THE COST STRATEGIC MANAGEMENT THROUGH TARGET COSTING, A MODERN INSTRUMENT OF MANAGEMENT CONTROL

Dragomirescu Simona Elena

University of Bacau, Faculty of Economic Sciences,

Bacău, Roumania

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Solomon Daniela Cristina

University of Bacau, Faculty of Economic Sciences

Bacău, Roumania

e-mail

Abstract

Traditional methods for costs calculation start form costs to which, in order to obtain the market sell price, the desired profit average is added. Under present conditions, when the market prices are already fixed, as a consequence of the demand – offer report, the use of an opposite calculation is imposed: starting form the sell prices, we determine the costs that must be reached by the respective products. These costs, cannot be surpassed under the conditions when the enterprises whishes to obtain the planned profit.

The Target costing method, a method of costs calculation oriented towards the market, answers best to this requires. It is described by Dan Swenson, Shahid Ansari, Jan Bell and Il-Woon Kim in „Best practices in Target Costing” paper as process of costs and profit simultaneous planning. Specialists succeeded in surprising the essence of the method in six characteristics[7], namely:

(a) Target costing is a cost calculation leaded by market, with the meaning that in order to determine the target costing, firstly the market’s price is established (competitive), from where the desired margin (profit) is extracted. The price is regarded a limit that cannot be surpassed due to competition. Therefore, the products are considered unviable, if from the conception phase up to final costs there are not framed under this limit.

(b) Orientation towards clients. The clients’ requires concerning quality, costs and time are simultaneously embodied in product and process decisions, these guiding the costs analysis. Value (for clients) of every characteristic of function embodied in product has to be bigger than its cost. It results, therefore, that the method is clients oriented one, the target costing should allow not only the attaining the desired profit, but also the maintenance of product’s competitively dimensions.

(c) Orientation towards product. The target costing operates even from the product’s conception phase. According to this method, approximately 80% from a product costs are engaged even from its conception, the margins realised on products during its life duration being mainly connected to the costs control even from the project phase. The changes should have been made before the fabrication’s start, the purpose being lower costs and a more reduced launching time on the market.

(d) Multifunctional teams, formed of designing engineers, production engineers, representatives from sell, supply, marketing, accountancy departments, answer in unanimity for the entire process (product and the established target costing), from the conception up to production phase.

(e) The involvement of value creation chain. In the multifunctional team other members from outside the country can be also attracted, such as, for instance, suppliers, clients, distributors etc., because the target costing system is based on a favourable collaboration on long term with all members of the value creation chain. They are all involved in the target costing process and follow the reducing of costs.

(f) Orientation on the product’s life cycle duration. The costs calculation and analysis is realised on the whole product’s life duration, all the costs associated to its control being taken into consideration, namely: the purchase price, exploitation expenses, expenses with maintenance and reparations and the expenses with dispatching and administration. Costs reduction is followed both for enterprise and client (possession account).

Keywords: target cost, target price,management control, markets and competition

JEL Classification: M41: Accounting

  1. CONCEPT, PRINCIPLES AND CALCULATION RELATIONS

Target costing represents a cost of management concept, developed and used even from the 70’s by Japanese enterprises (especially in the motor vehicles industry). This appeared from the need of producing smaller series, in order to answer better to the market’s requires and because of the introduction of new methods of production organization and technologies based on automation.

The target costing concept was defined on various means by specific literature. According to M. Sakurai, in his paper called „Target costing and how to use it” the target costing represent “a cost management tool for reducing the overall cost of a product over its product life cycle”. [5] R. Cooper says that the purpose of target costing “is to identify the production cost for a proposed product, in such manner that product, when sold, generates the desired profit average”. [3] T. Tanaka explains the target costing as “the effort made at the planning and development stages to obtain a cost target set by management and that it is used to bring the target cost and the estimated cost into line by better specification and design of the product”. [9]

According to the official terminology of the Chartered Institute of Management Accountants, “target cost is a product cost estimate derived by subtracting a desired profit margin from a competitive market price. This may be less than the planned initial product cost, but will be expected to be achieved by the time the product reaches the mature production stage”. [2]

Comparing the definitions it can be noticed a difference between the Japanese and Americans.In this sense, Tanaka T. wrote in one of his paper that “a manager from Europe or USA uses the cost information to adopt decisions regarding prices and investments, while a Japanese manager uses the price information to control costs”. [9]

The Target-costing method is defined as a “means of administration of costs, applied for reduction of inputs for products’ fabrication during the entire life cycle, through a consolidation of efforts of production, elaboration, research, marketing and accountancy sections of the enterprise”. The principles on which the target-costing method is based on are:

