Target costing can best be described as a systematic process of cost management and profit planning. The six key principles of target costing are:
1. Price-led costing. Market prices are used to determine allowable–or target–costs. Target costs are calculated using a formula similar to the following: market price - required profit margin = target cost.
2. Focus on customers. Customer requirements for quality, cost, and time 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.
3. Focus on design. Cost control is emphasized at the product and process design stage. Therefore, engineering changes must occur before production begins, resulting in lower costs and reduced “time-to-market” for new products.
4. Cross-functional involvement. Cross-functional product and process teams are responsible for the entire product from initial concept through final production.
5. Value-chain involvement. All members of the value chain–e.g., suppliers, distributors, service providers, and customers–are included in the target costing process.
6. A life-cycle orientation. Total life-cycle costs are minimized for both the producer and the customer. Life-cycle costs include purchase price, operating costs, maintenance, and distribution costs.
THE TARGET COSTING PROCESS
Essentially, companies use target costing to establish concrete and highly visible cost targets for their new products. To maximize cost control and enhance profit improvement, most companies set relatively aggressive targets. The process begins when top management establishes a target cost for a new product, for example, a Chrysler Neon or a Caterpillar Excavator. A cost estimating group will then decompose the target cost for the product as a whole into cost targets for subassemblies and... [continues]
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