still others country like Bangladesh use some elements of target costing but mistakenly think the have adopted the entire process.

2.03 Definition of Target Costing

Target costing concept is very straightforward. It is based on the logic that a company should manufacture the products that yield the desired profit. If the product is not yielding the desired amount of profit, the design of the product should be changed to obtain the desired profit or the product should be abandoned. A comprehensive definition of target costing as given in mentioned below:

The target costing process is a system of profit planning and cost management that is price led, customer focused, design centered, and cross functional. Target costing initiates cost management at the earliest stages of product development and apply it through out the product life cycle by actively involving the entire value chain.

To provide an exact definition of target costing is difficult because the Japanese companies where the system had been greatly used as a cost strategy vary and each one has its own unique approach to defining it.

Common to most definitions is a process founded on a competitive market environment whereby market prices drive cost and investment decisions, cost planning, management and reduction occurring early in the design and development process, and cross-functional team involvement.

2.04 Development of Target Costing from Traditional Cost plus Method

Traditionally, manufacturers would make use of the “cost-plus” approach to estimate the product price. This is done by first conducting market research to determine its market segment’s preferences and hence its product’s characteristics that will meet the consumer’s needs. This is followed by the design of the product and subsequently the manufacturing process is determined. Vendors will then be contacted to identify the total costs of the components as required by the design and engineering departments. Finally, cost components are added up and a selling price is set based on the costs. If management and the marketing department think that the price and cost are too high, the product design and engineering process will be repeated until a suitable cost is attained, after which, production will begin. This is known as “cost plus” method.

Conversely, target costing derives an “allowable” product cost by first carrying out market research to predict what the market division is willing to pay for the required product with definite features. Subtracting the desired profit margin set by the management from the predicted selling price derives an implied maximum per-unit target cost. This target cost is then compared to an expected product cost and if it is higher than the expected product cost, the company has several options. One is to lower costs; the product design and/or the engineering process can be changed. All the members of the planning team will engage in this process. They have the task of investigating the need for cost adjustment for each component. These members will work hand in hand, instead of going through various departments sequentially to reduce cost. When the target cost is reached, standards can be set and the product will then enter the manufacturing phase. The other option might be that, the organization may consider accepting a less-than-desired profit margin. This will depend on the numerical difference between expected cost and target cost. If the target cost is slightly highly than expected cost, a slightly lower profit margin will be sufficient. However, if the difference is too great and there is no way for the company to earn the profit margin that it desires, its third alternative would be to abandon that particular product.

The use of target costing forces managers to change their way of thinking concerning the relationship between cost, selling price, and profitability. The traditional mindset has been that a product is developed, production cost is identified and measured, a selling price is set, and either profits or losses will result. However, in target costing, a product is developed, a selling price and desired profit are determined, and maximum allowable costs are derived. This makes costs dependent on selling prices instead of selling prices dependent on costs. As a result, the incurrence of all costs must be justified which leads to the elimination of unnecessary costs without compromising the product quality.

2.05 Management Accounting and Target Costing

Traditionally management accountants have been functional experts who do not have much contact with their marketing and production counterparts. They see their role as providing financial data, measuring performance after the fact, and auditing resource usage. Target costing requires a change in the traditional role of management accountants and the type of information they provide.

Role of Management Accountants

Target costing systems require management accountants to have early involvement with a product and to learn to function as cross-functional team members.

Early involvement means starting when the product is still in the concept stage, and staying with it for the rest of the development cycle. A management accountant needs to provide good cost estimates for each design iteration. They must look ahead and information about product costs from incomplete design data. It is not helpful to wait until must be more the product specifications are final. Further, each successive cost estimate must be more accurate as the design moves from concept to release for manufacturing. The focus is on estimation and not on actual costs.

As a cross-functional team member, a management accountant must help other team embers from engineering and marketing to do their jobs. For example, engineers need to know the financial implications of their value engineering ideas. For example, design engineers need to know what cost savings will result from the redesign of the heating element. Similarly, marketing must know what the company cans afford to spend on a feature so they do not promise customers something that a company cannot deliver.

2.06 Principles of target Costing:-

Achieving target costs requires a formal process. Target costing is a system of profit planning and cost management is price led, customer focused, and design centered and cross functional. Target costing initiates cost management at the earliest stages of product development and apply it throughout the product life cycle by actively involving the entire value chain. The purpose of target costing is to ensure adequate profits by undertaking simultaneous profit and cost planning.

