The Target Costing Approach

An Explanation of the Goals and Method


Essay, 2007
16 Pages, Grade: 1,3

Excerpt

Table of Content

List of Abbreviations

List of Figures and Tables

1 Introduction

2 Basic ideas and historical development of Target Costing
2.1 Definition of Target Costing
2.2 Historical development
2.3 Areas of application
2.4 Separation from regular cost accounting

3 Goals of Target Costing

4 Target Costing process
4.1 Market information as basis for Target Costing
4.2 Definition of target costs
4.3 Splitting of target costs
4.4 Achievement of target costs

5 Conclusion

Reference List

Appendix

List of Abbreviations

illustration not visible in this excerpt

List of Figures and Tables

Figure 1 Procedure of definition of target costs

1 Introduction

Contemporary times are characterized by quick, dynamic, and continuing changes in the economy. Therefore, companies have to adapt flexibly and innovatively to these changes in order to stay competitive and cope with the increasing pressure of competi- tion. In particular, Asian and East-European competitors gain market share by offering products of better quality than in earlier times and for lower costs. Under these condi- tions, costs represent a fundamental factor for the success of western companies. Ac- cordingly, management and employees have to fully exploit the potential that cost man- agement and reduction measures offer. However, costs are not the only buying decision criterion. Customers expect products with high quality but for a low or moderate price. Correspondingly, companies have to adjust their new product developments and pro- duction systems to market requirements. This can be achieved by the Target Costing approach, a tool that is applied in more and more companies.

Therefore, the aim of this essay is to explain the goals and method of Target Costing. It starts with giving some background information about Target Costing and its historical development. Chapter three describes the goals of Target Costing. Then, the Target Costing process is explained in detail. Finally, this essay concludes by discussing that Target Costing is an effective cost management tool for developing new products ac- cording to market requirements.

2 Basic ideas and historical development of Target Costing

2.1 Definition of Target Costing

In general, Target Costing is considered as to be an instrument for management pur- poses. But there is less agreement on a general definition for this concept. One defini- tion that is commonly used in German studies was developed by Horváth, Niemand, and Wolbold (1993). According to them, Target Costing is “an extensive bundle of instru- ments for planning, controlling, and management of costs that are applied early in prod- uct and process development in order to be able to early arrange the cost structure with regard to the market requirements. Hence, the Target Costing Approach requests the cost-oriented coordination of all divisions which are involved in the product develop- ment process” (p. 4). This definition points out that Target Costing is a strategic cost management tool and emphasizes the importance of the planning aspect in the early stages of product and process development corresponding to the product life cycle cost approach, which says that 80% of product costs are determined in the first 20% of prod- uct development.

2.2 Historical development

Target Costing is a cost management technique that has its origins in the Japanese man- agement practice. Because of loss of competitiveness, the Japanese automotive manu- facturer Toyota developed this method in the 1970s to regain its competitiveness and to improve its earning potential. They determined the unit costs of their products as the target and intended to reduce the unit costs by means of Target Costing (Horváth et al., 1993; Kremin-Buch, 2004).

However, the basic concept of Target Costing is not completely new; similar ideas were used when Volkswagen developed the VW Käfer in the 1930s with a fixed product price in order to be affordable for all people (Arnaout, 2001) and according to Horváth et al. (1993), the Target Costing Approach “combines elements of established instru- ments of cost management (e.g., value analysis and design-to-cost) with the necessity to adjust the entire company to the requirements of the market” (p.3).

2.3 Areas of application

The Target Costing approach is mainly applied in manufacturing industries: for exam- ple, automotive manufacturers, automotive suppliers, or engineering. However, besides these manufacturing branches, it is also used occasionally in some service sectors like banking (Meyer, 2003, p. 155). Within these industries, Target Costing is employed in order to fulfil some branch-specific tasks and processes.

Horváth et al. (1993) depict that this approach is commonly adopted for four different areas. First, it is used in product development for efficiently influencing and optimizing costs in the early stages (see also 3: Goals of Target Costing). Meyer supports this when highlighting the importance of Target Costing especially for complex products and mass production (Meyer, 2003, p. 157). Furthermore, Horváth et al. mention that Target Cost- ing is applicable for cost reduction of existing products “while focusing on product components that are fundamental for satisfying customer needs” (p. 5). But they limit the expected effects in this area due to the inability to implement changes to existing cost structures. When planning the production process, it is also possible to resort to the Target Costing technique. Cost reduction and performance enhancements of the produc- tion process are feasible “when considering customer requirements in terms of variety of products and flexibility for the design of production systems” (p. 5). Finally, Horváth et al. highlight the increasing importance of Target Costing for the indirect business areas. Improvements of efficiency become possible in these areas by implementing a market-oriented design of processes according to market requirements.

2.4 Separation from regular cost accounting

The translation “Target Costing” for the original Japanese term “Genka Kikaku” is sometimes misleading. Therefore, it is important to highlight that Target Costing is a concept of cost management rather than a costing system like full costing or activity- based costing (Arnaout, 2001; Everaert, 2006). Target Costing is independent from cor- porate cost accounting as it defines its objectives by utilising market information. In order to clearly display the difference between Target Costing and cost accounting, Meyer (2003) mentions the different planning horizons that facilitate diverse possibili- ties for planning. Accordingly, he points out that information provided by cost account- ing can be used for planning and control of short-term product-related period costs due to the fact that this information is prepared for past or future accounting periods. In con- trast, the planning horizon of Target Costing is determined by the end of the product life cycle and therefore may cover many accounting periods. Hence, Target Costing can be characterised as “a concept for medium to long-term cost planning and control” (p. 136). Moreover, information in Target Costing is provided less frequently compared to cost- ing systems; typically, this occurs only when a specific milestone is reached.

