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Target costing is a pricing method used by firms. It is defined as "a cost management tool for reducing the overall cost of a product over its entire life-cycle with the help of production, engineering, research and design". A target cost is the maximum amount of cost that can be incurred on a product and with it the firm can still earn the required profit margin from that product at a particular selling price.
In the traditional cost-plus pricing method, materials, labor and overhead costs are measured and a desired profit is added to determine the selling price.
What is target costing?
A lengthy but complete definition is "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 product’s anticipated selling price over a specified period of time in the future." 
This definition encompasses the principal concepts: products should be based on an accurate assessment of the wants and needs of customers in different market segments, and cost targets should be what result after a sustainable profit margin is subtracted from what customers are willing to pay at the time of product introduction and afterwards. These concepts are supported by the four basic steps of Target Costing: (1) Define the Product (2) Set the Price and Cost Targets (3) Achieve the Targets (4) Maintain Competitive Costs.
Japanese companies have developed target costing as a response to the problem of controlling and reducing costs over the product life cycle.
Objectives of Target Costing
The fundamental objective of target costing is very straightforward. It is to enable management to manage the business to be profitable in a very competitive marketplace. In effect, target costing is a proactive cost planning, cost management, and cost reduction practice whereby costs are planned and managed out of a product and business early in the design and development cycle, rather than during the latter stages of product development and production.
- Cooper & Slagmulder (1997). "Target Costing and Value Engineering". Productivity Press, New York, NY, USA.
- Maskell & Baggaley (December 19, 2003). "Practical Lean Accounting". Productivity Press, New York, NY.
- Clifton, Bird, Albano & Townsend (2004). "Target Costing; Market-Driven Product Design". Marcel Dekker, Inc. ISBN 0-8247-4611-2.
- Management Accounting Quarterly 12 Winter 2003
- Focus Magazine
- Japanese Target Costing
- DRM Associates Target Costing
- Implementing Target Costing
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