1. Target Costing
If you cannot find the time to do it right, how will you find the time to do it over?

2. 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

3. Target Costing Characteristics
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 to these questions before committing to the project

4. 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
Saves costly changes later on

5. 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
Forces consideration of manufacturability
Reduces the need for subsequent changes

6. Target Costing Characteristics
Cost control at all phases of the product life cycle
Design
Production
Delivery/setup
Customer’s cost of ownership
Emphasizes future sales instead of current cost savings
Service and repair
Disposal and recycling

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

8. 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

9. 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

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

11. 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

12. Establishing the Target Cost
Unit Selling Price
Product Life Stage

13. Establishing the Target Cost
Gradual decline as volume increases
Competitors enter market, straining supply of resources
Unexpected events affect cost of resources
Unit Cost
Product Life Stage

14. 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

15. 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

16. Achieving the Target Cost
Rank customer requirements (exhibit 1)
What does the customer want?
How important is each function to the customer?
What do we and our competitors currently offer?
Competitive evaluation (exhibit 1)
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?

17. Achieving the Target Cost

18. 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.

19. 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.

20. 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

21. Achieving the Target Cost

22. Achieving the Target Cost
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 (exhibit 3)
Determine the current cost of each component or activity and convert to percentage of total cost
Costs include materials, labor, overhead, etc.

23. Achieving the Target Cost

24. Achieving the Target Cost
Relate the components to customer requirements (exhibit 4)
Develop Quality-Function-Deployment matrix
Indicates which components have the greatest impact on customer requirements
Develop a functional ranking (exhibit 5)
Indicates the importance of each component to the customer
Based on the component’s contribution to providing the desired functions

25. Achieving the Target Cost

26. Achieving the Target Cost
Contribution weight assigned to the component * importance to the customer (exhibit 1)

27. Achieving the Target Cost
Identify components for cost reduction
Calculate a value index for each major component (exhibit 6)
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

28. Achieving the Target Cost

29. Achieving the Target Cost
Generate cost reduction ideas
Eliminate over-engineering
Eliminate, replace, combine, rearrange
Seek ways to accomplish the goal at less cost
Consider the process as well as the product
More efficient manufacturing processes
Better logistics
Etc.

30. Achieving the Target Cost
Test the ideas
Will they be effective?
Are they technologically feasible?
Is there a domino effect?
Construct a component interaction matrix (exhibit 7)
Do activities interact?
Estimate the achievable costs
Use activity-based costing, cost tables, etc.

31. Achieving the Target Cost

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

33. 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