Target Costing

If you cannot find the time to do it right,

how will you find the time to do it over?

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General Concept

 Target cost is the cost that can be incurred

while still earning the desired profit
 Selling price – desired profit = target cost
 The customer sets the price
 Profit must be achieved through cost control

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Target Costing Characteristics
 Contradicts the traditional approach: design
product, determine cost, set price
 Intense customer focus
 What do they want?
 How much will they pay for it?
 Can we make a profit on it?
 Want answers to these questions before
committing to the project
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Target Costing Characteristics

 Cost control from the beginning

 70-90% of costs are committed to at the design
stage
 Focus on product and process design to engineer
out costs from the beginning
 Saves costly changes later on

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Target Costing Characteristics

 Product, manufacturing process, delivery

process designed simultaneously
 Ensures features customers demand, but within
acceptable cost parameters
 Eliminates the temptation to add costly features
 Customers may not value the added features

 Forces consideration of manufacturability

 Reduces the need for subsequent changes

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Target Costing Characteristics
 Cost control at all phases of the product life cycle
 Design
 Production
 Delivery/setup
 Customer’s cost of ownership
 Emphasizes future sales instead of current cost savings
 Service and repair
 Disposal and recycling

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Cross-Functional Team
 Marketing  Distribution
 Design/engineering  Service/support
 Manufacturing  Cost accounting
 Purchasing  Finance
 Including suppliers  Legal

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Target Costing Process

 Two stage process

 Establish the target cost
 Market research
 Product planning, concept development stages

 Achieve the target cost

 Value engineering, continuous improvement
 Design stage
 Continuous improvement in later stages

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Establishing the Target Cost

 Determine the product and its market

 Who is the target market?
 What do they want?
 What do competitors offer?
 Introduce concept or prototype
 Evolutionary or revolutionary?
 Refine until it meets customer needs
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Establishing the Target Cost

 Determine the selling price

 Must be acceptable to the customer
 Must be able to withstand competition
 Techniques
 Existing price +/- value of features added or deleted
 Consensus of focus group
 Price predicted to achieve a desired market share

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Establishing the Target Cost

 Determine the required profit

 Return on sales
 Desired return
 Historical return for similar products
 Industry average for similar products

 Return on sales will fluctuate over the life of the

product
 Price and costs fluctuate

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Establishing the Target Cost
Unit Selling Price

Product Life Stage

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Establishing the Target Cost
Gradual decline as volume
increases

Competitors enter market,

straining supply of resources
Unit Cost

Unexpected events affect

cost of resources

Product Life Stage

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Establishing the Target Cost
 Unit price, cost and profit are almost meaningless
because they fluctuate
 Life cycle totals are more meaningful

Total expected revenue throughout product life

- Total desired profit throughout product life
Total target cost

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Achieving the Target Cost

 Must include the features the customer wants

while maintaining cost at or below target
 Want to meet the customers needs, but not
exceed them
 Eliminating desired features will result in an undesirable
product
 Adding unwanted features will increase cost

 Failing to keep cost at or below target will result in

unacceptable profits
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Achieving the Target Cost
 Rank customer requirements (exhibit 1)
 What does the customer want?
 How important is each function to the customer?

 What do we and our competitors currently offer?

 Competitive evaluation (exhibit 1)
 Do our current product features meet the customer
needs?
 Are the customers’ needs met, unmet or exceeded?
 What can we learn from our competitors’ products?

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 Achieving the Target Cost
EXHIBIT 1
CUSTOMER REQUIREMENT RANKINGS

Less Ranking More Raw % of Total Competitive

Customer Requirement Important Important Score Raw Score Comparison
1 2 3 4 5 1 2 3 4 5
Multiple speeds 4 4 14.8%
Horizontal oscillation 3 3 11.1%
Vertical oscillation 1 1 3.7%
Light weight 4 4 14.8%
Adjustable height 1 1 3.7%
Airflow capacity 4 4 14.8%
Quietness 5 5 18.5%
Compact size 3 3 11.1%
Looks nice 2 2 7.4%

Total 27 100%

Us
Competitor
Both

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Achieving the Target Cost

 Determine the cost gap between current cost

and allowable cost
 Current cost is based on
 Currently used components
 Current suppliers
 Current manufacturing processes
 Current distribution network
 Etc.

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Achieving the Target Cost
 Decompose the cost gap (exhibit 2)
 Life cycle decomposition
 Cost reduction goals are divided among the functions in
the product’s life cycle
 Design/engineering
 Manufacturing
 Sales/distribution
 Service/support
 General administration
 Etc.

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Achieving the Target Cost
 Value chain decomposition
 Cost reduction targets are divided among internal and
external activities
 Internal costs
 Labor, overhead, selling and administrative costs, etc.
 External costs
 Components and services acquired from suppliers,
etc.
 Often represent a large proportion of total cost

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 Achieving the Target Cost

EXHIBIT 2
COST GAP BREAKDOWN BY LIFE CYCLE AND VALUE CHAIN

Value Chain
Life Cycle Internal Costs External Costs Total Costs
Target Current Gap Target Current Gap Target Current Gap
Research and development $ 0.30 $ 0.50 $ 0.20 $ 0.30 $ 0.50 $ 0.20
Manufacturing 4.00 5.00 1.00 $ 13.00 $ 15.00 $ 2.00 17.00 20.00 3.00
Marketing and distribution 1.50 2.00 0.50 4.50 5.00 0.50 6.00 7.00 1.00
Service and support 0.25 0.50 0.25 0.25 0.50 0.25
General administration 0.75 1.00 0.25 0.75 1.00 0.25

Total $ 6.80 $ 9.00 $ 2.20 $ 17.50 $ 20.00 $ 2.50 $ 24.30 $ 29.00 $ 4.70

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Achieving the Target Cost

 Perform value engineering to design out costs

without sacrificing needed features
 Perform a cost analysis of major components and
activities
 List components or activities and their functions
 Calculate a cost breakdown (exhibit 3)
 Determine the current cost of each component or activity and
convert to percentage of total cost
 Costs include materials, labor, overhead, etc.

