INTRODUCTION

Target costing is a system under which a company plans in advance for the selling price with correlation
to market value, product costs, and margins that it wants to achieve for a new product. If it cannot
manufacture a product at these planned levels, then it cancels the design project entirely, which is why
efficient, effective and realistic target cost planning is important to avoid any wasted effort and reduces
cost for the companyTarget costing is also a proactive and strategic cost management approach widely
used in product development and pricing. It is designed to control costs from the earliest stages of a
product’s lifecycle, ensuring that financial objectives are met without compromising quality or customer
satisfaction.

With target costing, it is a powerful tool for continually monitoring products from the moment the
product enters the design phase and onward throughout the product’s life cycles. It is considered one of
the most important tools for achieving consistent profitability especially for manufacturing
companies/management.

Unlike traditional costing methods, which focus on determining costs after a product is designed, target
costing normally works by starting with the market-driven price customers are willing to pay or simply
the current market value. From this price, the desired profit margin is subtracted to determine the
allowable cost, which then serves as a guiding constraint for the product’s design, development, and
production processes. This approach enables organizations to strike a balance between profitability, cost
efficiency, and customer value by integrating cost management into every phase of the product
development cycle. With its emphasis on cross-functional collaboration and value engineering, target
costing is particularly effective in highly competitive industries where price sensitivity and customer
expectations dictate market success. By aligning product costs with strategic goals and market demands,
target costing ensures companies remain competitive and profitable while meeting the needs of their
target audience.

Here are some examples of businesses and industries that use target costing:

●​ Automotive Industry
○​ Used by Toyota, Honda, and Ford to create affordable, high-quality vehicles.
○​ Ensures cost-efficient production and material sourcing.
○​ Keeps vehicles competitive and aligned with customer budgets.
●​ Consumer Electronics
○​ Apple, Samsung, and Sony balance innovation with affordability.
○​ Aligns product design with customer price expectations.
○​ Manages production costs while delivering high-quality features.
●​ Retail Industry
○​ Walmart, IKEA, and Target use target costing for private-label products.
○​ Sets price goals based on customer spending habits.
○​ Ensures cost control across suppliers and supply chains.
●​ Apparel and Fashion
○​ H&M, Zara, and Uniqlo create trendy, affordable clothing.
○​ Controls production costs by setting limits during design.
 ○​ Meets customer price expectations while staying profitable.
●​ Food and Beverage
○​ Nestlé, Coca-Cola, and McDonald’s align product costs with customer pricing.
○​ Manages ingredients, production, and delivery to meet cost targets.
○​ Offers consistent quality while staying competitive and profitable.

OBJECTIVE

Objective of Target costing as a cost management tool:

Target costing is a strategic approach to cost management that aims to ensure a product is developed and
delivered at a cost that allows the company to achieve its desired profit margins while meeting customer
expectations. Target costing also fosters cross-functional collaboration by requiring input from various
departments such as engineering, marketing, procurement, and manufacturing. This collaborative effort
ensures that all aspects of product development are aligned with cost and functional goals without
sacrificing quality. Additionally, it improves cost awareness across the organization, encouraging teams to
make cost-conscious decisions throughout the product life cycle.

Target Costing has 3 general objectives in terms of cost management:​

1.​ To lower the cost of products being developed or products that will be introduced in the market,
in order to arrive at the required profit level set by the management.

2.​ The quality, delivery timing, and standard pricing by the market, these standards should be met by
the new product developed to ensure profitability in the market (to sustain their competitive
position in the market for the near future)

3.​ Target costing encourages team collaboration and team motivation to achieve the target profit
during new product development and research, by making target costing as a company system
that fosters company wide collaboration to ensuring target profits are hit by the management

KEY FEATURES

1.​ The price of the product is determined by market conditions. The company is a price taker
rather than a price maker. Market conditions are various factors consisting of supply, demand,
competition, and the overall economic aspects. - They influence the price of a product to stay
competitive and profitable. In a competitive market, these market forces affect the price of a
product. A price taker is a business that functions in a highly competitive market where many
sellers provide comparable or identical products or services. In such markets, no single company
 possesses sufficient power over the price to change it. Rather, they adhere to the market price
determined by supply and demand analysis.
2.​ The minimum required profit margin is already included in the target selling price. The
target selling price includes the minimum required profit margin as it is a crucial component of
the company’s overall financial objectives. Businesses must guarantee their profitability, and the
target cost indicates the highest expense for producing the product to secure that profit. By
determining the target cost (selling price minus intended profit margin), the company can
concentrate on creating and producing a product in a way that fulfills both cost constraints and
market demands, thereby securing profitability and competitiveness in the marketplace.
3.​ It is part of management’s strategy to focus on cost reduction and effective cost
management. The management must regulate production expenses in order to achieve the target
cost established during the target costing phase. If the real cost of making the product surpasses
the target cost, the company won't achieve its intended profit margin, regardless of whether it
sells the product at the market price. Hence, minimizing costs is crucial to make certain that
production expenses remain below the target cost.
4.​ Product design, specifications, and customer expectations are already built-in while
formulating the total selling price. The management must make sure the product design and
specifications align with the budget limits while providing the expected customer value. If the
original design or specifications go over the target cost, management must either cut features or
seek cost-saving measures in production and sourcing to achieve the target cost, but still consider
the customer expectations.
5.​ The difference between the current cost and the target cost is the “cost reduction,” which
management wants to achieve. After determining the target cost, the business compares it with
the current cost (the existing expenses of producing the product). If the existing expenses exceed
the intended budget, the business needs to identify methods to lower costs in order to achieve the
target cost. The firm must lower expenses to ensure it can manufacture the product at the desired
cost while still obtaining a satisfactory profit.
6.​ A team is formed to integrate activities such as designing, purchasing, manufacturing,
marketing, etc., to find and achieve the target cost. Every department or function participating
in producing the product is responsible for making sure that the product can be produced
profitably at the target cost. Consequently, to reach the desired cost, a cross-functional team is
typically established, comprising individuals from different divisions such as product
engineering, production, procurement, marketing, selling, finance, accounting etc. The
cross-functional team guarantees that cost reduction is not delegated to just one department but is
incorporated throughout every phase of the product life cycle, design, procurement,
manufacturing, and sales. This wide approach frequently leads to more efficient methods for
reducing costs. Every function plays a part in cost management, and they are all held together
accountable for achieving the total financial objective.
 PROCESS

