Contemporary Management Technique Target Costing

CONTEMPORARY MANAGEMENT TECHNIQUE 16

Target costing regards to a system employed by a company in prospectplanning for price points, costs of production, and margins, which itdesires to attain for an advent product. In case the product isimpossible to manufacture during the levels, then the design projectis canceled completely. Target costing ensures that management has astrong tool for progressively observing products from their period ofentry in the design stage and all through the life cycle of theproduct. It is regarded as a relevant tool for attaining reliablesuccess within a manufacturing surrounding.

Rationale

Businesses have diverse objectives, like gratifying customer needsby providing high-quality goods, as well as services, attaining majorlevel market penetration, availing a proper working surrounding forworkers, and being monetarily triumphant. The lasting financialsuccess of businesses relies on if the prices surpass expenses enoughto finance development, facilitate reinvestment, and give way to anacceptable return to stakeholders (Cooper &amp Slagmulder, 1999). Incase there are minimal competitors and demand surpasses supply, itmight be probable to merely mark up prices to determine a price,which results in profit. Conversely, as competition rises, and supplysurpasses demand, market forces control prices considerably. Toattain a satisfactory margin over costs, a business needs to handlethe costs relating to prices the market permits. In the milieu ofthese traits, target costing has developed (Cooper &amp Slagmulder,1999).

After the Second World War, most North American organizationshastily developed due to the pent-up demand during the war period,restructuring of the Pacific Rim as well as Europe, in addition tofast increase in population (Cooper &amp Slagmulder, 1999). Highdemand, and frequently less competitors, allowed the organizations tocontinue making money and develop through the offsetting of pricerise with cost rise. Regrettably, cost-based pricing fails toencourage great cost management. It might form an umbrella of chancesfor competitors that intend to penetrate a market, except when thereare entry restrictions, like technological leadership and investmentstages. It might also run the peril of pricing goods from the market.Currently, most American manufacturers, familiarized with highdemand, less competition, and the capability to mark up prices togenerate good gains, are facing a unique and unfavorable market(Cooper &amp Slagmulder, 1999).

Starting companies endeavoring to make it in the market, likenumerous Japanese manufacturers following the war, noted theyrequired to provide advanced products at lesser prices to triumphinternationally and at home bases (Freedman, 1993). To recognize asufficient growth margin, reinvest, and gain return, their entirestrategy to relating cost as well as price, and handle costs, couldhave to mirror the greatly competitive market. Hence, such majorJapanese organizations like Toyota employed what is currentlyregarded as target costing. Several North American car manufacturerslike Ford have started to employ the strategy in their endeavors ofcompeting with Japanese manufacturers (Freedman, 1993). Start-uporganizations within the computer making business have also employedtarget costing in competing with well-known computer makers as IBM(Freedman, 1993).

Target costing is a unique manner of viewing the association amidprices and costs. The fundamental target cost equation, Price –Profit Margin = Cost, implies prices are driven and determinedthrough competitive market forces or through the company as itforcefully reduces prices to improve market entry (Freedman, 1993).The cost equation also implies that the importance of profit marginsis for companies to make capital and acceptable costs arise fromprice and margin. Leaders employing target costing realize that it isnot merely a change in mechanics rather, a mindset shift, whichfills the entire company. The notion that prices influence allowablecosts has an obvious behavior and production effect. It greatlydetermines the possibility of a business to survive, develop andthrive in a competitive and fast altering business environment.

In-depth Analysis of Target Costing

The basic aim of target costing involves allowing management toprogress making profits while operating in a highly competitivemarket (Wood, 1998). It is a practical cost development, organizationand reduction endeavor where expenses are calculated and handledduring the designing and improvement phase, in place of the latterphases of product manufacture. Target costing applies to adventproducts, product alterations and subsequent product generations(Wood, 1998). Costs, which are insisted upon are those directlyimpacted by target costing comprising of raw products and boughtproduct components, conversion expenses like labor, tooling expenses,and downgrading. Conversely, since target costing is an inclusiveplan on costs, expenses and products, which might be impacted byinitial product planning decisions, need to be regarded (Wood, 1998).This involves indirect overhead expenditures via the manufacturephase and past, like service expenses and assets like inventory.Target costing is aimed at ensuring managers foresee the impacts oftheir decisions during product manufacturing.

