AN OVERVIEW OF TARGET COSTINGIntroductionMany managers often underestimate the power of target costing as a serious competitive tool. When CEOs read the word “costs,” they naturally assume that it is a topic that concerns finance or accounting staff. They don't understand the fact that target costing is actually a systematic process of managing profits and costs. What is target costing? CAM-I defines target cost as the maximum amount of cost that can be incurred on a product and from which the required profit margin can still be earned. product. This is captured by the equation Target Cost = Price – Profit At first glance the equation appears to reverse the familiar cost plus price equals profit used by many companies. However, behind the inversion of the equation are two very powerful ideas; (1) market price and profit margins are exogenous variables that are beyond the control of an organization's management; and (2) financial and customer markets drive cost planning, not the other way around. Target costing, therefore, is a market-driven system in which customer needs and the likely reaction of competitors drive product and profit planning. Target costing has six key principles:11. Price-driven costs. Market prices are used to determine eligible or target costs.2. Focus on customers. Customer requirements for quality, cost and time are simultaneously incorporated into product and process decisions and drive cost analysis. The value (to the customer) of any features and functionality integrated into the product must be greater than the cost incurred in providing those features and functionality.3. Focus on the design. Cost control is emphasized in the product and process design phase. Therefore, technical changes must be made before the start of production, resulting in reduced costs and reduced “time-to-market” for new products.4. Cross-functional teams. Cross-functional product and process teams are responsible for the entire product, from initial concept to final production.5. Value chain involvement. All members of the value chain, such as suppliers, distributors, service providers and customers, are included in the target costing process.6. Reduced life cycle costs. Total life cycle costs are minimized for both the manufacturer and 1 These principles are adopted from S. Ansari, J. Bell and CAM-I Target Cost Core Group, Target Costing, The Next Frontier in Strategic Cost Management, ( Irwin/ McGraw-Hill, 1997).2the customer. Life cycle costs include the purchase price, operating costs, maintenance and distribution costs. The Target Costing Process To maximize cost control and enhance bottom-line improvement, most companies set relatively aggressive targets. The process begins when top management sets a cost target for a new product (e.g.