Target costing & Problems encountered in Target costing for services.
18th july 2015
Saturday, chilling time. Two days more before work, yaaaay!!. Woke up around 10 or 11. Met my family watching a comedy film and I joined in. We had a good laugh, then it was back to the books for me. Picked up my book and read on target costing. Here is the summary of what I learnt.
What is target costing ?
Target costing involves setting a target cost for a product. This occurs after identifying a target selling price and a required profit.
In a competitive market like most markets of today, it is very important that the prices of products remain competitive and also for the survival of the business. While ensuring competitiveness, it is also important that the price carries along the required profit. Achieving a target cost will usually require some redesigning of the product and the removal of unnecessary costs.
Target costing is more effective at the product design stage, and is less effective for established products with already established processes because they might be difficult or more expensive to alter. At the design stage, it is easier and cheaper to make changes that reduce costs.
Key terms: Target costing involves setting a target cost by subtracting a desired profit margin from a target selling price.
Steps in Implementing a target costing system
- 1) Determine a product specification of which an adequate sales volume is estimated.
- 2) Decide a target selling price at which the organization will be able to sell the product successfully and achieve a desired market share.
- 3) Estimate the required profit, based on required profit margin or return on investment.
- 4) Calculate the target cost which is the target selling price (-) Target profit
- 5) Prepare an estimated cost for the product based n the initial design specifications and current cost level.
- 6) Calculate Target cost gap: Estimated cost – Target cost.
- 7) Make efforts to close gap. It is more effective to design out costs, ie remove costs while still in the designing and planning stage, than to control out cost which is the looking for means to reduce costs after already starting production
In the case where a target cost gap exists, possible ways to reduce it is for the management to set benchmarks for improvement towards the target cost, by improving technologies and processes.
Some of the techniques that may be used include:
a) Reducing the number of components
b) Using standard components wherever possible
c) Removing or eliminating activities that do not add value
d) Using cheaper staff
e) Training staff to be efficient in production
f) Acquiring new and more efficient technologies
g) Using different materials (identified using activity analysis)
PROBLEMS WITH TARGET COSTING FOR SERVICES
Target costing is a daunting process for the service industry because it involves setting up a target cost for a product whose design and make up is specified in exact detail in a product specification. A target cost is the cost for this detailed specification. Services are much more difficult to specify exactly. This is due to some of the characteristics of a service, which are :
a) Intangibility: It is impossible to pinpoint what exactly drives the satisfaction of customers in a service, to say you want to exclude it or that it adds no value like under target costing for products. Some of the features of a service cannot be properly specified because they are tangible.
Also when services do not have any material content, it is not possible to reduce costs to a target level by reducing material costs.
b) Variability/ homogeneity: A service can differ every time it is provided, and a standard service may not exist.