Case study - Target costing as a strategic tool

Faced with increasing global competition, many firms are finding that price -based or target costing is emerging as a key strategic tool. The target co st is afinancial goal for the full cost of a product, derived from estimate s of selling price and desired profit (which top management sets on the bas is of firm strategy and financial goals). Product selling price is constrai ned by the marketplace and is determined by analysis along the entire indus try value chain and across all functions in a firm. Common to most target-cost applications is a belief that large-scale cost p lanning and reduction must occur early in the product life cycle. However, Shank and Fisher believe there is no conceptual reason the methodology cann ot be a value-added exercise applied to existing products during manufactur ing. They posit that if managers were to believe that, during manufacturing , only incremental (i.e., slight change is possible (through kaizen costing or controlling costs with standard-cost systems), firms would likely miss significant strategic opportunities. Shank and Fisher present a case study that demonstrates the relevance of ta rget-costing techniques for a process-industry plant built in the 1890s tha t had been making largely the same products for fifty years. The firm's man agers, who had used a standard-cost system for many years, might have concl uded that kaizen casting was most appropriate for this plant. However, comp etitive realities necessitated a major strategic change that employed targe t costing as an important ingredient in cost-reduction efforts leading to s trategic revitalization. At the beginning of this field study, plant managers focused too much atten tion on standard cost versus actual cost. There was heavy pressure to move standard cost toward actual cost in order to minimize unfavorable Variances for public financial reporting. Managers focused too little attention on i deal manufacturing cost, and target costing received no attention. At the e nd of the field study, the most useful cost-management tool focused on idea l manufacturing cost versus target cost in relation to actual cost. The sta ndard cost concept essentially dropped out of the picture. Target costing forced managers to rewrite the rules of the game by changing the way the mill delivered value to the customer. Because standard casting accepts the existing game rules and the existing value chain, the authors believe that fundamental cost breakthroughs are much more probable when usi ng target costing.