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12.1 Target Costing Process

2 min readLast Updated on August 9, 2024

Target costing flips traditional pricing on its head. Instead of adding profit to costs, it starts with market price and works backward. This process helps companies design products that meet customer needs while hitting profit goals.

Implementing target costing isn't easy. It requires teamwork across departments, breaking down costs to component levels, and constantly improving designs. But when done right, it can give companies a competitive edge in pricing and profitability.

Target Costing Fundamentals

Market-Driven Pricing and Target Cost

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Top images from around the web for Market-Driven Pricing and Target Cost
  • Market-driven pricing determines product's selling price based on customer preferences and competitor offerings
  • Target cost calculated by subtracting desired profit margin from market-driven price
  • Target cost represents maximum allowable cost to achieve profit goals
  • Focuses on designing products to meet both customer needs and cost constraints
  • Differs from traditional cost-plus pricing by starting with market price and working backwards

Cost Gap Analysis and Value Chain

  • Cost gap measures difference between current estimated cost and target cost
  • Identifies areas for cost reduction to achieve target cost
  • Value chain analysis examines all activities involved in creating and delivering product
  • Breaks down product costs across entire value chain (design, production, marketing, distribution)
  • Helps identify opportunities for cost reduction in each stage of product lifecycle

Examples and Applications

  • Automotive industry uses target costing to design cars within specific price points (economy, luxury)
  • Electronics manufacturers apply target costing to develop competitive smartphones and tablets
  • Retail chains employ target costing to create private label products at desired price points
  • Fast food restaurants use target costing to develop new menu items that meet profit margin goals

Target Costing Implementation

Cross-Functional Teams and Cost Breakdown

  • Cross-functional teams bring together experts from various departments (engineering, manufacturing, finance, marketing)
  • Collaborate to identify cost-saving opportunities and innovative solutions
  • Cost breakdown structure divides total product cost into component and feature levels
  • Assigns target costs to individual parts and processes
  • Enables focused cost reduction efforts on specific areas

Design for Manufacturability and Continuous Improvement

  • Design for manufacturability focuses on creating products that are easy and cost-effective to produce
  • Considers factors like material selection, assembly processes, and component standardization
  • Aims to reduce production costs without sacrificing quality or functionality
  • Continuous improvement involves ongoing efforts to refine processes and reduce costs
  • Kaizen events and value engineering used to identify and implement cost-saving measures
  • Encourages regular review and optimization of product design and manufacturing processes

Implementation Strategies and Challenges

  • Requires strong commitment from top management to support target costing initiatives
  • Necessitates cultural shift towards cost consciousness throughout organization
  • Involves extensive supplier collaboration to achieve cost targets for components and materials
  • May face resistance from traditional cost accounting practices and departmental silos
  • Requires investment in training and tools to support target costing methodologies
  • Balances cost reduction efforts with maintaining product quality and meeting customer expectations
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AP® and SAT® are trademarks registered by the College Board, which is not affiliated with, and does not endorse this website.


© 2025 Fiveable Inc. All rights reserved.
AP® and SAT® are trademarks registered by the College Board, which is not affiliated with, and does not endorse this website.

© 2025 Fiveable Inc. All rights reserved.
AP® and SAT® are trademarks registered by the College Board, which is not affiliated with, and does not endorse this website.
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