  • the calculation and costs analysis is made on product. Every fabricated product is the natural connection between the market and enterprise, constituting, for this, its source of profit;
  • the calculation and costs analysis is made on product’s life cycle.The target costing operates even from the conception phase of the product and it may be revised during the different phases of product’s life cycle. According to this method, approximately 80 % from a product’s costs are signed on even from its conception, the average realized on product during its life duration, being mainly connected to controlling the costs even from the study or project phase. After this phase, it becomes much difficult to exert any influence on the costs. The cost control is realized through the respecting of the established objectives (costs); also, time is an important factor.
  • a product’s viability is measured in rapport to the market. Two aspects are followed: the clients’ satisfaction and the price that should be a competitive one. In what the second factor is regarded, the price is seen as a limit that cannot be surpassed due to concurrence. Therefore, the products are considered unviable, if from the conception phase up to the final costs do not frame under this limit. Thus, the controlling a product’s cost is realized during the entire production cycle. [4]

On the basis of the aspects mentioned before results that the target cost may be defined as “an estimated production cost, calculated according to a predicted competition sell price”.1]

At the most basic level, the desired target cost is the cost of resources that should be consumed to create a product that can be sold at a target price. The target costing process begins with the target price which is determined through interaction with consumers. However, management must determine an acceptable profit margin for the product to compute the desired target cost. [8] The basic target cost formula is as follows:

Target Cost = Target Price - Profit Margin

The factors taken in consideration for establishing the target costs are, for instance, the appointed market, the competition degree, the type of the fabricated product etc.. Moreover, all the participants to the production process focus their efforts for products’ projection and fabrication in such way that the effective productive consumptions would frame in the awaited (established) limits. The only element that the enterprise cannot control is the sell price. This is formed according to: needs and incomes of the potential clients; product’s particularities; the production capacity on long term; the prices practiced by concurrence.

The target cost is situated, usually, between the acceptable cost and estimated cost.

  • the acceptable cost corresponds to the optic market and of a functional logic of products realization and is determined according to the concurrence;
  • the estimated cost corresponds to a organic construction logic of product and is determined according to present production means and used technologies.

The formulas used in target costing are:

  • the evaluation of acceptable price:
/ Competitive selling price – the expected average
  • the evaluation of target price:
/ Acceptable cost + Reduction and optimization cost
  • the evaluation of estimative price:
-the case of existent products
-the case of projecting of new products / Complete unitary cost determined on the basis of data from accountancy
Complete unitary cost determined on the basis of data from projection

The estimative cost is a cost build during the whole product’s life cycle that looked through the point of view of producer and user, has the following calculation relation:

The estimative cost
At producer / At user
Production cost
+ Research-development cost
+ Distribution cost
+ General administration cost / Acquisition/purchase cost
+Other costs connected to acquisition
+ Use (exploitation) cost
+ Maintenance and sustenance cost
+ Residual cost
= Estimated complete cost / = User’s possession cost

Fig. 1. The global cost on product’s life cycle

2. A CASE STUDY OF TARGET-COSTING METHOD FOR INDUSTRIAL ENTERPRISE„SIRCA” S.A. PIATRA-NEAMŢ

For S.C. „SIRCA” S.A. Piatra-Neamţ enterprise, that has as activity object the production of components for agricultural vehicles, the following data are established for a period of five years, data referring to the number of sold units and predicted sell price, for one of the predicted prices – semi-industrial bearings, for which the average life period is five years:

Table 1. The production and turnover volume estimation for the “semiindustrial bearings” product for 2009-2013 period

Explanation / Predicted quantities
(pieces/year) / Sell price
(thousands lei/piece) / Turnover
(thousands lei)
2009 / 4.820,00 / 900,00 / 4.338.000,00
2010 / 5.120,00 / 828,00 / 4.239.360,00
2011 / 5.200,00 / 792,00 / 4.118.400,00
2012 / 4.800,00 / 791,50 / 3.799.200,00
2013 / 4.800,00 / 790,00 / 3.792.000,00
Total / 24.740,00 / - / 20.286.960,00

Phase 1. The determining of the average sell price on the product’s life

The average sell price during the product’s life / = / 20.286.960,00 thousands lei / = 820,01
thousands lei/piece
24.740,00 pieces

Phase 2. The determining of the average profit margin

The profit rate is differently established every year, accordingly to products life duration. According to this rate the corresponding average profit margin is established.

Table 2. The average profit margin calculation

Explanations / Turnover
(thousands lei) / The profit rate toturnover / The average profit margin
(thousands lei)
2009 / 4.338.000,00 / 8% / 347.040,00
2010 / 4.239.360,00 / 10% / 423.936,00
2011 / 4.118.400,00 / 9% / 370.656,00
2012 / 3.799.200,00 / 8% / 303.936,00
2013 / 3.792.000,00 / 7% / 265.440,00
Total / 20.286.960,00 / - / 1.711.008,00
The average profit margin during the product’s life duration / = / 1.711.008,00 thousands lei / = 69,16 thousands lei
/piece
24.740,00 piece
The average profit during the product’s life duration / = / 1.711.008,00 thousands lei / x 100 = 8,43%
20.286.960,00 thousands lei
The percentage of target cost in price / = 100% - 8,43% = 91,57%

Phase 3. The target cost calculation

Target cost / = / Target selling price
(820,01 thousands lei/piece) / - / Target profit average
(69,16 thousands lei/piece) / = 750,85
thousands lei/piece

Phase 4. The target cost decomposition on costs components

For S.C. „SIRCA” S.A. Piatra-Neamţ industrial enterprise, the cost calculation is made according to method order – an absorbent one that takes under consideration for production costs both direct and indirect expenses distributed correspondently for every product.

