TARGET COSTING’S USE IN THE MAJOR LEADING

COMPANIES IN THE WORLD

A report submitted in partial fulfillment of the requirement for the degree of

MASTERS OF BUSINESS ADMINISTRATION

(2019-2021)
ACKNOWLEDGEMENT

In preparation of my assignment of AFM I would like to show my gratitude to some respective people
who helped directly or indirectly in completion of my work.

Firstly I would like to thanks my parent for giving encouragement and invaluable assistance to me
without which it would have not been possible to complete my assignment.

Secondly I would like to show my gratitude to my AFM professor DR. LIAQAT ALI for assigning
such topic so that I could discover new ideas and build my knowledge more. By doing this assignment
I got enriched with many information which can help me in future.
CONTENT
  INTRODUCTION

TARGET COSTING is a system under which a company plans in advance for the price points,
product costs, and margins that it wants to achieve for a new product. If it cannot manufacture a
product at these planned levels, then it cancels the design project entirely. With target costing, a
management team has a powerful tool for continually monitoring products from the moment they
enter the design phase and onward throughout their product life cycles. It is considered one of the
most important tools for achieving consistent profitability in a manufacturing environment

DEFINITION :- Target costing is defined as "a disciplined process for determining and achieving a
full-stream cost at which a proposed product with specified functionality, performance, and quality must
be produced in order to generate the desired profitability at the product’s anticipated selling price over a
specified period of time in the future.’ This definition encompasses the principal concepts: products
should be based on an accurate assessment of the wants and needs of customers in different market
segments, and cost targets should be what result after a sustainable profit margin is subtracted from what
customers are willing to pay at the time of product introduction and afterwards.
The fundamental objective of target costing is to manage the business to be profitable in a highly
competitive marketplace. In effect, target costing is a proactive cost planning, cost management,
and cost reduction practice whereby costs are planned and managed out of a product and business early
in the design and development cycle, rather than during the later stages of product development and
production.

Target Costing = Selling Price – Profit Margin

 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
 1) Market-driven target costing
Market driven target costing is the first section in the target costing process which focuses on studying
market conditions and determining the company’s profit margin in order to identify the allowable cost of
a product. Market driven costing can go through 5 steps including: establish company’s long-term sales
and profit objective; develop the mix of products; identify target selling price for each product; identify
profit margin for each product; and calculate allowable cost of each product.
Company’s long-term sales and profit objectives are developed from an extensive analysis of relevant
information relating to customers, market and products. Only realistic plans are accepted to proceed to
the next step. Product mix is designed carefully to ensure that it satisfies many customers, but also does
not contain too many products to confuse customers. Company may use simulation to explore the impact
of overall profit objective to different product mixes and determine the most feasible product mix.
Target selling price, target profit margin and allowable cost are identified for each product. Target
selling price need to consider to the expected market condition at the time launching the product.
Internal factors such as product’s functionality and profit objective, and external factors such as
company’s image or expected price of competitive products will influence target selling price.
Company’s long-term profit plan and life-cycle cost are considered when determining target profit
margin. Firms might set up target profit margin based on either actual profit margin of previous products
or target profit margin of product line. Simulation for overall group profitability can help to make sure
achieving group target. Subtracting target profit margin from target selling price results in allowable cost
for each product. Allowable cost is the cost that can spend on the product to ensure meeting profit target
if selling it at target price. It is the signal about the magnitude of cost saving that team need to achieve.

2) Product-level target costing

Following the completion of market-driven costing, the next task of the target costing process is
product-level target costing. Product-level target costing concentrates on designing products that satisfy
the company's customers at the allowable cost. To achieve this goal, product-level target costing is
typically divided into three steps as shown below.
The first step is to set a product-level target cost. Since the allowable cost is simply obtained from
external conditions without considering the design capabilities of the company as well as the realistic
cost for manufacturing, it may not be always achievable in practice. Thus, it is necessary to adjust the
unachievable allowable cost to an achievable target cost that the cost increase should be reduced with
great effort. The second step is to discipline this target cost process, including monitoring the
relationship between the target cost and the estimated product cost at any point during the design
process, applying the cardinal rule so that the total target costs at the component-level does not exceed
the target cost of the product, and allowing exceptions for products violating the cardinal rule. For a
product exception to the cardinal rule, two analyses are often performed after the launch of the product.
One involves reviewing the design process to find out why the target cost was unachieved. The other is
an immediate effort to reduce the excessive cost to ensure that the period of violation is as short as
possible. Once the target cost-reduction objective is identified, the product-level target costing comes to
the final step, finding ways to achieve it. Engineering methods such as value engineering (VE), design
for manufacture and assembly (DFMA), and quality function deployment (QFD) are commonly adopted
in this step.

