Costpluspricing

Under traditional approaches to pricing, businesses calculate the cost of manufacturing and selling a product, and then add mark up, to give the profit element. These methods are known as "cost plus pricing".

Step1:IdentifyCost Step2:calculateProfit(MarkuporMargin) Step3:Determinesellingprice

As product life cycles have become much shorter, the planning, development and design stage of a product is critical to an organisation's cost management process. Cost reduction must be considered at this stage of a products life cycle, rather than during the production process.

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Implementingtargetcosting
(a) Define product specification and estimate anticipated sales volume.

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Target costing involves setting a selling price for your product by reference to the market. From this your desired profit margin is deducted leaving you with a target cost.

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Step1:Determinesellingprice Step2:calculateProfit(MarkuporMargin) Step3:IdentifyCost

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A major criticism of cost plus pricing techniques is that they do not consider any external factors (eg demand for product; no. of competitors, etc). They are therefore unlikely to maximise the profits that a business will generate.

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(b)

Set a target selling price at which the company will be able to achieve the desired market share. Required profit is estimated based on profit margins or return on investment. Target cost is calculated as: Target selling price Less: target profit Target cost $ X (X) X

(c) (d)

(e)

The estimated cost of the product is calculated based on the product specification and current cost levels. Estimated Product Cost Target Cost = Cost Gap

(f) (g)

Efforts are made to close the cost gap. Aim to "design out" costs before production starts. Negotiate with customer on price before deciding whether the project will go ahead.

(h)

Required What is the target cost for annual production?

ClosingaTargetCostGap
Reducing the number of components Using standardized components Training staff in more efficient techniques Cheaper staff New/efficient technology Cutting out non-value activities

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Buildings and equipment needed for production are to cost 5,000,000. Expected sales levels are 40,000 racquets pa. at a selling price of $67.50 per racquet.

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ABC Ltd, a sports goods manufacturer is about to launch a new model of tennis racquet on which it requires a pretax ROI (return on initial investment) of 30%.

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F5:PerformanceManagement

Targetcosting

Targetcostinginserviceindustries
The target costing approach is a sensible basis for estimating / driving down costs regardless of the type of business. However, due to the nature of service industries this process is more difficult in these businesses. Unlike manufacturing, service industries have the following characteristics which make cost and performance measurement more difficult: Simultaneity created at time consumed Heterogeneity quality / consistency varies Intangibility of what is provided Perishability cannot make in advance and store up.

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Quality of service Repeat customers etc

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In addition to these problems, service organisations will require more qualitative information to arrive at a price and evaluate performance eg

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