Introduction

The business environment today is unstable and laced with uncertainty, which is continuously
changing and is full of opportunities as well as challenges. Fast changing business environment
makes it necessary to treat product innovation and strategic management awareness as the
keys to companies competitiveness, long term strategy implementation and survival. These
days, managements have to struggle with unstable, rapidly changing markets and technologies to
sell products and run their organizations profitably. To implement market driven management
policies across the organization, measurement and cost control systems must be designed to
motivate the desired consumeroriented behavior. Thus, strategies that determine the direction of
product innovation have become more crucial to corporate management today than ever before.
Due to all these changes, which the business world has witnessed during last few decades,
traditional cost accounting systems are found to be uncertain and ineffective. In this situation, the
targetcosting system of Japan has been identified as an effective system to cope with modern
day business environment. Approaches such as Activity-Based Costing (ABC), Activity-Based
Management (ABM), Total Quality Management (TQM), Target Costing or Target Cost
Management (TCM), life cycle costing, balanced scorecard, and other new concepts have
emerged to support the drive towards the need for strategic cost management. Target Costing is
often presented as one of the strategic cost management approaches better suited to strengthen a
companys competitiveness in meeting todays business challenges.
The modern business environment has necessitated implementing some of the latest techniques
like Target costing, Benchmarking, Balanced scorecard etc. Target costing builds upon a design
to the cost approach with the focus on market driven target prices as a basis for establishing

target costs. Benchmarking is an approach of setting goals and measuring productivity based on
bets industry practices. Balanced scorecard approach emphasizes the need to provide
management with a set of information, which deals with all relevant areas of performance in an
objective and unbiased fashion. The information provided may be both financial and nonfinancial.
Due to increasing competition the need to achieve competitive advantage is way too high.
However when working in similar market condition it is very much difficult to achieve any
advantage, until and unless a proper technique is used. The technique can be anything, like cost
reduction, target costing, or to improve quality benchmarking etc. such different techniques help
you to earn an advantage over your competitors.
Businesses have a number of objectives, including satisfying customers with high-quality goods
and services, quickly and on time; achieving high levels of market penetration; providing a good
working environment for employees; and being financially successful. The long-term financial
success of any business depends on whether its prices exceed its costs by enough to finance
growth, provide for reinvestment, and yield a satisfactory return to its stakeholders. If there are
few competitors, and if demand exceeds supply, it may be possible to simply mark up costs to
establish a price that yields a sufficient profit. However, as competition increases, and supply
exceeds demand, market forces influence prices significantly more. To achieve a sufficient
margin over its costs, a company must manage those costs relative to the prices the market
allows or the price the firm sets to achieve certain market penetration objectives. In the context
of these characteristics, the practice of target costing has evolved.

Target Costing
Target costing is defined as a cost management tool for reducing the overall cost of a product
over its product life cycle. It emphasizes the reduction of costs during the planning and design
stage of the product life cycle since the majority of product cost is determined at this stage. In
comparison to traditional product costing methods, target costing allocates more of the total cost
to the development stage, simultaneously reducing costs during the production stage.
Management utilizes this pricing technique to meet both the demands of its customers as well as
company profit goals.
Target Costing can be defined as "Target Costing is a disciplined process for determining and
achieving a full-stream cost at which a proposed product with specified functionality,
performance, and quality must be produced in order to generate the desired profitability at the
products anticipated selling price over a specified period of time in the future."
Target costing is a fundamentally different way to look at the relationship of prices and costs.
The basic target costing equation of Price Profit Margin = Cost means that prices are driven
and set either by competitive market forces or by the firm as it aggressively lowers its prices to
increase market penetration; that profit margins are established such that the firm can make
money; and that allowable costs are derived from price and margin. Target costing is a system
under which a company plans in advance for the price points, product costs, and margins that it
wants to achieve for a new product. If it cannot manufacture a product at these planned levels,
then it cancels the design project entirely. With target costing, a management team has a
powerful tool for continually monitoring products from the moment they enter the design phase