Table nr. 3 The target cost decomposing on costs components

The target cost components / The average in product’s cost
(%) / Target cost on costs components
(thousands lei/piece)
Direct expenses / 40% / 300,34
Indirect production expenses distributed / 60% / 450,51
Total / 100% / 750,85

Phase 5. The determining of the effective product’s cost with distribution on the direct and indirect production part and comparison with the target cost for deviation determination

Table 4. The calculation of the effective estimated cost of “semi-industrial bearings” product and comparison with the target cost for deviations determining

Cost components / Effective cost / Target cost on cost components / Deviations
Direct expenses
(thousands lei/piece) / 320,38 / 300,34 / + 20,04
Indirect production expenses distributed
(thousands lei/piece) / 465,55 / 450,51 / + 15,04
Total
(thousands lei/piece) / 785,93 / 750,85 / + 35,08
The formulation of objectives for the effective cost reduction until the level of the target cost

The data from the table no. 4 may be presented as follows:

Fig.2. The target costing between the acceptable cost and the estimated one

In the above presented example, the estimated cost is superior to the targeting cost, as consequence, its reduction objectives would have to be formulated. But the reductions should be the result of “changes of the product’s characteristics that would not alter the value perceived by the client” or “amelioration of supply, production, distribution existing methods”. The optimization processes suppose the performing of several successive value analysis before the estimated cost fixation to an acceptable level. The cost reduction supposes a series of phases:

  • the optimization in conception phase that supposes the reduction of cost departure: the estimated cost for a new product may be assimilated to a standard cost much lower than the actual cost practiced by economic agent (estimated cost = planned cost);
  • the optimization in proper production phase, that supposes the real cost control to maintain almost all targeting cost; the phase is named in specific literature “cost maintaining”.[6]

Costs reduction and adjusting may be presented by the schema known also as Maiko pattern.

Fig.3. Maiko Pattern

Source: Scorţe C., Farcaş M. - „Target-costing, a new possibility of cost calculation” [6]

3. CONTROL THROUGH TARGET COST

The “Target costing” concept seems to be quite simple on a first view: an enterprise will produce only the products for which it can assure an effective cost at the level of the predicted one (target). The question that appears would be: “what would happen in the case of the products for which there is demand and which is already produced, but for which the effective costs cannot be reduced?” The answer to this question was given also by the Japanese economists through Kaizen method. The difference between Target costing and Kaizen costing is in the fact that the former is mainly applied in the projecting and fabrication products, while the latter in the producing phase.

Target costing, looked at as a intercession management is based on the rule according which the market dictates the sell price and not the enterprise cost.

Target cost may be obtained by making the sum of partial costs that, on their turn, constitutes costs engaged by different functions of the enterprise for fabrication and sell of a product. Another approach supposes the determining of target costing as a sum of production costs of different components of the project. The ABC method or other methods such as value analysis may contribute to the simplification and acceleration of these calculations. The value analysis process supposes the following phases:

  • phase 1: the identification of a good’s functions – starting from the market’s requires, the product’s functions are ordered and divided in major and secondary functions, of amelioration, suppress or create, aesthetic and useless functions;
  • phase 2: the critical analysis of the manner in which the different components fulfill the respective functions;
  • phase 3: the searching for replacement solutions – the optimum process is the one fulfilling the functions on minimum cost. [3]

The target costing method is a part from a global intercession that regards the reduction of costs during a continuous amelioration process of technologies and fabrication processes aspect that supposes a new style of human resources management and increased competences. The continuous costs reductions should regard the whole enterprise. Concretely, are followed:

  • the controlling of different phases of product’s life;
  • costs analysis starting in the products’ conception phase according to their characteristics and possible selling price;
  • the assuring, permanently, that the new products will be advantageous on the life cycle duration, the predicted costs comparing with the realized one and, respective, their reporting to selling price;
  • the reducing of products’ conception terms;
  • the diminishing of development costs and assuring of a quick amortization;
  • a better organization of relations with the suppliers and collaborators;
  • mobilization and motivation of all the competences from the enterprise’s inside through a transversal approach in favor of a bigger competition. [1]

From this perspective, in order to integrate it in the management of an enterprise four dimensions are regarded:

  • markets and competition (taking into consideration the economic environment);
  • the integration of competences in different functions of the enterprise;
  • the products’ conception (the predictions of the effects of the decisions presented on the future results);
  • the creation of tighter connections between planning and current activity control.

References

[1] Caraiani C., Dumitrana M. (coord.) ş.a.- „Contabilitate de gestiune şi control de gestiune”, Editura InfoMega, Bucureşti, 2005, pp. 385-387.