Essay:

Essay details:

  • Subject area(s): Engineering
  • Price: Free download
  • Published on: 7th September 2019
  • File format: Text
  • Number of pages: 2

Text preview of this essay:

This page is a preview - download the full version of this essay above.

The background to target costing

According to the CIMA Official Terminology a target cost is ‘a product cost estimate derived by subtracting a desired profit margin from a competitive market price.’

Target costing is a technique which developed in the early 1970s in Japan’s manufacturing industry as consumer demand for more diversified products and shorter product life cycles made the development and planning stages of new products more important. At the same time increased automation and decreased labour costs made standard costing less important as the main method of cost management within manufacturing companies. It was also recognised that the major part of product cost (around 80%) is determined at the design stage and that cost management needed to start earlier in the process. Sakurai (1989) defines target costing as a ‘cost management tool for reducing the overall cost of a product over its entire life cycle with the help of the production, engineering, R&D, marketing, and accounting departments’.The use of target costing spread as increased competition, and shorter life cycles, in global markets meant that companies needed to manage costs from the design stage forward, and launch products at prices to attract customers and forestall imitation. Target costing as a technique to achieve these aims spread into other countries and industries.

A review of the literature, however, reveals that target costing is not seen as a technique for cost control but a management process which involves all all disciplines and brings a focus on the customer from the beginning of the design process. Cooper and Chew (1996) describe the value of target costing as its ‘ability to bring the challenge of the marketplace back through the chain of production to product designers.’

challenge of the marketplace back through the chain of production to product designers.’

The target costing process

Historically, target costing has been developed and used in manufacturing companies, and therefore the language used to describe it in the literature, and in this part of the discussion paper, reflects that. Later sections of the paper will consider the application in service oriented organisations.

There are a number of stages in the process of target costing, as described by Gagne and Discenza (1995)

1. Establish a selling price for the new product and estimated sales volume from analysis of the market, and a target profit.

2. Determine the target cost by subtracting the profit from the selling price.

3. Perform functional cost analysis for individual components and processes.

4. Determine the estimated cost for the product.

5. Compare estimate with target.

6.If estimated cost exceeds target cost, repeat cost analysis value engineering to reduce estimated cost (aniterativeprocess).

 7. Make the final decision whether or not to introduce the product on cost estimate is on target.

8. Manage costs during production of the product.

Determining estimated costs

Once an overall target cost has been established for the product, it is necessary to identify the gap between the target cost and the estimate of the cost to build the product based on current processes, suppliers, productivity levels and materials. The gap gives an estimate of the excess cost which must be taken out of the new product (Cooper and Chew, 1996).

Achieving target costs

Once the gap has been identified between the target cost and the cost estimate, it is necessary to identify ways to close the gap. Target, or allowable, costs are identified for individual components or processes and cost improvement teams work to reduce the estimated costs to meet the target. However, cost-reduction requirements are not usually applied uniformly across all the components and subsystems of the product, but based on an informed assessment of how much cost can be removed from each component based on value to the customer, historical trends and other data. There may also be a process of negotiation between different production departments and between the company and its supplier to arrive at final target costs for the individual components. This process of cost reduction is an iterative one which continues until the target cost is reached or it is concluded that the overall target cost can not be reached and a decision is made not to launch the product.

Cost management techniques and target costing

Target costing is not so much a cost management technique but rather an overall approach or framework within which a range of different techniques are used for the cost management required to achieve the target costs.The choice of technique or combination of techniques varies from one company to another. Specific techniques mentioned in literature on target costing, some of which have already been used in the NHS, include:

•  value analysis

• value engineering

•  just-in-time (JIT)

•  total quality management (TQM)

•  MRP (materials requirements planning)

•  kaizen

•  lean manufacturing

•  activity based costing and management (ABC/M)

•  cause-effect analysis (‘fishbone’ diagrams).

Sakurai (1989) describes target costing as a system for reducing cost and promoting the use of cost-engineering tools such as those listed above.

Managing costs once production commences

Once the target costs have been determined, actual costs can be monitored and managed against the targets using the usual budgeting and costing methods such as standard costing.

Advantages of target costing

Obviously a primary reason why companies use target costing is to plan or project the costs of products before they are introduced, and to ensure that low-margin products are not introduced which do not bring sufficient returns. There are, however, additional purposes for which companies have introduced target costing which vary from company to company. A number of other reasons are given in the literature for the use of target costing, as outlined below.

To reduce costs before they are locked in

As previously mentioned, it is being increasingly recognised that the major proportion of product costs, around 70 to 80% (Cooper and Chew,1996)are effectively fixedduring the design stage. Target costing provide same answer to management costs from the design stage to maximise the potential for cost reduction.

To control design specifications and production techniques

Target costing is a tool which can be used to control decisions such as design specifications and production techniques. For this reason it tends to be oriented more towards management and engineering than accounting, and to be successful requires the use of cost engineering techniques such as value engineering (Sakurai, 1989).

As an analysis which highlights other problems

 The discipline of target costing and the detailed review of costs can reveal more general managerial problems. For example, Chen and Chung (2002)  cite a company which uncovered corrupt practices in the purchasing department as a result of the detailed examination of component prices.

As a driver for cost improvement

As already discussed, target costing was originally introduced into Japanese companies as a way to integrate the use of other tools such as JIT and TQC (total quality control) and promote their use (Sakurai, 1989).

To encourage a focus on the customer

Target costing is, by nature, market-driven. It therefore stimulates behaviour which is customer-focused and encourages all functions within the company to respond to market demand and competitive trends rather than internal performance indicators. In addition the marketing department is free to make product decisions without the costs being a given (Gagne and Discenza, 1995).