Target costing insists on the comprehension of markets andcompetitors. It concentrates on clients needs about quality,performance, release and price. The system realizes the need tobalance trade-offs all over the company (Wood, 1998). Target costingcannot be effectively implemented without complete backing ofdifferent sections of the organization. The sections involvepromotion, procurement, product and process development andproduction. Management accountants are accountable for ensuring thatthe differing organizational sectors work together in ensuring targetcosting is achieved within a company. Because the accountants aretrained to collect, scrutinize, calculate and report information,their skills are imperative towards triumphant target costing (Wood,1998). Engaging management accountants in target costing ensuresreliability on monetary connotations of the several trade-offs anddecisions decided through the target costing procedure. Hence, theaccountant is accountable for holding the entire procedure in unison.

A significant function of the management accountant involvesassisting in determining what the suggested product’s present costsmay be, assuming the same product details and production procedure tothose applied by the company (Wood, 1998). Regrettably, mostbusinesses current cost accounting fails to avail precise and updatedinformation. Direct material expenses might be rationally detectedwith particular products. Conversion expenses, and those not linkedto production might be hard to determine with particular products.Most enterprises are employing activity-based costing in enhancingtheir comprehension of current costs (Wood, 1998). The accountant’srelevance lies in initiating activity-based costing to the companyand employs it in the organization’s available products, whichforms a basis for target costing.

Following the establishment of allowable cost and determination ofcurrent expense, it becomes possible to calculate price decreases(Ebuk &amp Balcioglu, 2011). Target costing commences at this phase,where probable trade-offs are contemplated and resolutions made indelivering products, which meet market needs at costs, which attainthe company’s profit goals. The many design suggestions, purchaseversus manufacture resolutions, suggested production procedures andcapital investment needs have cost repercussions, which ought to bemeasured, and traced (Ebuk &amp Balcioglu, 2011). Managementaccountants are accountable for the evaluation and trackingprocedure. They formulate a methodical structure of monetary andnonmonetary evaluations in ensuring that while target costing isunfolding, it is simple to achieve target objectives. Trackingprocedures are particularly crucial when numerous advent products areinitiated in a company and they have a major impact on financialperformance (Ebuk &amp Balcioglu, 2011).

Target costing can be summed up as a reverse procedure whereorganizations compare the possible expected gains of a product withthe most favorable price in the market. As soon as a suggested pricehas been determined, the principle profit margin is created (Ebuk &ampBalcioglu, 2011). The profit objectives depict the essential targetcost, which should be achieved during product development. Targetcosting is a common financial method, and specifically beneficial toresellers attempting to stay ahead of competitors. A major advantageis that it enables companies to assess the perfect manner of makingproducts while incurring minimal expenses. Reducing costs is awidespread monetary objective of any company (Ebuk &amp Balcioglu,2011). It provides the financial flexibility needed in concentratingon attaining great profit margins. It also makes it probable toventure the market with low price points, drawing many clients.

Target costing acts as a formal and methodical manner ofconcentrating on optimizing expenses, contrary to less-formalstrategies frequently employed by companies (Gagne &amp Discenza,1995). It mandates a lot of time in reviewing a methodical strategyas target costing however, the outcomes are beneficial to anybusiness. It entails consideration for all procedures, materialsrequired in production, machinery and workforce and preparing them tosell to consumers. Important to note when employing target costing isreducing the product cycle period. It regards to time taken from theidea to making a product ready for sale (Gagne &amp Discenza, 1995).Less cycle period implies that unwarranted steps are eradicated,which add no value to the product. A short cycle acts as acompetitive plus because it is possible to make the product availableto the market before competitors are done with their creation ofsimilar products. Many manufacturers commence with productdevelopment and price products depending on costs incurred.Conversely, beginning with market price guarantees that the producthas a favorable price for the target market.

Implementation Process of Target Costing

The process starts with conducting research. It is necessary toassess the market where a company intends to sell (Ellram, 2006). Thedesign group should validate the group of product facets, whichclients are more probable to purchase, and the money they can pay forsuch facets. The research also entails learning the supposed value ofspecific features, in case need arises later on to drop eitherfacets, or the impact the drops will have on product price. It mightbe important to eliminate a product facet later when the design grouprealizes their inability to provide the facet whereas still ensuringtarget cost (Ellram, 2006). Concluding the researchimplies that acompany has closure on the target price it can sell a suggestedproduct with a particular group of facets, and the method to employin altering price in case some features of a product are eliminated.

