TARGET

COSTING

By:
SHRINJAN KHOSLA (4488)
PRACHI KHANEJA (4490)
ANKUR JAIN (4501)
AADHAR AGGARWAL (4506)
 ACKNOWLEDGEMENT

We express our sincere gratitude to Mr. H.K. Porwal whose mere

presence provided immense support and without whose cooperation the
present work would not have been possible. He laid down such a strong
base of cost accounting that helped us in the completion of this project.

He always kept us on our toes and was a source of inspiration all

through.

We are thankful to him for his continued guidance and invaluable

encouragement in the making of this project.

Thank you.

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 TABLE OF CONTENTS
TABLE OF CONTENTS.....................................................................................................3
OBJECTIVES......................................................................................................................4
To understand the meaning and importance of target costing.............................................4
To understand how target costing can be applied in an organization..................................4
To know how to manage the target costs.............................................................................4
INTRODUCTION...............................................................................................................5
TARGET COSTING CHARACTERISTICS......................................................................8
TARGET COSTING PROCESS.......................................................................................13
ACHIEVING TARGET COSTS........................................................................................16
TARGET COST MANAGEMENT...................................................................................25
TARGET COSTING TO IMPROVE BOTTOM-LINE....................................................30
FACTORS INFLUENCING TARGET COSTING...........................................................34
EVALUATION OF TARGET COSTING..........................................................................36
CONCLUSION..................................................................................................................42
BIBLIOGRAPHY..............................................................................................................43

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 OBJECTIVES

 To understand 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 which influence target cost and its

merits and drawbacks.

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 INTRODUCTION
Target Costing is a simple, straightforward process that can have significant
impact on the health and profitability of many, if not most, businesses. It doesn't
require an army of specialists, large-scale software implementations, or complex
management structures and procedures. It's mostly logical, disciplined common
sense that can be imbedded into a company's existing procedures and
processes.

Target Costing is appliedto a wide range of products, processes and procedures

in a large manufacturing company. Target Costing helps to:

• assure that products are better matched to their customer's needs.

• align the costs of features with customers’ willingness to pay for them.
• reduce the development cycle of a product.
• reduce the costs of products significantly.
• increase the teamwork among all internal organizations associated with
conceiving, marketing, planning, developing, manufacturing, selling,
distributing and installing a product.
• engage customers and suppliers to design the right product and to more
effectively integrate the entire supply chain.

Target Costing has been shown to consistently reduce product costs by up to 20-
40%, depending on the product and market circumstances.

What is Target Costing?

Working definition is as follows:

“Target Costing is a disciplined process for determining and realizing a

total cost at which a proposed product with specified functionality must be
produced to generate the desired profitability at its anticipated selling price
in the future.”

Target Costing is a disciplined process that uses data and information in a logical
series of steps to determine and achieve a target cost for the product. In
addition, the price and cost are for specified product functionality, which is
determined from understanding the needs of the customer and the willingness of
the customer to pay for each function.

Another interesting aspect of Target Costing is its inherent recognition that there
are important variables in the process that are essentially beyond the control of

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the design group or even the company. For example, the selling price is
determined by the marketplace -- the global collection of customers, competitors
and the general economic conditions at the time the product is being sold. The
desired profit is another variable that is beyond the control of the design
organization. It may be set at the corporate level. It is influenced by the
expectation of the stockholders and the financial markets. And, the desired profit
is benchmarked against others in the same industry and against all businesses.
In this complicated environment, it is the role of Target Costing to balance these
external variables and help develop a product at a cost that is within the
constraints imposed. In short, traditional approaches, such as simple “cost-plus”
is a recipe for market failure, and giving the customers more than they are willing
to pay for is a recipe for insolvency.

There are seven typical characteristics for target costing. These conditions
are:
I. The target sales price is set during product planning, in a market-
oriented way.
II. The target profit margin is determined during product planning,
based on the strategic
III. profit plan.
IV. The target cost is set before the new product development process
(NPD) really starts.
V. The target cost is subdivided (into target costs for components,
functions, cost items or
VI. designers).
VII. Detailed cost information is provided during NPD to support cost
reduction.
VIII. The cost level of the future product is compared with its target cost
at different points
IX. during NPD.
X. A general rule is aimed for that “the target cost can never be
exceeded”.

That target costs are not the only elements that design engineers need to aim
for when designing and developing a future product. As mentioned, the quality of
the future product in terms of performance, features, reliability, etc. need to be
considered as well as the time schedule of the NPD process. It is indeed the
combination of the quality of the product, its cost level and the achieved time-to-
market that determines (among other elements) the success of the new product.

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Figure shows the interrelationship between target costing and new product planning. As shown,
all elements influence each other and are mutually intertwined.

Cost information on current products as well as cost estimates on future products

provide necessary input during the whole target costing process, both for
determining the target cost and achieving it.

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 TARGET COSTING
CHARACTERISTICS
1.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 provide an initial starting point for firms using target costing. A higher
price point is only justified if the perceived value for the customer is much better
than the existing product or competitor’s offerings.

2. 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. It is quite a difficult task to imagine a
future product portfolio in today’s environment, but adds that without doing this it
is impossible to decompose the total target profit into targets for each product.
The procedures to compute target profits should be scientific, rational and
agreed, otherwise nobody will accept his/her responsibility for achieving the
target profit.

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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.

3. 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. Each of these cost items will be
discussed next. Figure 12 shows the global picture by a numerical example.

First, the ongoing cost, or the drifting costing is determined which is defined as
the best estimate of the future product’s cost. When NPD starts, this best
estimate is based on the actual cost of the current product, considering cost-
down and cost-up factors.

Second, the as-if cost is calculated. the as-if cost represents the cost of making
the future product if the company had implemented all available cost-
reduction activities. As shown in figure, the as-if cost represents in fact a real

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cost reduction, however, it was unlikely to be sufficient to realize the medium-
term profit target, given the market determined sales price.

Third, the allowable cost is calculated as the difference between the target
sales price and the target profit margin. As mentioned before, the target sales
price is set based on market information and top management strategically
determines the target profit margin. The allowable cost represents the cost at
which the product must be manufactured in order to gain the target profit margin,
when sold at the target sales price.

