The strategic cost management tool “target costing” incorporates customer-centric pricing principles instead of traditional firm-oriented pricing.
A target cost is a basis for establishing and controlling individual costs. The objective of target costs is to provide incentives to lower costs and increase the quantity of output in the same unit of time.
CIMA defines target cost as “a product cost estimate derived from a competitive market price.”
What is Target Costing?
Target costing is an approach for setting the budget based on a defined set of target indicators. Target costing is used as a method to set an appropriate budget based on established criteria for setting the budget.
The basic assumption behind target costing is that the use of the resources and their allocation will be based on the most appropriate use of the resources. The resources may be personnel, plants, raw materials, or other resources.
Target costing is a systematic procedure that employs data and information in a logical sequence of actions to establish and attain a product’s target cost. Additionally, the price and cost are set functionally for the stated product, which is determined by balancing the customer’s wants (benefits) with a market price that satisfies the company’s profitability goals.
Unlike cost-plus pricing, which begins by establishing the cost of a good or service, then the markup, and lastly the price of the good or service itself, target costing takes an entirely different method.
Target costing is a proactive strategy for cost management in which the first step is to search outside the organisation for the price that consumers are willing to pay in the marketplace for the good or service.
After establishing the target selling price, the following stage establishes the target volume and profit. After resolving all of these issues, the target price for the good or service is defined. In the case of production, a design is chosen based on the goal cost.
Target costing is similar to price-lead costing in that target costs are established by computing the competitive market cost and subtracting the target profit or needed profit margin from it. Additionally, this strategy is regarded as customer-driven and design-driven, with a larger emphasis on the features and timeliness that customers need from an item or service at a specific market price.
Target costing is a management technique that is used to provide a measure of cost control. It involves monitoring costs as a measure of the output provided and a function of time spent on the job. One important element of target costing that measures output is the “target output”, or product that is desired to be produced. It is normally an established “level” of output by which management plans to measure the company’s performance.