Target costing is a type of cost management tool that is aimed at minimizing the cost of products produced over the life cycle of those products. The idea is to use this approach as a means of creating an ideal balance between the demands of consumers regarding durability and use of the manufactured products, and the goals of the manufacturer in terms of generating profits from those products. With target costing, companies employ strategies to keep operational costs under a certain amount, which in turn makes it possible to maintain an acceptable profit margin by selling the products for a unit price that consumers feel is reasonable and competitive with the products offered by other companies.
With target costing, the approach to arriving at the ideal balance between operational costs and the profit margin achieved is somewhat different from other methods, such as what is known as general or traditional costing. A traditional method essentially begins by assessing the costs of production, including advertising, distribution, and administrative costs, then uses that data to arrive at a unit price that is presented to consumers for their consideration in the marketplace. By contrast, target costing begins with a determination of what type of price consumers are likely to require in order to purchase the products, then works backward to bring operational and production costs in line with that figure. This often means operating the production facility with a high level of efficiency as well as making prudent and cost effective choices with advertising and other tools used to reach consumers.
When the target costing is successful, a business is able to maintain a profit margin over an extended period of time. While there may be minor fluctuations in some factors, such as seasonal ups and downs in consumer purchasing habits or increases in the costs of labor or raw materials, businesses usually move quickly to compensate for those factors and protect the level of profit generated. Depending on what is happening in the marketplace, there may be a need to adjust the unit pricing for products in some manner. For example, if the market for similar products is experiencing a trend in which unit prices are increasing, the target costing approach may allow the manufacturer to also adjust prices upward slightly, taking care to still remain within a comfortable profit margin and continue to be competitive with other companies attempting to attract attention from consumers.
One of the benefits of target costing is that it can often eliminate the time required to go back and adjust operational costs at a later date. Since the approach began by identifying the price that consumers are likely to be willing to pay, the design of the production process often already eliminates waste and is designed to operate at the highest degree of efficiency possible. In theory, this means that target costing saves time and money by minimizing the chances of having to rework the process as often in order to remain efficient and competitive in the marketplace.