Setting the Target Cost for the Future Product between the Allowable Cost
and the As-if Cost

Fourth, the target cost is set somewhere between the as-if cost and the
allowable cost. Different

methods are described in literature to set the final target cost. According to the
deductive method, the target cost is set at the level of the allowable cost, i.e. at
the difference between the target sales price and the target profit margin

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 (i.e. too difficult to attain), 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. This difference
between the as-if cost and the target cost is also called the target cost-reduction
objective. Indeed, design engineers need to find ways to reduce the cost of the
future product with this amount in order to attain the target cost. Filling the gap
between the target cost and the allowable cost is then the objective of the kaizen
costing process, during manufacturing. This difference between the target cost
and the allowable cost is also called the kaizen cost-reduction objective.

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4. 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.

5. 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. Detailed cost
information is necessary for mainly three reasons: First, to see the impact of
design decisions on the cost level of the future product; Second, to support cost
reduction ideas and; Third, to estimate the progress towards achieving the target
cost.

6. The Cost Level of the Future Product is

compared with its Target Cost at Different Points
during NPD

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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.

7. Aiming 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 have 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.

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 TARGET COSTING PROCESS
As a totally new product and its industry develops, it starts to compete based on
its new technology, concept, and/or service. 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 begin 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.

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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 tradeoff's 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
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.

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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

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 ACHIEVING TARGET COSTS
A competitive product must address
aesthetics, schedule or time-to-market,
factors will vary from product to product
customers or users of a product will
performanceat less cost.
factors such as cost, performance,
and quality. The importance of these
and market to market. And , over time,
demand more and more, e.g., more

Cost will become a more important factor in the acquisition of a product in two
situations. First, as the technology or aesthetics of a product matures or
stabilizes and the competitive playing field levels, competition is increasingly
based on cost or price. Second, a customer's internal economics or financial
resource limitations may shift the acquisition decision toward affordability as a
more dominant factor. In either case, a successful product supplier must focus
more attention on managing product cost.

The management of product cost begins with the conception of a new product. A
large percentage of the product's ultimate acquisition or life cycle costs, typically
seventy to eighty percent, is determined by decisions made from conception
through product development cycle. Once the design of the product has been
established, relatively little latitude exists to reduce the cost of a product.
Decisions made after the product moves into production account for another ten
to fifteen percent of the product's costs. Similarly, decisions made about general
and administrative, sales and marketing, and product distribution activities and
policies account for another ten to fifteen percent of the product's cost.

When a company faces a profitability problem and undertakes a cost reduction

program, it will typically reduce research and development expenditures and
focus on post-development activities such as production, sales, and general and
administrative expenditures. While not suggesting that these are inappropriate
steps to take, the problem is that it is too late and too little. Most of the cost
structure in a company has been locked into place with the design decisions
made about the company's products. A cost reduction or profitability program has
to start with the design of the company's products at the very beginning of the
development cycle.

DEFINITION OF TERMS
The following definition of terms will provide a common basis for discussion:

Recurring production cost = production labor + direct materials + process costs +

overhead + outside processing

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Non-recurring costs = development costs + tooling

Product costs = Recurring production costs + allocated non-recurring costs

Product price or acquisition costs = Product costs + selling, general &

administrative + warranty costs + profit

Life cycle costs = Acquisition costs + other related capital costs + training costs +
operating costs + support costs + disposal costs

TRADITIONAL APPROACH
In many companies, product cost or life cycle cost considerations are an
afterthought. Costs are tallied up and used as the basis for determining the
product's price. The primary focus is on product performance, aesthetics, or
technology. Companies may get by with this approach in some markets and with
some products in the short term, but ultimately competition will catch up and the
product will no longer be competitive.

In other companies, cost is a more important factor, but this emphasis is not
acted upon until late in the development cycle. Projected costs of production are
estimated based on drawings and accumulated from quotes and manufacturing
estimates. If these projected costs are too high relative to competitive conditions
or customers requirements, design changes are made to varying degrees to
reduce costs. This may occur before or after the product has been released to
production. The result is extended development cycles and added development

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cost with these design iterations.

In some organizations, development costs receive relatively little attention as

well. There may not be a rigorous planning and budgeting process for
development projects. Budgets are established without buy-in from development
personnel resulting in budget overruns.

DESIGN TO COST
Effective product cost management requires a design to cost philosophy as its
basis since a substantial portion of the product's cost is dictated by decisions
regarding its design. Design to cost is a management strategy and supporting
methodologies to achieve an affordable product by treating target cost as an
independent design parameter that needs to be achieved during the
development of a product. A design to cost approach consists of the following
elements:

• An understanding of customer affordability or competitive pricing requirements by

the key participants in the development process;
• Establishment and allocation of target costs down to a level of the hardware
where costs can be effectively managed;
• Commitment by development personnel to development budgets and target
costs;
• Stability and management of requirements to balance requirements with
affordability and to avoid creeping elegance;
• An understanding of the product's cost drivers and consideration of cost drivers
in establishing product specifications and in focusing attention on cost reduction;
• Product cost models and life cycle cost models to project costs early in the
development cycle to support decision-making;
• Active consideration of costs during development as an important design
parameter appropriately weighted with other decision parameters;
• Creative exploration of concept and design alternatives as a basis for developing
lower cost design approaches;
• Access to cost data to support this process and empower development team
members;
• Use of value analysis / function analysis and its derivatives (e.g., function
analysis system technique) to understand essential product functions and to
identify functions with a high cost to function ratio for further cost reduction;
• Application of design for manufacturability principles as a key cost reduction
tactic;
• Meaningful cost accounting systems using cost techniques such as activity-
based costing (ABC) to provide improved cost data;
• Consistency of accounting methods between cost systems and product cost
models as well as periodic validation of product cost models; and

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 • Continuous improvement through value engineering to improve product value
over the longer term.