and onward throughout their product life cycles. It is considered one of the most important tools
for achieving consistent profitability in a manufacturing environment.
The target costing for a product is calculated by starting with the products anticipated selling
price and then deducting the desired profit. Following formula or equation further explains this
concept:
Target Cost = Anticipated selling price Desired profit
The product development team is then given the responsibility of designing the product so that it
can be made for no more than the target cost.
Reasons for using target costing technique:
The target costing approach was developed in recognition of two important characteristics of
markets and costs. The first is that many companies have less control over price than they would
like to think. The market (i.e., supply and demand) really determines prices and a company that
attempts to ignore this does so at its peril. Therefore, the anticipated market price is taken as a
given in target costing. The second observation is that most of the cost of a product is determined
in the design stage. Once a product has been designed and has gone into production, not much
can be done to significantly reduce its cost. Most of the opportunities to reduce cost come from
designing the product so that it is simple to make, uses inexpensive parts, and is robust and
reliable. If the company has little control over market price and little control over cost once the
product has gone into production, then it follows that the major opportunities for affecting profit
come in the design stage where valuable features that customers are willing to pay for can be
added and where most of the costs are really determined. So that it is where the effort is
concentratedin designing and developing the product. The difference between target costing and
other approaches to product development is profound. Instead of designing the product and then
4

finding out how much it costs, the target cost is set first and then the product is designed so that
the target cost is attained.
Advantages and Disadvantages of Target Costing
Target costing has the following main advantages or benefits:
1.

Proactive approach to cost management.

2.

Orients organizations towards customers.

3.

Breaks down barriers between departments.

4.

Implementation enhances employee awareness and empowerment.

5.

Foster partnerships with suppliers.

6.

Minimize non value-added activities.

7.

Encourages selection of lowest cost value added activities.

8.

Reduced time to market.

Target costing approach has the following main disadvantages or limitations:

1.

Effective implementation and use requires the development of detailed cost data.

2.

Its implementation requires willingness to cooperate.

3.

Requires many meetings for coordination.

4.

May reduce the quality of products due to the use of cheep components which may be of
inferior quality.

Target Costing Process

The primary steps in the target costing process are:
1. Conduct research. The first step is to review the marketplace in which the company
wants to sell products. The design team needs to determine the set of product features that
customers are most likely to buy, and the amount they will pay for those features. The

team must learn about the perceived value of individual features, in case they later need
to determine what impact there will be on the product price if they drop one or more
features. It may be necessary to later drop a product feature if the team decides that it
cannot provide the feature while still meeting its target cost. At the end of this process,
the team has a good idea of the target price at which it can sell the proposed product with
a certain set of features, and how it must alter the price if it drops some features from the
product.
2. Calculate maximum cost. The company provides the design team with a mandated gross
margin that the proposed product must earn. By subtracting the mandated gross margin
from the projected product price, the team can easily determine the maximum target cost
that the product must achieve before it can be allowed into production. This involves a
number of considerations: what the market wants and needs now and in the future; what
the customers want and how much they really are willing to pay for alternative features;
and what the competitive offerings are and may be in the future. Obviously, the best way
to determine current and future wants and needs is to ask current, or prospective,
customers.
3. Engineer the product. The engineers and procurement personnel on the team now take
the leading role in creating the product. The procurement staff is particularly important if
the product has a high proportion of purchased parts; they must determine component
pricing based on the necessary quality, delivery, and quantity levels expected for the
product. They may also be involved in outsourcing parts, if this results in lower costs.
The engineers must design the product to meet the cost target, which will likely include a

number of design iterations to see which combination of revised features and design
considerations results in the lowest cost.
4. Ongoing activities. Once a product design is finalized and approved, the team is
reconstituted to include fewer designers and more industrial engineers. The team now
enters into a new phase of reducing production costs, which continues for the life of the
product. For example, cost reductions may come from waste reductions in production, or
from planned supplier cost reductions. These ongoing cost reductions yield enough
additional gross margins for the company to further reduce the price of the product over
time, in response to increases in the level of competition.
The design team uses one of the following approaches to more tightly focus its cost reduction
efforts:

Tied to components. The design team allocates the cost reduction goal among the
various product components. This approach tends to result in incremental cost reductions
to the same components that were used in the last iteration of the product. This approach
is commonly used when a company is simply trying to refresh an existing product with a
new version, and wants to retain the same underlying product structure. The cost
reductions achieved through this approach tend to be relatively low, but also result in a

high rate of product success, as well as a fairly short design period.

