Practice & implementation of target costing – bangladesh perspective

“Practice & implementation of Target Costing – Bangladesh Perspective” Executive Summary Today fast changing business environment makes urgent necessity of product innovation and strategic management awareness, keys to companies’ competitiveness, long-term strategy implementation and survival. Firms can no longer produce and market huge amounts of standard products with a relatively stable market and technological climate. The business management has to grapple with unstable, rapidly changing markets and technologies in order to run their organizations and be able to sell products. To implement market-driven cost management policies across the organization, measurement and cost control systems must be designed to motivate the desired consumer-oriented behavior. Thus, strategies that determine the direction of product innovation have become more crucial to corporate management today than ever before. In this situation therefore, Target Costing technique has been identified as the system, which will help managers push forward this badly needed strategy. The increasing popularity of the technique as opposed to “cost plus”, has influenced my study in this thesis. Use of the Target Costing technique is high among manufacturers and cost reduction is among their main motive for adopting the technique.

In today’s intensely competitive and highly volatile business environment, consistent development of low cost and high quality products meeting the functionality requirements is a key to a company's survival. Companies continuously strive to reduce the costs while still producing quality products to stay ahead in the competition. Many companies have turned to target costing to achieve the objective. Target costing is a structured approach to determine the cost at which a proposed product meeting the quality and functionality requirements must be produced in order to generate the desired profits. It subtracts the desired profit margin from the company's selling price to establish the manufacturing cost of the product.

Target costing is a widely used technique for cost management during product development.

Despite target costing strategic intuitiveness, its operational during product development requires careful decomposition of a product's constituent cost elements. The main objective of this thesis is to describe an experience developing early-stage cost parameters for a specific product development process effort for manufacturing company by proposing and applying a

Target Costing technique. One secondary objective is to provide a model to operational “Target Costing technique” by breaking down cost targets into product parts, features and common elements, focusing on creating parameters for cost control during product development.

Target costing is a strategic weapon that is being increasingly adopted by a number of leading firms across the world. Despite a proven record of success, many managers often underestimate the power of target costing as a serious competitive tool. When they read the word “costing,” they naturally assume that it is a topic for their finance or accounting staff. They miss the fact that target costing is really a systematic profit planning process. Rather than the inward orientation of traditional cost methods, Target costing is externally focused taking its cue from the market and customers. It is market-driven costing that develops new products that meet customer price and quality requirements as opposed to cost-driven development of products that are then pushed on to customers in the hope that they will buy the products.

This thesis explains the use of target costing as a strategic profit planning and cost management tool. This will identify its key principles, contrast it with traditional cost management tools, show the critical steps in the process, and demonstrate its functioning in practice.

Chapter 1 provides a review and analysis of the study on target costing and provides a background expression of the study. Define what is the objective of the study is & the methodology used to conduct the survey to prepare the thesis. Define the limitation hindrances to make the thesis are.

Chapter 2 provides a complete literature review of the study on target costing, that covered the following topics- history & background of target costing, principles of target costing that consider as a foundations, process of target costing and process for new product development, characteristics of target costing also advantage & disadvantage of target costing.

Chapter 3 mention the role of target costing in an organization which implies the strategic mean of target costing & need for target costing various Bangladeshi companies. This chapter expresses the target costing approach & various pricing approach and element that influence the target costing technique. This chapter also mentions that how to established target costing various companies & how to attain this technique.

Chapter 4 shows an analysis on the practice & prospect of target costing in Bangladesh, by conducting survey, to various companies & professional accountants. Study data put by appropriate coding into SPSS and derive the findings.

Chapter 5 provides finding of the study that is found from the previous analysis covered various essential issues & recommend the action should take to established the thesis topic- “Practice & implementation of Target Costing – Bangladesh Perspective”

Introductory Section 1.01 Introduction of the Report:The most important feature of any company is its ability to stay ahead of the competition. In the midst of a plethora of products and choices for the customer, it becomes increasingly important for any company to make its products better, faster, cheaper and more innovatively. Increasing the efficiency of products has the two aspects of cost and functionality attached to it. An efficient designing technique takes the cost and functionality aspects into consideration during the early stages of product design. Such an approach provides us with the chance to concentrate our design efforts on important features and at the same time reduce the costs incurred on less important features. Target costing is like a planning tool that helps us to identify the features to be improved and helps us in setting targets for designing and cost reduction.

Target Costing is often presented as one of the strategic cost management accounting approaches better suited to strengthen a company’s competitiveness in meeting today’s business challenges. Target Costing is an “open system” which links external and internal factors from the inception. The activities to optimize the key success factors of a product are carried out mainly at the development and design phases, involving a multi-functional team of a company’s participating functions as well as other members of the value-chain, mainly the suppliers. Since Target Costing has begun to be adopted and implemented by business organizations operating in other business environments than its original one, it can be assumed that something new about the approach can be learned by exploring what is happening in other business contexts.

Aim of this thesis is to investigate the core components of target costing that’s executed in Bangladesh, how its principles will apply in the firms of Bangladesh for rapid expansion.

1.02 Background of the Report:Globalization or Free market economy is now world’s major challenge to every business industry. Recent business world as well as Bangladesh faces highly economic recession, with this situation the present economy of Bangladesh demands immediate development of business technique, tools and proper decision making policy. This report has been prepared in the light of emerging management accounting technique “Practice & implementation of Target Costing – Bangladesh Perspective” as a part of the fulfillment of thesis program required for the completion of the BBA program Major in Accounting under the Faculty of Business Administration of Stamford University Bangladesh.

This thesis report is a mandatory requirement of my BBA program, and prepared by supervision of thesis supervisor. The report was prepared under the supervision of Asif Mahbub Karim, Assistant Professor, Faculty of Business Administration, Stamford University of Bangladesh. The thesis supervisor authorized me to submit the report of “Practice & implementation of Target Costing – Bangladesh Perspective”

1.03 Objective of the Study:With aim of completion the BBA program, the objective of this study is dividing in two categories- General Objective & Specific Objective. The General objective of the report is to express the gather knowledge by conducting study about Target Costing, also this management accounting techniques functional activities & performance in various industries in Bangladesh.

The Specific objective of this thesis is: To understanding the meaning and importance of target costing. To understand how target costing can be applied in an organization. To know how to manage the target costs. To know the factors that influence target cost and its merits and drawbacks.

To investigate and assess how target costing can be used as an efficient cost management tool for managers and as such be an effective planning strategy in this changing business world and Bangladesh, it has been observed that more than 80% of major manufacturing of world business as well as of other levels of production have used target costing.

To diagnose the core concept of target costing and, attempt to provide some understanding that might explain the degree of reliability of the system. Some of the shortcomings of the system will be identified and how they can be overcome.

To investigate that Target costing is being used by various firms as a strategic cost management method, if so, the intensity of its application and the prospect in Bangladesh.

1.04 Scope of the Study:Investigative study method is used in writing this report. This study method was significant for me because before this study I have not enough understanding to proceed with such type of research project also on this topic.

This study is characterized by flexibility and resourcefulness with respect to the methods, formal research method employed by investigating various business industries in Bangladesh and obtaining information by asking question to qualified personnel.

The study involves structured questionnaire, large sample and probability sampling plans.

Under the study once a new idea or insight is discovered, they may shift their exploration in that direction. Observation method is used to complete this qualitative research.

Finally the purpose of this study is to determine whether target costing is used by the Bangladeshi manufacturing companies and whether those companies using the technique apply the principles of the target costing application process in their customer expectation, profit margin, cost and price determination, cost reduction and management operations.

1.05 Methodology of the Study:In order to make the Report more meaningful and presentable, two sources of data and information have been used widely- Primary Data & Secondary Data. Both primary and secondary data sources were used to generate the report.

Primary Data Sources Conversation with the accounting professional Observing various organizational procedures Relevant field study as supervisor concerned Information through interviews with respective personnel

Secondary Data Sources Published article and manuals on Target Costing Periodicals published by ICAB & ICMAB Various books, articles, compilations etc.

From newspapers and internet

Table 1:- Methodology of the Study

To successfully finish the project certain methodology has been followed to cover the followings: o The Preparation of the Survey structure & Selection of the Sample o The Data Gathering Technique The Preparation of the Survey structure & Selection of the Sample size The data used in the study consist of the information gathered via the survey applied to the various department executives from the companies selected and the qualified personnel by the simple casual method. In my study, the default sample size was 20. In the case of control and random designs, I used 10 cases control for the user of TC & 10 for random, whose hypothesis were then estimated.

The Data Gathering Technique Considering the relevant literature and study about the topic subject in the direction of the purpose and scope of the study, the questionnaire form is formed in three sections.

The first section consists of personal information of the respondents such as names, titles and positions.

The second section of the questionnaire consists of questions regarding general information about the company such as industry; manufacturing method and the personnel questions aimed at detection of the level of current applications in terms of the basic principles and applications of target costing.

The third section is discussed in this study consists of questions related to the analysis of the companies which use target costing or a similar application in Bangladesh, in terms of the benefits those companies obtain and the factors affecting the success of target costing. SPSS-11.5 (Statistical Package for Social Sciences) was used for the analysis of data obtained from the questionnaire.

1.06 Limitation of the Study:On the way of my study, I have faced some problems that termed as the limitations of the study.

In all respect following limitation and weakness remain within which I failed to escape by any means. These are follows: Budgeted time limitation: - It was one of the main constraints that hindered to cover all aspects of the study.

Confidentiality of data: - Because of some divisional and confidential problem, I could not get enough information. Every organization has their own secrecy that is not revealed to others.

While collecting data some company personnel did not disclose enough information for the sake of confidentiality of the organization.

Data Insufficiency: - Especially there is a lack of information about the determination of the companies applying target costing method and the level of target costing applications in these companies. Sufficient books, publications, fact and figure are not available. These constrains narrowed the scope of accurate analysis. If these limitations had not been there, the report would have been more useful and attractive.

Literature Survey 2.01 Introduction: The literature about target costing deals more with the concepts of target costing than with its practical application. Literature describes the concept of target costing and various techniques used in target costing.

The definitions of target costing are many, but they all focus on the same point of cost reduction.

However, definitions vary in the scope of cost reduction. Some definitions take the overall product life cycle into consideration while some consider particular functions or just product development, along with some important definitions of target costing are mentioned as follows: “Target costing is a set of management methods and tools used to drive the cost and activity goals in design and planning for new products, to supply a basis for control in the subsequent operations phase, and to ensure that those products reach given life cycle profitability targets.�

Target costing has been defined in by listing all stages of product life cycle, while Cooper and Slagmulder defined target costing in Target Costing and Value Engineering by placing emphasis on the aspects of cost, quality and functionality as follows:

“Target costing is a structured approach to determine the life cycle cost at which a proposed product with specified functionality and quality must be produced to generate the desired level of profitability over its life cycle when sold at its anticipated selling price.�

Different aspects of target costing including those of interest to management are detailed in.

The following are the key messages sent by target costing according to: 1. Target costing takes place within the strategic planning and product development cycles of a firm. Product design goes through this development cycle in a recursive, rather than in a linear fashion.

2. The first phase of target costing is the establishment phase. The focus here is on defining a product concept and setting allowable cost targets for a product or a family of products.

3. The second phase of target costing is the attainment phase. This phase transforms the allowable target costs into achievable target costs.