Next is the calculation of maximum cost. The design panel employs agross margin, which is the earning for the suggested product. Throughdeduction of the gross margin from the anticipated product cost, thedesigners are capable of deciding the maximum possible expense to beachieved prior to progressing with production of the product. Third,engineering the product commences. Procurement and engineers’ stafftake over the manufacture of the product (Gagne &amp Discenza,1995). Procurement employees are specifically relevant when theproduct comprises of many purchased components they ought to decidecomponent pricing founded on the essential delivery, quality as wellas quantity levels anticipated (Gagne &amp Discenza, 1995). Theirrole might also entail outsourcing components, when the outcome isreduced expenses. Engineers ought to design a product in meeting theexpected cost, which involves several design iterations in validatingwhat blend of reviewed facets and design deliberations leads toreduced cost.

Following the finalization of a design and its approval, moreindustry engineers are involved. The design team begins the processof cost reduction, which progresses all through the product’s lifecycle (Zengin &amp Ada, 2010). For instance, costs might beminimized via waste minimization during manufacture, referred tokaizen costing. Reductions may also arise from calculated supplierexpense. The progressive cost cutbacks result in enough extra grossmargins for the organization to minimize more on the product pricewith time, in reaction to heightened competition (Zengin &amp Ada,2010). The design panel employs either a tied to components orfeatures approach in its cost minimization attempts. Tiedto components – the team allots the objective of minimizingexpenses amid the several product works (Zengin &amp Ada, 2010). Thestrategy seems to lead in incremental price decreases to the similarparts, which were employed in the previous product iteration. Thestrategy is normally applied when an organization is merelyendeavoring to refresh a current product with an advent one, anddesires to maintain the similar underlying product system. The fallson cost attained via the strategy seem to be rather minimal, yet theapproach leads in more product success and a reduced design time.

Tied to features – production team allots the cost-reducingobjective amid several product facets, taking away focus fromdesigns, which might have been borrowed of previous products (Zengin&amp Ada, 2010). The strategy seems to attain more fundamental costdrops, yet mandates more time that is in designing. The approach islinked to more peril of product failure thus increasing warrantyexpenses. Amid both approaches, organizations are more probable toemploy the initial strategy when intending to upgrade an establishedproduct. The later applies when intending to deviate from existingdesign. Target costing applies more to organizations, which competethrough progressively providing a stream of advent products to themarket. This is because such products are highly competitive.

Application by other Organizations

ITT Automotive is an illustration of a company that has successfullyapplied target costing management technique. The technique hasmajorly focused on brakes, which have a highly competitive market(Schmelze, Geier &amp Buttross, 1996). The initial stage in theprocedure happens when ITT gets a bid invitation from a client. Thecompetitive industry makes it impossible for the company to employcost-plus pricing. The quoted price is one set by marketstipulations. An assessment is then conducted in verifying whetherthe product bid fits the company’s strategic objectives, as well aspossibility of producing the volume (Schmelze, Geier &amp Buttross,1996). Financial data entailing internal rate of return andreturn on investment are analyzed to guarantee if ITT will geta proper return (Schmelze, Geier &amp Buttross, 1996). To validatethe price feasibility, a target-costing panel comprising of workerswith cost accounting, sales and engineering experience get the quote.Considering the quoted product will not be created for years, thepanel determines if ample value engineering is achievable prior toproduction to meet the quoted price.

Setting the price is an iterative procedure. The panel will endeavorto find manners of reducing expenses to agree with the bid withoutITT compromising on anticipated return. For instance, designengineers might propose use of new technology, which decreasesproduction cost (Schmelze, Geier &amp Buttross, 1996). In ITT,target costs entail direct labor, materials, tooling expenses,promotion and working capital. Following computation of the targetcost, particular targets are initially assigned to ultimateassemblies, subparts and later to specific parts. Persons from thefixed cost target panel execute the targeting (Schmelze, Geier &ampButtross, 1996). Specific targets are created for every componentbought, in line with labor and burden targets. Target costs aretracked all through the product’s life sequence, commencing fromdesigning. In most cases, prices ITT gets for products reduce yearly.Hence, target costs must reduce yearly providing the company withsimilar return. In the end, the margin reduces compelling thedevelopment of advent products (Schmelze, Geier &amp Buttross,1996).