TARGET COSTING AS A FOUNDATION

Executive management, marketing, program/product managers, and
development team personnel all need to have an understanding of customer
affordability constraints or competitive market place requirements. Everyday
customers buy products with functions, features and performance in excess of
their needs and wonder how much is money is wasted on these unneeded
capabilities. A keener awareness of design to cost requirements is needed. This
happens when product development team members and executive management
have direct contact with customers to understand their true needs and hear their
sensitivity to costs directly, or when they are exposed to competitor's product
pricing in the market place.

Based on this awareness of customer affordability or design to cost

requirements, cost targets should be formally established. These targets should
be developed based on pricing formulas and strategies and consideration of
price elasticity. Prices and target costs will also have to consider projected
production volumes and amortization of non-recurring development costs. In a
more complex product or system, the top-level target cost will need to be
allocated to lower level subsystems or modules. This will establish a measurable
objective for a product development team where multiple teams are involved in a
development project.

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In an environment where development cost is significant relative to total recurring
production costs, more attention will need to be paid to managing these non-
recurring development costs. Non-recurring development cost will be a function
of the extent of new product and process technology and the extent of use of
new materials, parts and subsystems. If product is an evolutionary step with
minimal development risk, non-recurring development costs will be lower. The
use of standard parts and modules from other existing products will also lower
non-recurring development costs. This suggests a strategy of not letting product
and process technology application get too far ahead of customer affordability
requirements.

Product development team members should buy-in to or commit to these product

cost targets and development budgets to improve the chances of meeting these
objectives. When empowered product development teams actually develop these
budgets and targets, a sense of commitment to these budgets or targets
develops. If the budgets or targets are established by someone outside the
product development team (e.g., by a product or program manager, a
management team, a system integration team, or a project engineer), the targets
and budgets should be carefully reviewed with the team members to insure they
understand these cost objectives and the assumptions behind them. While
competition will generally dictate that stretch goals be established, these goals
should be accepted by the team as achievable.

COST MODELS AND COST DATA

Once a team has a set of requirements and a cost target established, they will
begin exploring alternatives as part of the design process. In the absence of
other information, they will tend to evaluate a product concept primarily based on
its performance merits and, at best, secondarily consider a subjective estimate of
the relative costs of the design alternatives. Ad-hoc cost studies or trade studies
may be prepared for significant issues, but tools to regularly support this process
are lacking. Tools and information need to be provided to a product development
team so that they can more proactively and objectively consider the cost
implications of various design approaches on a regular basis. A product cost
model or life cycle cost model provides an objective basis for evaluating design
alternatives from a very early stage in the development cycle.

As the organization proceeds through the design of both product and process,
the product cost model is used to project and accumulate product costs to use as
a factor in evaluating design alternatives and to refine the design to meet cost
targets. If it is determined after extensive evaluation that the product
requirements cannot be achieved at the target cost, the requirements and targets
will need to be re-evaluated and modified.

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Early in the development cycle, the product cost model will be based primarily on
characteristics of the product design with relatively little consideration of the
actual manufacturing process. The model will be driven by general design
parameters, product/part characteristics, and critical parameter tolerances. The
model will be implicitly based on assumptions about existing processes and
process relationships to types of materials, sizes and tolerance requirements.

Later in the development cycle, a different type of product cost model will be
used that will consider the specific manufacturing processes. This type of model
will be built around existing processes where relatively good historical cost data
should exist. On occasion, new manufacturing processes will need to be
considered. Data will need to be gathered as a basis for creating or extending the
product cost model for the new process(es). Information to support this model
development can be obtained from equipment suppliers, other users of this
manufacturing process, facility engineers, and manufacturing engineers.

Cost data will also need to be obtained for many purchased parts and sub-
assemblies. This information may be available in the form of catalog prices or
supplier quotations. However, to support cost projections much earlier in the
development cycle, a close working relationship with the company's supplier
base will allow preliminary cost projections to be obtained without the formalized
commitment of a quotation. The supplier relationship and company information
needs may even develop to the point that the company works with the supplier to
develop a supplier cost model based on the supplier's process capabilities.

A company's initial attempt with a product cost model may utilize a spreadsheet
program or a bill of material cost roll-up capability. The focus is on accumulating
and tracking estimated material, part and assembly costs. This summarization
capability may start with cost estimates and update the estimates with quoted
prices or catalog prices for purchased items or manufacturing's estimates based
on preliminary drawings for fabricated items and assemblies.

Over time, a more sophisticated product cost model should be developed that will
project costs based on the characteristics of parts and the overall product design.
This type of cost model might be based on commercially available design for
manufacturability (DFM) or design for assembly (DFA) software packages. These
systems typically generate an estimate of fabrication or assembly labor time and
costs or machine cycle time. and costs as part of their capabilities. In addition,
there are commercially available cost models that allow a company to develop a
custom model of their manufacturing processes and project even more exacting
cost estimates based on their product or part characteristics. These individual
packages or modules will be oriented toward a limited part or product domain,
e.g., manual or automated assembly, printed circuit boards, sheet metal, injection
molding, casting, etc. Multiple modules will typically be needed to support overall
product cost modeling. In addition, a database reporting capability or
spreadsheet will be needed to accumulate the many individual elements of cost

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from these various cost modeling system components so that effective overall
trade-off's can be made.

Over the course of the development cycle, several different costing tools may be
used by an organization. In the early stages of product development, an
estimating system may be used to respond to a customer request for quotation or
request for proposal or to develop an internal estimate to prepare a cost
justification for the development project to management. This cost model would
be based on parametric or analogy techniques. Parametric techniques would
take general characteristics about the product such as size, weight, number of
functions, etc., and use these parameters to develop a general cost estimate.
Analogy techniques would take a similar product's cost and use a "same as
except for" approach to develop a cost estimate based on the cost of an existing
item.

As the development cycle moves into the product design phase, cost models and
DFM/DFA tools as just described would be used. These estimates would be more
refined since more is known about the design of the product and its cost drivers.
Once the product design is essentially complete, tools and methods such as
computer-aided and manual process planning and tools to support the
development of labor standards would be used to develop even more refined
cost estimates. Finally, as the product moves into production, cost accounting
systems would collect costs by product, assembly, part, and operation. These
costing tools are illustrated below.