1. Research Market Conditions

Analyze the market into which the product or service will be released. It is important to who potential
customers are, what they seek, and their financial capabilities. This offers valuable information that can
be utilized later in calculations to generate more precise estimations.

2. Establish the product's target price

One should establish the ideal sale price for their product or service. The calculation of a target price
depends on various factors that may vary according to the industry, market conditions, and the company's
objectives. For instance, a product targeting wealthy consumers might justify a higher price, while a
company aiming to enhance public awareness could opt for a lower price point to boost overall sales and
start cultivating a loyal customer

3. Determine your target profit margin

The target profitability for the product or service should be established to align with the financial goals set
by the individual or organization. Similar to the sale price, numerous factors can influence the ideal profit
margin. Important considerations encompass the financial capabilities, the company’s short- and
long-term goals, as well as any financial obligations that the company may have.

4. Calculate the target cost

The desired profit margin per sale should be subtracted from the target sale price. The resulting value
represents the target cost. This indicates the permissible financial expenditure required to generate a
single sale of the product at the intended price, ensuring the achievement of the desired profit margins.

Target Cost = Selling Price - Desired Profit

5. Close the cost gap, if there is any, and examine potential areas for cost reduction

The cost gap refers to the difference between estimated product cost and target cost. To bridge the gap, a
company may examine the following:

●​ Is it possible to reduce certain materials, such as minimizing packing materials?

●​ Is it possible to replace a more expensive material with a less costly option while maintaining the
same level of quality?
●​ Is it possible to achieve efficiency gains without sacrificing quality, such as by employing less
skilled personnel?
●​ Is it possible to enhance productivity by boosting motivation, for instance?
Example:

ABC Cosmetics is interested in producing a new mascara product, and the company uses a target costing
strategy to find the target cost per unit of their new mascara.

First, ABC Cosmetics performs market research and finds that customers pay a maximum of $9 on
average for mascara in the current market. This means ABC's target price for its new product is $10. The
company's desired profit margin on the new mascara product is 20% of the target price, which equals $2.
By subtracting the profit margin from the target price, ABC Cosmetics calculates a target cost per unit of
$8. After calculating the target cost of the new mascara product, the company creates a plan to
manufacture the products while aligning with the target cost per unit.

ADVANTAGES

Better decision making. Target costing facilitates effective data analysis. It enables informed
decision-making by comparing the outcomes. Target costing offers a structured framework wherein the
business must make decisions.

Competitive advantage. Target costing establishes a benchmark for production costs, which the business
must try to achieve. The business makes an effort to minimize production costs as much as possible. It
allows the business to provide goods and services at lower prices than its competitors.

Innovation. The product design team creates products based on customer needs while focusing on
providing goods and services in a cost efficient manner. This approach motivates product designers to
develop better goods in order to meet customer expectations.

Profitability. Target costing focuses on reducing costs and maximizing efficiency. As a result, it enables
the business to maintain a lower cost level and boost profit margins.

Cost reduction. Target costing helps to pinpoint and remove unnecessary costs. It helps to lower
production costs compared to the competitors. Target costing helps to increase the sales of a business by
making the products more appealing to consumers.

Customer focus. Another benefit of target costing is its role in product design. Target costing ensures that
the goods are designed to meet consumers needs. Producing affordable and high-quality products. This
approach helps in fulfilling customer expectations.

Proper use of resources. Target costing removes unnecessary activities from the production process.
Target costing ensures that resources are used effectively by minimizing inefficient activities.
More and better options. Target costing encourages innovation to stay ahead of the competition. This
benefits consumers because it offers them innovative and modern products. It also helps to increase the
variety of goods available in the market.

CHALLENGES

Time-consuming. Target costing necessitates collaboration among numerous departments of the firm.
This collaborative effort contributes to an accurate cost analysis. The time-consuming nature of the report
review procedure will cause delays.

Overemphasis on cost. Starting costs may overemphasize cost reduction. This will result in a decline in
quality and innovation. This may also result in lower consumer satisfaction with goods and services.

Limited applicability. Target costing is often used in the industrial business. However, target costing is
difficult to implement in the service sectors, such as hospitality and tourism. Target costs may not be
appropriate for customized or unique products.

Difficulty in establishing targets. Estimating manufacturing costs is difficult. Setting reasonable target
costs and profit margins is difficult. It is difficult to determine target expenses while considering shifting
factors. These variables could be the result of a market change or a shift in consumer needs.

Inflexibility. Another downside of target costing is its rigidity. The market environment, as well as
several other factors are constantly changing. When changes occur in multiple sectors, it is extremely
difficult to adjust. The product cost and pricing should be adjusted to reflect the changes. Unexpected
market developments cause a lack of flexibility in target costs.
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Mohan, A. (2021, January 4). Target Costing: meaning, objectives, features, steps, advantages,
disadvantages, process and example. Learn Accounting: Notes, Procedures, Problems and
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