There are six major principles that provide the conceptual foundations for target costing. In order to reduce costs once a product reaches production is very difficult. Therefore, focusing on costs during the early design stages to ensure that the target profit and cost can be realized is critical. That means product designs, material choices, specifications and tolerances, buy versus make decisions, process designs and investment decisions need to be thought through before product design and development decisions are finalized. The foundation of target costing therefore will look as follows.

¯ Price led costing: By this principle, target-costing system sets cost targets by subtracting the required profits margin from the competitive market price.

Price led costing means that first determining a competitive market price and then subtracting the required profit margin from it establish a target costs. This is summarized in the equation:



C = Target cost

P = Competitive market price

R = Target profit

In target costing, market price is the independent variable; costs allowed for designing, manufacturing, marketing, and other functions (the target costs) are dependent on the market price. For example, if the competitive price for a product is 100, and the company requires a 15 percent profit margin, then the target cost for this product is set at 85.

¯ Customer focus: This focuses on customer requirements for quality, cost, and times, which are simultaneously incorporated in product and process decisions and guide cost analysis. The value (to the customer) of any features and functionality built into the product must be greater than the cost of providing those features and functionality.

It is essential to understand what quality features and timeliness customers expect at a given market price and what competition is currently doing or might do to respond to a company’s product offerings. The target cost must not only yield the target profit but also allow the manufacturer to match competitive product dimensions. The target cost cannot be attained by sacrificing the features that customers want, lowering the performance or reliability of the product, or delaying its introduction in the marketplace.

¯ Focus on design process: Design of product and processes is the key to cost reduction efforts. Target cost systems design products and their manufacturing and delivery processes simultaneously. This is sometimes called concurrent engineering. Traditional cost reduction methods focus on production efficiencies such as waste reduction or buying in quantity to reduce cost. This is not the prime focus of target costing. Target costing focuses on product design because most costs, nearly 70-80 percent, are committed at the design stage, while only 10-20 percent of the costs are incurred at this stage.

¯ Cross-functional teams: This relates to the facts that cross-functional team of producers and products and, members of the organization are responsible for the whole process from inception, testing to finish. Cross-functional team here refers to the interaction of the various departments, for example, the financial analyst who projects demand for supplies and sales, and interacts with designers to agree on a conclusive target cost.

Cross-functional product teams with members representing design and manufacturing engineering, sales and marketing, material procurement, cost accounting, service, and support typically are jointly responsible for attaining target costs. The teams also include outside participants such as suppliers, customers, dealers, and recyclers. The teams are responsible for a product from initial concept through production. A cross-functional team is not q set of specialists who contribute their expertise and leave. They are responsible for the entire product.

¯ Life cycle cost reduction: Total life cycle cost is minimized for both producers and customers. Life cycle costing considers all costs of owning a product over its life, such as purchase price, operating costs, maintenance and repairs, and disposition costs. Life cycle costing goal is to minimize the cost of ownership to a customer. Most products today are required to have a shorter life cycle in order to remain competitive.

¯ Value chain involvement: This refers to the involvement of all the members of the value chain. All members in the supply, distribution, service providers and customers are included in the target costing process. Target costing systems involve an active and collaborative relationship in which cost-reduction techniques are shared by all members of this extended enterprise. A target costing system is based on long term, mutually beneficial relationships with suppliers and other members of the value chain such as distributors and recyclers. The value chain Integration (VCI) enables a coordinated, collective approach to resolving industry-level issues. VCI also facilitates opportunities between member companies to define a balanced set of supplier priorities, develop industry-unique solutions, and improve communications throughout the supply chain.

2.07 Target Costing Process:-

Target costing process consists of two phases known as establishment phase and implementation phase. The establishment phase defines goals for product concepts based on strategic plans and the implementation phase achieves the set goals.

The process of target costing for product design can be described in the following steps:

1. Consider strategic and financial goals: Top management sets long-term goals for the complete corporation and every product should be designed to help the company to achieve these goals.

2. Determine the customer attributes or demands: This process involves conducting thorough market analysis and customer surveys to determine what the customer’s needs and demands are for a given product.

