Target costing is a strategic cost management technique used to determine the maximum cost that can be incurred on a product or service while still ensuring profitability. Here are the steps typically followed in target costing:
1. Market Research and Analysis: The process begins with comprehensive market research and analysis to understand customer needs, preferences, and price expectations. This includes studying competitors' offerings, market trends, and customer feedback.
2. Set Target Selling Price: Based on market research, a target selling price is determined. This price should be competitive in the market and provide value to customers while also generating the desired level of profitability for the company.
3. Identify Target Profit Margin: The target profit margin is established by subtracting the desired profit from the target selling price. This margin represents the profit that the company aims to achieve from the sale of the product or service.
4. Determine Target Cost: The target cost is calculated by subtracting the desired profit margin from the target selling price. This represents the maximum allowable cost that can be incurred to produce the product or service while still achieving the target profit margin.
5. Value Engineering/Analysis: Value engineering techniques are employed to identify opportunities for cost reduction without compromising product quality or customer satisfaction. This involves analyzing the functions and features of the product or service and finding more cost-effective ways to deliver them.
6. Cost Reduction and Optimization: Once potential cost-saving opportunities are identified through value engineering, efforts are made to implement cost reduction measures across the product development and production processes. This may involve redesigning components, optimizing manufacturing processes, or sourcing materials more efficiently.
7. Continuous Monitoring and Improvement: Target costing is an iterative process that requires continuous monitoring of costs and performance against targets. Throughout the product lifecycle, costs are tracked and compared to the target cost to ensure that profitability objectives are being met. Any deviations from the target cost are investigated, and corrective actions are taken as necessary to realign costs with targets.
By following these steps, companies can effectively manage costs while delivering products or services that meet customer expectations and achieve the desired level of profitability in the market.
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