4. The establishment and attainment phases of target costing occur at different points in the product development cycle. Different organizational processes play primary and secondary roles in these two phases.

5. Many other business processes support target costing, and the success of target costing depends on these other processes being performed effectively within an organization.

The literature review of target costing shows us that the concept of target costing and the tools used for its implementation are described in detail. Several companies where target costing is used are mentioned, but specific details about product designing and cost reduction are not available in literature review. The later chapter will explains target costing and discusses the issues of implementation.

2.02 History of Target Costing:Target costing originated in Japan in the 1960s. As it did with quality, Japanese industry took a simple American idea called value engineering and transformed it into a dynamic cost reduction and profit-planning system. Value engineering originated at General Electric during World War II. It was an organized engineering approach to determining how to produce products in the face of parts' shortages. The practice instituted to design products that could do more with fewer parts. Later it became an organized effort to examine how to provide the needed features or functions in a product at the lowest possible cost. Japanese industry expanded the basic concepts of value engineering into the target-costing process. Today more than 80 percent of all

assembly industries in Japan, such as automobiles, electronics, consumer appliances, and machine tools and dyes, use target costing. Naturally, some of the best practitioners of target costing are leading Japanese companies such as Toyota, Nissan, Sony, Nippon Denso, Daihatsu, Cannon, NEC, Olympus, and many others.

In the United States, target costing has been used only since the late 1980s. The loss of market share to Japanese companies, as in Chrysler's case, has been a major motivation for adopting target costing. Adoption of target costing in the United States remains slow for several reasons, some managers fail to appreciate its strategic importance. Others mistake it for a narrow cost reduction technique and confuse the simplicity of its ideas for a simplistic process. Still others country like Bangladesh use some elements of target costing but mistakenly think the have adopted the entire process.

2.03 Definition of Target Costing Target costing concept is very straightforward. It is based on the logic that a company should manufacture the products that yield the desired profit. If the product is not yielding the desired amount of profit, the design of the product should be changed to obtain the desired profit or the product should be abandoned. A comprehensive definition of target costing as given in mentioned below: “The target costing process is a system of profit planning and cost management that is price led, customer focused, design centered, and cross functional.

Target costing initiates cost

management at the earliest stages of product development and apply it through out the product life cycle by actively involving the entire value chain.�

To provide an exact definition of target costing is difficult because the Japanese companies where the system had been greatly used as a cost strategy vary and each one has its own unique approach to defining it.

Common to most definitions is a process founded on a competitive market environment whereby market prices drive cost and investment decisions, cost planning, management and reduction occurring early in the design and development process, and cross-functional team involvement.

2.04 Development of Target Costing from Traditional Cost plus Method Traditionally, manufacturers would make use of the “cost-plus” approach to estimate the product price. This is done by first conducting market research to determine its market segment’s preferences and hence its product’s characteristics that will meet the consumer’s needs. This is followed by the design of the product and subsequently the manufacturing process is determined. Vendors will then be contacted to identify the total costs of the components as required by the design and engineering departments. Finally, cost components are added up and a selling price is set based on the costs. If management and the marketing department think that the price and cost are too high, the product design and engineering process will be repeated until a suitable cost is attained, after which, production will begin. This is known as “cost plus” method.

Conversely, target costing derives an “allowable” product cost by first carrying out market research to predict what the market division is willing to pay for the required product with definite features. Subtracting the desired profit margin set by the management from the predicted selling price derives an implied maximum per-unit target cost. This target cost is then compared to an expected product cost and if it is higher than the expected product cost, the company has several options. One is to lower costs; the product design and/or the engineering process can be changed. All the members of the planning team will engage in this process. They have the task of investigating the need for cost adjustment for each component. These members will work hand in hand, instead of going through various departments sequentially to reduce cost. When the target cost is reached, standards can be set and the product will then enter the manufacturing phase. The other option might be that, the organization may consider accepting a less-than-desired profit margin. This will depend on the numerical difference between expected cost and target cost. If the target cost is slightly highly than expected cost, a slightly lower profit margin will be sufficient. However, if the difference is too great and there is no way for the company to earn the profit margin that it desires, its third alternative would be to abandon that particular product.

The use of target costing forces managers to change their way of thinking concerning the relationship between cost, selling price, and profitability. The traditional mindset has been that a product is developed, production cost is identified and measured, a selling price is set, and either profits or losses will result. However, in target costing, a product is developed, a selling price and desired profit are determined, and maximum allowable costs are derived. This makes costs dependent on selling prices instead of selling prices dependent on costs. As a result, the

incurrence of all costs must be justified which leads to the elimination of unnecessary costs without compromising the product quality.

2.05 Management Accounting and Target Costing Traditionally management accountants have been functional experts who do not have much contact with their marketing and production counterparts. They see their role as providing financial data, measuring performance after the fact, and auditing resource usage. Target costing requires a change in the traditional role of management accountants and the type of information they provide.

Role of Management Accountants Target costing systems require management accountants to have early involvement with a product and to learn to function as cross-functional team members.

Early involvement means starting when the product is still in the concept stage, and staying with it for the rest of the development cycle. A management accountant needs to provide good cost estimates for each design iteration. They must look ahead and information about product costs from incomplete design data. It is not helpful to wait until must be more the product specifications are final. Further, each successive cost estimate must be more accurate as the design moves from concept to release for manufacturing. The focus is on estimation and not on actual costs.

As a cross-functional team member, a management accountant must help other team embers from engineering and marketing to do their jobs. For example, engineers need to know the financial implications of their value engineering ideas. For example, design engineers need to know what cost savings will result from the redesign of the heating element. Similarly, marketing must know what the company cans afford to spend on a feature so they do not promise customers something that a company cannot deliver.

2.06 Principles of target Costing:Achieving target costs requires a formal process. Target costing is a system of profit planning and cost management is price led, customer focused, and design centered and cross functional.

Target costing initiates cost management at the earliest stages of product development and apply it throughout the product life cycle by actively involving the entire value chain. The

purpose of target costing is to ensure adequate profits by undertaking simultaneous profit and cost planning.

There are six major principles that provide the conceptual foundations for target costing. In order to reduce costs once a product reaches production is very difficult. Therefore, focusing on costs during the early design stages to ensure that the target profit and cost can be realized is critical. That means product designs, material choices, specifications and tolerances, buy versus make decisions, process designs and investment decisions need to be thought through before product design and development decisions are finalized. The foundation of target costing therefore will look as follows. ď‚Ż Price led costing: By this principle, target-costing system sets cost targets by subtracting the required profits margin from the competitive market price.

Price led costing means that first determining a competitive market price and then subtracting the required profit margin from it establish a target costs. This is summarized in the equation: C=P-R Where; C = Target cost P = Competitive market price R = Target profit In target costing, market price is the independent variable; costs allowed for designing, manufacturing, marketing, and other functions (the target costs) are dependent on the market price. For example, if the competitive price for a product is 100, and the company requires a 15 percent profit margin, then the target cost for this product is set at 85. ď‚Ż Customer focus: This focuses on customer requirements for quality, cost, and times, which are simultaneously incorporated in product and process decisions and guide cost analysis.

The value (to the customer) of any features and functionality built into the product must be greater than the cost of providing those features and functionality.

It is essential to understand what quality features and timeliness customers expect at a given market price and what competition is currently doing or might do to respond to a company's product offerings. The target cost must not only yield the target profit but also allow the manufacturer to match competitive product dimensions. The target cost cannot be attained

by sacrificing the features that customers want, lowering the performance or reliability of the product, or delaying its introduction in the marketplace. 

Focus on design process: Design of product and processes is the key to cost reduction efforts. Target cost systems design products and their manufacturing and delivery processes simultaneously. This is sometimes called concurrent engineering. Traditional cost reduction methods focus on production efficiencies such as waste reduction or buying in quantity to reduce cost. This is not the prime focus of target costing. Target costing focuses on product design because most costs, nearly 70-80 percent, are committed at the design stage, while only 10-20 percent of the costs are incurred at this stage .

 Cross-functional teams: This relates to the facts that cross-functional team of producers and products and, members of the organization are responsible for the whole process from inception, testing to finish. Cross-functional team here refers to the interaction of the various departments, for example, the financial analyst who projects demand for supplies and sales, and interacts with designers to agree on a conclusive target cost.

Cross-functional product teams with members representing design and manufacturing engineering, sales and marketing, material procurement, cost accounting, service, and support typically are jointly responsible for attaining target costs. The teams also include outside participants such as suppliers, customers, dealers, and recyclers. The teams are responsible for a product from initial concept through production. A cross-functional team is not q set of specialists who contribute their expertise and leave. They are responsible for the entire product.  Life cycle cost reduction: Total life cycle cost is minimized for both producers and customers. Life cycle costing considers all costs of owning a product over its life, such as purchase price, operating costs, maintenance and repairs, and disposition costs. Life cycle costing goal is to minimize the cost of ownership to a customer. Most products today are required to have a shorter life cycle in order to remain competitive. 

Value chain involvement: This refers to the involvement of all the members of the value chain. All members in the supply, distribution, service providers and customers are included in the target costing process. Target costing systems involve an active and collaborative relationship in which cost-reduction techniques are shared by all members of this extended enterprise. A target costing system is based on long term, mutually beneficial relationships with suppliers and other members of the value chain such as distributors and recyclers. The value chain Integration (VCI) enables a coordinated, collective approach to resolving industry-level issues. VCI also facilitates opportunities between member companies to

define a balanced set of supplier priorities, develop industry-unique solutions, and improve communications throughout the supply chain.

2.07 Target Costing Process:Target costing process consists of two phases known as establishment phase and implementation phase. The establishment phase defines goals for product concepts based on strategic plans and the implementation phase achieves the set goals.

The process of target costing for product design can be described in the following steps: 1. Consider strategic and financial goals: Top management sets long-term goals for the complete corporation and every product should be designed to help the company to achieve these goals.

2. Determine the customer attributes or demands: This process involves conducting thorough market analysis and customer surveys to determine what the customer’s needs and demands are for a given product.

3. Consider costs and processes while designing: This step must result in the design specification of the product. The major tools used to obtain the design specification of a product are (a) Pugh Method and (b) QFD. 4. Determine the target price: Target price is the price a customer is willing to pay for the new product. Thorough market analysis must be conducted to determine the target price.

5. Determine the target cost: Target cost, also known as the allowable manufacturing cost, is calculated by subtracting the profit required (ROS can be used to determine the profit required from the new product) from the target price.

Target Cost = Target Price – Desired Profit 6. Determine the drifting cost and product feasibility: Drifting cost, also known as the actual cost of manufacturing is the present cost of manufacturing the new product and this is calculated with the help of the engineering department. It is also analyze to see if all the desired functions can be provided in the new product.

7. Process Improvements: If the designed product yields the required profit, the new product can be manufactured. If the new product does not yield the required profit, the product needs to be re-designed or the process of manufacturing should be improved to yield the required profit. The components or functions that are cost inefficient should be re- designed to reduce

costs. If the products are found not to meet the financial profit requirements, they should be abandoned.

8. Implementing / evaluating long term effects: It is essential to make sure that the new product will yield the required profits through its complete life and the product mix must be regularly adjusted to meet the strategic goals of the company.