Key characteristics of successful target costing

Focus on the customer

Target costing focuses on the customer. Customer requirements for quality, cost and time are incorporated into the product decisions and guide the analysis of costs. Indeed target costing forces companies to be specific about what customers want and the prices they are prepared to pay (Cooper and Chew, 1996). Swenson et al (2003) identify as a feature of best practice in target costing that companies actively solicit input from their customers on design issues to examine whether or not customers are willing to pay for the design innovation and to ascertain whether the cost exceeds the value to the customer, in which case the innovation is abandoned. The process may also involve discussions with customers of different design options, making trade-offs between cost and value. This is a key difference from other cost management processes which tend to be disconnected from the value perceptions and requirements.

Emphasis on cost reduction at early stages in product development

Target costing starts at the earliest stage in new product development, indeed is embedded in the development process, such that detailed financial analysis takes place from the outset and engineering changes are made before production begins. This often means initial designs are simplified before manufacture, resulting in lower costs and time-to-market once the design is finalised.

Consideration of the whole product life-cycle

In order to ensure that total costs are minimised for both the producer and the customer, successful target costing examines the full life-cycle cost of the product. This includes consideration of the purchase price, operating costs, maintenance and distribution costs (Swenson et al, 2003).

A multidisciplinary process

A characteristic mentioned in all literature on target costing is the multidisciplinary nature of the process and the importance of the involvement of all functions in the analysis and decision-making. Responsibility for achieving targets must also be shared across functions. In a study of Toyota Australia’s target costing system, the International Federation of Accountants’ (IFAC) Financial and Management Accounting Committee (now Professional Accountants in Business) highlighted the multi-disciplinary involvement in the cost management process and the vital roles played by different functions:

•  Finance — a co-ordinating role, managing the assignment of cost targets for individual components and subsystems, performance reporting and monitoring performance achievements across the business, and promoting target achievement and highlighting the need for action when deviations occur.

•  Sales planning and distribution – driving the formulation of the overall target cost.

• Purchasing – looking for cost savings through the analysis of parts and components to be used in the new product and working with suppliers to improve their cost base and to redesign parts.

• Engineering – using techniques such as value engineering to identify cost savings which can be made whilst maintaining the functionality of the product.

•  Manufacturing – looking for cost savings through improvements in the manufacturing processes, either through continuous improvement or more long-term fundamental changes.

Team members understand their role and how it impacts cost

According to Gagne and Discenza (1995), the target costing teams which are the most successful are those whose members have a basic understanding of how their work is translated into numbers which represent the firm’s performance, using indicators which are meaningful to them. In addition, the best team members are those who have rotated through several departments, including design, purchasing and marketing before being assigned to a cost-planning project, as broad backgrounds give team members a unique ability to spot and implement ways to improve costs.

Involvement of the whole value/supply chain

1. A number of writers describe the importance of working with the company’s supply chain to identify opportunities for cost savings. This is particularly important where a high proportion of the total cost of a product is in purchased raw materials and components, and target costing goals would be impossible to achieve without supplier involvement. Some companies view their supply chains as part of an ‘extended enterprise’ where design and cost information is shared and inter-company teams are established to meet cost reduction goals (Swenson et al, 2003).

Banham (2000) identifies getting suppliers to buy in to target costing as probably the most difficult aspect of target costing as experienced by US companies implementing the process.Amongst the methods used to achieve this are joint classes and team-building and promises of shared savings.

An iterative process

Target costing is not an exact science and depends on credible data and sometimes difficult judgements. It is also an iterative process where targets evolve as teams seek to balance functionality, price, volumes, capital investment and costs (Cooper and Chew, 1996). However, it is important the overall top-level target cost is regarded as an unalterable commitment and if this cannot be met, the product cannot be launched.

Specific and real targets for improvement

Although the cost targets for individual components or processes evolve, once they are set, they should not be changed. Also, as Cooper and Chew (1996) point out, targets must be more than hypothetical, so that managers have an imperative to meet them in order to ensure the launch of products. They should also be attainable, but require effort to meet them (Sakurai, 1989).

Target costing in process and service businesses

Target costing is as relevant to the service sector as the manufacturing sector. Cooper and Chew usefully (1996) identify ways in which target costing can be applied to service-oriented businesses, which is of particular interest when looking at its applicability to the NHS.

The key issues are still relevant

For process businesses, the focus of target costing shifts from the product to the process, and for service businesses the focus is the service delivery system. Although, the key issues – understanding the needs of the market, customers and users, and ensuring satisfactory financial performance at a given cost or price which does not exceed the target cost – remain.

Focus on the impact of new services on the whole system

Cooper and Chew (1996) point out that in people-intensive, customer-responsive service-delivery systems, it is not only possible to add new services, it can be hard not to – for example menus are easy to extend and firms can enter new areas of practice. But a discipline is still needed which ensures that these service extensions are still profitable.

Where a single delivery system is used to deliver a wide range of services, determining the profitability of individual services can be an exercise in the arbitrary allocation of costs. In services, particularly where waiting time is critical, it is the systemic effects of individual new services, such as whether they make the process more complex, which determine whether their revenue and value to customers offset the costs. Target costing which focuses on the systemic impact of new services can help organisations resist the urge to create new services just because they can (Cooper and Chew, 1996).

...(download the rest of the essay above)

About this essay:

This essay was submitted to us by a student in order to help you with your studies.

If you use part of this page in your own work, you need to provide a citation, as follows:

Essay Sauce, . Available from:< https://www.essaysauce.com/essays/engineering/2017-2-28-1488297640.php > [Accessed 14.10.19].