The primary steps in the target costing process are:
Conduct 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 determine 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.
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 pro...
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...ace (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.
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