Introduction
Target costing: a term that at first may sound like a new diet plan but is actually a savvy business strategy for keeping your company’s wallet fat while trimming costs. Imagine you’re at a carnival, trying to knock down cans with a bean bag to win a prize. Target costing is somewhat similar — you have your prize (profit goals) in sight, and you must knock down costs strategically without toppling over product quality.
What is Target Costing?
Target Costing is a pricing approach adopted by enterprises to determine the cost of a product based on what customers are willing to pay, rather than merely adding a standard profit margin to the cost of production. It’s like reverse-engineering a price tag, starting from the customer’s wallet back to the manufacturing process.
The Four Stages of Target Costing
Target Price Determination: First, grab your spyglass and delve into the market. Here, businesses engage in espionage (a.k.a. market research) to unearth what the competition is charging. This step determines the “buy me” price — what customers are willing to pay before they start considering a cheaper knockoff.
Target Cost Identification: This is where you pull out your calculator and crunch some numbers. Subtract your desired profit margin (a number that would make Sony blush) from your target price. The remainder is your budget for creating the product. Yes, it’s like telling Gordon Ramsay he’s got $10 to make a Michelin-star dish.
Actual Cost Forecasting: Don your wizard hat because it’s time to predict the future costs of producing your product. This spot involves estimating costs associated with materials, labor, and overhead. Forecasting wrong here could be as tragic as investing all your savings in beanie babies in the 90s.
Cost Gap Bridging: If your actual cost forecast throws a pie in your face and it’s higher than your target, it’s time for damage control. Get your designers and engineers on a treadmill to brainstorm ways to make your product without breaking the bank. If they can’t, it’s a sign that maybe this product is better off left as a blueprint.
Comparing with Cost-Plus Pricing
Target costing flips traditional cost-plus pricing on its head. Instead of crafting a product, slapping on an arbitrary profit margin, and watching tumbleweeds roll by, target costing starts at the finish line (the price) and races backward to the start (the cost).
Related Terms
- Cost-Plus Pricing: Traditional pricing strategy where a fixed percentage is added onto the total cost of production.
- Market Research: The often undercover operation businesses conduct to collect data about market trends, consumer behavior, and competition.
- Profit Margin: A financial ratio that indicates the percentage of revenue that exceeds the costs of production — crucial for keeping businesses afloat.
Recommended Reading
For those who wish to dive deeper into the riveting world of cost management and strategic pricing, consider these enlightening tomes:
- Strategic Cost Management: The New Tool for Competitive Advantage by Shank and Govindarajan
- Target Costing and Value Engineering by Cooper and Slagmulder
Conclusion
Remember, target costing isn’t just a practice; it’s an art form and strategic weapon. It allows businesses to engineer their products not just with quality and efficiency in mind, but with a keen insight into the consumer’s universe. Step into the carnival of target costing, and you might just walk away with that oversized teddy bear of business success.
