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Develop Profitable New Products with Target Costing

July 15, 1999 | Robin Cooper , Regine Slagmulder | Innovation

To survive today, firms must become adept at developing products that deliver the quality and functionality that customers demand while generating the desired profits. To ensure that products are sufficiently profitable when launched, many firms subject them to target costing, a profit management technique. The authors studied the mature, highly effective target costing systems of seven Japanese companies and documented their costing procedures. Although practices differ among these firms, the authors identified an underlying generic approach for implementing target costing systems.

A highly disciplined process, effective target costing comprises the following facets that the authors discuss in detail:

-- Market-driven costing consists of three companywide tasks -- setting the company's long-term sales and profit objectives, structuring product lines to achieve maximum profitability, and establishing a product's target selling price -- and two steps applicable to new products -- setting a target profit margin consistent with the company's long-term profit objectives and computing the product's allowable cost (by subtracting the target profit margin from the target selling price).

-- Product-level target costing comprises setting a reasonably achievable product-level target cost, imposing discipline upon the development process to attain the target cost (whenever feasible), and achieving the cost goal without sacrificing functionality and quality (primarily through value engineering and other engineering-based cost reduction techniques).

-- Component-level target costing includes decomposing the product-level target cost to the major functions or subassemblies (e.g., in a car, the engine, transmission, cooling system, air conditioning system, and audio system), setting component-level target costs, and managing suppliers (clearly conveying to them the competitive cost pressures facing the lean enterprise).

The cardinal rule of the companies studied is: "Never exceed the target cost." They enforce this rule in three ways -- by offsetting design improvements that result in increased costs with savings elsewhere in the design, by not launching products that exceed the target cost, and by carefully managing the transition to manufacturing in order to achieve the target cost.

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