APS1023H:

New Product Innovation

University of Toronto

Amir Rahim

Target Costing

Teaching materials to accompany:

Product Design and Development
Chapter 6
Karl T. Ulrich and Steven D. Eppinger
5th Edition, Irwin McGraw-Hill, 2012.

Amir Rahim

Target Costing
Cost is of process through life cycle.
Target costing is a design/costing method that
allows to set the TC and how much the end user
will pay for the product.
It is a systematic approach to profit planning &
cost management
Helps to achieve certain desire profit at the same
time not sacrificing quality or features etc.
Has a cohesion between different departments in
the company.
Amir Rahim

Target Costing
Goal:
Lower cost over life cycle of product
Customer value expectations
Difference between TC and cost-plus approach:
Cost-plus- It expects costs at each stage and fixes it
TC- Based on how much the end user is going to pay
for the product, the costs are fixed finally. (allows
product to be competitively priced)
Amir Rahim

Re-arranging:
PM=(P-C)
C=P-PM
C=P(1-M)

Let M be the gross profit margin on a stage in the

distribution channel
Where P is the price this stage charges it customer
And C is the cost this stage pays for the product it sells

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Target Costing, C is given by the above expression

Where P is the price paid by the end user
n is the number of stages in the distribution cycle
Mi is the margin of the ith stage

Amir Rahim

Manufacturer

Customer

Mm

Manufacturer

Retailer

Mm

Mr

Manufacturer
Mm

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Customer

Retailer

Distributor

Mr

Md

Customer

Example:
Assume the end user price, P, equals $250
If the product is sold directly to the end user by the
manufacturer, and the desired gross profit margin of the
manufacturer, Mm, equals 0.4, then the target cost is:
C = P (1 - Mm)
= $250 (1 - 0.4)
= $150

Amir Rahim

If the product is sold through a retailer, and the desired

gross profit margin for the retailer, Mr, equals 0.45, then:
C = P (1 - Mm)(1 - Mr)
= $250 (1 - 0.4)(1 0.45)
= $82.50

If the product is sold through a distributor and a retailer,

and the desired gross profit margin of the distributor, Md,
equals 0.2, then:
C = P (1 - Mm)(1 - Md)(1 - Mr)
= $250 (1 - 0.4) (1 - 0.2)(1 - 0.45)
= $66.00

Amir Rahim

Approximate gross
margins by various
sectors, actual values
can vary depending on
factors such as:
competitive intensity,
volume of units sold,
and the level of
customer support
required.

Amir Rahim

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