How to price using Target Costing

How to price using Target Costing is this week’s podcast theme.  Do you want to reduce your costs by 25% to 30%?

If so, then target costing is the right choice for you. Above all How to price using Target Costing can help you cut costs without sacrificing quality.

The focus of Target Costing is reducing waste from the start of production.  Don't wait until products are made. Moreover, this means that every step of the process is designed with cost-cutting in mind.  You gain better prices and margins for your business.

Listen now to find out more about how Target Costing works!

Traditional costing is the most used method for pricing goods and services. The two methods share things in common but also have differences. You choose the method most appropriate for your target customers and product mix. Target costing has been around for many decades, much longer than cost-plus costing.

Target costing was developed by Toyota Motor Corporation to reduce costs while increasing quality of its products. It’s now widely used throughout many industries from automotive to consumer electronics.

Conclusion

Moreover, if interested in dealing with pricing, controlling costs this is explained here for you.  You learn how it affects you, avoid confusion and overwhelm.  Many businesses, start-up to established find themselves in the same situation.  Wanting to know about How to price using Target Costing, more particularly taking steps to avoid it.  This podcast will help.

Listen to find out more.

My mission is to inform, inspire and educate you to get closer to your numbers. You can make more profits, save tax and time, improve your well-being and your money mindset.

Help me to help you and others by subscribing and sharing this episode in your network.  Listen now and subscribe to I Hate Numbers, so I can send it straight to your inbox every week with all the latest updates.

If you found this podcast useful then share this episode on social, leave a review on Apple podcast .  Connect with me on Instagram, You Tube, Twitter, LinkedIn and Facebook,

Links

https://podcasts.apple.com/podcast/proactiveresolutionss-podcast/id1500471288

https://open.spotify.com/show/5lKjqgbYaxnIAoTeK0zins

https://www.stitcher.com/podcast/proactiveresolutionss-podcast

https://tunein.com/podcasts/Business–Economics-Podcasts/I-Hate-Numbers-p1298505/

https://www.google.com/podcasts?feed=aHR0cHM6Ly9mZWVkcy5jYXB0aXZhdGUuZm0vaWhhdGVudW1iZXJzLw%3D%3D

How much should you charge for your products? That's a question that's occupied the minds of millions of business owners over the century. There are many answers to that question, and one such answer is to apply something called target costing, and target costing is the theme of this week's podcast on I Hate Numbers.

You are listening to the I Hate Numbers Podcast with Mahmood Reza. The I Hate Numbers podcast mission is to help your business survive and thrive by you better understanding and connecting with your numbers. Number love and care is what it's about. Tune in every week. Now, here's your host, Mahmood Reza.

Hi folks. Welcome to another weekly episode of I Hate Numbers, the podcast that has as part of its mission to help you increase your financial awareness, improve your money mindset, help you make more profit, save tax and time. What's not to love about that? Let's crack on with the podcast. Now, it's generally observed under target costing that costs you have in your business can be reduced by as much as 25 to 30%.

That's some saving, and that's compared to using traditional costing techniques. Target costing bases its price on what the customer is prepared to pay. It ignores the cost to begin with, and it ultimately ends up figuring out how much your product should cost you as opposed to how much your product does cost you.

Let me expand that in more detail. Now, under traditional or cost plus costing, what happens is we figure out the cost of making the product, we take into account the cost of labor, the cost of materials, we take into account the production cost, the support cost, to work out, to manufacture that product, work out an average unit cost, add on an expected profit

element, the profit margin, and we arrive at the base price that we charge to our customers. Target costing, on the other hand, ignores that approach and even though target costing has some similarities with traditional or cost-plus costing, it also has some marked differences. Remember, ultimately, folks, choose the pricing option, the pricing strategy that best fits your market, your customers, your mix, your position in your industry.

And remember, pricing is a tool that you use in your toolkit depending on what your expectations and requirements actually are. Now, traditional costing to give you some background has been around for much longer than target costing. Target costing is considered very much the new kid on the block, and by new kid on the block,

it's been with us since the 1960s. Target costing was developed way back in the 1960s by market and cost researchers working for that big well-known Japanese car manufacturer Toyota. Target costing is still most widely practiced in and mostly connected with Japan. Many Japan's leading manufacturers such as Nissan, Toshiba, Toyota are still known for their devotion

and admiration of target costing. Let's explore the methodology behind it. Now, traditional costing involves, first of all, as we said, figuring out the total cost of the product, taking into account all the direct, indirect, and fixed costs of the production, figuring out an average unit cost, and then adding an amount for that, that gives you the profit. In target costing,

however, the profit margin that we require is taken away, is subtracted from a determined market price to give us our target cost. That target price, that target cost, by the way, is figured out by talking to our consumers, talking to our clients, asking them based on the attributes of what we are delivering, what price are they prepared to pay.

