Introduction

Target Costing is a process of developing costs for a product (or services) based on market driven considerations. A method that allows firms to provide consumers with products that they want, at a price they can afford, and still earn desired financial returns. Key Attributes Price Led Costing Customer Focus Focus on design of products and processes

Life Cycle cost reduction

Value Chain involvement

Application

To start from the market and work back to production process, through design and development of product that customer needs at acceptable prices. It is applied in the design and development stage. Target Cost of a product = Target selling price less Target Profit Value Engineering is a key to achieving target costs.

It is a systematic evaluation of all aspects of production and marketing that starts from R&D, Design of products, and distribution to customers, ending with customer service.

Target costing is widely used by Japanese and American Industries in automobiles (Toyota), Electronics (Panasonic), Information Technology (Apple).

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 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

Target Costing Characteristics

Cost control at all phases of the product life cycle

Design Production Delivery/setup

Customers cost of ownership

Emphasizes future sales instead of current cost savings

Service and repair

Disposal and recycling

Traditional costing process model

Product Requirement

Product Design and Development

Process Design & Product Cost Estimates

Supplier Cost Estimates

Cost is too high Production

Target costing process model

Market Research

Value Engineering

Product Strategy and profit plan

Competitive Strategy and Intelligence

Product Design and Development

Voice of Customer
Production and Logistics

Establish and Attain Target cost

Sales

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 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

Establishing the Target Cost

Determine the product and its market

Who is the target market?

What do they want?

What do competitors offer?....Benchmarking

Introduce concept or prototype

Evolutionary or revolutionary? Refine until it meets customer needs

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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 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?....Voice of Customer

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 Important 1 2 Ranking 3 3 1 4 1 4 5 3 2 More Important 4 5 4 Raw Score 4 3 1 4 1 4 5 3 2 27 % of Total Raw Score 1 14.8% 11.1% 3.7% 14.8% 3.7% 14.8% 18.5% 11.1% 7.4% 100% Us Competitor Both Competitive Comparison 2 3 4

Customer Requirement Multiple speeds Horizontal oscillation Vertical oscillation Light weight Adjustable height Airflow capacity Quietness Compact size Looks nice Total

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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 products 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 External Costs Target Current Gap

Life Cycle Research and development Manufacturing Marketing and distribution Service and support General administration Total

Internal Costs Target Current Gap $ 0.30 $ 0.50 $ 0.20 4.00 5.00 1.00 $ 13.00 $ 15.00 $ 1.50 2.00 0.50 4.50 5.00 0.25 0.50 0.25 0.75 1.00 0.25 $ 6.80 $ 9.00 $ 2.20 $ 17.50 $ 20.00 $

Target $ 0.30 2.00 17.00 0.50 6.00 0.25 0.75

Total Costs Current Gap $ 0.50 $ 0.20 20.00 3.00 7.00 1.00 0.50 0.25 1.00 0.25 4.70

2.50 $ 24.30 $ 29.00 $

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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 total cost 40% 20% 15% 10% 5% 10% 100%

Component Motor Transmission Speed control/switch Body Blade Blade guard Total

Function Turns blade Provides oscillation capabilities Controls blade speed Houses motor, transmission, speed control Moves air Protects blade from contacting objects $

Cost 8 4 3 2 1 2 20

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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 components contribution to providing the desired functions

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Achieving the Target Cost

EXHIBIT 4 QUALITY-FUNCTION-DEPLOYMENT (QFD) MATRIX Components Speed control Body

Customer Requirements Motor Multiple speeds Horizontal oscillation Vertical oscillation Light weight Adjustable height Airflow capacity Quietness Compact size Looks nice Strong correlation Moderate correlation Weak correlation Transmission

Blade

Blade guard

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Achieving the Target Cost

EXHIBIT 5 COMPONENT CONTRIBUTION TO CUSTOMER REQUIREMENTS Components Speed control Body 60 X 14.8 = 8.88 20 X 11.1 = 2.22 20 X 3.7 = 0.74 20 X 14.8 = 2.96 100 X 3.7 = 3.70 Customer Requirements Multiple speeds Horizontal oscillation Vertical oscillation Light weight Adjustable height Airflow capacity Quietness Compact size Looks nice Total contribution percentage Motor 40 X 14.8 = 5.92 Transmission 80 X 11.1 = 8.88 80 X 3.7 = 2.96 10 X 14.8 = 1.48 Blade guard

Blade

70 X 14.8 = 10.36 50 X 14.8 = 7.40 40 X 18.5 = 7.40 5 X 11.1 =0.56

5 X 11.1 =0.56

30 X 11.1 =3.33 50 X 7.4 = 3.70 8.88% 16.65%

50 X 14.8 = 7.40 60 X 18.5 = 11.10 30 X 11.1 =3.33

30 X 11.1 =3.33 50 X 7.4 = 3.70 7.03%

31.64%

13.88%

21.83%

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 components 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 Total Cost (Exhibit 3) 40% 20% 15% 10% 5% 10% Contribution Percentage (Exhibit 5) 31.64% 13.88% 8.88% 16.65% 21.83% 7.03%

Component Motor Transmission Speed control Body Blade blade guard

Value Index 1.26 1.44 1.69 0.60 0.23 1.42

Action Implied Reduce cost Reduce cost Reduce cost Improve Improve 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 control Blade guard

Component Motor Transmission Speed control Body Blade Blade guard

Motor X X

Transmission X

Body X X X

Blade

X X X

X X

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Make the Decision

Begin Value engineering

Yes

Repeat value engr.? No Abort project

No

Close enough?

No

Achieve target cost? Yes

Yes

Release design for production

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CASE STUDY: Tata Nano

To develop a product for people who want to move from 2 wheeler to 4 wheeler in affordable price. Car to cost within a price range of Rs 1,00,000. Car to be developed with low cost, safety, low on emissions and fuel efficient.

To be a truly peoples car.

Car to be developed on three main factors. Cost

Safety
Regulatory requirement

Product development (Target costing)

No radio, No AC, No side mirrors Just one wind shield wiper Plastic panel designed to eliminate need of screws Seats with integrated head rest

Material Substitution (i.e. Engineering Plastics)

Use of Plastic and adhesive rather than Welding and metal body.

Use of aluminum engines to reduce weight and cost.