2.08 Target Costing Process for New Product Development:Since target costing relies on design for cost reduction, it is applied primarily to new product development efforts. Most products are developed in four stages: Product planning, during which a product and customer niche is defined.  Concept development and feasibility testing, during which a product concept is developed and its feasibility is tested.  Design development, during which a feasible concept is turned into a detailed product design.  Production, which occurs after a final design is released.

Target costing occurs in two phases that correspond roughly to the first and second halves of this product development cycle. They called the establishment phase and the attainment phase of target costing. The establishment phase occurs during the product planning and concept development stages of the product development cycle and involves establishing a target cost.

The attainment phase occurs during the design development and production stages of the cycle and involves achieving a target cost. The relationship of target costing to the product development cycle is shown in Exhibit –

Table 2: - Target Costing & Product development Cycle Target costing involve in product development process that can be described as a continuous cycle divided into four phases:-

 Product planning  Basic design  Detailed design and  Process design Taken as a whole the four phases involve the determination of a target cost with the cycle being repeated in order to ensure attainment of the target cost.

1. In the product-planning phase, rough blue prints are drawn up based on a rough concept of the product under consideration. These blue prints are based on the product’s expected performance, size, weight, shape, color and a rough estimate of the target cost is made. This phase also assists in determining the new product’s lead-time as well as helps plan the expected operational activities that will be needed.

2. In the basic design phase additional basic plans for the product are prepared, including design ideas and potential cost reductions that can be achieved in due course.

3. The above stage 2 sets the basis for the creation of the components of the product at the detailed design phase. Blueprints for each component part are drawn up and comparisons made with the design of production, which is important for achieving cost reductions.

4. In the fourth phase of process design, blueprints are constructed for assembly of the components into the final product. The cycle is effectively repeated and any refinements necessary are made at each phase in order to move closer towards the attainment of the target cost.

2.09 Characteristics of Target Costing:There are seven typical characteristics for target costing. These conditions are: The target sales price is set during product planning, in a market-oriented way The target profit margin is determined during product planning, based on the strategic profit plan The target cost is set before the new product development (NPD) process really starts The target cost is subdivided (into target costs for components, functions, and cost items) Detailed cost information is provided during NPD to support cost reduction The cost level of future product is compared with its target cost at different points during NPD A general rule is aimed for that “the target cost can never be exceeded”

The Target Sales Price is set during Product planning, in a Market- Oriented Way Establishing the target sales price is the starting point in the target costing process. This implies that the target sales price is decided during product planning, when the characteristics of the future product are determined. The target sales price is set realistic in companies using target costing, and that the process of setting the target price is taken very thoroughly at most firms.

The sales price of existing products or the price level of competitor’s offerings typically provides an initial starting point for firms using target costing.

The Target Profit Margin is determined during Product planning, based on the Strategic Profit Plan The second characteristic of a target costing system is the early establishment of the target profit margin during the product planning of the future product. Corporate strategic profit planning should drive the target profit margin for a particular future product. Total target profit for a future product should be derived from the medium-term profit plans, reflecting management and business strategies over a period of three to five years. These target profits should then be decomposed into target profits for each product over its expected life cycle.

With the estimation of the future sales volumes, the target profit for a future product can be converted to a target profit margin. The procedures to compute target profits should be scientific, rational and agreed, otherwise nobody will accept the responsibility for achieving the target profit.

Target costing assumes that the target profit margin is set for each new product during the product planning, i.e. before NPD really starts, to ensure the achievement of the firm’s long-term profit plan. That’s why some authors refer to target costing as a technique for profit management.

The Target Cost is set before NPD really starts The third and most well-known characteristic of the target costing process is that the target cost is set early in the new product development process, before design and developing really starts. The decision on the appropriate level of the target cost for the new product to be developed involves a number of calculations. First, the ongoing cost is calculated and then the as-if cost is estimated. Third, the allowable cost is determined and finally the target cost is set between the allowable cost and the as-if cost.

The target cost can also be determined by what is called the adding-up or bottom-up method.

Here, setting the target cost starts within the NPD department itself. For each subassembly or component the cost is estimated, based on the actual cost of current parts. A cost reduction on each part of the new product is taken into account to get the target for each component of the

new product. The total target cost is then obtained by adding up all target costs of the individual parts or subassemblies.

Determining the level of the final target cost is an important issue. If the target cost is set consistently too low, the work force will be subjected to excessive cost reduction objectives, risking burnout. The discipline of target costing might then be lost, as target costs will frequently be exceeded. On the other hand, if the target cost is set at a level that is too easy to achieve, the firm will loose competitiveness because new products will have excessively high cost levels. Once the target cost is set, filling the gap between the as-if cost and the target cost is then the major focus for design engineers.

The Target Cost is subdivided into Target Costs for Components, Functions, Cost Items or Designers For target costing to work, the target cost for the future product needs to be decomposed in order to have specific targets for designers internally and subcontractors externally. This is the fourth typical characteristic of target costing. Decomposing the target cost to target costs for subassemblies is a difficult issue, since it indirectly determines the necessary cost reduction objectives

for

the

different

design

teams.

Depending on the complexity of the future product, the global target cost should be decomposed into target costs for functions, components, cost items and even for individual designers.

Detailed Cost Information is provided to support Cost Reduction The fifth typical characteristic of the target costing process is the provision of detailed cost information. To see the impact of their design decisions on cost and to monitor the progress towards the cost reduction objective, design engineers need to estimate the cost of the future product during design and development. Information systems such as the target costing support system must provide cost information anytime the designers require it, and not only at the so called milestones in the NPD process. One essential condition for target costing to work is the provision of detailed cost information during the design and development of a future product.

The Cost Level of the Future Product is compared with its Target Cost at Different Points during NPD The sixth characteristic of target costing involves the comparison of the estimated cost level of the future product with its target cost at different points during NPD. The progress towards the

target cost is essential in target costing. Therefore the cost level of the future product needs to be compared to the target cost, either formally at different points, either continuously during new product development.

Aim for the General Rule that “The Target Cost can never be exceeded�

The seventh and last characteristic of target costing involves the policy not to exceed the target cost. Without the strict application of such a rule, the cardinal rule, target costing typically lose its effectiveness. The general rule that the target cost can never be increased requires a strong commitment of managers and design engineers to attain the target cost.

The general rule that the target cost can never be increased has three consequences. First, whenever costs increase somewhere in the product during NPD, costs has to be reduced elsewhere by an equivalent amount. Second, launching a product with a cost above the target is not allowed; only profitable products are launched. Third, the transition to manufacturing is managed carefully to ensure that the target cost is indeed achieved.

2.10 Advantages of Target Costing The process of target costing creates a team based, proactive atmosphere, where representatives from different departments get together to make decisions. This leads to a reduction in the information gap between different departments and makes the departments more responsive as they realize the importance of their activities. The major advantages of target costing as mentioned in are listed below:o Target costing provide management methods and analytical techniques for developing products and services whose costs support strategic objectives for market position and profit. o Product costs defined from the customer’s viewpoint; they will include functionality, cost of ownership and manner of delivery. o Target costing is a critical component of product development teams and concurrent engineering. o Target costing incorporate as wide a range of costs and life cycle phases for the product or service as can be logically assigned and organizationally managed.

o Target costing provide analytical techniques to indicate where cost reduction efforts on parts and processes will have most impact, and where commonality and simplification can be increased. o The quality of cost data will be consistent with the responsiveness and level of detail required at various development phases: The system will use the logic and benefits of activity-based costing. o The achievement of market-driven product attributes will be protected from cost reduction ambitions. o Targets for product cost will be set for various life cycle phases in development and production. o Target costing will aim for appropriate simplicity, relevance and ease of use by product development teams; it avoids unnecessary complexity of language and time consumption in cost assessments.

If a company successful in implementing and maintaining an effective target costing system, the company may be able to get the following advantages: Determine an expected cost of manufacturing a product or providing a service  Achieve greater cost efficiencies  Spend money where it will have the greatest impact  Identify customers' real needs  Match firm's activities to customers' requirements  Increase customer satisfaction  Give co-workers a better understanding of cost objectives  Allow co-workers to participate in setting quality, cost and time targets  Become more competitive globally  Another significant advantage of target costing is its inherent flexibility  Proactive approach to cost management  Orients organizations towards customers  Breaks down barriers between departments  Implementation enhances employee awareness and empowerment  Foster partnerships with suppliers  Minimize non value-added activities  Encourages selection of lowest cost value added activities  Reduced time to market

2.11 Disadvantages of Target Costing Target costing do have its bad points just like any other technique. One of the disadvantages of target costing is the possible misuse of the technique. Producers might make use of cost-based target costing to squeeze the profit margins of suppliers, thereby getting materials at the lowest cost possible. This over-emphasis on cost cuts often-blind producer to the real essence of target costing.

The second disadvantage is the stress on the design team of companies using target costing. As the technique place great emphasis on keeping cost below the target cost, design teams might feel all the burden on their shoulders as they will determine whether the product will eventually make it to the market or not.

The last disadvantage is to the company. Product development time might be lengthening as product is repeatedly designed to bring cost below that of target. This is the value engineering stage. This stage could drag for a long time as the design team meets difficulty in meeting cost target.

In shortly, Target costing approach has the following main disadvantages or limitations: Effective implementation and use requires the development of detailed cost data  Its implementation requires willingness to cooperate  Requires many meetings for coordination  May reduce the quality of products due to the use of cheep components which may be of inferior quality

The Role of Target Costing in a Company 3.01 Strategic Implications of Target Costing:A target cost is the allowable amount of cost that can be incurred on a product and still earn the required profit from that product. It is market driven costing. This thesis shows how a target costing process when well executed, can improve a firm's competitive position by improving quality, reducing costs, and accelerating the time to market.  Quality: - Target costing improves product quality by making it an explicit objective of the product development and costing processes. Cost targets cannot be achieved by

compromising the features that a customer desires or by reducing the performance or reliability of a product.  Cost: - Reducing costs is at the heart of target costing. Unlike traditional methods, however, target costing does not wait for production to start before managing costs. It makes cost planning a part of profit planning and uses an intelligent, customer-focused design process to manage costs before they incurred.  Time: - Target costing reduces the time from concept to marketing of products because products and processes are designed simultaneously. No time is lost in trying to determine how to manufacture a product after it designed or in correcting design errors.

3.02 Need for Target Costing: What makes target costing so important today? The answer lies in the nature of the recent industrial competitive environment. Today businesses face a global environment that has following four characteristics:  Competitive: - Because prices cannot be increased in many key industries. Many new producers, some with a lower cost of doing business, have entered the global market place.  Rapidly changing: - Because the dissemination of technology and knowledge has accelerated considerably. This faster pace makes it difficult to use any one factor, such as quality, for a long-lasting competitive advantage.  Unforgiving of mistakes or delays: - Since shorter product lives leave little time to respond to changes in the marketplace or to recover from mistakes.  Demanding: - Because sophisticated consumers have knowledge of many products and want better quality products at an affordable price. It is difficult to sell inferior products with reduced features at a lower price.