The Japanese manufacturing industry is a different illustration onthe application of target costing. In the manufacturing industry, thetechnique is a wide-ranging cost management structure where thecustomer, constructor and designer work uniformly from the beginningto conclusion of the construction (Yook, Il-Woon &amp Yoshikawa,2005). The cost is the construction financial plan that is fixed. Thecompany involved in the building validates the budget throughaddition of the cost of every building part required in construction.It is founded on past cost information and any alterations likeinflation, anticipated all through the building. In Japan,restrictions on cost variation are set at every phase of theconstruction. In the proposal phase, total cost difference amid thecost approximate founded on the client’s wants and entire budgetdetermined by the client can total to 20% (Yook, Il-Woon &ampYoshikawa, 2005). The financial plan acts as the price of agreementthe contractor charges. As the building plan approaches construction,the variation restriction lessens. When the design is made availablefor building, no alterations are permitted. Attaining a percent pricerestriction at every phase is relevant prior to progressing to thesubsequent phase. Effective target costing ensures design alterationare initiation during the conception and preliminary phases, andalteration within the construction procedure eradicated. This ensuresthat costs are reduced and as the construction ends, the companybenefits by getting their desired gain (Yook, Il-Woon &ampYoshikawa, 2005).

Applicability to Mattel

Target costing is a management method, which can be applied byMattel. Reasons include the fact that the company has not adopted thetechnique Mattel operates in a competitive industry, and is engagedin the creation of products. Although Mattel has managed to remainahead of its competitors in the toy production industry for years,one of the company’s weaknesses arises from emerging competitionand imitation of products. Since imitators have not created anoriginal product, they will most definitely sell at lower prices.This poses a threat for Mattel, as they may lose clients that cannotdifferentiate between the original and imitated toys. Notably, therehave been different toy production organizations that are emerging.The new market entrants realize the success factors of Mattel, areable to imitate and make toys available in the market at reducedprices. Customers may shift from Mattel to purchase from emergingmarkets with similar toy designs, yet selling at lower prices.

Mattel has the advantage of designing their own toys, which meansthat they already have engineers and designers in place to maketarget costing available. The company mainly focuses on improvingquality, to draw more customers to buying quality products. Thismeans that more resources are invested in improving the quality oftoys. When the product is released in the market, the company iscompelled to charge high prices to cover expenses incurred whenimproving quality. Considering that there are other similar productsfrom competitors in the market, customers will opt for cheaper toys.There are many features incorporated in creating toys that meetmarket demand. Despite the insistence on quality, Mattel has facedserious allegations in its toys that have been considered harmful tochildren. Hence, having to recall such toys and guarantee expenseslinked imply the company fails to attain expected returns fromproducts.

Target costing is a more applicable approach to Mattel, whichcompels the company to becoming highly competitive. The company isoperating in an industry where slight price drops will draw morecustomers to their toys. Mattel will apply target costing in theredesigning of its toys. This entails removing some components, whichmake product production costly, employing cheap raw material andfeatures, and redesigning the manufacturing procedure to minimizeproduction expenses. The outcome is that the target cost will beachieved. It is easy for Mattel to redesign its toys, eliminatecomponents that are unnecessary and create an affordable product. Italso ensures that the quality of toys is maintained. Target costingapplies when designing a new product. There are numerous cartooncharacters emerging daily, creating new design characters for Matteltoys. Through target costing, the company can create the new designtoys at production expenses, which ensure they gain the anticipatedreturn. At the same time, Mattel will sell the new designs ataffordable and competitive prices.

Plan for Implementation

In the greatly competitive business, originality and competition inregards to cost, eminence and functionality determine a company’ssurvival. Target costing will be implemented to assist in makingtrade-offs amid these aspects through guaranteeing that, toysmanufactured are only those meeting customer demands and anticipatedgains developed. Being the first to release a product in the marketwill no longer improve Mattel’s competitiveness, as has been thecase. This is because imitations infiltrate the market almostimmediately following release of an advent product. Target costingwill be employed in launching toys, which enhance on past generationsthrough reduced prices or enhanced eminence as well as functionality.

Sending developers to the market to validate if toy designalterations have influenced the price clients will to pay is theinitial step in implementing target costing in Mattel. Researchdepicts that just as customers value the quality of products, pricereductions have a major influence on the buying behavior (Souissi &ampIto, 2004). Notably, customers want quality and affordable products.Product planning and design teams including persons from severaldepartments of Mattel are a major part of target costing. This isbecause they introduce diverse notions for improving designs.Employees from the different departments directly involved inproduction from the idea to final product, will be engaged in diversetarget cost teams. Mattel’s suppliers will also be involved. Thisis because they deliver the toys to consumers and have knowledge ofconsumer reactions to prices set on products. Market pressure may beconveyed to suppliers endorsing their creativity and regulation ofcosts.