Secondly, Meyer depicts the differences between Target Costing and cost accounting in the recognition of “cost units”. In decision-oriented costing systems, cost units are mar- ketable products that are completely determined in terms of their features whereas in Target Costing, a product is already considered as a cost unit when it is in the first stages of development.

Finally, Meyer discusses diversity regarding the type of cost control. He argues that cost control in decision-oriented cost accounting is carried out by comparing the periodical actual cost with the budgeted cost for the specific period (variance analysis). This can be recognized as some kind of “reactive control” (Meyer, 2003, p. 137). However, Tar- get Costing can be considered as “anticipatory control” (Meyer, 2003, p. 138) because it checks costs before they have occurred.

3 Goals of Target Costing

Target Costing is established for attaining a range of different objectives. It depends on the company which goals obtain priority when adopting this approach. But in general, Target Costing pursues the following purposes:

- Market-oriented alignment of the whole company and especially of cost man- agement in order to adapt the cost structure of new product developments to the requirements of the market and the customer (Dinger, 2000).
- Strategic orientation of market-oriented research and development ought to be used to determine target markets, products, and required resources (Horváth et al., 1993).
- Influencing costs in early stages of product development with the employment of cost management, as cost-efficient products and processes can be accomplished by early control and steering of cost (Seidenschwarz, 1997).
- A more dynamic execution of cost management by permanent market-driven re- views of cost objectives in order to adjust corporate structures to changing mar- ket requirements and to strengthen both competitiveness and profitability (Horváth et al., 1993; Kremin-Buch, 2004).
- Ensuring profitability in the short- and long-term by constant checking of mar- gins during the new product development process and rapidly dropping out of unprofitable products (Meyer, 2003; Everaert, Loosveld, Van Acker, Schollier,
& Sarens, 2006).
- Provision of explicit guidelines in terms of mandatory cost limits for an increase of motivation of employees as vague corporate objectives are not able to guide employees’ behaviour and raise their motivation (Meyer, 2003).
- Reduction of drifting costs by comparing allowable costs (see also 4.2 Definition of Target Costs), support of Total Quality Management, and maximization of profits (Seidenschwarz, as cited Sakurai, 1993)

4 Target Costing process

The actual process of Target Costing is analysed by numerous authors. Accordingly, there are varying conceptions of the specific number and definition of phases in the Target Costing approach (Arnaout, 2001). However, in general, three steps can be iden- tified that are common to all studies. However, in order to secure the market orientation, it is essential to conduct market research before the actual Target Costing process starts.

4.1 Market information as basis for Target Costing

One objective of Target Costing is, as mentioned earlier, the market orientation of cost management in order to align the whole company according to market requirements. Therefore, the starting base for Target Costing is extensive market research, an analysis of prices of competitors, and a systematic analysis of information that originates from direct customer contact in order to provide relevant information for product develop- ment. Besides information regarding the selling price, which is often not the only crite- ria and influencing factor in buying decisions, it is also essential to gather other data about, e.g., the length of the product life cycle, the estimated sales volume, or the amount of expected R&D expenditure (Arnaout, 2001).

In order to ensure the market orientation throughout the whole development process, Horváth et al. (1993) highlight that it is necessary to establish an organizational connec- tion between market research and other involved departments. Therefore, by several rounds of feedback and feedforward, a constant exchange of information can be initi- ated in order to gain assurance that product design is strictly geared to market informa- tion and customer requirements. This entails the transformation of information into con- crete requirements for product functions that are weighted according to the relevance for the customer (Horváth et al., 1993). These product functions are often drawn from the customer needs by statistical techniques like Conjoint Analysis, which is a method for measuring psychological value judgements (Meyer, 2003).

The information advantage of market research is especially important in the early phase of product development. However, it is vital to also guarantee a constant comparison of product design and current market requirements in later stages.

In the next step, the price information collected in market research and competitor analysis is then employed for the definition of target costs.

[...]

Excerpt out of 16 pages

Details

Title
The Target Costing Approach
Subtitle
An Explanation of the Goals and Method
College
European Business School - International University Schloß Reichartshausen Oestrich-Winkel
Course
Vertiefung Controlling
Grade
1,3
Author
Year
2007
Pages
16
Catalog Number
V119311
ISBN (eBook)
9783640228584
ISBN (Book)
9783640230365
File size
469 KB
Language
English
Tags
Target, Costing, Approach, Vertiefung, Controlling
Quote paper
Hendrik Vedder (Author), 2007, The Target Costing Approach, Munich, GRIN Verlag, https://www.grin.com/document/119311

Comments

  • No comments yet.
Read the ebook
Title: The Target Costing Approach


Upload papers

Your term paper / thesis:

- Publication as eBook and book
- High royalties for the sales
- Completely free - with ISBN
- It only takes five minutes
- Every paper finds readers

Publish now - it's free