These costing tools should have a consistent basis for accounting for costs and a
consistent set of rates. In addition, the organization should establish procedures
to periodically validate the cost models by comparing the projected costs with
actual costs and adjusting parameters in the model to yield projections closer to
actual experience.

In some cases, life cycle costs may need to be considered as the basis for
making design decisions. This will add to the complexity of a cost model. Data
will need to be gathered on operating costs (e.g., facilities, training, manpower,
fuel or energy consumption, etc.), maintenance costs, and disposal costs. While
these costs can be modeled, historical data related to operations, reliability and

22
maintenance often is needed. This means that a customer will need to provide
this data or that the company have close working relationships with customers
where this data is routinely gathered.

To support the operation of these cost models, cost data will need to be readily
accessed. Some companies try to restrict access to cost data to prevent this
information leaking out to competitors. This restricted access undermines a
design to cost methodology and empowerment of the product development
teams. This data needs to be made available to support cost modeling. Typical
data required will be labor rates, overhead rates, learning curves, efficiencies,
historical and projected parts costs, and escalation projections for labor and
materials.

Traditional approaches to allocating overhead or burden costs generally based

on direct labor. However, direct labor is becoming an insignificant cost
component in many products. Further, there is frequently a lack of understanding
of sunk costs and fixed versus variable indirect costs. All of this has led to
distortion of overhead cost allocations and inappropriate design and sourcing
decisions. As companies move toward activity-based costing, the quality of the
cost data will improve. Costs will be more closely based on the consumption of
resources and the aberrations associated with allocating indirect costs will
diminish.

DECISION-MAKING
In the absence of product cost models and product development teams, each
functional organization will make decisions from their own perspective, trying to
manage the elements of cost that they are responsible for. For example,
decisions to minimize non-recurring design engineering expenditures may result
in a less producible product, driving up material and labor costs in manufacturing.
Decisions to minimize tooling capital expenditures may also have the same effect
in manufacturing costs. Test engineering may try to minimize its non-recurring
development budgets and capital expenditures resulting in a less automated test
process and higher recurring test costs for production verification.

Product development teams provide the organizational mechanism to bring the

various disciplines together to optimize product costs from an enterprise
perspective. Cost models provide the means for the team to objectively consider
the implications of various development decisions. A company operating
philosophy that emphasizes cost as a factor in the development decision-making
process is a final requirement.

Access to product cost projections early in the development cycle will improve
decision-making about design alternatives and lead to refinement of the design to

23
come closer to the established cost targets. These costs projections will aid
decisions about the design of the manufacturing process as well, focusing
attention of elements of the product costs that do not meet the target and
allowing consideration of alternative processes while it is still early enough in the
development cycle to introduce new processes. The key is to emphasize
management of product costs during development, not merely accumulating
costs as designs are completed.

Since the decisions made during the product development cycle account for seventy to
eighty percent of product costs, product cost management must begin with the start of
product development. Product development personnel must understand competitive
pricing or customer affordability requirements. Target costs must be established at the
start and used to guide decision-making. Development personnel must operate as
entrepreneurs in making hard decisions about the product and process design to
achieve target costs. Cost models must be provided to support decision-making early in
the development cycle. And the quality of information and the cost models must be
continually improved and refined. This increased focus on product or life cycle costs will
lead to significantly reduced costs and more satisfied customers.

24
 TARGET COST MANAGEMENT
CAM-I (Consortium for Advanced Manufacturing – International) was
established 1972 as an international non-profit-organization to carry out
research and scholarship on management and manufacturing technology
systems. CAM-I has launched an extensive study labeled as target cost
management (TCM). The CAM-I study group made the following
conclusions concerning the major changes needed:

• An overall management system is required to set the targets and to

channel the decisions of all those involved in product definition and
development towards wider corporate goals.
• Product management must widen to incorporate both physical and
service attributes measured in terms of customer value.
• Cost management must shift its focus from accounting for the sake
of accounting to enable expenditures to be used as a planning tool
for creative product and process design.
• Product profitability must be assessed and planned in the context
of a comprehensive life cycle and the relationship of a broad
market value chain.

Target costing is a cost management concept. It is built on a

comprehensive set of cost planning, cost management and cost control
instruments which are aimed primarily at the early stages of product and
process design in order to influence product cost structures resulting from
the market-derived requirements. The target costing process requires the
cost orients coordination of all product related functions. Japanese
management accounting uses classification of predetermined and actual
costs. Predetermined costs are the expected measures of the cost before
production, while actual costs are calculated after production.
Predetermined costs are divided into standard costs and estimated costs.
Standard costs depend on statistical data and are utilized as an index for
cost management. Estimated costs depend on the managers’ past
experience or intuition.

Target costing, as it has been developed in Japan, was invented by

Toyota in 1965. Thus, the use of target costing has a long tradition at
Toyota. At Toyota, they talk about cost planning and cost control, i.e.
influencing product costs during the design phase and keeping the
running costs as low as possible. Reducing cost through continuous
improvement, “cost kaizen”, is becoming relatively less important,
because the efforts made throughout the company will inevitably lead to
fewer opportunities to cut costs.

25
For example, the lifetime target profit Ps of a new model (e.g. Celica) is
calculated as follows:

Ps = P% * Sa

where P% is the profit ratio of sales and

Sa is the target sales.

The sales target is calculated using the retail price

Sa = Us * Qs

where

Us is the target retail price and

Qs is the target production volume over the product’s life.

The present cost control system is focused on the design phase. The
system consists of five stages: planning, concept design, basic design
and manufacturing preparation. The phases are outlines below:

STEP1: Planning

Summarize the new product plan in a document that clarifies the design
requirements:

1. Outline the product’s concept and mission.

2. Generate primary specifications for the product’s
performance and design.
3. Schedule the product’s design, manufacturing and
marketing.
4. Define product target cost, selling price and volume.

STEP2: Concept design

Formulate the basic concept of the new product based on the design
requirements mentioned in step 1.

1. Formulate the main functional areas.

2. Assign the target cost to the functional area of the new
product.
3. Design the basic product concept under the target cost.