3. Consider costs and processes while designing: This step must result in the design specification of the product. The major tools used to obtain the design specification of a product are (a) Pugh Method and (b) QFD.

4. Determine the target price: Target price is the price a customer is willing to pay for the new product. Thorough market analysis must be conducted to determine the target price.

5. Determine the target cost: Target cost, also known as the allowable manufacturing cost, is calculated by subtracting the profit required (ROS can be used to determine the profit required from the new product) from the target price.

Target Cost = Target Price – Desired Profit

6. Determine the drifting cost and product feasibility: Drifting cost, also known as the actual cost of manufacturing is the present cost of manufacturing the new product and this is calculated with the help of the engineering department. It is also analyze to see if all the desired functions can be provided in the new product.

7. Process Improvements: If the designed product yields the required profit, the new product can be manufactured. If the new product does not yield the required profit, the product needs to be re-designed or the process of manufacturing should be improved to yield the required profit. The components or functions that are cost inefficient should be re- designed to reduce costs. If the products are found not to meet the financial profit requirements, they should be abandoned.

8. Implementing / evaluating long term effects: It is essential to make sure that the new product will yield the required profits through its complete life and the product mix must be regularly adjusted to meet the strategic goals of the company.

2.08 Target Costing Process for New Product Development:-

Since target costing relies on design for cost reduction, it is applied primarily to new product development efforts. Most products are developed in four stages:-

¯ Product planning, during which a product and customer niche is defined.

¯ Concept development and feasibility testing, during which a product concept is developed and its feasibility is tested.

¯ Design development, during which a feasible concept is turned into a detailed product design.

¯ Production, which occurs after a final design is released.

Target costing occurs in two phases that correspond roughly to the first and second halves of this product development cycle. They called the establishment phase and the attainment phase of target costing. The establishment phase occurs during the product planning and concept development stages of the product development cycle and involves establishing a target cost. The attainment phase occurs during the design development and production stages of the cycle and involves achieving a target cost. The relationship of target costing to the product development cycle is shown in Exhibit –

Table 2: – Target Costing & Product development Cycle

Target costing involve in product development process that can be described as a continuous cycle divided into four phases:-

¯ Product planning

¯ Basic design

¯ Detailed design and

¯ Process design

Taken as a whole the four phases involve the determination of a target cost with the cycle being repeated in order to ensure attainment of the target cost.

1. In the product-planning phase, rough blue prints are drawn up based on a rough concept of the product under consideration. These blue prints are based on the product’s expected performance, size, weight, shape, color and a rough estimate of the target cost is made. This phase also assists in determining the new product’s lead-time as well as helps plan the expected operational activities that will be needed.

2. In the basic design phase additional basic plans for the product are prepared, including design ideas and potential cost reductions that can be achieved in due course.

3. The above stage 2 sets the basis for the creation of the components of the product at the detailed design phase. Blueprints for each component part are drawn up and comparisons made with the design of production, which is important for achieving cost reductions.

4. In the fourth phase of process design, blueprints are constructed for assembly of the components into the final product. The cycle is effectively repeated and any refinements necessary are made at each phase in order to move closer towards the attainment of the target cost.

2.09 Characteristics of Target Costing:-

There are seven typical characteristics for target costing. These conditions are:

The target sales price is set during product planning, in a market-oriented wayThe target profit margin is determined during product planning, based on the strategic profit plan

The target cost is set before the new product development (NPD) process really starts

The target cost is subdivided (into target costs for components, functions, and cost items)

Detailed cost information is provided during NPD to support cost reduction

The cost level of future product is compared with its target cost at different points during NPD

A general rule is aimed for that “the target cost can never be exceeded”

The Target Sales Price is set during Product planning, in a Market- Oriented Way

Establishing the target sales price is the starting point in the target costing process. This implies that the target sales price is decided during product planning, when the characteristics of the future product are determined. The target sales price is set realistic in companies using target costing, and that the process of setting the target price is taken very thoroughly at most firms. The sales price of existing products or the price level of competitor’s offerings typically provides an initial starting point for firms using target costing.

