1. Tehran University Management Faculty Management Accounting Presentation Target Costing Vina Tarjoman Supervisor : Dr. Nikbakht November,2006

2. Target Costing

3. Outline Definition of target costing General concept Target costing characteristics Target costing process Establishing target cost Achieving target cost Organizational impact Conclusion

4. What is Target Costing

5. A target cost is the allowable amount of cost that can be incurred on a product and still earn the required profit from that product A strategic profit and cost management process  Price-led  Customer-focused  Design-centered  Cross-functional  Life cycle oriented  Value Chain-based

6. General Concept  Target cost is the cost that can be incurred while still earning the desired profit  Selling price – desired profit = target cost  The customer sets the price  Profit must be achieved through cost control

7. Target Costing Characteristics  To these Contradicts the traditional approach: design product, determine cost, set price  Intense customer focus  What do they want?  How much will they pay for it?  Can we make a profit on it? Want answers questions before committing to the project

8. Target Costing Characteristics Cost control from the beginning  70-90% of costs are committed to at the design stage  Focus on product and process design to engineer out costs from the beginning

9. Target Costing Characteristics Product, manufacturing process, delivery process designed simultaneously  Ensures features customers demand, but within acceptable cost parameters  Eliminates the temptation to add costly features Customers may not value the added features

10. Target Costing Characteristics Cost control at all phases of the product life cycle  Design  Production  Delivery/setup  Customer’s cost of ownership  Service and repair  Disposal and recycling

11. Cross-Functional Team  Marketing  Design/engineering  Manufacturing  Purchasing  Including suppliers  Distribution  Service/support  Cost accounting  Finance  Legal

12. Concept development Planning and market analysis Production design and value engineering Production and continuous improvement Target price Profit margin Target cost Establishing the Target Price Achieving the target cost The Target Costing Process

13. Target Costing Process Two stage process  Establish the target cost  Market research  Product planning, concept development stages  Achieve the target cost  Value engineering, continuous improvement  Design stage  Continuous improvement in later stages

14. Establishing the Target Cost Determine the product and its market  Who is the target market?  What do they want?  What do competitors offer? Introduce concept or prototype  Evolutionary or revolutionary?  Refine until it meets customer needs

15. Establishing the Target Cost Determine the selling price  Must be acceptable to the customer  Must be able to withstand competition Existing price +/- value of features added or deleted Consensus of focus group Price predicted to achieve a desired market share

16. Establishing the Target Cost Determine the required profit  Return on sales Desired return Historical return for similar products Industry average for similar products  Return on sales will fluctuate over the life of the product  Price and costs fluctuate

17. Establishing the Target Cost Unit price, cost and profit are almost meaningless because they fluctuate  Life cycle totals are more meaningful Total expected revenue throughout product life- Total desired profit throughout product life = Total target cost

18. Achieving The Target Cost

19. TARGET COSTING... Achieving Target Costs Initial Cost Estimate s Perform Value Engineerin g Perform Cost Analysis Design Products/ Processe s Release Design to Productio n COMPUTE COST GAPDESIGN COSTS OUTPRODUCE Compare To Target Cost ACTUAL COST Estimate Achievabl e Cost Undertake Continuous Improvemen t

20. Achieving the Target Cost Must include the features the customer wants while maintaining cost at or below target Want to meet the customers needs, but not exceed them Eliminating desired features will result in an undesirable product Adding unwanted features will increase cost Failing to keep cost at or below target will result in unacceptable profits

21. Achieving the Target Cost Determine the cost gap between current cost and allowable cost  Current cost is based on Currently used components Current suppliers Current manufacturing processes Current distribution network Etc.

22. Achieving the Target Cost Decompose the cost gap (exhibit 2)  Life cycle decomposition  Cost reduction goals are divided among the functions in the product’s life cycle  Design/engineering  Manufacturing  Sales/distribution  Service/support  General administration  Etc.

23. Achieving the Target Cost  Value chain decomposition Cost reduction targets are divided among internal and external activities  Internal costs  Labor, overhead, selling and administrative costs, etc.  External costs  Components and services acquired from suppliers, etc.  Often represent a large proportion of total cost

24. Achieving the Target Cost

25. Perform value engineering to design out costs without sacrificing needed features  Perform a cost analysis of major components and activities  List components or activities and their functions  Calculate a cost breakdown  Determine the current cost of each component or activity and convert to percentage of total cost  Costs include materials, labor, overhead, etc.

26. Achieving the Target Cost Rank customer requirements (table 1)  What does the customer want?  How important is each function to the customer?  What do we and our competitors currently offer?  Competitive evaluation (table 2)  Do our current product features meet the customer needs?  Are the customers’ needs met, unmet or exceeded?  What can we learn from our competitors’ products?

