Target Costing

Definition

Target costing is a pricing strategy where a company determines the desired profit margin and then works backward to establish the maximum allowable cost for a product or service. This approach encourages cost control and efficient resource allocation by ensuring that costs are aligned with market expectations while still achieving profitability.

5 Must Know Facts For Your Next Test

1. Target costing emphasizes proactive cost management from the very beginning of the product development process.
2. This method requires collaboration across departments, including marketing, engineering, and production, to ensure that products meet customer expectations while staying within cost limits.
3. Target costing is especially useful in competitive markets where price pressures necessitate tight control over costs to maintain margins.
4. By focusing on the target cost, companies can identify opportunities for cost reduction without compromising quality or customer satisfaction.
5. This approach aligns closely with lean manufacturing principles, as it encourages continuous improvement and waste reduction throughout the product lifecycle.

Review Questions

• How does target costing influence the decision-making process in product development?
  • Target costing influences decision-making by setting a predetermined cost based on market conditions and desired profit margins. This backward approach means that product features, materials, and processes must be evaluated to ensure they align with the established target cost. As a result, teams are pushed to innovate and find cost-effective solutions while maintaining quality, leading to more strategic choices throughout the development phase.
• In what ways can target costing be integrated with activity-based management to enhance overall efficiency?
  • Integrating target costing with activity-based management (ABM) allows organizations to identify the activities that add value to products while controlling costs. ABM provides detailed insights into cost drivers, enabling teams to focus on activities that meet target costs effectively. This synergy enhances overall efficiency by aligning resources towards activities that support both cost objectives and customer satisfaction, ultimately improving profitability.
• Evaluate the long-term implications of using target costing on a company's competitive strategy in evolving markets.
  • Using target costing can significantly shape a company's competitive strategy by fostering a culture of cost consciousness and continuous improvement. In evolving markets, where customer preferences shift rapidly, this method allows companies to stay agile and responsive to market demands while controlling costs. Over time, organizations that effectively implement target costing may achieve sustainable competitive advantages through enhanced product value propositions, optimized resource utilization, and improved profitability.

Related terms

Cost-Volume-Profit Analysis: A financial analysis tool that helps companies understand how changes in costs and volume affect their operating income and net income.

Value Engineering: A systematic method to improve the value of a product by analyzing its functions and reducing costs without affecting quality.

Market Research: The process of gathering, analyzing, and interpreting information about a market, including information about the target audience and competitors.