Target Costing


Most firms have largely misunderstood target costing, like many other new concepts that Western companies have attempted to adopt over the past two decades. Target costing is an extremely powerful concept when properly utilized. Unfortunately, most companies have failed to take the time to understand the basic philosophical drivers that that underlie the value of using target costing. Instead, they have tried to adopt the mechanics of target costing as best they understood them, within the context of their traditional financial management processes. It is therefore no surprise these firms do not receive all the value that target costing could provide, and the experience has been very frustrating for those in the trenches who were held responsible for making target costing work. In a very real sense these firms have been attempting to do the financial equivalent of designing a supersonic plane while insisting on using the design requirements of a bi-plane.

Target costing is not a project-based process for cost reduction. It is an integral part of a coordinated company-wide cost management process, which in turn is a major component of a holistic company-wide strategic management process. In short, target costing is an essential part of a unified approach to company-wide profit planning. Target costing is therefore a proactive approach to insuring that a desired profit is achieved in a project. But it is used to achieve that desired profit in an integrated and company-wide approach in which the entire company is aimed at making sure that each of the company’s endeavors are in fact profitable, at planned levels. This is a concept that is fundamentally different from traditional Western financial thinking, which has been focused on project-based cost reduction after costs have strayed beyond acceptable boundaries.

If achieving a target costing plan is so important, then why do so many Western industries rarely do it. A few years ago when an Arthur Andersen global study was made public, many Japanese firms said that the data collected must be wrong. Japanese feel that the key to making a profit is to know the cost of each product component and/or process within the development cycle and how that cost compares to the required target cost. Survey results from many Western companies stated that detailed cost knowledge was not available during the design process. Japanese companies reviewing this information did not believe that any large company would not do this as a normal part of its product development system. In essence they believed the study to be inaccurate.

Companies need to ask themselves several questions before embarking on the target costing course. They are:

  • Can your firm continue to survive with inconsistent and unacceptable profits? Is your corporate leadership under constant pressure to reduce costs? Are your sales revenues growing? Are your profits growing?
  • Are your customers becoming more critical and more difficult to satisfy? Do you really know what your customers want? Does your product conform to their requirements? Or does your product conform to what you are capable of doing?
  • Is your product design process under continued pressure to perform more with less resources and in shorter periods of time? Are your engineers and designers held accountable to design a product to a specific cost target? Do your designs incur “cost creep”? Do you meet launch schedules? Do you use “Cost Tables”?
  • How critical are supplier relations becoming to the survival of your firm? Do your suppliers work with you or sometimes against you? What do they think about your pricing practices? How much control do you have on your supplier network?
  • Is cost management the right place to expend resources? Can you continue to survive in this new global competitive environment without a more detailed and planned approach to cost management?
  • Is your business open to organizational changes to support target costing and value engineering programs? Are your leaders willing to leave their “ego at the door” to allow your company to undergo the radical change required to implement a fully institutionalize a target costing system.

Applying this process properly will most certainly require a firm to rethink its entire strategic planning process and its costing philosophy. Despite the pain to change, the pay-off is high. Four decades of experience in Japan stand in testimony to the power of target costing to deliver planned profit, and in so doing keep the organization constantly focused on delivering Value. Look at the regular profit levels of companies that excel in target costing, namely, Toyota, Honda, Hitachi Construction Machinery, Sharp and Canon. The companies in the West that can adopt target costing quickly will find that they will have a very important strategic and competitive edge, that will take them far into the next millennium.