27. Prouct FeaturesCustomer RankingRelative Customer Ranking Great fit30%0.30 Large selection15%0.15 High product quality15%0.15 Trendy appearance10%0.10 Reduced shopping time15%0.15 Advising,consulting5%0.05 Delivery time10%0.10 Sum:100%1.00 Table 1: Cusomer Requirements

28. Achieving the Target Cost  Relate the components to customer requirements (table 2)  Develop Quality-Function-Deployment matrix  Indicates which components have the greatest impact on customer requirements  Develop a functional ranking (table 3)  Indicates the importance of each component to the customer  Based on the component’s contribution to providing the desired functions

29. ProductRCRSuitServiceCR CutFabric and access. Measurements Customer Great fit0.301=0.253=0.75D Big choice0.153=0.751=0.25C High product quality0.153=0.751=0.25B Trendy appearance0.103=0.602=0.40B Reduced shopping0.153=1.00D Conulting0.053=1.00B Delivery time0.101=0.20 3=0.60A Sum:1.00 RCR= relative customer ranking CR= Competitive ranking 3=strong correlation 2=modrate correlaion 1=weak correlation Degree of performance: A=excelent,B=good, C= moderate, D= low Table 2: QFD-Matrix for Customer Requirements and Product Components

30. ProductRC R SuitService CutFabric and access. Measurements Customer Great fit0.300.25*0.30=0.080.75*0.30=0.22 Big choice0.150.75*0.15=0.110.25*0.15=0.04 High product quality 0.150.75*0.15=0.110.25*0.15=0.04 Trendy appearance 0.100.60*0.10=0.060.40*0.10=0.04 Reduced shopping 0.150.15*1.00=0.15 Consulting0.050.05*1.00=0.05 Delivery time0.100.25*0.10=0.020.20*0.10=0.020.60*0.10=0.06 Sum:1.000.160.280.220.34 Table 3 : QFD- Computing the componenet value

31. Achieving the Target Cost  Identify components for cost reduction  Calculate a value index for each major component (table 4)  Component cost as a percentage of total cost divided by the component’s relative importance to the customer  Index greater than 1  Disproportionately high cost in relation to its importance  Implies cost reduction should be considered  Do not manage by the numbers alone

32. Product component ValueAllowable Cost per unit Value index Cut0.160.16*$324=$51.240.16 / 0.20=0.8 Fabric and accessories 0.280.28*$324=$90.270.28 / 0.25=1.12 Measurement0.220.22*$324=$71.280.22 / 0.20=1.1 Service0.340.34*$324=$110.160.34 / 0.35=0.97 Table 4: allowable cost for product component

33. Achieving the Target Cost  Generate cost reduction ideas  Seek ways to accomplish the goal at less cost  Consider the process as well as the product  More efficient manufacturing processes  Better logistics  Etc.

34. Achieving the Target Cost  Test the ideas  Will they be effective?  Are they technologically feasible?  Estimate the achievable costs  Use activity-based costing, cost tables, etc.

35. Make the Decision Achieve target cost? Close enough ? Release design for production Abort project Repeat value engr.? Value engineering Yes No Yes No Yes

36. Organizational Impact Positives  Customer focus  Cross-functional integration  Open sharing of information  Better process understanding Negatives  Too much customer focus  Potential organizational conflict  Too much pressure to attain targets  Longer development times

37. Conclusion  Selecting target costing process  Using of cost reduction culture  Directing material producer  Sharing staff in company’s achievment  Using of complete information systems

38. reference 1. Alexander Krueger, Helmut Hergeth, “Target costing and mass customization”, Journal of Textile and Apparel,Technology and Management,Volume 5, Issue 1, Winter 2006. 2.Horongren and foster, “Cost Accounting and Mongagerial Emphasis”, 8 th ed, prentice Hall. Inc, newjersey. USA, 1994 3.Castellano and Young, “Speed splasher an interactive team – based target costing exercise”, journal of Accounting Education 2003, pp 149-155 www.elsevier.com/locate/jaccedu www.elsevier.com/locate/jaccedu

39. 4.I busuki, U., Kaminski, P.C., 2003. “Value engineering and target costing as methodology of work in the product development process”. Master Thesis, Polytechnic School of the University of Sao Paulo, Sao Paulo. 5.Wu. H. H. 2003. Quality management: “A Ttarget Costing Approach, Journal of Chinese Institute of Industrialo Engineers 20,1: 13-20 6.Cooper, R. and Slagmulder, R. 1997. “Target Costing and Value Engineering”. Productivity Press, Portland, OR, U.S.A.

40. Thanks for your attention

41. Any Questions Any Questions ?