Target costing
Target costing derives the maximum allowable cost for a product by subtracting the required profit from the market price customers will accept. This reverses the conventional cost-plus logic.
Also known astarget cost
FrameworkTarget costing
See it move
A bar representing the market price of €120 is split into two segments: a target cost of €96 and a required profit margin of €24 (20% of price). The current estimated cost stands at €110, which exceeds the target by €14 per unit — a gap the design team must close through value engineering before launch. Working backwards from the market price in this way means cost is determined by what customers will pay, not by what the firm historically spends.
The formula
Variables
- Target cost — maximum allowable unit cost (€ per unit)
- Target selling price — price the market will accept (€ per unit)
- Target profit — required profit per unit (€ per unit)
Derives the cost ceiling by subtracting the required profit from the market-determined price; any estimated cost above TC must be removed through value engineering before launch.
Check yourself
A kitchen-equipment firm plans to price a new product at €180. Management requires a 25 % profit on selling price. The current design costs €145 per unit. What is the target cost, and is the current design acceptable?