AN OVERVIEW OF OBJECTIVE COSTINGIntroductionMany managers often underestimate the power of target costing as a serious competitive tool. When general managers read the word “costing,” they naturally assume that it is a topic reserved for their finance or accounting staff. They don't realize that target costing is actually a systematic process of managing profits and costs. product. This is captured by the equation Target Cost = Price – Profit. At first glance, the equation seems to reverse the cost plus price equals profit that many companies use. However, behind the inversion of the equation lie two very powerful ideas; (1) market prices and profit margins are exogenous variables beyond the control of an organization's management; and (2) customers and financial markets drive cost planning, not the other way around. Target costing is therefore a market-driven system in which the needs of the customer and the likely reaction of competitors determine product and profit planning. Target costing is based on six key principles:11. Price-driven costing. Market prices are used to determine eligible or target costs.2. Focus on customers. Customer requirements for quality, cost and time are simultaneously integrated into product and process decisions and guide cost analysis. The value (to the customer) of all features and functionality built into the product must exceed the cost of providing those features and functionality.3. Focus on design. Cost control is emphasized from the product and process design phase. Therefore, engineering changes must take place before production begins, leading to lower costs and reduced “time to market” for new products.4. Cross-functional teams. Cross-functional product and process teams are responsible for the entire product, from initial concept to final production.5. Involvement in the value chain. All members of the value chain, for example suppliers, distributors, service providers and customers, are included in the target costing process.6. Reduced life cycle costs. Total life cycle costs are minimized for both the producer and 1 These principles are adopted by S. Ansari, J. Bell and the CAM-I Target Cost Core Group, Target Costing, The Next Frontier in Strategic Cost Management, ( Irwin/McGraw-Hill, 1997).2the customer. Life cycle costs include purchase price, operating costs, maintenance and distribution costs. The Target Costing Process To maximize cost control and enhance profit improvement, most companies set relatively aggressive targets. The process begins when senior management establishes a target cost for a new product (e.g...