Tied to features. The product team allocates the cost reduction goal among various
product features, which focuses attention away from any product designs that may have
been inherited from the preceding model. This approach tends to achieve more radical
cost reductions (and design changes), but also requires more time to design, and also runs
a greater risk of product failure or at least greater warranty costs.
7

Of these methods, companies are more likely to use the first approach if they are looking for a
routine upgrade to an existing product, and the second approach if they want to achieve a
significant cost reduction or break away from the existing design.
What if the project team simply cannot meet the target cost? Rather than completing the design
process and creating a product with a substandard profit margin, the correct response is to stop
the development process and move on to other projects instead. This does not mean that
management allows its project teams to struggle on for months or years before finally giving up.
Instead, they must come within a set percentage of the cost target on various milestone dates,
with each successive milestone requirement coming closer to the final target cost. Milestones
may occur on specific dates, or when key completion steps are reached in the design process,
such as at the end of each design iteration.
Though management may cancel a design project that cannot meet its cost goals, this does not
mean that the project will be permanently shelved. Instead, management should review old
projects at least once a year to see if the circumstances have changed sufficiently for them to
possibly become viable again. A more precise review approach is to have each project team
formulate a set of variables that should initiate a product review if a trigger point is reached
(such as a decline in the price of a commodity that is used in the product design). If any of these
trigger points are reached, the projects are immediately brought to the attention of management
to see if they should be revived. Such a revival should take into consideration any changes in the
market prices of comparable products since the project was last examined.
Case Study
Tata MotorsA Case Study:
8

Tata Motors is one of the largest among the top automobile players in India. During the financial
year 2006 07 its revenue was 7.2 billion US dollars. It is the leader in the field of commercial
vehicles and second largest in the manufacturing of the passengers vehicles in India. Along with
that it is the worlds fifth largest manufacturer of medium & heavy trucks at global level. Target
costing and Tata Nano are in a way quite synonymous. Tata Nano is one of the major projects
lunched by Tata motors on 10 January 2008; it had been initially started four years back in the
year 2003. It is one of the latest examples of the target cost management by Indian automobile
industry how an Indian company fixed the target price according to market condition and
based on that controlled cost during designing and production stage of the product. The target
price of Tata Nano had been decided four years before. Even after rapid increases of inflation,
the company maintained price at target level of Rs. 1 lakh. After the analysis of data and
information collected various sources, the following cost reduction strategy was adopted by the
Tata Motors.
Innovation and Redesigning: Innovation and redesigning is one of the key features of the
car Nano. Ratan Tata knows the importance of it thats why he suggested the Nano have one
windscreen wiper instead of two. The design was outsourced to Italy's Institute of
Development in Automotive Engineering, which had also designed the Indica over a decade
earliera more sedatelooking car. But Tata himself ordered changes along the way. Most
recently, he vetoed the design of the windshield wipers. His solution: a single wiper instead
of two, giving the car a cleaner look. In addition, cutting the cost of windshield wipers for the
People's Car in half. Tata want to deploy homegrown engine, but dropped the idea when it
did not meet the core team benchmark. The entire body was designed twice, while the engine

