What is Target Costing?
Target costing is a proactive cost-management method that starts with the market: you set the price customers will pay, subtract the profit you need, and design the product to hit the resulting cost. It flips traditional cost-plus pricing on its head and is widely used in competitive industries like electronics and automotive.
Target costing determines the maximum allowable cost of a product by subtracting the desired profit margin from the target selling price: Target Cost = Target Selling Price − Desired Profit.
- 1↓Market ResearchDetermine what customers are willing to pay
- 2↓Set Target PriceEstablish the competitive selling price
- 3↓Determine Desired ProfitSet the required profit margin
- 4↓Calculate Target CostTarget Cost = Target Price − Desired Profit
- 5Value EngineeringRedesign the product/process to meet the target cost
Try it: interactive calculator
Step-by-step worked examples
A tablet maker wants to sell a new tablet for $300 and needs a $60 profit per unit. What is the target cost?
TSP = $300 DP = $60 TC = TSP − DP = 300 − 60 = $240
A car company sets a target price of $25,000 and requires a 15% profit margin on that price. Find the target cost.
DP = 15% × 25,000 = $3,750 TC = TSP − DP = 25,000 − 3,750 = $21,250
A toy manufacturer's current production cost is $18, but the target cost calculated from market price is $14. What must happen?
Cost gap = current cost − target cost = 18 − 14 = $4 This $4 must be eliminated through value engineering (materials, design, process) If it can't be closed, the product may not be launched at the planned price
Flashcards
Quick quiz
Q1.Target selling price is $150, desired profit is $30. What is the target cost?
Q2.Target costing starts with:
Q3.If actual production cost is higher than the target cost, the company should:
Q4.Target costing is best described as:
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Common mistakes
Confusing target costing with cost-plus pricing. — Correct: Cost-plus starts with cost and adds a markup; target costing starts with price and derives allowable cost.
Setting the target price based on internal costs. — Correct: The target price comes from market research and competitor pricing, not internal costs.
Giving up when actual cost > target cost. — Correct: Apply value engineering — redesign materials, process or features to close the gap.
Treating target costing as a one-time calculation. — Correct: It's an ongoing process throughout product design and production.
FAQ
What is target costing?
A method that sets the maximum allowable product cost by subtracting desired profit from the market-driven target price.
What is the target costing formula?
Target Cost = Target Selling Price − Desired Profit.
What are examples of target costing?
Automakers and electronics firms set a competitive price first, then design products to hit the resulting target cost.
How do you calculate target cost?
Subtract the desired profit margin from the target selling price determined by market research.