26
 4. Use a rough cost estimate to ascertain whether the basic
product concept has been designed to fit the target cost.

STEP3: Basic design

Make a general drawing of the product based on the previous steps:

1. Assign target cost to the top and middle functions of each

functional area or main component of the new product.
2. Frame a general drawing under the target cost.
3. Use a rough estimate to ascertain whether the general
drawing has been designed to fit the target cost.

STEP4: Detailed design

Write the product’s manufacturing specifications based on:

1. The detailed manufacturing specifications under the target

cost.
2. A detailed cost estimate to ascertain whether the product’s
manufacturing specifications have been designed to fit the
target cost.

STEP5: Manufacturing preparation

Write the product’s manufacturing specifications based on:

1. The design of the manufacturing process, type and jig under

the target cost.
2. The detailed cost estimate used to ascertain whether the
manufacturing preparations for the product are
accomplished within the target cost.

EXAMPLES:

Boer and Ettlie (1999) report a case where a car manufacturer could have
prevented a $300 million mistake by using proactive target costing. The
survey was conducted among the top-performing US R&D units and
resulted in 126 questionnaires, of which 77 showed an orientation towards
market-driven cost control. Xerox is mentioned as one the well-known
practitioners of systematic proactive cost planning. (Boer & Ettlie 1999.)

27
According to Shank & Fisher (1999), target costing seems to be applied
mostly at the early stages of product development, but the case of
Montclair Paper Mill shows how the target costing principle can be applied
at a later stage of the product life cycle. The situation of Montclair Mill
seemed gloomy: The mill was making $700 loss per every ton of paper
sold. The management believed that the loss was related to the market
price rather than their own manufacturing. The standard cost of $2900 per
ton was thought to be based on a solid analysis and was taken for
granted.

The implementation of target costing was introduced with a new target of

$1162 per ton, which equals a 60% cost reduction. The management
accepted the challenge, and after ta cost-driven analysis, four major
reductions were accomplished:

1. Fiber cost: 60% cost reduction.

2. Paper machine cost: Yield from 47% -> 75%.
3. Dye costs: material savings of $250 per ton incorporated in the
yield improvement at the paper machine resulted in an amazing
$769 reduction per ton.
4. Conversion costs: Based on benchmarking, a reduction from $303
to $150 was challenged with the risk of possible outsourcing.
During 18 moths, the cost dropped to $240, and the continuous
improvement seemed to gain even more.

Together, these produced the desired level of costing and a dramatic

turnaround in the mind set. (Shank & Fisher 1999.)

Cooper & Slagmulder (1999) gives a comprehensive review of the

application of target costing. He emphasizes the strategic value of target
costing in managing the company’s future profits. According to their study
of seven Japanese companies, the target costing discipline has been
structured into three sections.

Three main elements of the target costing process (Cooper & Slagmulder 1999).

28
Successful application of this process requires a highly disciplined
approach. Each of the main phases must be balanced to avoid unrealistic
target setting. The process starts from the left, by setting the company’s
long-term sales and profits objectives, and continues through the product
level targets to component level target costing. The role of the product
chief engineer is remarkable in the fundamental decisions concerning
product and component target costing. The senior management tends to
push down the product target costs as much as possible while the chief
engineer must find the realistic limits in co-operation with the design
teams and the suppliers. Once these have been decided on, the Cardinal
Rule is applied to ensure that discipline is maintained throughout the
design process. The Cardinal Rule of target costing is: “The target cost
must never be exceeded”. The Cardinal Rule controls the process in three
ways:

1. If the design does not reach the target costs, the offsetting saving
must be found somewhere else.
2. The company does not launch any product exceeding the target
costs.
3. The design transfer to manufacturing must be well controlled to
achieve the target cost.

As a conclusion, the early involvement of proactive product cost

management has been highlighted as a major advantage of some leading
companies in highly competitive markets.

29
 TARGET COSTING TO
IMPROVE BOTTOM-LINE

Changing Product Life and Requirement

Product life cycles are getting shorter and shorter, quite often one or two years,
and sometimes to less than one year in high-tech industries. Consumers are
demanding new and diversified products in short intervals. Due to factory
automation, robots and computer-controlled manufacturing systems are replacing
the conventional production lines. What all these changes mean is the traditional
standard costing systems, which emphasize cost control in the manufacturing
phase of the product life cycle, are no longer effective. With a one-year product
life, controlling costs in the manufacturing phase simply doesn't accomplish
much. Once the product is developed and designed, there is a limit to how much
cost cutting companies can do in the manufacturing stage. Manufacturers have
learned cost management should start up front at the initial stage to be effective
and measure up to their foreign counterparts.

A new cost management concept has been developed and practiced by world-
class manufacturers to deal with the needs in the product development and
design phase.

Control Costs Early

Target costing, although its concept is used throughout the product life cycle, is
primarily used and most effective in the product development and design stage.
Born out of the market-driven philosophy, target costing is based on the
pricedown, cost-down strategy, which has allowed companies like Sony and
Toyota to win a considerable share of their respective markets.

In companies, costs of designing, producing, marketing, and delivering products

dictate the mode of competition. Accountants usually measure, based on
allocation routines, the total cost of each product. Most popular cost accounting
methodologies, including the emerging activity-based costing, focus on product
profitability. No matter how effective the cost accounting methodology may be,
managers and accountants must heed the shareholders' needs for satisfactory
short- term profits, measured by ROI or ROE.

This focus on meeting the shareholders' short-term needs has been well
documented, and easily understood if we look at the Big Three automakers'
practice of raising prices whenever there is a restriction placed on Japanese

30
imports. The practice is effective in achieving the desired ROI or ROE, but it hurts
the carmakers' ability to increase market share in sales volume. An increased
market share would give them a buffer in the future if they choose to sacrifice
sales volume to increase revenue and longterm profit.

In companies where target costing is used, there seems to be a different culture

and attitude. They place more emphasis on their relative position in the market
and product leadership. Since more than 80% of product cost is already
determined by the time product design and processing is complete, cost
management must start (and done substantially) at the design stage.