was designed thrice. Every design was based on three key requirementscost, regulatory
requirements and acceptable performance standards.
Packaging Design: The basic architecture is the placement of engine below the rear seatit
delivers cost and operational efficiency. Due to the rear seat engine, they are saving space for
that they design a new type of seat and cutting cost everywhere. The engine is driving wheels
directly and they are saving engineering for the drive and the resultant saving in space of
bonnet and construction helps cut down the costs. There are many such innovations that are
low-cost and future-oriented, but meet all the safety standards.
Outsourcing of Components: During the manufacturing of Tata Nano, Tata motors
outsourced many components from various suppliers like Bosch for powering the car, Lumax
for lights, Sona for steering, Shriram and Ricoh. The engine, alternators, management
systems and brakes come from Bosch; transmission comes from Birla's Avtec Ltd, steel from
its own Tata Steel, castings from Tata Metallics, and batteries from Exide. All these
components are different from the others which are used for other small cars and the
companies are spending more time on R&D to cut the cost and material for the dream car.
Each and every component in the Nano has been designed based on the functionality, cost
and performance requirement. Without that there was no other way to reduce costs.
Adoption of Target Costing: The secret of designing the Tata Nano is a concept called
target pricing or target costing. Once the features and functions are finalized, target costs are
assigned to each and every component/system-transmission system, instruments, engine,
body, interiors and electrical systems. The sub-teams then design the components/systems
within the target cost. They look at every bolt and nut and keep driving cost out of the
components/system. For example the Nano has a variable transmission instead of the
standard gears. It has instrument clusters which do not have anti-glare coating and does not
use screws for fixing. In case of Tata Nano, Tata motors used first method profit planning
10

(Top to down) because first they decided expected selling price of the car Rs. 1 lakh and
based on that they decided the profit and cost structure of the product.
Kaisen Costing: During the designing and manufacturing process of Tata Nano, workers at
the Tata motors have been trained in Japanese manufacturing technique that call continuous
improvement or Kaisen costing. A worker engaged in building Safaris observed that each day
on an average, one front grille was broken when a worker leaned over to work on the engine
and unintentionally scratched the grille with his belt buckle. Cost: about 2,500 rupees $ 57 a
day, or $17,000 a year. Tata designed a simple protective cover for the grilles, plus a slipon
fabric cover for belts and watches that is now used to cut down on expensive waste at each of
Tata Motors' factories. Cost: about 25 cents per vehicle.
Benchmarking with Maruti 800: Benchmarking involves the process of making
comparison the strategies of the worlds best establishments and analyzing and learning form
their strategic approaches. Tata treated maruti 800 car as benchmark. In terms of acceleration
and drive ability, it should at least equal the Maruti and in some areas, it should exceed the
Maruti. For that purpose, they used world class benchmarking to improve the quality with
cost reduction at global level.
Experience form Tata Ace and Indica: During the designing and production of Nano, they
benefited with the experience of Indica and the Ace. Ace especially, because it was another
tight, cost based exercise. Ace's success convinced Tata that a small car built frugally but
practically, would sell. Nano was a concept that was in Tata's mind even as Ace was being
developed. In many ways, it is a pioneer to Nano and its success convinced him of its
saleabilityan important facet for a listed entity with shareholders riding on it.
Supply Chain Management: Supply chain management refers to the management of
upstream and downstream relationship with supplier and customers to deliver superior
customer value at less cost to the supply chain as whole. It includes procurement of inputs,

11

manufacturing, assembling, transportation to warehouse, transportation from warehouse to

retail outlet and finally transportation from retail outlets to the customers. On a strategic
level, supply chain network design locating plants, contract manufacturers, distribution
centres and warehousesis important because 70% of the cost of a supply chain is fixed at
the design stage. Designing of Tata Nano is also based on the efficient supply management.
Great Combination and Cooperation: In case of Tata Nano, management had taken a great
support and cooperation from all the angles. During the designing phase, they called small
group of machines for the future service ability and repair ability of the car. In addition,
suggestions are closely watched by the experts related with cost. They arrange early vendors
integration programme for various inputs on their redesigning and cut down the cost during
the production period, which helps to maintain the target cost.
Continuous Research and Development: Tata Nano is a result of continuous research and
development in all aspects, whether related with designing or cost cutting strategy. As an
example, they have cut down cost related with the wheel. In normal wheel, mounting has
four pins while Nano's wheel has only three. Along with that they reduced the thickness of
the bumpers. Similarly, they are using e-sourcing to cut down the cost.

Bibliography

Books

12

Articles
Singh Pradeep, (January 2009), Target Costing: Conceptual Analysis and Application in
India.
Institute of Management Accountants, Implementing Target Costing.

Internet
Wikipedia, http://en.wikipedia.org/wiki/Target_costing
Accounting Tools, http://www.accountingtools.com/target-costing
Accounting for Management,
http://www.accounting4management.com/target_costing_pricing_products_and_services.
htm

13