3.03 Target Costing Approach:As a totally new product and its industry develop, it starts to compete based on its new technology, concept. Competitors emerge and the basis for competition evolves to other areas such as cycle time, quality, or reliability. As an industry becomes mature, the basis of competition typically moves to price. Profit margins shrink. Companies begin focusing on cost reduction. However, the cost structure for existing products is largely locked in and cost reduction activities have limited impact. As companies begins to realize that the majority of a

product's costs are committed based on decisions made during the development of a product, the focus shifts to actions that can be taken during the product development phase.

The following ten steps are required to install a comprehensive target costing approach within an organization.

1. Re-orient culture and attitudes: - The first and most challenging step is re-orient thinking toward market-driven pricing and prioritized customer needs rather than just technical requirements as a basis for product development. This is a fundamental change from the attitude in most organizations where cost is the result of the design rather than the influencer of the design and that pricing is derived from building up a estimate of the cost of manufacturing a product.

2. Establish a market-driven target price: - A target price needs to be established based upon market factors such as the company position in the market place (market share), business and market penetration strategy, competition and competitive price response, targeted market niche or price point, and elasticity of demand. If the company is responding to a request for proposal/quotation, the target price is based on analysis of the price to win considering customer affordability and competitive analysis.

3. Determine the target cost: - Once the target price is established, a worksheet (see example below) is used to calculate the target cost by subtracting the standard profit margin, warranty reserves, and any uncontrollable corporate allocations. If a bid includes non-recurring development costs, these are also subtracted. The target cost is allocated down to lower level assemblies of subsystems in a manner consistent with the structure of teams or individual designer responsibilities.

4. Balance target cost with requirements: - Before the target cost is finalized, it must be considered in conjunction with product requirements. The greatest opportunity to control a product's costs is through proper setting of requirements or specifications. This requires a careful understanding of the voice of the customer, use of conjoint analysis to understand the value that customers place on particular product capabilities, and use of techniques such as quality function deployment to help make these tradeoffs among various product requirements including target cost.

5. Establish a target costing process and a team-based organization: - A well-defined process is required that integrates activities and tasks to support target costing. This process needs to be based on early and proactive consideration of target costs and incorporate tools and methodologies described subsequently. Further, a team-based organization is required that

integrates essential disciplines such as marketing, engineering, manufacturing, purchasing, and finance. Responsibilities to support target costing need to be clearly defined.

6. Brainstorm and analyze alternatives: - The second most significant opportunity to achieve cost reduction is through consideration of multiple concept and design alternatives for both the product and its manufacturing and support processes at each stage of the development cycle.

These opportunities can be achieved when there is out-of-the-box or creative consideration of alternatives coupled with structured analysis and decision-making methods.

7. Establish product cost models to support decision-making: - Product cost models and cost tables provide the tools to evaluate the implications of concept and design alternatives. In the early stages of development, these models are based on parametric estimating or analogy techniques. Further on in the development cycle as the product and process become more defined, these models are based on industrial engineering or bottom-up estimating techniques.

The models need to be comprehensive to address all of the proposed materials, fabrication processes, and assembly process and need to be validated to insure reasonable accuracy. A target cost worksheet can be used to capture the various elements of product cost, compare alternatives, as well as track changing estimates against target cost over the development cycle.

8. Use tools to reduce costs: - Use of tools and methodologies related to design for manufacturability and assembly, design for inspection and test, modularity and part standardization, and value analysis or function analysis. These methodologies will consist of guidelines, databases, training, procedures, and supporting analytic tools.

9. Reduce indirect cost application: - Since a significant portion of a product's costs (typically 30-50%) are indirect, these costs must also be addressed. The enterprise must examine these costs, re-engineer indirect business processes, and minimize non-value-added costs. But in addition to these steps, development personnel generally lack an understanding of the relationship of these costs to the product and process design decisions that they make. Use of activity-based costing and an understanding of the organization's cost drivers can provide a basis for understanding how design decisions impact indirect costs and, as a result, allow their avoidance.

10. Measure results and maintain management focus: - Current estimated costs need to be tracked against target cost throughout development and the rate of closure monitored.

Management needs to focus attention of target cost achievement during design reviews and phase-gate reviews to communicate the importance of target costing to the organization.

3.04 Target Costing Approach to Pricing:In traditional costing system it is presumed that a product has already been developed, has been costed, and is ready to be marketed as soon as a price is set. In many cases, the sequence of events is just the reverse. That is, the company already knows what price should be charged, and the problem is to develop a product that can be marketed profitably at the desired price. Even in this situation, where the normal sequence of events is reversed, cost is still a crucial factor. The company can use an approach known target costing.

In the target costing approach, the selling price is taken as a given and the company strives to design and manufacture the product so that its cost is low enough to yield a satisfactory profit.

Target costing is a market-driven approach that puts the emphasis on managing processes inside the company, rather than hoping that consumers will accept a price high enough to cover all of the costs the company has incurred. Following set of activities is the concept of target costing technique:Table 3: - Target Costing Approach Determine Customer Wants and Price Sensitivity ↓ Planned Selling Price is Set ↓ Target Cost is Determined As: Selling Price Less Desired Profit ↓ Teams of Employees From Various Areas and Trusted Vendors Simultaneously ↓ Design Product

Determine

Determine

Manufacturing

Necessary Raw

Process

Materials

↓ Costs are Considered Throughout this Process. The Process Requires Trade-offs to Meet Target Cost ↓ Once Target Cost is Achieved the Manufacturing Begins and Product is Sold

3.05 Factors Influencing Target Costing:-

Target costing is a very progressive cost management technique that can bring long-term benefits to a firm if properly applied. However, it is not in every case that it can be applied.

Hence target costing, as the ultimate strategy, is worthy when applied in certain conditions. For this reason, study shows that, it is best applied as follows: Market driven costing  Product level costing and  Component level costing 1. Market driven factors: This refers to costing strategy that is influenced by the market forces. The most influential forces here are the power of competition and the nature of the customer.

i. Power of competition: This determines the amount of attention the firm pays to the competitive offerings of target costing and the volatility of the “survival triplet”. The survival triplet is identified as the strategic boundary for the target-costing firm to operate. In such conditions, where the manager understands the survival triplet well, the benefits of target costing become realistic.

ii. Nature of customer: The nature of the customer with such qualities as sophistication, changes in requirements or taste and their degree of understanding their future product requirement will influence the use of target costing. From research, it is believed that these features will determine the benefits a firm will get from using target costing since they deal with the width, rate of change of location and ease of predicting the location of survival zones.

Therefore, it is suggested that target costing become valuable where there is increased consumer sophistication. Products must be designed to meet consumer requirement as closely as possible.

iii. Rate of change in customer requirements: The rate at which customer requirement changes, is another factor influencing the use of target costing. This is because it affects the structure of the survival zone as time passes and makes the zone change regularly. It is difficult to predict how to launch a new product under such circumstances. This inability to determine the centre point of the survival zone creates uncertainty and may warrant the use of target costing. Therefore, it is hypothesized that target costing is more beneficial in environments where consumer preferences change rapidly.

iv. Extent to which customers understand their future product requirements: How much consumers understand of the future requirements of a product will determine the amount of energy and whether to apply target-costing process or not. As the degree of understanding increases, it becomes more beneficial to rely upon adopted customer preferences to determine location of the survival point. Likewise, when consumers have less knowledge of their future

product requirements, firms paying much attention to customers’ risk, might launch products that fail because they are outside the survival zone. Therefore, it is easy for a firm to fail if the product is launched with attributes that do not appeal to the customer. Target costing, therefore, is less beneficial in environments were there is difficulty in predicting the next location of the survival zone and vice versa.

2. Product level target costing: This refers to structuring of cost management at the product level and it is largely influenced by product strategy and the characteristics of the product.

These factors determine the current and historic future of the product.

a) Product strategy: Firms with product strategy that create lots of uncertainty, such as consumer reaction to that product, will be more likely to use target costing in its production than otherwise. Production characteristics therefore will include issues such as number of products in the line, those that provide horizontal or vertical differentiation, the frequency of redesign and the degree of innovation. Horizontal differentiated products are those sold at same price but deliver at different bundles and functionalities. Vertical differentiation refers to how products differ by degree of functionality and selling price. Products that are frequently redesigned are those where producers aim to achieve advancements in technology and increase in functionality. Therefore, the higher the rate of new product introduction, the greater the benefit derived from target costing. Target costing has increased benefits in areas where the degree of innovation is relatively low and decrease benefits where it is high. Where innovation is low, the target costing system will rely more heavily upon historic information than in areas where the rate of innovation is higher.

b) Characteristics of product: This aspect encompasses product complexity, magnitude of upfront investment and duration of product development processes.

Product complexity relates to components that make up the product where, it captures a number of distinct inputs. Some of the components may be difficult to obtain, as well as the technology required to produce it. Target costing may become more important in such a situation because of high product complexity than otherwise. This is due to the high degree of cost associated ranging from the design to manufacturing stage.

In addition, it becomes difficult to manage the product design process and ensure that component level cost adds up to product level target cost. Therefore, the more the complexity, the more the cost at component level and hence the need to target manage it. Research therefore postulates that target costing becomes more beneficial with increased product complexity.

Size of upfront investment influences target costing in that the magnitude of upfront will influence the attitude of the firm towards target costing. This is because up-front investment will determine the rate at which products will be launched. It may decrease if the firm wants to adjust to risk. Consequently, firms that produce products that have high upfront investment will develop a small range of product each carefully design to satisfy market needs.

Duration of product development refers to the time it will take for a new product to be developed, as it will explain the benefits to be gained from the use of target costing. As the duration of the design gets longer, the probability that the market condition that used to validate this design might change is more possible. As the length of product review cycle increases therefore, it becomes better to use target-costing methods since there is a very long tine between design and launch.

3. Component level target costing : This portion of the factors influencing target costing deals with the costs associated with components that make up the product. It is important to know the cost of the components and cost charged by suppliers to project a long-term performance of the whole product when launched into the market. Therefore, the strength of the suppliers is vital here. Firms that rely on imported raw materials or sourcing of component production must guard against the cost associated to such activity. Consequently, a very flexible supplier based strategy is necessary. This is synonymous to the degree of horizontal integration, power over major suppliers, and nature of suppliers’ relations.

a) Degree of horizontal integration: Lean production, which is strongly associated with target costing, encourages large external supply of inputs such as raw materials and components. This makes it imperative those targets cost producers have efficient relations with suppliers to ensure a regular supply Therefore, lean producers or firms operating with horizontal integration will reap benefits from target costing.

b) Power over major suppliers: - will determine how much energy will be used to determine purchase price of components and hence influence the use of target costing. When buyer power is high, it is considered that much energy will be used to develop component level target cost.

On the other hand, where buyer’s power is low, the firms will use less energy to develop target cost for purchased components. Therefore, it is postulated that the more power the firm has over its suppliers, the more benefit it can derive from target costing.

c) Nature of supplier relations : - also determines the use of target costing in that when firms become more co-operative target costing also becomes more beneficial especially at the component level. In the heart of this rich co-operation lies the potential of the firms to combine

design initiative and other means to collectively reduce cost. Co-operative relation between suppliers and users will determine the use of Target costing.

