How to Manage a Product cost effectively?
Created on 30 Mar 2020
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Updated on 01 Oct 2020
We all hear the word “COST” frequently in our day to day life. But have you ever heard the term “TARGET COSTING”?
Here’s all you need to know about target costing which will help you to keep yourself updated.
As we all know in today’s time competitive pricing is a challenge for all the companies. Because the customer is price sensitive. So to maintain a low price with quality and at same time earning profit is a big challenge. The supportive tool which helps companies to accomplish this challenge is Target Costing.
So “TARGET COSTING” is the process of determining the maximum allowable cost for a new product and then developing a prototype that can be made for that maximum target cost figure.
Target cost = Anticipated Selling Price – Desired Profit
Now let’s understand this with the help of Example: In the year, 1996 Cadbury launched a bar of chocolate called Perk. Then in the year 1999 Nestle came up with Munch. And both of these chocolates cost Rs. 5. It is obvious that Nestle came up with Munch to counter the Perk. So when Nestle was thinking to develop a product like Munch, the selling price of the product is already fixed i.e. Rs.5 because they cannot offer it for more than Rs. 5 because then the customer’s preference will shift to competitors product i.e. Perk. After all they are similar products. Now, suppose if Nestle decides to earn the profit of Rs. 1 on this product that means Nestle can only spend Rs. 4 to manufacture the product. So Rs. 4 is the “TARGET COST” of the product.
HOW IT IS DIFFERENT FROM TRADITIONAL COST
Traditionally cost is calculated by adding the individual components of the cost like, raw material, labor, overheads, etc. and then we arrive at Total Cost and then we add a profit margin and after this we know the Selling Price of the product.
So, general formula for traditional costing is :
Raw Material + Labour + Overheads = Total Cost +Profit margin= Selling Price
In Target Cost, we follow a reverse mechanism. As the selling price of the product is already known to us and we subtract the profit margin and then we get the target cost.
In Target Costing Price- Leads to the costing of the product instead of Cost- Leads pricing.
REASONS TO USE TARGET COSTING
In the view of the target costing much importance is given to the needs of the customers in terms of Quality Quantity and Price, understanding the market conditions and competition and making profits with the objective of reinvestment and growth.
It is an integral part of the management process of a company, it is a process plan and is used in the reduction of the cost and to manage the cost of the product.
The selling price of the product is fixed with the help of various sales forecasting techniques. As the target cost of a product is based on a standard selling margin already prevailing in the market.
It is useful while the companies plan a new product. As it controls the strategies of the management and identifies the opportunities that can help in saving along with offering the best value for money to the consumer than by just offering them the product at a lower price.
The emphasis is on earning the least target profit margin at any cost in each of the products and greater consumer satisfaction. So that the ordinary consumer can easily be converted to a loyal consumer.
The profit margin required by a company on a product is already included in the target selling price. As the motive of the companies is to make a target profit during the new product development by making the target cost spread throughout the company managing the profit activities efficiently.
The level of cost reduction is measured as the difference between the current cost and the target cost.
While designing the product target cost is kept in mind. So that product planning, manufacturing, marketing, etc. do not absorb more than the target cost.
WHY WE NEED TARGET COSTING
The two basic feature of the product cost is
The Market that determines the price of the product ( i.e. through Demand and Supply mechanism as the target cost of a product is determined on the basis of the survey of the target market in order to know the right price at which the consumer is willing to buy a product.)
Most of the time, the product cost is determined in the product designing stage to create a market-driven management that satisfies the demand of the consumer with the price required to be successful in the market.
Target costing begins with product development when the companies recognize and respond to the existing market competition and market price. This can be used for the planning of new products and can also be used for making changes in the existing products of a company. Target cost helps companies to focus on reducing the cost of the products, when the products are at the designing stage. It typically focuses on the costing of the development of the product, taking into account costs such as Raw materials, labor, tools, other overhead expenses, etc.
Target costing is one of the most systematic and formal approaches available with the companies to focus on determining the cost of the product. As target costing is helping the companies to listen and analyze the demand of the consumer and serve them with the right product at the right price, which will help the companies to boost their profitability! Target costing also demands the companies to have strong control over the designing team, followed by good guidance of a leader, so that the companies are able to meet their commitments on time and within the cost.
The main purpose of target costing is to enable the management of a company to use intensive approach towards the planning of the cost of a product as well as manage the cost of a product in such a way that reduction in the cost does not affect the quality and standards of that product so that the expectations of consumers are met both in terms of price and quality.
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