Target Costing
Target Costing
What is target costing?
- Start from the price, then set the allowable cost
- Most of a product’s cost is determined at the design stage
- Guard against eroding quality and safety, and against shifting costs onto suppliers
What target costing really changes isn’t the formula but the order of meetings and who has sign-off authority. Where a cost accountant used to walk in with a tally sheet after the drawings were final, a cost-planning lead now sits in from the start of planning and can say, “This structure won’t get approved.” At every design review gate, the target-cost achievement rate becomes a pass condition, and a design that falls short can’t move to the next stage. Cost shifts from being a result metric to being a design constraint.
In practice, you start by putting two numbers side by side: the allowable cost, which is the market price minus target profit, and the achievable cost you get when building with current technology and supplier terms. The difference is the gap, and the core of cost planning is splitting that gap by function and closing it through value engineering. If the gap is within 10% of the achievable cost, consolidating parts and adjusting specs can usually close it, but beyond 20% you need to redraw the structure or decide to drop the product plan altogether. It is easily confused with standard cost control, but standard costing is an after-the-fact tool that tracks variances once mass production begins, whereas target costing is an upfront tool used before the drawings are done. It works best for products with model replacement cycles and remaining design freedom, and has little room to apply to one-off order-based items whose specs are fixed by the customer.
The most common failure is when the target cost turns into an order to cut purchase prices. If the design doesn’t change by a single line and suppliers just receive a notice saying “Please cut 8% this year,” they hit the number by downgrading materials or trimming inspection steps. The bill comes due as field claims six months after mass production starts and, in the worst case, escalates into a subcontracting payment dispute. The second is conditional approval along the lines of “let’s launch first and fix it later”. Once the tooling is cut and the line is installed, few items are left to change. The third is calling a number a target price when it is simply your own cost plus margin; that only reorders the steps and leaves the old method in place.
Jinho DanAccounting instructor who makes financial statements, costing, and tax easy to follow
Kwangdong MinSpecialist in business models, revenue models, and market researchIt was systematized in Japanese manufacturing from the 1960s, especially in automotive cost-planning practice (原価企画), and later became widely known after being introduced to Western management accounting as target costing.
Consider a hypothetical case: Company A, a home appliance maker, is planning a new entry-level air purifier. It has 320 employees and annual revenue of about KRW 140 billion (≈ US$104,743,400). The merchandiser at its main retail channel drew a line: “Above KRW 199,000, (≈ US$150) it’s hard to get a promotion slot.” Using the existing platform, manufacturing cost was KRW 142,000, (≈ US$105) so hitting a 12% target operating margin meant bringing it down to KRW 115,000 (≈ US$86).
- At the first meeting, the product planning lead put the allowable cost of KRW 115,000 (≈ US$86) next to the achievable cost of KRW 142,000 (≈ US$105) and made it clear: “If we can’t close the KRW 27,000 (≈ US$20) gap within six months, we drop this model.”
- They split the gap by function and allocated targets of KRW 42,000 (≈ US$31) for airflow, KRW 31,000 (≈ US$23) for the filter, and KRW 28,000 (≈ US$21) for controls and display. The design team started with the touch display, which ranked lowest in user research.
- The lead design engineer replaced the two-piece upper/lower housing with a single injection-molded part, eliminating 9 component types and 14 fastening screws and cutting assembly time per unit from 4 minutes 30 seconds to 3 minutes 10 seconds.
- Instead of sending a price-cut notice, the purchasing deputy manager committed to a two-year volume of 180,000 units with the motor supplier and cut KRW 3,800 (≈ US$3) per unit. The supplier’s CEO said, “Once we can see the volume, we’ll rework our line too.”
- The quality assurance team used a separate gate to check noise, dust-collection efficiency, and safety certification items against the specs from before the cost change, and rejected one airflow-vent shape that raised noise by 0.8 dB, sending it back for redesign.
- Final mass-production cost came in at KRW KRW 118,000, (≈ US$88) 3,000 over target, but the KRW 199,000 (≈ US$150) retail price held. The model sold 110,000 units in its first year and delivered an operating margin of 10.4%.