Connect with Profit Planning

Target costing is very closely linked with the company's long-term profit and
product planning process. This link allows the company to focus on profit and
product in an integrated strategy, which does not discriminate against high-
quality, high-price, high-margin products that require high costs.

This is in direct contrast to a typical manufacturer's practice, in which the

question persists, "How much does the product cost?" This question follows a
new product design into the cost accounting department, which estimates the
new product costs based on the prices of purchased materials and parts, labor
costs, and other manufacturing overhead costs under the current production
standards. The marketing department then addresses the issue of whether they
can sell the new product. This departmentalized policy formulation of a typical
company, which focuses on cost, tends to discriminate against developing a new
high-quality, high-price product. Target costing derives its bases from the
company-wide profit plan. The target profit for each period is determined for each
of the new and existing product portfolios. The profitability of each group of
related products is the focus, rather than the profitability of individual products.
The desired profit margins are traded between products in the same group,
depending on what stage the product is in its life cycle and what leadership role
the product can play in acquiring a new segment of the market.

Setting the Target Costs

The main theme in the entire target costing practice is, "What should the new
product cost?" It is not, "What does it cost?" Wben the target sales price is
established based on market research, the desired profit is subtracted to yield
the allowable cost. This allowable cost is top management's dream. This is a
target which is very hard to attain, usually impossible in the short run.

The desired profit is determined based on the company's desired return on sales
(ROS), rather than ROI. There are two primary reasons for using ROS. The first
is technical, the second is strategic:

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* The Technical Reason. In the fastchanging market of today, manufacturers
need a variety of products in low volumes to survive. Calculating the profitability
of each of those products in ROI is well- nigh impossible.

* The Strategic Reason. In the implementation of long-term strategies,

manufacturers need to focus on the profitability of portfolios of related products
and the role each product plays for the product group. For this, ROS provides a
better measure. The allowable cost is compared to the estimated cost, which is
based on the current standards of materials, labor, and overhead. In the
meantime, intensive studies of competitors' parts are done. After motivational
considerations have been made, the gap between allowable cost and estimated
cost is reviewed on various dimensions. The target cost is then established as an
attainable target which will motivate all personnel to achieve. Now, the struggle
begins.

Achieving The Target Costs

At this point, cost management people help engineering planners and designers
decompose the target cost into each cost element according to their relations to
detailed production functions. Production engineers determine standards for
material and part usage, labor consumption, etc., which become the basic cost
data for financial accounting purposes. These standards are also used as a
database for material requirements planning (MRP).

The struggle to achieve the target costs takes place in and outside the company.
As soon as the above-mentioned standards are established, purchasing people
negotiate with outside suppliers as to the prices of purchased materials and
parts. Negotiations also take place among design, engineering, marketing, and
other departments in the company, and compromises are made in their efforts to
get within the target cost range.

The fundamental mechanism manufacturers use to achieve target cost,

nevertheless, is value engineering (VE).

Value Engineering
The idea behind VE is very similar to activity analysis which was first developed
and used by General Electric. GE's activity analysis was not, however, and was
not intended to be, linked to corporate profit planning, target profit, and target
costs as they are practiced In Japan.

VE is a mechanism Japanese manufacturers use to enhance the value of

products and services, which is measured by the relationship between the
functions performed by products and services and the costs incurred. The
functions are defined by different companies in different ways. Some are geared

32
toward process improvement while others are focused on satisfying the needs of
customers.

The process of VE consists of describing the functions of each product, part, and
service, and quantifying the components of those functions. For example, a
printed circuit board (PCB) manufacturer's VE activities for the drilling operation
include panel size, number of images per panel, lot size and frequency, number
of holes, hole size, stack height, laminate thickness, post plate drill, and fine line
class. In the design phase, management science techniques are employed on
the many aspects of the drilling operation to improve upon the current method.

Post-Audit of Target Costing Performance

The short life cycles of manufactured goods in today's market require

manufacturers to recover investment in a short time. A short payback period is
usually assumed in planning and evaluating target costs. Post- audit of target
costing performance is done on a regular basis to examine the degree to which
targets have been achieved. If targets have not been achieved, investigations
follow.

The Real Weapon

The real power of target costing is that it allows companies to successfully motivate
employees and enforce cost management action plans. It is a disciplined approach to
managing costs and improving processes and products. Target costing, as briefly
illustrated here, is also very compatible with the emerging ABC, which can provide
necessary cost information for implementing target costing.

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 FACTORS INFLUENCING
TARGET COSTING
A number of factors influence target costing, including senior management's
objectives and your company's long-term profit objectives. But while every
company uses target costing differently, there are some things that will influence
one’s target costing efforts no matter what type of business one is in or what
one’s corporate culture is. They are the type of customer one sell to and the type
of product you make or service you offer.

It may seem obvious to tie the cost of one product or service to the needs of
one’s customers. But target costing makes more of a defined effort to achieve
this objective than traditional costing methods. That effort extends to researching
customer needs.

"In research-gathering seminars, I ask how many people own one of our
products, and no one raises their hand," says Boeing's Hallin. "Then I ask how
many people have ever flown in one of our planes, and everyone's hand goes up.
Although ours is a business-to-business company, we want to understand not
only how our immediate customers [airplane purchasers and lessors] use our
product, but how their customers, the passengers, use it as well."

Target costing says you need to match your firm's activities to your customer's
requirements. For example, Suppose you're an automaker and you've
determined your customers want comfort. Evaluate your product as it relates to
enhancing customer comfort, perhaps by looking at the springs in the seat, the
upholstery, the angle of the seat, the car's suspension. Enhance those things and
reduce costs in areas that aren't as important to the customer.

Uncovering customers' real needs can occasionally be difficult even with a simple
product, and even for the best of companies. When Procter & Gamble developed
their Pringle's potato chip, they asked people what they wanted from a potato
chip, and the answer uniformly was freshness. The product was launched in a
vacuum-sealed can to maximize freshness, and initially, it was successful. But
then customers found out that the product didn't taste very good. Procter &
Gamble had missed taste as a customer need.