3.06 Factors help in Achieving Target Costing: Target Costing has been described, as being a largely quantitative process, whereby there are many tools and techniques that can be used in attaining it. Some examples of such techniques and tools include:  Conjoint Analysis, Quality Function Deployment, Market Analysis, Competitor Analysis, Product Road mapping, Market-Feature Tables etc, helps to define the Product.  Conjoint Analysis, Experience Curves, Price road mapping, Competitive Intelligence, Reverse Engineering helps in setting the target.  Value Engineering & Analysis, Component road mapping, Cost Analysis Tools, ABC Practices, Simulation Tools, Supply-Chain Analysis achieve the Target.  Cost-Reduction Methodology helps to maintain competitive cost.

It makes no sense to try to define each of these tools since they are numerous. I have just mentioned and identified them to underscore the fact that they are the most used. The fundamental mechanism various manufacturers use to achieve target cost, nevertheless, is value engineering.  Value Engineering (VE): Value Engineering is a mechanism manufacturers use to enhance the value of products and services, which is measured by the relationship between the functions performed by products and services, and the costs incurred. Different companies define the functions in different ways.

Some are geared toward process improvement while others are focused on satisfying the needs of customers. The process of VE consists of describing the functions of each product, part, and service, and quantifying the components of those functions. In the design phase, management science techniques are employed on the various aspects of the operation to improve upon the current method. Various manufacturer uses these as a tool to assist in attaining the objectives behind target costing have therefore used VE.  Lean manufacturing: Lean production has characteristics such as elimination of waste and inefficiency, redevelopment or R&D, customer satisfaction and their involvement in the process of designing, time management, inventory control etc. Efficient implementation of lean production will lower

cost of production and make the firm competitive. Therefore, it becomes a potential enabler of target costing.

 Evolution in Information technology (IT): The expansion of information technology on its own typically fosters production systems and boosts the coordination of the various production components and departments within the company and with its collaborators. The Japanese were among the first in the world to invest heavily in automated production systems and they are one of the most used IT in production in the world. This must have been the reason for their success in designing the JIT system.

Probably this was due to the concurrent development of the target costing. IT has greatly influenced the flexibility of the value chain and makes the market more opened and accessible and makes producers able to position themselves as they find it easier to sample the market, check competitors’ products and work directly with consumers. The use of the IT system therefore has been considered a great facilitator to target costing.  Strategic Outsourcing: One of the main futures of target costing is out sourcing. Here I introduce the concept of strategic outsourcing, which refers to the tendency where some components of a product may be allowed to be produced elsewhere. This maybe is due to cost factors, raw materials, or related factors. Where transportation of raw material maybe expensive or tend to add unnecessary cost of finished product, it might be cheaper to outsource that component of production other cheaper locations e.g. to the source of raw material.

Conversely, other forms of outsourcing whereby management want to run away from purported high cost are not likely to be a long-term benefit to those firms. Outsourcing which is not typically strategic will not help in cutting cost, as most managers would want to convince stake / shareholders.  Supply chain management: The term supply chain refers to the entire network of companies that work together to design, produce, deliver, and service products. In the past, companies focused primarily on manufacturing and quality improvements within their four walls; now their efforts extend beyond those walls to encompass the entire supply chain. Effective supply chain management helps the firm achieve the following:Appropriate inventory levels, and the ability to predict and react to shifts in demand, shortened cycle times and faster delivery, real-time visibility into order and inventory status, pricing, and

availability of product and material automated alerts about order or shipment problems, rapid response to market opportunities, increased free cash flow from increased effectiveness and effective target costing. ď‚Ż Kaizen philosophy: Some researcher defines this concept separately from target costing. This is not correct because the major viewpoint behind the Kaizen philosophy is the Japanese cost control system, which is practiced outside the traditional cost accounting system. This is because Kaizen costing is set to meet cost reduction various activities, which require changes in the way the company operates.

This is attained through continuous improvement, which is an integral part of target costing.

3.07 Process to Establishing Target Costing: Target costs established within the parameters defined by a firm's product strategy and longterm profit plans. These plans define new markets, customers, and products that a company plans to pursue. Product concepts aimed at specific customers are tested for feasibility and then target costs are set for feasible products. In establishing target costing, some major processes have been identified as vital. The following Figure provides an overview of the establishment phase of target costing:-

Table 4: -The Establishment phase of Target Costing It shows that there are seven major activities that must performed to establish target costs-

Market research: This helps provide information about customer needs or want that might not be recognized during product conception. A market niche can be a best way to describe a core market such as high computer users, or fashion inclined people etc.

Market research gains information about unmet needs and wants of customers. This research defines the market and/or product niche that a company plans to exploit.

Competitive analysis: To understand the competitors and their products in the market and how they evaluate the products. This might give the company a glimpse of how their products might be received when launched. Competitor analysis determines what competitors' products are currently available to our target customers, how the customers evaluate these other products, and how our competitors might react to our company's new product introductions.

Customer or market niche: To study and understand the market core areas and competitors information so as to know how to attract them to buy a product. Factors may include their ages, family type, sizes, and their incomes level etc. A customer or product niche is defined by analyzing market and competitor information to decide what particular customer segment to target. A customer niche is a more specifically defined customer, such as young, professional, two income families.

Customer requirement: this relates to what specifically customers want in their product specification. Initial product concept is set up to gather customers input to upgrade the product to the most satisfied level. Customer requirements are determined by introducing an initial product concept and asking customers for their reactions. Preliminary designs are then refined, based on continued input from customers, until the product meets their requirements.

Product features: are defined by setting specific requirements for the features the product will have and the levels of performance of each feature.

Market price: this to establish a price that is acceptable to customers and one that is capable of withstanding competition. This can be done in several ways as discussed latter in this report. A market price is established that is acceptable to customers and capable of with standing competition. Market prices can be established in many different ways. Three common methods are:

a) Existing price plus the market value of new features added. For example, if a new car model has dual air bags, we might take the price of the previous model and add the value of the air bags to determine the new price. b) The projected market price that will provide a target market share. c) Existing price plus the value of added physical attributes. This method is typically used for products for which a customer's desired performance is captured by some physical characteristic of the product.

Required profits: This refers to the target profit that the product will yield if sold at a particular target price, usually expressed in returns on sales ratio (ROS). This ROS must take into account the long-term profit plans and the return on assets (ROA) for the company. The required profit target is set. A product must yield this profit. It typically expressed as a return on sales (ROS) percent. This ROS percent depends upon the long-term profit plans and the financial return on assets a company must earn in a given industry. Companies typically ignore the return on assets since it is difficult to determine and complicates the calculation of target profit.

3.08Attaining Target Costs The second phase of target costing addresses how to attain the target cost that is, how to turn this allowable cost into an achievable cost. There are three steps in attaining target costs: 1. Compute cost gap, 2. Design costs out of a product, and 3. Release

design

for

manufacturing

and

perform

continuous

improvement.

1. Computing the Cost Gap Computing the difference between the allowable cost and the current cost is the first step in attaining target costs. The current cost is the initial "as-is" estimate of the cost of producing based on current cost factors or models. The overall gap between allowable and current must be decomposed by life cycle and by value chain. Life cycle decomposition assigns total product cost to the birth-to-death categories of research, manufacturing, distribution, service, general support, and disposal.

2. Designing Costs Out Reduction of cost through product design is the most critical step in attaining target costs.

The key to cost reduction is to ask one simple question: How does the design of this product affect all costs associated with the product from its inception to its final disposal? To include all costs, not just manufacturing costs, may appear farfetched at first. However, many downstream costs such as distribution, selling, warehousing, service, support, and recycling can be greatly impacted by product design.

Cost reduction relies on four major activities: product design, cost analysis, value engineering, and cost estimation. Cost reduction is recursive since the activities cycle back several times as the product goes from an initial concept to a final design. The recursion is a characteristic of target costing. Recursion exists to generate a cost effective design, not to correct design errors.

3. Release Design and Undertake Continuous Improvement The final stage in attaining target costs is to continue to make product and process improvements that can reduce costs beyond that which is possible through design alone. It includes steps such as eliminating waste, improving production yields and other such measures.

It is after production starts that actual costs can be compare against targets and instruction can apply to the next invention of products developed.

3.09 Determination of Target Costing:3.09.1 Setting the Target cost The main theme in the whole target costing practice is - what should be the new product cost. It is not - what does it cost. Therefore, when the target sales price is established based on market research, the desired profits is subtracted to yield the allowable cost. This allowable cost is the management’s top dream and it is also very hard to attain, usually impossible in the short run.

This allowable cost is computed thus

Target sales price - target profits = allowable cost.

Or

Market driven selling price – desired profit = target cost .

The desired profit is set based on the company’s desired return on sales (ROS), rather than return on investment (ROI). Researchers identify that using ROS is reasonable for technical and strategic reasons.

The technical reason is that associated with the fast changing market of today where manufacturers need a wide variety of products in low volume to survive. It is impossible to use ROI to calculate the profitability of each of these products.

For strategic reasons, ROS is a better option in that to implement long-term strategies manufacturers need to focus on the profitability of portfolios of related products and the role played by each product in the product group. Through the ROS method, the allowable cost compared to the estimated cost, which based on the current standard materials, labor and overhead cost. Meanwhile serious studies are done on competitors’ products and position. Then when all is assessed the gap between allowable costs and estimated cost is reviewed from various perspectives. The target cost is then established as an attainable target, which will motivate all personnel to achieve.

Target Costing at – Akij Group:-

Suppose Akij Group is planning to launch a new Energy drinks with advanced formula. The company believes that such a product should sell for about taka 95 and total annual sales of about 400,000 units. In order to design, develop, and produce this Energy drinks, an investment of taka 10 million would be required. Due to the very short product lives of such products, the company Particulars

Factors

Amount

Projected sales

(400,000 drinks × 95 per drinks)

38,000,000

Less desired profit

(40% × 10,000,000)

4,000,000

Target cost Target cost per drinks

400,000 Energy drinks Per Energy drinks(34,000,000 ÷ 400,000)

34,000,000 85

requires a return on investment (ROI) of 40%. If target-costing calculations revealed cost reduction, Akij Group's current manufacturing cost must be: Target Cost = Projected Sales Price – Desire Profit 3.09.2 Setting target price Table 5: - Calculation of Target Costing The main idea behind target cost system is to minimize the cost of the ownership and not just the price a customer pays at a time or purchase. Cost of ownership includes invoice cost plus transportation, repairs and maintenance, services and support and disposal cost. The cost associated with the cost of ownership must be considered at the time the initial purchase is set for a product.

Within this context therefore, unlike the old cost plus method, setting prices in a target-costing regime takes into consideration the following:

a) Consumer need, want or taste. This may refer to the physical and related function of the product that will influence the price. b) Satisfactory price. This is the price consumers are willing to pay for a desired function and feature. c)

Competitive position of competitors, their prices, range of products and product

functionality. d) Market share goal relating to the size of the market a company wants to attain. a) Setting Target prices for new products: Setting prices for new product is very difficult since the company does not yet have any historic cost information to estimate market evolution. The most helpful strategy here is to do intensive market research, studying competitors’ products, techniques etc, and to assess those factors that will help the producer to evaluate the production cost to selling price and assess the expected profit. However, setting prices when the product is going to the market for the second time might be less challenging. b) Setting prices for exiting products: Setting allowable cost when the product has been in the market for some time is easier because the producer can assess the performance of that product in the market in relation to that of the competitors. Feedback on quality, functionality, new technology, new designs, environmental changes etc, will help the producers to adjust and restructure the pricing system. The fact that there is some historic information about the performance of the last product makes it easier to draft a price plan. Ordinarily, current selling price would have been an adjustment to added functions and feature of the product. This is known as function based adjustment.  Functioned based adjustment: Here adding or subtracting the value of the function added or taken off from an existing product sets prices. Prices of some products drop as technology improves e.g., computers, cameras, mobile phones, consumer electronics etc. It is argued that the computer companies for example add new features at a planned target price reduction on the older model.  Physical attribute based adjustments: This relates to how prices are set influenced by the physical attributes attached to the product.

