CIMA defines target cost as “a product cost estimate derived from a competitive market price.”
Target Costing is a systematic procedure that employs data and information in a logical sequence of actions to establish and attain a product’s target cost. Additionally, the price and cost are set functionally for the stated product, which is determined by balancing the customer’s wants (benefits) with a market price that satisfies the company’s profitability goals.
Unlike cost plus pricing, which begins by establishing the cost of a good or service, then the mark-up, and lastly the price of the good or service itself, target costing takes an entirely different method. Target costing is a proactive strategy to cost management in which the first step is to search outside the organisation for the price that consumers are willing to pay in the marketplace for the good or service.
After establishing the target selling price, the following stage is to establish the target volume and profit. After resolving all of these issues, the target price for the good or service is defined. In the case of production, a design is chosen based on the goal cost.
Target costing is similar to price-lead costing in that target costs are established by calculating the competitive market cost and subtracting the target profit or required profit margin from it. Additionally, this strategy is considered customer-driven and design-driven, with a higher emphasis on the features and timeliness that customers demand from a good or service at a certain market price.