Target Costing – Insurance Against Failure


Post by Dr Walter Dolan

Thinking about creating a new product for the market place?  You will benefit from conducting Target Costing. Or, is ascertaining accurate costings an insurmountable hurdle?

Target costing has become vital when making decisions about introducing a new product.

Traditionally, the selling price for a new product was arrived at by estimating the total cost of the individual product and adding a mark-up to give an acceptable profit for the product. However, consumer resistance to the selling price often means less product sells than hoped for. So where to from here?

Best we conduct Target Costing!

A target costing approach first establishes a selling price that the market is prepared to pay, deducts a reasonable profit margin and thus arrives at the maximum allowed cost for the product. This maximum allowed cost is virtually ‘set in concrete’, and the combined efforts of researchers, designers, and engineers must not arrive at a prototype cost in excess of the allowed cost. Anecdotally, 80% of the product cost is usually fixed at the stage of accepting the prototype, and there is often little scope for cost reduction after the product is launched. So, best we solve the problem before hand, not after!

Thus, product cost must be tackled at the design stage.

What happens if designers and engineers – in spite of good intentions – finish with a product cost in excess of allowed cost?
At this point a ‘value engineering’ approach is adopted. Value engineering involves analysing the product under four aspects:

Function • Appeal • Quality • Cost

The aim is cost reduction. Clearly, any trade-off is not likely to be in function, unless the functioning capability can be maintained.
There may be an opportunity in the area of operations for cost reductions. On the other hand, quality may be regarded as not negotiable. This brings us to appeal and cost. There may also be room for a trade-off between appeal (appearance, cosmetics and the like) and the cost applicable. But this must be assessed before production-ready for market.

Finally, the method used to assign overhead expense to the product is worth revisiting. Was the treatment of overhead expense carried out incrementally or was there an allocation of existing overheads?
Maybe the overheads just are too high to sustain profitability.

So, how do we reduce overheads? Well, there are many ways, notwithstanding using or creating a separate entity (or newly created business) with less overheads to produce and market the product.

There are many variables that add to costs, all of which do not make Target Costing simple, but it sure is critical to the survival of  your new venture.

If you have some thoughts on the matter or need more information, then post a comment or a request.

Hope this helps

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