This raises the idea of weight, horsepower, and influence to the environment etc, in cars for example. This can be very highly thought of in times when functionality is tied to these physical attributes and where functionality changes very slowly. According to researchers, Caterpillar and Komatsu present a very good example.

 Competitors based adjustments: Here the firm sets price with an eye on the competitors’ prices and their product attributes. The main strategy here is just to estimate the differentials value that market places on a competitor’s products based on functionality and attributes.  Few reasons why target costing is used for existing products:o To provide ongoing tracking of actual cost-versus-target cost o To monitor actual-versus-planned price reductions from suppliers o To achieve cost reduction in order to pass price reduction onto customers as a product/service matures o To encourage suppliers to remain competitive o To measure supply management’s performance o To meet or beat competitive pricing 3.09.3 Setting target profits Marketing plays a crucial role in the determination of the target cost. The starting point for a target cost is the estimated selling price for the product determined by market analysis. Sales volume is also estimated and, from the total estimated sales revenue, the desired profit is subtracted. Management determines this desired profit margin in reference to the company’s long – term strategy. Retail prices and sales volumes are proposed by the marketing function based on its research and the company desired market shares. Total sales revenue for each new product over its life can now be estimated. The target profit, usually determined by using return on sales, is subtracted from the total sales revenue. The target cost is now determined.

3.10 Technical Properties of Target Costing As a cost and profit management tool, target costing must possess two important technical properties. It must lead to better decisions, and it must provide a good process understanding of cost drivers and work flows in an organization. It performs well on both these criteria.

No 1:- Decision Relevance- The six fundamental ideas of target costing, discussed earlier in this thesis, show how target costing brings together five critical management decisions. These are:  How to increase profits and returns  How to react to competition  What prices to charge for products  What features to provide and what specifications to use for those features

ď‚Ż When to introduce new products and stop building old products Target costing integrates cost, quality, and time related issues into a single decision round product design. Managers consider profits and competitive reaction as part of setting prices.

Costing is aimed at achieving target profits and returns. New products are timed by considering lifetime profitability and technology cycles of new products.

No 2:- Process Understanding- Enhancing process understanding is at the heart of target costing. Target-costing focuses on the product as it moves through time, across units, across organizations, and across activities. All of this is accomplished by cross-functional teams who have a product and process focus, not a responsibility unit or single organization focus. In fact, target costing cannot function in an organization that is not ready to adopt a process orientation.

3.11 Behavioral Issues in Target Costing There are two sets of behavioral issues in target costing. The first is the behaviors needed for successful target costing. The other is the behavioral consequences of using target costing.

Behaviors NeededTarget costing requires different behaviors from all members of an organization. In this thesis, I focus only on the behavioral implications for management accountants. They need to change their behaviors in two ways:ď‚Ż Management accountants must learn to get involved early and develop a tolerance for ambiguity. Design is by nature an incomplete process. It is forward looking and requires much estimation. Accountants always want verifiable data. They must shed this desire.

Team playing is an important attribute for management accountants. They need to get involved with other disciplines, understand the technical dimensions of the product, and know what customers require. They must learn to talk to other team members from marketing, engineering, and procurement, and explain to them the financial implications of design decisions in an easy and understandable way. Effective communication is an essential behavioral requirement for management accountants who participate in target costing.

3.12 Target Costing in the Budget Model Target costing is the process of setting a target cost for a new product design, and requiring the product design team to either meet the cost target or abandon the project if it cannot do so. The

accounting department’s sole involvement in this process is typically the inclusion of a cost accountant on the design team who monitors the team’s ongoing progress in meeting its cost goals.

The problem with this level of accounting involvement is that there is no linkage to the corporate budgeting process, so there is likely to be a reduced level of budgeting accuracy for the cost of goods sold. To improve the situation, require the participating cost accountants to forward status reports to the budgeting staff for the current status of all product design projects for which target costing is used. This has the following positive impacts on the budgeting process:  The preliminary budget can be adjusted continually to reflect the go/no go status of each design project. Thus, if the decision is made to eliminate a prospective product, its related revenues and costs can be immediately removed from the budget model.  The budgeted cost of goods sold for each product can be adjusted to match the estimated final cost of each new product design.

To incorporate this target costing information into the budgeting process, the budget model must already itemize revenues and costs at the individual product level. However, if the current budget model only aggregates revenues and costs at the product line level, one can at least incorporate into the model (in percentage terms) the general impact expected from a target costing program.

3.13 Target Costing in Service Industries Target costing is still an evolutionary process and it has not been fully institutionalized in most service organizations. Some service firms use a modified approach to target costing, in which the targets are not related directly to the target-selling price for a good or service.

For those organizations, target costing is currently more of a supply management tool than an organizational process, although some of those firms seem to be working toward instituting target costing as an organizational process.  Barriers to implementing target costing in service organizations:Some barriers to implementing target costing in service organizations are that, in general, purchase costs in the service sector are a much smaller percentage of total cost than they are in the manufacturing sector. This may make the importance and potential contribution of target costing less apparent to functions outside supply management.

In addition, it may be more difficult to tie the purchase price of an item directly to the target price to customers in the service sector, because the impact of individual items is services that will be sold to customers. Again, the demand for services are not easily determined as cannot be projected. Unlike normal products, services do not have regular changes to functionality and value added.

3.14 Target Costing to Improve Bottom-Line Changing Product Life and Requirement Product life cycles are getting shorter and shorter, quite often one or two years, and sometimes to less than one year in high-tech industries. Consumers are demanding new and diversified products in short intervals. Due to factory automation, robots and computer-controlled manufacturing systems are replacing the conventional production lines. What all these changes mean is the traditional standard costing systems, which emphasize cost control in the manufacturing phase of the product life cycle, are no longer effective. With a one-year product life, controlling costs in the manufacturing phase simply doesn't accomplish much. Once the product is developed and designed, there is a limit to how much cost cutting companies can do in the manufacturing stage. Manufacturers have learned cost management should start up front at the initial stage to be effective and measure up to their foreign counterparts.

A new cost management concept has been developed and practiced by world-class manufacturers to deal with the needs in the product development and design phase.

Control Costs Early Target costing, although its concept is used throughout the product life cycle, is primarily used and most effective in the product development and design stage. Born out of the market-driven philosophy, target costing is based on the price down, cost-down strategy, which has allowed companies like Sony and Toyota to win a considerable share of their respective markets.

In companies, costs of designing, producing, marketing, and delivering products dictate the mode of competition. Accountants usually measure, based on allocation routines, the total cost of each product. Most popular cost accounting methodologies, including the emerging activitybased costing, focus on product profitability. No matter how effective the cost accounting methodology may be, managers and accountants must heed the shareholders' needs for satisfactory short- term profits, measured by ROI or ROE.

This focus on meeting the shareholders' short-term needs has been well documented, and easily understood if we look at the Big Three automakers' practice of raising prices whenever there is a restriction placed on Japanese imports. The practice is effective in achieving the desired ROI or ROE, but it hurts the carmakers' ability to increase market share in sales volume. An increased market share would give them a buffer in the future if they choose to sacrifice sales volume to increase revenue and long-term profit.

In companies where target costing is used, there seems to be a different culture and attitude.

They place more emphasis on their relative position in the market and product leadership. Since more than 80% of product cost is already determined by the time product design and processing is complete, cost management must start (and done substantially) at the design stage.

Connect with Profit Planning Target costing is very closely linked with the company's long-term profit and product planning process. This link allows the company to focus on profit and product in an integrated strategy, which does not discriminate against high-quality, high-price, high-margin products that require high costs. This is in direct contrast to a typical manufacturer’s practice, in which the question persists, "How much does the product cost?" This question follows a new product design into the cost accounting department, which estimates the new product costs based on the prices of purchased materials and parts, labor costs, and other manufacturing overhead costs under the current production standards. The marketing department then addresses the issue of whether they can sell the new product. This departmentalized policy formulation of a typical company, which focuses on cost, tends to discriminate against developing a new high-quality, high-price product. Target costing derives its bases from the company-wide profit plan. The target profit for each period is determined for each of the new and existing product portfolios. The profitability of each group of related products is the focus, rather than the profitability of individual products. The desired profit margins are traded between products in the same group, depending on what stage the product is in its life cycle and what leadership role the product can play in acquiring a new segment of the market.

Setting the Target Costs The main theme in the entire target costing practice is, "What should the new product cost?" It is not, "What does it cost?" When the target sales price is established based on market research, the desired profit is subtracted to yield the allowable cost. This allowable cost is top management's dream. This is a target, which is very hard to attain, usually impossible in the short run.

The desired profit is determined based on the company's desired return on sales (ROS), rather than ROI. There are two primary reasons for using ROS. The first is technical, the second is strategic: 1. The Technical Reason. In the fast changing market of today, manufacturers need a variety of products in low volumes to survive. Calculating the profitability of each of those products in ROI is well- nigh impossible.

2. The Strategic Reason. In the implementation of long-term strategies, manufacturers need to focus on the profitability of portfolios of related products and the role each product plays for the product group. For this, ROS provides a better measure. The allowable cost is compared to the estimated cost, which is based on the current standards of materials, labor, and overhead. In the meantime, intensive studies of competitors' parts are done. After motivational considerations have been made, the gap between allowable cost and estimated cost is reviewed on various dimensions. The target cost is then established as an attainable target which will motivate all personnel to achieve. Now, the struggle begins.

Achieving the Target Costs At this point, cost management people help engineering planners and designers decompose the target cost into each cost element according to their relations to detailed production functions.

Production engineers determine standards for material and part usage, labor consumption, etc., which become the basic cost data for financial accounting purposes. These standards are also used as a database for material requirements planning (MRP).

The struggle to achieve the target costs takes place in and outside the company. As soon as the above-mentioned standards are established, purchasing people negotiate with outside suppliers as to the prices of purchased materials and parts. Negotiations also take place among design, engineering, marketing, and other departments in the company, and compromises are made in their efforts to get within the target cost range. The fundamental mechanism manufacturers use to achieve target cost, nevertheless, is value engineering (VE).

Value Engineering The idea behind VE is very similar to activity analysis which was first developed and used by General Electric. GE's activity analysis was not, however, and was not intended to be, linked to corporate profit planning, target profit, and target costs as they are practiced In Japan.

VE is a mechanism Japanese manufacturers use to enhance the value of products and services, which is measured by the relationship between the functions performed by products and services and the costs incurred. The functions are defined by different companies in different

ways. Some are geared toward process improvement while others are focused on satisfying the needs of customers.

The process of VE consists of describing the functions of each product, part, and service, and quantifying the components of those functions. For example, a printed circuit board (PCB) manufacturer's VE activities for the drilling operation include panel size, number of images per panel, lot size and frequency, number of holes, hole size, stack height, laminate thickness, post plate drill, and fine line class. In the design phase, management science techniques are employed on the many aspects of the drilling operation to improve upon the current method.