To apply target costing effectively, Mattel can use it in its supplychain. The reason is, it enhances the chances for design alterations.It also creates an integral section of inter-organizationalregulations, where the company endeavors to handle and regulate itsindividual, as well as supplier’s actions. To involve supplierstriumphantly, the company must build mutual trust, and reactpositively to their contributions. Because Mattel produces diversetypes of toys, the target return margins, must also differ. When theproposed toy is a redesign of a current toy, Mattel already has theircost basis for verifying what the possible costs of the suggestedredesign toy may be. By applying the current toy design requirementsand production procedures, it will be probable to approximate thetarget costing procedure. The target and allowable expenses are thenallotted to functional areas of the product. This applies to Mattelbecause the client’s needs, in the beginning of target costingimplementation, have been determined.

As the technique advances in every phase, the company must monitorhow effectively objectives are being attained. It calls forprogressive input from current and possible clients through focusgroups and different methods. It also entails determining ifcompetitor behavior is as anticipated. Ensuring a precise analysis ofpresent costs is relevant because it acts as the basis for shapingprojected target cost, and accounts how allowable expenses areaccomplished. The company needs to realize that implementation of themanagement technique takes time. It mandates education in alldepartments, backing from senior managers, and engaging allorganizational sections. The aftermath is that the company progressesto be competitive and ahead of competitors in the toy industry.

Conclusion

Every business has to meet the objective of fulfilling consumerneeds, whereas at the similar time making profit and Mattel is noexception. The lasting financial success of a business relies on itscapacity to assure client needs, in terms of providing high qualitygoods and services at affordable prices. Thus, target costing becomesa viable contemporary management technique in ensuring suchobjectives are met. It is a unique technique of evaluating therelationship between prices and costs. Target costing is effective ina competitive market because it makes it possible for management toproceed in making profits, and at the same time operate in a highlycompetitive market. The expenses incurred during manufacturing arecalculated and handled during the designing and improvement stage,instead of the latter product phases of manufacturing.

Target costing emphasizes on the understanding of markets, as well ascompetitors. It focuses on clients needs concerning quality,performance, price and release. The structure realizes therequirement to balance trade-offs in the entire company. Theadvantage of employing target costing is that it does not affect allsectors of the company, rather includes the promotion, product andprocess advancement, manufacture and procurement. Applying themanagement technique to Mattel will be beneficial to the companybecause it operates in a competitive market, hence, it will be ableto create original products and sell them at reduced prices. Sincethe company is directly engaged in the designing of its own toys, itbecomes easier to incorporate target costing due to the availableengineers and designers. Success witnessed in other companies likeITT and the Japanese manufacturing industry without a doubt enhancethe effectiveness of target costing.

References

Cooper, R., &amp Slagmulder, R. (1999). Develop profitable newproducts with target costing. Sloan Management Review, 40(4),23-33.

Ebuk, E., &amp Balcioglu, H. (2011). Profit maximization with targetcosting. International Journal of Economic Perspectives, 5(3),303-309.

Ellram, L. M. (2006). The implementation of target costing in theUnited States: Theory versus practice. Journal of Supply ChainManagement, 42(1), 13-26.

Freedman, J. M. (1993). Target costing focus. ManagementAccounting, 74(7), 68.

Gagne, M. L &amp Discenza, R. (1995). Target Costing. Journal ofBusiness and Industrial Marketing, 10(1), 16-22.

Schmelze, G., Geier, R., &amp Buttross, T. E. (1996). Target costingat ITT automotive. Management Accounting, 78(6), 26-30.

Souissi, M., &amp Ito, K. (2004). Integrating target costing and thebalanced scorecard. The Journal of Corporate Accounting &ampFinance, 15(6), 57-62.

Wood, J. C. (1998). First annual international congress on targetcosting. Management Accounting, 79(7), 63.

Yook, K., Il-Woon, K., &amp Yoshikawa, T. (2005). Target Costing inthe Construction Industry: Evidence from Japan. ConstructionAccounting &amp Taxation, 15(3), 5-18.

Zengin, Y., &amp Ada, E. (2010). Cost management through productdesign: target costing approach. International Journal ofProduction Research, 48(19), 5593-5611.