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Target costing is a cost used by a firm to reduce the cost of the product rather than its product life cycle. It is a management cost tool to reduce the overall cost of the product by having the help from production, engineering, research and design. Target costing concerned the setting of the target cost by subtracting the profit margin from the competitive market price. It is the maximum amount of cost that the firm can incurred to the product to earn a profit from a particular product's selling price. Management always makes use of this system to convene both the need of its customers and the company profit goals. Target costing particularly highlighted the reduction of costs during the planning and design stage of the product life cycle because the cost will be determined in this stage rather than development and production stage. This is an efficient way to set the cost because management set the cost in mind rather than waiting for the product to produce, and then set the cost and practice cost saving. This is too late if the firm set the product price after the product had produced. In comparing with traditional costing, the product costs are more likely to be measure in development and production stage.
Target costing is mostly involved product marketing managers, engineers and others who are parts of the design and development process of the product. Those management persons know the costs incurred rather than accountant. Target costing is popular in Japanese firm and they had used this approach to reduce the cost of the product such as Toyota, Toshiba and Nissan. When the Japanese taste had become more varied, the assembly oriented production grown, and this increased the demand for the diverse range of the products to shorten the product life cycle. As a result, there will be more focus on the cost of the product in manufacturing, design and development of the product. Thus, target costing is useful for the firms. There is some methods are promoted by target costing such as Just-in-Time, Total Quality Control, material Requirement Planning and Value Engineering.
In addition, target costing also supported four basic steps which are define the product, set the price and cost targets, then achieve the targets and lastly maintain competitive costs.
Advantages of Target Costing
Basically, company used the target costing method to plan the costs of product before they are introduced and to ensure that the low-margin products are not introduced which do not bring sufficient returns. There are additional purposes for companies to introduce target costing which vary from company to company.
Target costing used to reduce costs before the products are locked in, it provides a means to manage costs from the design stage to maximize the potential for cost reduction. Besides, target costing is also a tool that can used to control decisions such as design specifications and production techniques.
Furthermore, target costing also can be as analysis which highlights other problems. The discipline of target costing and the detailed review of costs can reveal more general managerial problems. It's also can act as driver for the cost improvement in the companies.
Lastly, target costing also used to encourage a focus on the customer. It stimulates behavior which is customer-focused and encourages all functions within the company to respond to market demand and competitive trends rather than internal performance indicators.
Disadvantages of target costing
Although have so many advantages as what is stated above, but it do have its disadvantages just like any other method. One of the disadvantages of target costing is the stress on the design team of companies using target costing. Design teams might feel stress and the entire burden on their shoulders because they need to determine whether the product will ultimately promote to the market or not due to it place a great emphasis on keeping cost below the target cost.
Besides, the producer might use the cost based target costing to squeeze the profit margins of suppliers, in that way to get the materials at as lower cost as possible. This over-emphasis on cost cuts often- blind producer to the real essence of target costing and will cause the possible misuse of the technique happened.
Lastly, the time costing might happen due to the development time of the product will be longer because the product is repeatedly designed to meet or below the target cost. This might bring a disadvantage to the product's company.
Key Principles of Target Costing
Target costing consist of several key principles. Target costing acted as price-led costing. Companies used this costing method to determine the market price. Besides, the target costing also focuses on the customers and also product's design. The value of the features and the function of the product must be greater than the cost of the product and need to meet the requirement of the customers. The entire products from initial concept through final production are responsible by the cross functional product and process teams. Furthermore, the value chain involvement members like suppliers, service providers, distributors and customers are also included in this costing process. Moreover, the total life cycle costs that are included operating, maintenance, distribution and purchase costs are minimized for both of the customers and producers. So that, target costing can be described as a systematic process of cost management and profit planning.
"The purpose of target costing is to identify the production cost for a proposed product, such that the product, when sold, generates the desired profit margin." based on Robin Cooper (1992). Unlike Robin Cooper, Takao Tamaka defines that, target costing is more elaborately as "the effort made at the planning and development stages to obtain a cost target set by management. Besides, he also stated that target costing method is used to bring the target cost and the estimated cost into line by better specification and design of the product". These definitions bring out the main objectives of the target costing system as explained in the foregoing paragraphs.
As the conclusion, target costing can be said to be the only system that involved two major elements within the control of the firm, which are target price and target profits. as the foremen who are the group leaders and also other technical personnel are involved in the design stage in redesigning or in modifying the design of the product. So that the commitment of all concerned to achieve the target cost is assured and for now, the only control that has to be exercised is to contain costs within the allowable or target cost.