134 ACCOUNTING FOR MANAGERS
The design and development phase can determine up to 80% of costs in many
advanced technology industries. This is because decisions about the production
process and the technology investment required to support production are made
long before the product/services are actually produced. This is shown in Figure 9.4.
Consequently, efforts to reduce costs during the production phase are unlikely
to be successful when the costs are committed or locked in as a result of technology
and process decisions made during the design phase.
Target costing
Target costingis concerned with managing whole-of-life costsduring the design
phase. It has four stages:
1 Determining the target price that customers will be prepared to pay for the
product/service.
2 Deducting a target profit margin to determine the target cost, which becomes
the cost to which the product/service should be engineered.
3 Estimating the actual cost of the product/service based on the current design.
4 Investigating ways of reducing the estimated cost to the target cost.target price−target profit margin=target costThe technique was developed in the Japanese automotive industry and is customer
oriented. Its aim was to build a product at a cost that could be recovered over the
product lifecycle through a price that customers would be willing to pay to obtain
the benefits (which in turn drive the product cost).
Target costing is equally applicable to a service. The design of an Internet
banking service involves substantial up-front investment, the benefits of which
must be recoverable in the selling price over the expected lifecycle of the service.
Using a simple example, a new product is expected to achieve a desired volume
and market share at a price of £1,000, from which the manufacturer wants a 20%
margin, leaving a target cost of £800. Current estimates suggest the cost as £900. An
investigation seeks to find which elements of design, manufacture or purchasing
contribute to the costs and how those costs can be reduced, or whether features
£ Capital investmentDesign phase Launch Production phase
Figure 9.4 Investment decisions