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 Achieving the Target Cost
EXHIBIT 3
COMPONENT COST BREAKDOWN

Percent of
Component Function Cost total cost
Motor Turns blade $ 8 40%
Transmission Provides oscillation capabilities 4 20%
Speed control/switch Controls blade speed 3 15%
Body Houses motor, transmission, speed control 2 10%
Blade Moves air 1 5%
Blade guard Protects blade from contacting objects 2 10%

Total $ 20 100%

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Achieving the Target Cost
 Relate the components to customer requirements
(exhibit 4)
 Develop Quality-Function-Deployment matrix
 Indicates which components have the greatest impact
on customer requirements
 Develop a functional ranking (exhibit 5)
 Indicates the importance of each component to the
customer
 Based on the component’s contribution to providing
the desired functions
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 Achieving the Target Cost
EXHIBIT 4
QUALITY-FUNCTION-DEPLOYMENT (QFD) MATRIX

Components
Customer Requirements Speed Blade
Motor Transmission control Body Blade guard
Multiple speeds
Horizontal oscillation
Vertical oscillation
Light weight
Adjustable height
Airflow capacity
Quietness
Compact size
Looks nice

Strong correlation
Moderate correlation
Weak correlation

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 Achieving the Target Cost

EXHIBIT 5
COMPONENT CONTRIBUTION TO CUSTOMER REQUIREMENTS

Components
Customer Requirements Speed Blade
Motor Transmission control Body Blade guard
Multiple speeds 40 X 14.8 = 5.92 60 X 14.8 = 8.88
Horizontal oscillation 80 X 11.1 = 8.88 20 X 11.1 = 2.22
Vertical oscillation 80 X 3.7 = 2.96 20 X 3.7 = 0.74
Light weight 70 X 14.8 = 10.36 10 X 14.8 = 1.48 20 X 14.8 = 2.96
Adjustable height 100 X 3.7 = 3.70
Airflow capacity 50 X 14.8 = 7.40 50 X 14.8 = 7.40
Quietness 40 X 18.5 = 7.40 60 X 18.5 = 11.10
Compact size 5 X 11.1 =0.56 5 X 11.1 =0.56 30 X 11.1 =3.33 30 X 11.1 =3.33 30 X 11.1 =3.33
Looks nice 50 X 7.4 = 3.70 50 X 7.4 = 3.70

Total contribution percentage 31.64% 13.88% 8.88% 16.65% 21.83% 7.03%

Contribution weight assigned to the component * importance to the customer (exhibit 1)

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Achieving the Target Cost
 Identify components for cost reduction
 Calculate a value index for each major component
(exhibit 6)
 Component cost as a percentage of total cost divided
by the component’s relative importance to the
customer
 Index greater than 1
 Disproportionately high cost in relation to its
importance
 Implies cost reduction should be considered
 Do not manage by the numbers alone

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Achieving the Target Cost

EXHIBIT 6
CALCULATION OF VALUE INDICES FOR COMPONENTS

Percent of Contribution
Component Total Cost Percentage Value Action
(Exhibit 3) (Exhibit 5) Index Implied
Motor 40% 31.64% 1.26 Reduce cost
Transmission 20% 13.88% 1.44 Reduce cost
Speed control 15% 8.88% 1.69 Reduce cost
Body 10% 16.65% 0.60 Improve
Blade 5% 21.83% 0.23 Improve
blade guard 10% 7.03% 1.42 Reduce cost

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Achieving the Target Cost
 Generate cost reduction ideas
 Eliminate over-engineering
 Eliminate, replace, combine, rearrange
 Seek ways to accomplish the goal at less cost
 Consider the process as well as the product
 More efficient manufacturing processes
 Better logistics
 Etc.

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Achieving the Target Cost
 Test the ideas
 Will they be effective?
 Are they technologically feasible?
 Is there a domino effect?
 Construct a component interaction matrix (exhibit 7)
 Do activities interact?

 Estimate the achievable costs

 Use activity-based costing, cost tables, etc.

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 Achieving the Target Cost

EXHIBIT 7
COMPONENT INTERACTION MATRIX

Speed Blade
Component Motor Transmission control Body Blade guard
Motor X X
Transmission X X
Speed control X
Body X X X X
Blade X
Blade guard X X

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Make the Decision
Begin

Value engineering

Repeat Achieve
Yes No Close No
value target
enough?
engr.? cost?

Yes Yes
No

Abort
project

Release design
for production

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Organizational Impact
 Positives  Negatives
 Customer focus  Too much customer
focus
 Cross-functional
integration  Potential organizational
conflict
 Open sharing of
information  Too much pressure to
attain targets
 Better process
understanding  Longer development
times

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