Target cost is the process the entity desire to incur in order to earn a specific amount of profit from the market price. The whole process of computing target cost is known as target costing.
The following are advantages of adopting target costing:
- In target costing only those features that are of value to customers will be included in the product design. Target costing at an early stage considers carefully the product that is intended. Features that are unlikely to be valued by the customer will be excluded. The consideration of features according to customer needs is often not considered in cost-plus methodologies.
- It is often argued that target costing reduces the time taken to get the product to market. Under traditional methodologies, there are often lengthy delays while a team goes back to the drawing board. Target costing because it has an early external focus, Tend to help get things right the first time and thus reduce time to market.
- Cost per unit is often lower under the target costing the environment. This enhances profitability. Target costing has been shown to reduce product cost by between 20% and 40% depending on product and market conditions. In traditional cost plus system an organization may not be fully aware of the constraints in the external environment until after production has started. Cost production at this point is much more difficult as many of the cost are already designed in the product.
- In target costing the entity has an early external focus on its product development. The business has to compete with others (competitors) and an early consideration of this will tend to make the business more successful. Traditional approaches such as the cost price approach are often far too internally driven.
- In target costing, cost control begins much earlier in product development. If it is clear at the product design stage that a cost gap exists then more can be done to close it by the design team. Traditionally, cost control takes place at a cost incurring stage, which is often far too late to make a significant impact on a product that is too expensive to make.