Target costing is an approach to determine a product's life-cycle cost which should be sufficient to develop specified functionality and quality, while ensuring its desired profit. It involves setting a target cost by subtracting a desired profit margin from a competitive market price.
History
Target costing was developed independently in both USA and Japan in different time periods. Target costing was adopted earlier by American companies to reduce cost and improve productivity, such as Ford Motor from 1900s, American Motors from 1950s-1960s. Although the ideas of target costing were also applied by a number of other American companies including Boeing, Caterpillar, Northern Telecom, few of them apply target costing as comprehensively and intensively as top Japanese companies such as Nissan, Toyota, Nippondenso. Target costing emerged from Japan from 1960s to early 1970s with the particular effort of Japanese automobile industry, including Toyota and Nissan. It did not receive global attention until late 1980s to 1990s when some authors such as Monden (1992), Sakurai (1989), Tanaka (1993), and Cooper (1992) described the way that Japanese companies applied target costing to thrive in their business (IMA 1994). With superior implementation systems, Japanese manufacturers are more successful than the American companies in developing target costing. As a new strategy, target costing is replacing traditional cost-plus pricing strategy by maximizing customer satisfaction by accepted level of quality and functionality while minimizing costs.
Process of target costing
The process of target costing can be divided into three sections: the first section involves in market-driven target costing, which focuses on studying market conditions to identify a product's allowable cost in order to meet the company's long-term profit at expected selling price; the second section involves performing cost reduction strategies with the product designer's effort and creativity to identify the product-level target cost; the third section is component-level target cost which decomposes the production cost to functional and component levels to transmit cost responsibility to suppliers. plays a crucial role in the target costing process, particularly at the product level and the component level. Among the three aforementioned methods in achieving the target cost, VE is the most critical one because not only does it attempt to reduce costs, but also aims to improve the functionality and quality of products. There are a variety of practical VE strategies, including zero-look, first-look and second-look VE approaches, as well as teardown approaches.
Regarding the complexity of problems in the real world, implementing the target costing process often relies on the computer simulation to reproduce stochastic elements. For example, many firms use simulation to study the complex relationship between selling prices and profit margins, the impact of individual product decisions on overall group profitability, the right mix of products to enhance overall profit, or other economic modeling to overcome organizational inertia by getting the most productive reasoning. In addition, simulation helps estimate results rapidly for dynamic process changes.
Factors affecting target costing
The factors influencing the target costing process is broadly categorized based on how a company's strategy for a product's quality, functionality and price change over time. However, some factors play a specific role based on what drives a company's approach to target costing.
Factors influencing market-driven costing
Intensity of competition and nature of the customer affect market-driven costing. Competitors introducing similar products has been shown to drive rival companies to expend energy on implementing target costing systems such as in the case of Toyota and Nissan or Apple and Google. The costing process is also affected by the level of customer sophistication, changing requirements and the degree to which their future requirements are known. The automotive and camera industry are prime examples for how customers affect target costing based on their exact requirements.
Factors influencing product-level costing
Product strategy and product characteristics affect product-level target costing.
Target Value Design Decision Making Process (TVD-DMP) groups a set of energy efficiency methods at different optimization levels to evaluate costs and uncertainties involved in the energy efficiency process. Some major design parameters are specified using this methods including Facility Operation Schedule, Orientation, Plug load, HVAC and lighting systems.
The entire process consists of three phases: initiation, definition and alignment. Initiation stage involves developing a business case for energy efficiency using target value design (TVD) training, organization and compensation. The definition process involves defining and validating the case by tools such as values analysis and bench marking processes to determine the allowable costs. By setting targets and designing the design process to align with those targets, TVD-DMP has been shown to achieve a high level of collaboration needed for energy efficiency investments. This is done by using risk analysis tools, pull planning and rapid estimating processes.
Healthcare
Target costing and target value design have applications in building healthcare facilities including critical components such as Neonatal Intensive Care Units (NICUs). The process is influenced by unit locations, degree of comfort, number of patients per room, type of supply location and access to nature. According to National Vital Statistics Reports, 12.18% of 2009 births were premature and the cost per infant was $51,600. This led to opportunities for NICUs to implement target value design for deciding whether to build a single-family room or more open-bay NICUs. This was achieved using set-based design analysis which challenges the designer to generate multiple alternatives for the same functionality. Designs are evaluated keeping in mind the requirements of the various stakeholders in the NICU including nurses, doctors, family members and administrators. Unlike linear point-based design, set-based design narrows options to the optimal one by eliminating alternatives simultaneously defined by user constraints.
Construction
Jacomit et al. (2008) noted that about 15% of construction projects in Japan adopted target costing for their cost planning and management. In the U.S., target costing research has been carried out within the framework of lean construction as target value design (TVD) method and have been disseminated widely over construction industry in recent years. Research has proven that if being applied systematically, TVD can deliver a significant improvement in project performance with average reduction of 15% in comparison with market cost.
TVD in construction project considers the final cost of project as a design parameter, similar to the capacity and aesthetics requirements for the project. TVD requires the project team to develop a target cost from the beginning. The project team is expected not to design exceeding the target cost without the owner's approval, and must use different skills to maintain this target cost. In some cases, the cost can increase but the project team must commit to decrease and must try their best to decrease without impacting on other functions of the project.
In Scotland, guidance on the use of pain share/pain gain arrangements and target cost contracting was issued to public sector construction procurers in 2017. This guidance refers to reimbursement to contractors calculated in two stages:
- an initial target cost and the percentage basis for the gain share/pain share calculations are agreed, and during the project the contractor is paid on a cost reimbursement basis
- on conclusion of the project, the final target cost is compared to the actual cost. The final target cost will reflect the initial target cost and any employer changes and employer risk events which have occurred during the construction period, and changes should be recorded as they occur. If the actual cost is less than the target cost, the contractor is rewarded with a share of the "gain" according to the pre-determined percentage, and if the actual cost is greater than the target cost, the "pain" is likewise shared between the employer and the contractor.
The guidance stresses the importance of "good faith and reasonableness" in calculating the target cost,