So, it's definitely a market research, a market-orientated approach. The production procedures are then lasered in, are centered on this cost, and target costing goes in the opposite direction of traditional costing. Now, each method that we've mentioned here, traditional costing and target costing, both have their benefits.

Businesses do like the simplicity of traditional costing. We require relatively small amounts of information initially for cost-plus-pricing, and later on, we can make more adjustments to the price and tweak it much more easily than target costing. Target costing has at the top of its recommendations, its efficiency and focus on keeping costs low.

Now, as with all methods, there are drawbacks. The drawbacks of traditional costing is the tendency to underestimate costs and overestimate profits. Wasteful spending and unprofitable products become a result. Also, we create that climate that we accept costs, we don't challenge them as much, and one well-known fact is that in designing a product, most of the costs are locked in at the design phase.

So, going forward, once we’ve introduced our product into our production schedules, we're making that product, it becomes very difficult to actually reduce the cost significantly. Target costing has criticisms. It's criticised for its complexity, its rigidity, and it requires much more attention to the production life cycle.

Traditional costing is suited, however, to process-orientated businesses that use continuous production. Very much ones, there's a repetition, assembly-based orientated businesses, ones that such as car manufacturing, are very well suited to target costing. Now, target costing is not just about selling prices, but it's a modern method of cost control, it’s costing in reverse.

The selling price is determined by reading the market environment, the customer expectations, and then deducting a desired profit margin from the selling price. Towards the end of this podcast, I'm going to go through a five-step approach as to how target costing works in practice. In the traditional system,

we, first of all, calculate the budget, we then start the production, and once we've calculated the production, the total cost is calculated, and from this cost, we work out the desired profit margin. Any differences between the actual and expected cost is calculated as a variation and a variance. Now, a target cost is a cost estimate derived by taking off a desired profit margin from your market price,

and your market price is considered to be a competitive one, it is customer-orientated. In some circles, target costing is referred to as price minus costing. Target costing is much shorter in shorthand. Now, target costing doesn't focus on finding out what a new product does cost. Instead, it focuses on finding out what a new product should cost. Quite a distinction between those two.

Any cost reductions have got to be done in such a way that quality is unaffected, because once you go down that quality-damaging route, then your target costing plan will immediately fail. And the last part of this podcast, I'm going to go through this five-step process that one adopts to go through target costing.

Step one, figure out, calculate your selling price at which your product could be sold. Again, market research, asking the client, doing some desk-based research, getting out there and doing some testing, conversations with your customers is absolutely essential. Having got a figure for your target selling price, based on your product attributes, based on the value that you're going to deliver to that customer, you then work out what your desired, required profit margin is.

Typically, this could be expressed as a percentage of selling price or maybe a flat currency figure. Deduct your profit margin from the selling price to arrive at your target cost. Once you've got your target cost, you then consider, over the life cycle of that product, what's the estimated cost of the product, and compare it with your target cost.

It's likely in the last step, you're going to get a cost gap, and that's the cost gap that needs to be closed. Let me throw some numbers into the mix. So, for example, you've determined that a price of a product you wish to sell is going to be $25. You require a profit margin of $5, therefore your target cost will be $20.

That's the 25 less the 5. Now, you calculate the actual cost of the product comes out to be $22, so, therefore, you've got a $2 cost gap. This $2 cost gap is what you've got to reduce. Now, you could do things by examining the product, removing aspects of that product, which don't add any value to the customer experience, but actually still have a component of cost.

You can look at your production processes to see if there are any efficiencies that can be made in how you produce that product. You look at the design phase, and your culture is about challenging costs before you've actually incurred them. Folks, I hope you found this podcast useful. I'd love it if you could share some feedback, give me some comments on them, what you found on them.

If you check out the show notes, I'm going to give you a couple of links also to some further information you can explore and podcasts on the whole world of costs. Until next week, have a fantastic week. We hope you enjoyed this episode and appreciate you taking the time to listen to the show. We hope you got some value.

If you did, then we'd love it if you shared the episode. We look forward to you joining us next week for another I Hate Numbers episode.