Post-Audit of Target Costing Performance The short life cycles of manufactured goods in today's market require manufacturers to recover investment in a short time. A short payback period is usually assumed in planning and evaluating target costs. Post- audit of target costing performance is done on a regular basis to examine the degree to which targets have been achieved. If targets have not been achieved, investigations follow.

The Real Weapon The real power of target costing is that it allows companies to successfully motivate employees and enforce cost management action plans. It is a disciplined approach to managing costs and improving processes and products. Target costing, as briefly illustrated here, is also very compatible with the emerging ABC, which can provide necessary cost information for implementing target costing.

3.15 Suitable Industry for Target Costing Application It can be said that whenever a management approach is developed, question arises as to which firm such a system may fit appropriately. However, consistent with many new financial or operational approaches, target costing may not be for everyone. Some companies, which seem to benefit most from target costing, are those, which maintain the following criteria: 1. Assembly – oriented industries, as opposed to repetitive-process industries that produce homogeneous products; 2. Involved heavily with the diversification of the product lines; 3. Use technologies of factory automation, including computer – aided design, flexible manufacturing systems, office automation, and computer-aided manufacturing;

4.

Have experienced shorter product life cycles where the payback for factory

automation typically must be achieved in a short time; 5.

Must develop systems for reducing costs during the planning, design and

development stages of a product’s life cycle; 6. Are implementing management methods such as just-in-time, value engineering, and total quality control.

3.16 Evaluation of Target Costing

3.16.01 Benefits derived from Target Costing:Successful planning and implementation of the effective target costing system helps to derive the following benefits: Target costing is future-oriented: - Some companies more often design the product, then calculate the cost, and finally try to figure out whether it will sell. If the cost is too high, the product goes back to the drawing board for redesign or if no additional time is available the company launches the product and settles for a smaller profit.

The use of target costing ensures profitability on the short and long run: - Products that show up as low-margin or unprofitable are quickly dropped. Similarly, ideas for new products whose profitability projections fail to clear certain hurdle rates usually wither away on the accountant’s spreadsheet. In the past, many leading companies, especially those that led by technical differentiation, could release new products anticipating a future price increase.

Explain that competitive markets no longer allow a company time to introduce a product and then scale up, because imitators bring me-too products to market so rapidly that first mover companies have no time to establish brand loyalty, let alone recover their development costs.

Target costing reasons backward from customers’ needs and willingness to pay: -Target costing focuses the design team on the ultimate customer and on the real opportunities in the market. They call it “commitment to the customers”. If targets cannot be met, the company cannot simply raise the price and launch the product. Admit that such discipline may be painful to the people who work on a project, but it sends the important message that the customers come first, and that if the company does not create value for them, a competitor will.

Target costing is used at the design stage, focusing on the cost implications of design decisions. Designers must know how design affects such things as material consumption, yield,

machining methods, and line time. The intensity by which the product is designed to its target cost is contrary to a situation where the projected cost can be exceeded without penalty. By setting a target cost for a future product, all members of the design team consider the impact on the cost while deciding on design alternatives. The use of a target costing system prevents design engineers saying: “If we just add this feature, the product will be so much better and only cost a little more.”

Target costing gives a clear, quantitative cost objective to design engineers: - Target costing is totally different from the traditional approach or the cost-plus approach. Under the traditional approach the new product’s expected profit margin, not the cost level of the future product becomes the dependent variable when launching a new product. Under this traditional approach, the profit margin is determined by subtracting its estimated cost from its anticipated sales price (sales price - cost = profit margin). Under the cost-plus approach, the product’s expected sales price becomes the dependent variable. This means that the sales price is determined by adding the desired profit margin to the expected cost of the product (cost + profit margin = sales price). Under both approaches, product designers have no specified cost objective to achieve. Instead, they are expected to minimize the cost of the product as they design it.

The use of a target costing system forces management to set the NPD goals early in the NPD process: - Setting target costs requires that management decides on the quality of the future product as well as on the time-to-market, based on market research and the company’s strategy. Setting NPD goals requires making trade-offs between the different characteristics of a future product. Marketing people are traditionally oriented to sell products and want as much features as possible for a new product, but do not want customers to pay for it. Under target costing, management needs to balance cost and features against the customer’s ability (or willingness) to pay for all this.

3.16.02 Drawbacks of target costing:Nevertheless, some authors also suggest that the use of target costing during NPD can lead to some undesirable consequences.

First, it takes time and money to bring sweeping changes into an organization. There's also the problem of changing workers' behavior. Why rock the boat if things are going well? The answer, target costing proponents say, is simple: In The Long Run Company will be better positioned to compete in the marketplace with target costing than without target costing.

Second, target costing can be severely criticized because of excessive demands it puts on subcontractors. As major customers pass their cost-reduction demands down to suppliers, the suppliers push their suppliers and employees to do more, some of whom are already doing all they can handle. It can be called the battle of intense negotiation between the company and its outside suppliers. This excessive demand goes hand in hand with a restricted autonomy of the suppliers.

Third, the use of target costing information might cause organizational conflicts. One aspect involves the difficulty to decompose the total target cost to target costs of individual components. It can be called as the battle among the departments, since most of the time different departments are responsible to design parts or subassemblies. Deciding on the component-level target cost means deciding on the effort the different departments will need to do in reducing costs. Organizational conflicts might also arise when design engineers feel that other parts of the organization are getting a free ride while they try to squeeze every penny out of a product.

Finally, some researchers conclude that the extreme customer focus of target costing might lead to market confusion, with too many products, too many options. Constant attention to customers’ desires causes extreme market segmentation. As a result the large number of different products confuses customers. In general, most researchers extensively report on the benefits, while the drawbacks are discussed to a less extent.

3.17 Target Costing as Problem Solving Tools 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 yields a satisfactory return to its stakeholders. As competition increases, and supply exceeds demand, market forces influence prices more significantly. 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 company sets to achieve within certain market penetration objectives. In this context, the practice of target costing has evolved and would stand as a force to support this argument. The problems raised here in this thesis are: ď‚Ż The difficulty for modern company management to develop strategies that catches up with modern business trends. Instead, they blame their failure to attain expected goals on other non-related issues such as high cost of production or political policies such as high taxation.

The inability to apply efficient Cost management therefore remains the major source of all

business problems. Market sizes of firms have shrunk due to widespread technological advancement and, again, nobody can boast of exclusivity in technology today as before. If low cost environments can be technologically efficient, and can supply

cost efficient

products for the market, the company’s management has to consider more rigorous costing systems able to work in this competitive environment. Like Target costing, a tool to keep a tab on long-term planning and production projection.  During periods of market depression, managers tend to conclude that the cost of production is unbearable. They may make rash decisions such as moving production to other locations, which they deem are cheaper or they tend to cut cost through excessive layoffs.

Firms can lay off workers when they cannot be paid but some analyst see migration as a very short term solution because soon those countries will start regulating their own markets higher taxes. To take a stand on that, I have distinguished between two types of outsourcing- strategic and non-strategic outsourcing. Some researchers propose that target costing when understood and well implemented can provide an alternative solution to the above problem.  Cost management systems, as a company’s strategic force ordinarily, should be designed to support a company’s operations and strategy. Traditional cost systems provide information that is distorted, too exaggerated, and too late to be used in reducing cost or providing productivity and market projection. Management accounting systems in general and cost management in particular has to be re- examined and made in such a way that the risk of understanding projections are minimized so that long term production and product planning within this period of uncertainty can be projected with some amount of certainty, such as Target costing approach.  With globalization and increasingly easy means of communication there has been effortless flow of information enabling markets to become easy to access from distant areas.

Consumers can compare quality, durability and prices of a product from one market with those of other markets. South Asian countries as well as European countries are becoming technology holders effecting prices and therefore becoming price leaders as a result.

Therefore, conventional notion whereby the owner of technology or core competence would be considered a market leader and price giver is not longer fashionable. For an organization to succeed consequently, and effect cost, structured systems have to be designed whereby expected profits can be assessed from what consumers are ready to pay and what quality they want . To attain this strategy target costing can be a viable solution as most of those mechanisms are contained in its principles.

3.18 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 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 it is where the effort is concentrated in 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 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.

3.19 Some Myths about Target Costing: Target costing has now been around long enough and gained sufficiently wide acceptance that it can no longer be called an emerging management technique. Yet there remains a certain amount of ambivalence and confusion about target costing. Some companies have experimented with target costing only to abandon it after encountering resistance from managers to the change from traditional cost management systems. Others have moved in the direction of target costing, but have failed to make the necessary strategic commitment to the idea to reap its full benefits.

The following discussion addresses some of the myths about target costing:The first myth is that target costing is primarily about setting cost targets. Target costing is not just the act of setting cost targets—it is an entire value chain approach to managing an enterprise. A value chain approach is totally different. Target costing begins with understanding what the market values are—what the customer or prospective customer wants and is willing to pay. It is especially important to keep these customer value expectations at the

front of the workforce’s awareness throughout the whole product development cycle and to take a very disciplined approach to deciding where to position a new product or modification Target costing involves translating customer value expectations into an acceptable product price and taking away the profit that shareholders expect to make to get the target cost. Once a product target cost is determined, decomposing the cost into the parts of the product can be difficult, and it has to be done based on the features that a product provides to the market place and/or the functions it performs. Customers don’t care how many engineers were on the project or how much tooling cost was incurred, they care only about the cost of the various product features and functions.

Another myth is that cost targets are just cost budgets. Target costing is totally different from traditional budgeting systems, especially those in contract environments where managers have been taught for years that budgets are something you spend. It is difficult to change the workforce mindset from cost budget (which represents something to be spent) to cost target (which represents something to be achieved). Cost budgets and cost targets are, fundamentally, conflicting concepts that don’t belong in the same universe. Ideally, the word “budget” should be banned in a target costing environment because it carries too much baggage from the old model.

A final myth about target costing involves where it fits in the developmental life cycle of a product. Design-to-cost systems were tried at Boeing and other companies years before the introduction of target costing, but many of these applications failed miserably because they focused on far too small a part of the product life cycle. They mistakenly assumed that everyone else in the value chain was going to engage in the system and that all of the financial information was readily available so that people could do value engineering and value analysis studies. In a lot of cases the value chain was simply not ready to accept the new model.

To be successful, target costing, like value engineering, must be embraced across the entire product life cycle, from the very early concept development and market research all the way down to disposal of the product.

Although not limited to target costing, there is also a common misconception within the broader framework of corporate financial systems regarding the idea of “cost management.” In most present day financial systems, there are organizations that are in charge of cost management, but what they really do is report cost, not manage it.

Suggestions for successful implementation of target costing:-To have a successful target costing application, one must begin by determining the product’s strategic market position and customer expectations regarding product features and functions. Cost targets must not be

viewed by managers as spending allowances or unrealistic spending limits, but rather as goals to be achieved through collaboration with colleagues and other parties up and down the value chain. Above all, target costing must be viewed not as a costing method, but as a model for managing across the entire value chain. If this is done well, the final product will meet customers’ expectations and both costs and profits will be within acceptable boundaries.