The Target Profit Margin is determined during Product planning, based on the Strategic Profit Plan

The second characteristic of a target costing system is the early establishment of the target profit margin during the product planning of the future product. Corporate strategic profit planning should drive the target profit margin for a particular future product. Total target profit for a future product should be derived from the medium-term profit plans, reflecting management and business strategies over a period of three to five years. These target profits should then be decomposed into target profits for each product over its expected life cycle. With the estimation of the future sales volumes, the target profit for a future product can be converted to a target profit margin. The procedures to compute target profits should be scientific, rational and agreed, otherwise nobody will accept the responsibility for achieving the target profit.

Target costing assumes that the target profit margin is set for each new product during the product planning, i.e. before NPD really starts, to ensure the achievement of the firm’s long-term profit plan. That’s why some authors refer to target costing as a technique for profit management.

The Target Cost is set before NPD really starts

The third and most well-known characteristic of the target costing process is that the target cost is set early in the new product development process, before design and developing really starts. The decision on the appropriate level of the target cost for the new product to be developed involves a number of calculations. First, the ongoing cost is calculated and then the as-if cost is estimated. Third, the allowable cost is determined and finally the target cost is set between the allowable cost and the as-if cost.

The target cost can also be determined by what is called the adding-up or bottom-up method. Here, setting the target cost starts within the NPD department itself. For each subassembly or component the cost is estimated, based on the actual cost of current parts. A cost reduction on each part of the new product is taken into account to get the target for each component of the new product. The total target cost is then obtained by adding up all target costs of the individual parts or subassemblies.

Determining the level of the final target cost is an important issue. If the target cost is set consistently too low, the work force will be subjected to excessive cost reduction objectives, risking burnout. The discipline of target costing might then be lost, as target costs will frequently be exceeded. On the other hand, if the target cost is set at a level that is too easy to achieve, the firm will loose competitiveness because new products will have excessively high cost levels. Once the target cost is set, filling the gap between the as-if cost and the target cost is then the major focus for design engineers.

The Target Cost is subdivided into Target Costs for Components, Functions, Cost Items or Designers

For target costing to work, the target cost for the future product needs to be decomposed in order to have specific targets for designers internally and subcontractors externally. This is the fourth typical characteristic of target costing. Decomposing the target cost to target costs for subassemblies is a difficult issue, since it indirectly determines the necessary cost reduction objectives for the different design teams.

Depending on the complexity of the future product, the global target cost should be decomposed into target costs for functions, components, cost items and even for individual designers.

Detailed Cost Information is provided to support Cost Reduction

The fifth typical characteristic of the target costing process is the provision of detailed cost information. To see the impact of their design decisions on cost and to monitor the progress towards the cost reduction objective, design engineers need to estimate the cost of the future product during design and development. Information systems such as the target costing support system must provide cost information anytime the designers require it, and not only at the so called milestones in the NPD process. One essential condition for target costing to work is the provision of detailed cost information during the design and development of a future product.

The Cost Level of the Future Product is compared with its Target Cost at Different Points during NPD

The sixth characteristic of target costing involves the comparison of the estimated cost level of the future product with its target cost at different points during NPD. The progress towards the target cost is essential in target costing. Therefore the cost level of the future product needs to be compared to the target cost, either formally at different points, either continuously during new product development.

Aim for the General Rule that “The Target Cost can never be exceeded”

The seventh and last characteristic of target costing involves the policy not to exceed the target cost. Without the strict application of such a rule, the cardinal rule, target costing typically lose its effectiveness. The general rule that the target cost can never be increased requires a strong commitment of managers and design engineers to attain the target cost.

The general rule that the target cost can never be increased has three consequences. First, whenever costs increase somewhere in the product during NPD, costs has to be reduced elsewhere by an equivalent amount. Second, launching a product with a cost above the target is not allowed; only profitable products are launched. Third, the transition to manufacturing is managed carefully to ensure that the target cost is indeed achieved.

2.10 Advantages of Target Costing

The process of target costing creates a team based, proactive atmosphere, where representatives from different departments get together to make decisions. This leads to a reduction in the information gap between different departments and makes the departments more responsive as they realize the importance of their activities. The major advantages of target costing as mentioned in are listed below:-

o Target costing provide management methods and analytical techniques for developing products and services whose costs support strategic objectives for market position and profit.

o Product costs defined from the customer’s viewpoint; they will include functionality, cost of ownership and manner of delivery.

o Target costing is a critical component of product development teams and concurrent engineering.

o Target costing incorporate as wide a range of costs and life cycle phases for the product or service as can be logically assigned and organizationally managed.

o Target costing provide analytical techniques to indicate where cost reduction efforts on parts and processes will have most impact, and where commonality and simplification can be increased.

o The quality of cost data will be consistent with the responsiveness and level of detail required at various development phases: The system will use the logic and benefits of activity-based costing.

o The achievement of market-driven product attributes will be protected from cost reduction ambitions.

o Targets for product cost will be set for various life cycle phases in development and production.

o Target costing will aim for appropriate simplicity, relevance and ease of use by product development teams; it avoids unnecessary complexity of language and time consumption in cost assessments.

