CIMA defines target cost as “a product cost estimate derived from a competitive market price.”
Target Costing is a disciplined process that uses data and information in a logical series of steps to determine and achieve a target cost for the product. Also, the price and cost are for specified product functionally, which determined from understanding the needs of the customer (benefits) with a viable market price that achieves the company’s profitability goals.
Unlike cost plus pricing, where the cost of good or service is first determined, followed by determining the mark-up and finally the price of the good or service itself, target costing approach follows a completely different approach. Target costing is a proactive approach to cost management where the initial step in target costing involves looking outside the organisation toward the price in which consumers are willing to pay for the good or service in the marketplace.
Once the target selling price is established, the next step is to determine the target volume and target profit. After all these factors have been sorted out, the target cost for the good or service is established. In the case of production, a production design is determined in accordance with the target cost.
Target costing is considered price-lead costing in that target costs are established by determining the competitive market cost and subtracting from this the target profit or required profit margin. This approach is also considered customer-driven and design centered and a greater attention is provided to features and timeliness that customers are expecting from a good or service at a given market price.