If in creating product functions that reflect what the customer wants your costs
become too high to hit your target, then its advisable not to give up. Find other
areas less important for customer satisfaction and try to reduce those costs. If
the process doesn't work the first time around, try again. Sometimes, target
costing needs many iterations to carry it through.

34
How does product influence target cost? Generally, the longer the product
development cycle from the design stage to the production stage, the more
difficult it may be to establish firm target costs early on. For instance, if cycle is
up to four years, which is how long it typically takes at Boeing according to Hallin,
the target cost establish may need to be revised over the years.

Some companies with a long product development cycle take the process in
incremental steps. They have an allowable cost for each component function,
and then the total allowable costs of all the functions for making the product are
added to arrive at an expected cost of manufacturing the product. It's usually
impractical for a company with hundreds of design and production components to
evaluate all of them, so a representative sample of allowable costs is taken and
applied to all components. From these costs comes an updated target cost.
Companies with shorter product development cycles may find they can stick to
their initial target cost more easily because they are not as susceptible to the
changes that time can impose.

So, the simpler and more straightforward is the product, the easier it is to
implement target costing,

35
 EVALUATION OF TARGET
COSTING

BENEFITS
Successful planning and implementation of the effective target costing system
helps to derive the following benefits:

First, target costing is future-oriented. Some companies more often design

the product, then calculate the cost, and finally try to figure out whether it will sell.
If the cost is too high, the product goes back to the drawing board for redesign or
if no additional time is available the company launches the product and settles for
a smaller profit.

Traditional Method versus the Target Costing Approach

Under this traditional western approach cost reduction activities can only start
late in the NPD process, whereas companies using a target costing system start

36
with cost reduction from the concept generation phase, hence long before a
prototype of the product even exists. Therefore, target costing a “feedforward”
system, whereas the traditional system is a feedback system. The single largest
change in firms, implementing target costing is to stop reporting what products
should cost, but instead report what products will cost. This pro-active
concentration on a future product’s cost allows to prevent costs rather than to
reduce them after the fact.

Second, the use of target costing ensures profitability on the short and long
run. Products that show up as low-margin or unprofitable are quickly dropped.
Similarly, ideas for new products whose profitability projections fail to clear
certain hurdle rates usually wither away on the accountant’s spreadsheet. In the
past, many leading companies, especially those that led by technical
differentiation, could release new products anticipating a future price increase.
Explain that competitive markets no longer allow a company time to introduce a
product and then scale up, because imitators bring me-too products to market so
rapidly that first mover companies have no time to establish brand loyalty, let
alone recover their development costs.

Third, target costing reasons backward from customers’ needs and willingness to
pay. Target costing focuses the design team on the ultimate customer and
on the real opportunities in the market. They call it “commitment to the
customers”. If targets cannot be met, the company cannot simply raise the price
and launch the product. Admit that such discipline may be painful to the people
who work on a project, but it sends the important message that the customers
come first, and that if the company does not create value for them, a competitor
will.

Four, target costing is used at the design stage, focusing on the cost
implications of design decisions. Designers must know how design affects
such things as material consumption, yield, machining methods, and line time.
The intensity by which the product is designed to its target cost is contrary to a
situation where the projected cost can be exceeded without penalty. By setting a
target cost for a future product, all members of the design team consider the
impact on the cost while deciding on design alternatives. The use of a target
costing system prevents design engineers saying: “If we just add this feature, the
product will be so much better and only cost a little more.”

Five, target costing gives a clear, quantitative cost objective to design

engineers. Target costing is totally different from the traditional approach or the
cost-plus approach. Under the traditional approach the new product’s expected
profit margin, not the cost level of the future product becomes the dependent
variable when launching a new product. Under this traditional approach, the profit
margin is determined by subtracting its estimated cost from its anticipated sales

37
price (sales price - cost = profit margin). Under the cost-plus approach, the
product’s expected sales price becomes the dependent variable. This means that
the sales price is determined by adding the desired profit margin to the expected
cost of the product (cost + profit margin = sales price). Under both approaches
product designers have no specified cost objective to achieve. Instead,
they are expected to minimize the cost of the product as they design it.

Six, the use of a target costing system forces management to set the NPD
goals early in the NPD process. Setting target costs requires that management
decides on the quality of the future product as well as on the time-to-market,
based on market research and the company’s strategy. Setting NPD goals
requires making trade-offs between the different characteristics of a future
product. Marketing people are traditionally oriented to sell products and want as
much features as possible for a new product, but do not want customers to pay
for it. Under target costing, management need to balance cost and features
against the customer’s ability (or willingness) to pay for all this.

DRAWBACKS
Nevertheless, some authors also suggest that the use of target costing during
NPD can lead to some undesirable consequences.

First, it takes time and money to bring sweeping changes into an organization.
There's also the problem of changing workers' behavior. Why rock the boat if
things are going well? The answer, target costing proponents say, is simple: In
the long run company will be better positioned to compete in the marketplace
with target costing than without target costing.

Second, target costing can be severely criticized because of excessive demands

it puts on subcontractors. As major customers pass their cost-reduction demands
down to suppliers, the suppliers push their suppliers and employees to do more,
some of whom are already doing all they can handle. It can be called the battle of
intense negotiation between the company and its outside suppliers. This
excessive demand goes hand in hand with a restricted autonomy of the
suppliers.

Third, the use of target costing information might cause organizational conflicts.
One aspect involves the difficulty to decompose the total target cost to target
costs of individual components. It can be called as the battle among the
departments, since most of the time different departments are responsible to
design parts or subassemblies. Deciding on the component-level target cost

38
means deciding on the effort the different departments will need to do in reducing
costs. Organizational conflicts might also arise when design engineers feel that
other parts of the organization are getting a free ride while they try to squeeze
every penny out of a product.

Finally, some researchers conclude that the extreme customer focus of target
costing might lead to market confusion, with too many products, too many
options. Constant attention to customers’ desires causes extreme market
segmentation. As a result the large number of different products confuses
customers.

In general, most researchers extensively report on the benefits, while the drawbacks are
discussed to a less extent. Orientation on the future by feedforward control, ensuring
profitability on the short and long run, providing clear cost objectives for designers and
suppliers, and focusing on the cost implications of design decisions are just a few of the most
frequently mentioned benefits. Though, the use of target costing can also lead to extensive
pressure on design engineers and subcontractors, which can raise organizational conflicts
and management burnout.