If a company successful in implementing and maintaining an effective target costing system, the company may be able to get the following advantages:-

¯ Determine an expected cost of manufacturing a product or providing a service

¯ Achieve greater cost efficiencies

¯ Spend money where it will have the greatest impact

¯ Identify customers’ real needs

¯ Match firm’s activities to customers’ requirements

¯ Increase customer satisfaction

¯ Give co-workers a better understanding of cost objectives

¯ Allow co-workers to participate in setting quality, cost and time targets

¯ Become more competitive globally

¯ Another significant advantage of target costing is its inherent flexibility

¯ Proactive approach to cost management

¯ Orients organizations towards customers

¯ Breaks down barriers between departments

¯ Implementation enhances employee awareness and empowerment

¯ Foster partnerships with suppliers

¯ Minimize non value-added activities

¯ Encourages selection of lowest cost value added activities

¯ Reduced time to market

2.11 Disadvantages of Target Costing

Target costing do have its bad points just like any other technique. One of the disadvantages of target costing is the possible misuse of the technique. Producers might make use of cost-based target costing to squeeze the profit margins of suppliers, thereby getting materials at the lowest cost possible. This over-emphasis on cost cuts often-blind producer to the real essence of target costing.

The second disadvantage is the stress on the design team of companies using target costing. As the technique place great emphasis on keeping cost below the target cost, design teams might feel all the burden on their shoulders as they will determine whether the product will eventually make it to the market or not.

The last disadvantage is to the company. Product development time might be lengthening as product is repeatedly designed to bring cost below that of target. This is the value engineering stage. This stage could drag for a long time as the design team meets difficulty in meeting cost target.

In shortly, Target costing approach has the following main disadvantages or limitations:-

¯ Effective implementation and use requires the development of detailed cost data

¯ Its implementation requires willingness to cooperate

¯ Requires many meetings for coordination

¯ May reduce the quality of products due to the use of cheep components which may be of inferior quality

The Role of Target Costing in a Company

3.01 Strategic Implications of Target Costing:-

A target cost is the allowable amount of cost that can be incurred on a product and still earn the required profit from that product. It is market driven costing. This thesis shows how a target costing process when well executed, can improve a firm’s competitive position by improving quality, reducing costs, and accelerating the time to market.

¯ Quality: – Target costing improves product quality by making it an explicit objective of the product development and costing processes. Cost targets cannot be achieved by compromising the features that a customer desires or by reducing the performance or reliability of a product.

¯ Cost: – Reducing costs is at the heart of target costing. Unlike traditional methods, however, target costing does not wait for production to start before managing costs. It makes cost planning a part of profit planning and uses an intelligent, customer-focused design process to manage costs before they incurred.

¯ Time: – Target costing reduces the time from concept to marketing of products because products and processes are designed simultaneously. No time is lost in trying to determine how to manufacture a product after it designed or in correcting design errors.

3.02 Need for Target Costing: –

What makes target costing so important today? The answer lies in the nature of the recent industrial competitive environment. Today businesses face a global environment that has following four characteristics: –

¯ Competitive: – Because prices cannot be increased in many key industries. Many new producers, some with a lower cost of doing business, have entered the global market place.

¯ Rapidly changing: – Because the dissemination of technology and knowledge has accelerated considerably. This faster pace makes it difficult to use any one factor, such as quality, for a long-lasting competitive advantage.

¯ Unforgiving of mistakes or delays: – Since shorter product lives leave little time to respond to changes in the marketplace or to recover from mistakes.

¯ Demanding: – Because sophisticated consumers have knowledge of many products and want better quality products at an affordable price. It is difficult to sell inferior products with reduced features at a lower price.