3.20 Suggestion for recovery MIS and Accounting Limitations:Information systems are evolving, but too slowly, from a traditional view of internal cost accounting measuring cost centers in predetermined accounting periods. They must move faster to a market-driven system starting with the customer. The study found target costing systems and the quick reporting of information facilitated learning, the study focus that under a high level of advanced manufacturing technology, a target costing system must be introduced and information should be provided frequently and quickly.

This information or organizational learning support system is a requirement for improvement and encompasses accounting information, planning, control, production, and meeting budgets, forecasts, and performance standards. Thus the information is a facilitator of corporate learning.

The new information must be adjusted to satisfy diverse information needs of managers and include non-financial measures as well.

A company should know the costs of its own operations and should share part of the cost information with cooperating firms in an open information network. Few firms know the full costs of each product and stress the ability to cost new activities depends on mutually accepted accounting practices among the suppliers in the supply chain. Target costing has gained prominence within business organizations, the traditional management accounting practices of standard costing and contribution margin analysis continues to predominate.

The professional bodies need to organize a management accounting curriculum to cover such topics as target costing, along with activity based costing, and some others approach of examining both quantitative and qualitative costs in a systematic, activity-oriented approach well executed in various Bangladesh industries for increase the rapid growth. This curriculum change is needed to meet the changing marketing place which is more global and is experiencing deregulation and advances in information technology along with a customer focus and constant change.

Analysis of Target Costing In Bangladesh

4.01 Data Processing: The number of personnel and the manufacturing methods of the participating companies and the distribution of the respondents of the questionnaire in terms of position were assessedPercentage Respond With Question Under the Survey Participant business industries

Sample Cases Included Excluded N Percent N Percent 20 100.0% 0 0%

Total Percent 100.0%

Participant business engaged period

20

100.0%

0

0%

100.0%

Participant company face competition Participant rate intensity of competition

20 20

100.0% 100.0%

0 0

0% 0%

100.0% 100.0%

Origin of the Competitor Participant company position under Competition

20 20

100.0% 100.0%

0 0

0% 0%

100.0% 100.0%

Factors important to positioning product in the market Company used technique for Product Costing

20 20

100.0% 100.0%

0 0

0% 0%

100.0% 100.0%

Satisfactory level with current technique

20

100.0%

0

0%

100.0%

Chance to improve growth with developed M. Accounting technique Does the company follow described Target Costing for product development How long used the target costing technique

20

100.0%

0

0%

100.0%

20

100.0%

0

0%

100.0%

8

40.0%

12

60.0%

100.0%

Assess for using Target Costing

8

40.0%

12

60.0%

100.0%

Reason for not using Target Costing

13

65.0%

7

35.0%

100.0%

Company might want to stay with Target Costing

20

100.0%

0

.0%

100.0%

Company goal to used Target Costing for achieve

8

40.0%

12

60.0%

100.0%

Benefit derived for using Target Costing

8

40.0%

12

60.0%

100.0%

Which department executed Target costing technique

8

40.0%

12

60.0%

100.0%

Implementing pattern of Target Costing

8

40.0%

12

60.0%

100.0%

Evaluation of Target Costing to various company

8

40.0%

12

60.0%

100.0%

Table 6:- Case processing summary

ď‚Ż Here, the application level and form of target costing among the participating companies and the distribution level in terms of industries are given. In Table 4, shows the 20 companies, which were the top companies in Bangladesh & the responses with the survey. The 20 respondents the question asked in order to determine which types of business they run:-

Chart:-1

Participant business industries 5

4

3

2

1

0 T

T

ti ex le

C e h

in ng

&

E

l ca

&

i un m m o C

on

i ut ce

i ct

&

ic m ra e C

d e ll i A

y er nn a

tru

&

a rm

ns

ha P

o C

od o

&

i le ob

t

ic n ro ct le E

F

m to u A

en em C

 Here, the question asked to the 20 respondent’s to determine whether they face any types of risk in business. They mention that they face risk from home as maximum, also for abroad & E- market. The rate of the intensity of competition:Frequency Moderate High Very High Total

4 9 7 20

Percen t 20.0 45.0 35.0 100.0

Valid Percent

Cumulative Percent

20.0 45.0 35.0 100.0

20.0 65.0 100.0

Table 7: - Participant rate intensity of competition they face

 Here, the question asked to the respondent’s to determine which factor is important to take position in the market for their business product. Majority of them reply that sales price is main factor, then cost of product & quality.

Sales Price Cost of Product Total

Frequency

Percent

Valid Percent

11 9 20

55.0 45.0 100.0

55.0 45.0 100.0

Cumulative Percent 55.0 100.0

Table 8:- Factors important to positioning product in the market  The question was asked to the respondent’s to determine which technique they use for producing their business product. Majority of them engage in food & allied response that they use full & process costing, thirty percent of them engage in textile business use target costing. Others reply that they use technique similar with target costing but differently termed, some mention that they use other technique.

Process Costing Target Costing Throughput Costing Full Costing Total

Frequency

Percent

Valid Percent

Cumulative Percent

5 7 3 5 20

25.0 35.0 15.0 25.0 100.0

25.0 35.0 15.0 25.0 100.0

25.0 60.0 75.0 100.0

Table 9:- Company used technique for Product Costing Chart: - 2 Company used technique for Product Costing

Thoughtput Costing

Target Costing

Process Costing

Full Costing

 The question was asked to the respondent’s, to express the level of satisfaction with their current technique, user of target costing technique replied that they are satisfied but over the percentage is very much poor.

Chart:-3 Satisfactory level with current technique Satisfactory Good

Very Good

Poor

 The question was asked to the respondent’s, why they didn’t use target costing technique for producing their business product. Majority of them replied that the technique is unknown to them and others replied that this is costly & excessive them to collect information.

Chart: - 4

Reason for not using Target Costing 8

6

4

2

0 Unknow n

Complex

Expensive to collect

Costly

 The question was asked to the respondent’s, to assess the operation target costing, majority (thirty eight percent) user of target costing technique replied that this is very efficient , other replied as efficient & manageable.

Chart: - 5 Assess for using Target Costing 3.5

3.0

2.5

2.0

1.5

1.0

.5 0.0 Manageable

Efficient

Very Efficient

 The question was asked to the respondent’s, why they use target costing. Majority of them replied that they use the technique to producing new product, some portion respond that they use for cost budgeting & others purpose Chart: - 6

Company used purpose of Target Costing Others

Budgeting Cost

New Product Dev.

 The question was asked to the respondent’s to determine what benefits they got for use the technique. They replied that they able to reduce the production of cost & control the quality for producing their business product. Others replied that they got higher margin for used the technique.

Chart: - 7 Benifit derived for using Target Costing Higher Margin

Quality Control

Cost Reduction

 The question was asked to the respondent’s, to define that how they executed the operation of target costing in their organization, majority user of target costing technique replied that they implement this technique through accounting department, other replied as engineering expert & departmental team, workforce.

Chart: - 8 Implementing pattern of Target Costing 3.5

3.0

2.5

2.0

1.5

1.0

.5 0.0 Dept. Workf orce

Int. discip. Team

Acc.Department

Through Expert

 Finally the question was asked to the respondent’s, to evaluate & express the

experience of using target costing in their business. Most of the user of target costing technique replied that this technique is excellent, others rates is very good & above average. No negative experience or comment was found against the target costing.

Chart: - 9

Evaluation of Target Costing By various company 5

4

3

2

1

0 Above Average

Very Good

Excellent

Findings of the Study 5.01 Findings: - After the analysis and review the role of target costing in various Bangladesh industries the following findings are observed during the study:-

 Rather than Textile & food manufacturing industries, the percentage of implementation of target costing in Bangladesh is very poor.

 Chemical & Pharmaceutical industries are unaware of this useful technique.  Electronics, Construction, Telecom & beverage industries use little bit this technique, whether this sector is the most useful prospect for using target costing.

 Lacking

of using the wrong or inefficient technique, almost fifty percent of the

respondent business under the survey faced high risk for the competition in their business at home & abroad, they are poorly satisfied with their current management accounting technique.

 Whether the users who use Target costing are highly satisfied & they express that this is very much efficient, & they strongly agreed that they will stay with target costing.

 Almost

all the respondent company under the survey agreed with that a developed

management accounting technique helps in achieve business growth.

 Some respondent company uses the similar process of target costing in their own manner but this is not much efficient as target costing.

 Majority

percent of respondent who don’t use target costing mention that they are

unknown about the developed technique, others mention that it is costly & take excessive time.

 Majority of the respondent who use target costing mention that they use this technique for development of new product, and other respondent mention that they use for cost budgeting.

 The highest portion of the user of target costing company mentioned that they executed this technique with the help of accounting department.

 All the respondents evaluate target costing as excellent technique for the business.

5.02 Recommendation:To enhance the management accounting technique such as target costing practices and to gain competitiveness of the Bangladeshi companies the following recommendations have been made after analyzing all major and associated findings. The key results of this evaluation study regarding the application level of target costing in various Bangladeshi industries can be show as follows:  A higher percentage of firms in all sectors use cost plus principle for product costing but this costing is not useful for product costing. So it is suggested to use target costing for product costing.  The companies applying target costing or having a similar process have narrow market analysis and marketing information systems. They follow balanced competition strategies  They must give more importance to determine the customer expectations before the product design, in order to fully provide the expected benefit from target costing  Their pricing of the new products by depending on cost usually poses an obstacle to the successful application of target costing  Rather than textile industries, over the fifty percent other industries such as food, cement etc use full costing for product costing, but this costing technique is not appropriate for product costing. So it is suggested to use target costing for product costing.

 The weak relationships between these companies and their suppliers is transformed to a more collaborative structure and if the integration degree of the design processes is increased, the benefits to be gained from the target costing process will increase evenly.  Majority of these companies operate in competitive market conditions. Target costing should be used to increase the competitiveness of the firms within the industry and in the global market.  Higher percentage of workforce in Jute, Paper, and Printing, Tannery, and Textile sectors implies that the factory is not automated enough. So, automation is recommended in order to reduce production costs and to increase profitability by implementing Target costing.

5.03 Conclusion:Strategic management accounting is taking a more central role in companies’ decision making plans than ever before and target costing is one of the tools they are adopting. The target costing process considers the voice of the customer, incorporates earlier supplier involvement and concurrent engineering, utilizes cross-functional teams, and focuses on creating a good or service that is both desirable and affordable to the customer and profitable to the producing organization.

Target costing is still a relatively new concept to Bangladeshi companies, but is being adopted in some key industries such as textile and manufacturing and the trend should carry over into other industries as all firms can benefit from the increased competitiveness that cost management and profit planning can provide.

The study shows that though privatization and authoritative pronouncement has contributed a lot in the development of management accounting in Bangladesh, the survey result of the present practices of management accounting technique in listed manufacturing sector reveals that state of use of developed techniques (like target costing, throughput costing, life cycle costing) is not satisfactory.

Modern techniques are being used to face complex situation. Bangladeshi manufacturing business firms remain far behind the expected situation due to lack of awareness as to benefit of using the management accounting techniques for better decision making. All concerned people need to realize the situation and take appropriate action from every corner to overcome this unwarranted situation. To keep pace with the world changing management accounting environment, Bangladeshi firms should use the newly developed techniques such as target

costing. The soon it is done, the better it will be, otherwise we shall perish in this competitive world.

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