39
 CASE STUDY
The company, Major-Cable, implemented Target Costing for a standard product
they had just started selling to a new OEM customer.
The company had beaten their competitors owing to ease of use of their patented
cable products. The OEM used these cables on the industrial machines they
manufacture. Major-Cable was excited about this opportunity because it was
their first sale to this OEM which is a very large user of specialized shielded
cables.

In order to capture this business marketing had authorized a very low price. The
Target Costing project was designed to improve the profitability of these cables to
this customer and other OEM customers.

The Process
• Identifying the customer; and the people within the customer that affect the value
created for the customer.
• Reviewing the customer’s stated needs in detail. In preparation for the Target
Costing event, the marketing team had conducted several interviews with the
customers. The interviews included purchasing, engineering, materials handling,
production, and sales personnel.
• Linking the customer’s needs to the features of the company’s products and
service to understand how Major-Cable fills the customer’s needs.
• Understanding the amount of value created by each of the customer’s needs and
converting them into hard dollars.

The Issue
Target Costing step was undertaken to nail down the customer’s needs by specifying
them exactly. One need from this customer was to have cable with a minimum of 20
meters length. This has been a problem for the client because delivery is made from
their centralized distribution center which cuts the cable to the customers required length
and they can not always guarantee to have the right quantity of 20 meter lengths. The
plant provides the distribution center with much longer lengths, but the specific 20 meter
length is difficult to maintain.

The Solution
The initial solution to this problem was for the production plant to create a new product
number for 20 meter lengths and manufacturing these specially for the OEM customer.
The team then asked the question; “Why does the customer need 20 meter minimum

40
lengths?” It turned out that the machines the customer manufactures require several
pieces of cable and the total amount of cable for any machine never exceeds 20 meters.
They wanted the 20 meter lengths so they can issue those to the manufacturing location
that then cut them into the lengths they require for the specific machine they are
currently manufacturing.

Our client’s plant has “off-cuts” of cable that are too short to send to the distribution
center. These off-cuts are stored as finished goods in case there is occasional demand
for a short length; but these off-cuts are mostly scrapped at year-end.

The customer’s need for short lengths interested the production manager. He suggested
that instead of supplying the product from the distribution center, they deliver directly to
the customer. Instead of delivering 20 meter lengths, they can deliver the cable cut to the
precise lengths required by the customer that day. Instead of supplying the product on
large round spools, they can place the cut pieces into production kits in cardboard tubes
or boxes to suit the customer's needs.

After this was discussed and agreed with the customer, the result was:

• The customer is delighted to have just-in-time deliveries of cable kits. This

reduces their manufacturing costs.
• The customer is paying a higher price because they are receiving kits instead of
spooled cable.
• Many of the cable lengths can be provided from the off-cuts that previously were
mostly scrapped. The cost of these pieces is effectively zero.
• The cardboard boxes or tubes are much less expensive than the previously used
spools and the overall cost of the packed product is less.

The sales people were also delighted. They did not know the production plant could
supply cut pieces. They thought the production plant would only make long lengths
(economic order quantities) on large spools.

The Power of Target Costing

This is an example of how Target Costing creates more value. Many people think of
Target Costing as a method for cost cutting. We always focus on increasing value as
well as reducing cost. Without Target Costing this company would not have had the
opportunity to bring together the cross-functional team needed to understand the
customer’s needs and find manufacturing, logistics, and marketing methods to create
more value for the customer.

Everybody has “won”. The customer has reduced their costs, their inventory, and their
production lead time. The production plant has reduced it’s material costs and scrap.
The company's revenues (and sales commissions) have increased owing to the higher
price of the cut piece kits. This shows the power of Target Costing in practical action.

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 CONCLUSION
This project help us understand that target costing is the process of
determining the target cost for future products early in the new product
development (NPD) process and of supporting the attainment of this target
cost during the product development process. The target cost represents
the maximum cost for the future product, given the quality requirements
and the time-to-market objective. Its importance lies in the fact that this
helps in forecasting at the initial stages. With product life cycle becoming
small and small, sometimes to one year, traditional methods of modifying
the cost at the manufacturing stage do not hold much importance as
there is a limit to how much cost can be controlled at the manufacturing
stage. Though target-costing technique is applied in all the stages of
product life cycle, but it plays an important role particularly in product
development and design stage.

Target costing management suggests that one is best able to control the
cost through the proactive involvement in the product cost, which has
been highlighted in some of the leading companies.

Also, it’s important to understand that the factors that influence the
implementation of target costing. It can be senior management attitude,
long-term company objectives. Each company must set its target cost on
the basis of the environment in which it operates while keeping in mind
the type of customers it deals with and the type of product it offers to
them.

Many benefits of the use of target costing information are reported. In

sum, the target costing process enables a future-orientated view on cost
management, it secures profitability on the short and the long run, it
motivates design engineers to look at the cost implications of design
decisions and it establishes an unmistakable cost objective in designing
and developing a future product. Though, some drawbacks of target
costing are reported as well in current literature, such as extreme
pressure to design engineers and subcontractors.

On the whole, target costing is an important tool to increase the

efficiency and position of the organization in the market if it is carefully
implemented and managed.

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 BIBLIOGRAPHY
Following are the sources used for completing this project:

Internet
 http://www.focusmag.com/pages/targetcosting.html
 http://www.npd-solutions.com/target.html
 http://www.npd-solutions.com/dtc.html
 http://herkules.oulu.fi/isbn9514264509/html/x1194.html
 http://www.nysscpa.org/cpajournal/old/14979931.htm
 http://www.businessfinancemag.com/magazine/archives/article.html?articleID=4
308&pg=2
 http://www.businessfinancemag.com/magazine/archives/article.html?articleID=4
308&pg=3
 http://www.maskell.com/FieldStories1.htm

Book
 TARGET COSTING: MARKET DRIVEN PRODUCT DESIGN, M. Bradford
Clifton and Henry M. Bird.

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