Target Costing (#57)

In this podcast episode, we discuss, the nature of target costing and how the process functions. Key points made are:

  • Most of the cost structure of a product is already built into it during the design stage. Any later cost variances cannot usually be mitigated.

  • Target costing is about deciding what price the market will bear, and designing a product to sell at that price, with a predetermined margin. If the targeted margin cannot be achieved, then the product is not released.

  • Target costing involves extensive market research, market share analysis, and feature analysis.

  • The determination of all component costs during the design stage is the role of the cost accountant. This person will need to compile cost estimates at different volume levels, to arrive at more accurate margin models.

  • It will likely take multiple design iterations to arrive at the targeted product margin.

  • The design team includes engineering, production, purchasing, marketing, and accounting personnel.

  • It may be acceptable to reduce a product’s reliability and durability in order to reach a targeted margin. Other options are to substitute parts, change distribution channels, and outsource production.

  • There will be a series of milestone reviews, at which the team must meet an incremental target margin goal. If this cannot be done, the project will be shelved, though it may be restarted if the circumstances change.

  • This approach can greatly increase profits, but it requires massive inter-departmental cooperation.

Related Courses

Activity-Based Costing
Cost Accounting Fundamentals