Target costing involves setting a desired profit margin and then working backward to establish the maximum allowable cost for a product or service. This approach differs significantly from cost-plus pricing, which calculates cost and then adds a markup. For example, if a company desires a 20% profit margin on a product expected to sell for $100, the target cost would be $80. This requires meticulous planning and cost management throughout the entire product lifecycle, from design and development to production and distribution.
This method offers several advantages. By focusing on cost from the outset, organizations can enhance profitability, improve competitiveness, and encourage innovation in design and production processes. Historically, target costing emerged in the Japanese manufacturing sector during the 1960s and has since gained global adoption as a powerful cost management technique, particularly in industries with intense price competition. It fosters a proactive approach to cost control rather than a reactive one, leading to more efficient resource allocation and greater overall value creation.