3.03 Target Costing Approach:-

As a totally new product and its industry develop, it starts to compete based on its new technology, concept. Competitors emerge and the basis for competition evolves to other areas such as cycle time, quality, or reliability. As an industry becomes mature, the basis of competition typically moves to price. Profit margins shrink. Companies begin focusing on cost reduction. However, the cost structure for existing products is largely locked in and cost reduction activities have limited impact. As companies begins to realize that the majority of a product’s costs are committed based on decisions made during the development of a product, the focus shifts to actions that can be taken during the product development phase.

The following ten steps are required to install a comprehensive target costing approach within an organization.

1. Re-orient culture and attitudes: – The first and most challenging step is re-orient thinking toward market-driven pricing and prioritized customer needs rather than just technical requirements as a basis for product development. This is a fundamental change from the attitude in most organizations where cost is the result of the design rather than the influencer of the design and that pricing is derived from building up a estimate of the cost of manufacturing a product.

2. Establish a market-driven target price: – A target price needs to be established based upon market factors such as the company position in the market place (market share), business and market penetration strategy, competition and competitive price response, targeted market niche or price point, and elasticity of demand. If the company is responding to a request for proposal/quotation, the target price is based on analysis of the price to win considering customer affordability and competitive analysis.

3. Determine the target cost: – Once the target price is established, a worksheet (see example below) is used to calculate the target cost by subtracting the standard profit margin, warranty reserves, and any uncontrollable corporate allocations. If a bid includes non-recurring development costs, these are also subtracted. The target cost is allocated down to lower level assemblies of subsystems in a manner consistent with the structure of teams or individual designer responsibilities.

4. Balance target cost with requirements: – Before the target cost is finalized, it must be considered in conjunction with product requirements. The greatest opportunity to control a product’s costs is through proper setting of requirements or specifications. This requires a careful understanding of the voice of the customer, use of conjoint analysis to understand the value that customers place on particular product capabilities, and use of techniques such as quality function deployment to help make these tradeoffs among various product requirements including target cost.

5. Establish a target costing process and a team-based organization: – A well-defined process is required that integrates activities and tasks to support target costing. This process needs to be based on early and proactive consideration of target costs and incorporate tools and methodologies described subsequently. Further, a team-based organization is required that integrates essential disciplines such as marketing, engineering, manufacturing, purchasing, and finance. Responsibilities to support target costing need to be clearly defined.

6. Brainstorm and analyze alternatives: – The second most significant opportunity to achieve cost reduction is through consideration of multiple concept and design alternatives for both the product and its manufacturing and support processes at each stage of the development cycle. These opportunities can be achieved when there is out-of-the-box or creative consideration of alternatives coupled with structured analysis and decision-making methods.

7. Establish product cost models to support decision-making: – Product cost models and cost tables provide the tools to evaluate the implications of concept and design alternatives. In the early stages of development, these models are based on parametric estimating or analogy techniques. Further on in the development cycle as the product and process become more defined, these models are based on industrial engineering or bottom-up estimating techniques. The models need to be comprehensive to address all of the proposed materials, fabrication processes, and assembly process and need to be validated to insure reasonable accuracy. A target cost worksheet can be used to capture the various elements of product cost, compare alternatives, as well as track changing estimates against target cost over the development cycle.

8. Use tools to reduce costs: – Use of tools and methodologies related to design for manufacturability and assembly, design for inspection and test, modularity and part standardization, and value analysis or function analysis. These methodologies will consist of guidelines, databases, training, procedures, and supporting analytic tools.

9. Reduce indirect cost application: – Since a significant portion of a product’s costs (typically 30-50%) are indirect, these costs must also be addressed. The enterprise must examine these costs, re-engineer indirect business processes, and minimize non-value-added costs. But in addition to these steps, development personnel generally lack an understanding of the relationship of these costs to the product and process design decisions that they make. Use of activity-based costing and an understanding of the organization’s cost drivers can provide a basis for understanding how design decisions impact indirect costs and, as a result, allow their avoidance.

10. Measure results and maintain management focus: – Current estimated costs need to be tracked against target cost throughout development and the rate of closure monitored. Management needs to focus attention of target cost achievement during design reviews and phase-gate reviews to communicate the importance of target costing to the organization.

3.04 Target Costing Approach to Pricing:-

In traditional costing system it is presumed that a product has already been developed, has been costed, and is ready to be marketed as soon as a price is set. In