 The PRIMARY STEPS in the target costing process are:

1) Product research. The first step is to review the marketplace in which the company wants to
sell products. The design team needs to determine the set of product features that customers
are most likely to buy, and the amount they will pay for those features. The team must learn
about the perceived value of individual features, in case they later need to det ermine what
impact there will be on the product price if they drop one or more features. It may be
necessary to later drop a product feature if the team decides that it cannot provide the
feature while still meeting its target cost. At the end of this process, the team has a good
idea of the target price at which it can sell the proposed product with a certain set of
features, and how it must alter the price if it drops some features from the product.
 2) Calculate maximum cost. The company provides the design team with a mandated gross
margin that the proposed product must earn. By subtracting the mandated gross margin from
the projected product price, the team can easily determine the maximum target cost that the
product must achieve before it can be allowed into production.

3) Engineer the product. The engineers and procurement personnel on the team now take the
leading role in creating the product. The procurement staff is particularly important if the
product has a high proportion of purchased parts; they must determine component pricing
based on the necessary quality, delivery, and quantity levels expected for the product. They
may also be involved in outsourcing parts, if this results in lower costs. The engineers must
design the product to meet the cost target, which will likely include a number of design
iterations to see which combination of revised features and design considerations results in
the lowest cost.

4) Ongoing activities. Once a product design is finalized and approved, the team is
reconstituted to include fewer designers and more industrial engineers. The team now enters
into a new phase of reducing production costs, which continues for the life of the product.
For example, cost reductions may come from waste reductions in production (known as
kaizen costing), or from planned supplier cost reductions. These ongoing cost reductions
yield enough additional gross margins for the company to further reduce the price of the
product over time, in response to increases in the level of competition.

 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.] Characteristics of
product strategy such as number of products in line, rate of redesign operations and level of innovation
are shown to have an effect. Higher number of products has a direct correlation with the benefits of
target costing. Frequent redesigns lead to the introduction of new products that have created better
benefits to target costing. It has to be noted that the value of historical information reduces with greater
innovation, thereby, reducing the benefits of product level target costing.
The degree of complexity of the product, level of investments required and the duration of product
development process make up the factors that affect the target costing process based on product
characteristics. Product viability is determined by the aforementioned factors. In turn, the target costing
process is also modified to suit the different degrees of complexity required.
 Factors influencing component-level costing
Supplier-Base strategy is the main factor that determines component-level target costing because it is
known to play a key role in the details a firm has about its supplier capabilities.[1] There are three
characteristics that make up the supplier-base strategy, including the degree of horizontal integration,
power over suppliers and nature of supplier relations. Horizontal integration captures the fraction of
product costs sourced externally. Cost pressures on suppliers can drive target costing if the buying
power of firms is high enough. In turn, this may lead to better benefits. More cooperative supplier
relations have been shown to increase mutual benefits in terms of target costs particularly at a
component level.

 APPLICATION OF TARGET COSTING

Target costing is most applicable to companies that compete by continually issuing a stream of new
or upgraded products into the marketplace (such as consumer goods). For them, target costing is a
key survival tool. Conversely, target costing is less necessary for those companies that have a small
number of legacy products that require minimal updates, and for which long-term profitability is
more closely associated with market penetration and geographical coverage (such as soft drinks).

The target costing concept has limited application in a services business where labor comprises the
primary cost.

Target costing is an excellent tool for planning a suite of products that have high levels of
profitability. This is opposed to the much more common approach of creating a product that is based
on the engineering department’s view of what the product should be like, and then struggling with
costs that are too high in comparison to the market price.

FEW EXAMPLES OF COMPANIES USING TARGET COSTING

 AUTOMOBILE COMPANY – TOYOTA

INTRODUCTION
Toyota Motor Corporation is a Japanese multinational automotive manufacturer headquartered
in Toyota, Aichi, Japan. In 2017, Toyota's corporate structure consisted of 364,445 employees
worldwide and, as of September 2018, was the sixth-largest company in the world by revenue. As of
2017, Toyota is the largest automotive manufacturer.
Toyota was the world's first automobile manufacturer to produce more than 10 million vehicles per year
which it has done since 2012, when it also reported the production of its 200-millionth vehicle.[ As of
July 2014, Toyota was the largest listed company in Japan by market capitalization and by revenue.
The company was founded by Kiichiro Toyoda in 1937, as a spinoff from his father's company Toyota
Industries to create automobiles. Three years earlier, in 1934, while still a department of Toyota
Industries, it created its first product, the Type A engine, and its first passenger car in 1936, the Toyota
AA. Toyota Motor Corporation produces vehicles under five brands, including the Toyota
brand, Hino, Lexus, Ranz, and Daihatsu. It also holds a 16.66% stake in Subaru Corporation, a 5.9%
stake in Isuzu, a 5.5% stake in Mazda, as well as joint-ventures with two in China (GAC
Toyota and Sichuan FAW Toyota Motor), one in India (Toyota Kirloskar), one in the Czech
Republic (TPCA), along with several "nonautomotive" companies. TMC is part of the Toyota Group,
one of the largest conglomerates in Japan.

Application of target costing