Target Costing: Definition, Formula & Example

Target Costing: Definition, Formula & Example
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  • 0:03 Definition of Target Costing
  • 1:00 Target Costing Steps
  • 1:39 Example of Target Costing
  • 3:02 Target Costing &…
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Lesson Transcript
Instructor: Kevin Newton

Kevin has edited encyclopedias, taught middle and high school history, and has a master's degree in Islamic law.

Target costing is the practice by which companies set a cost for a product and stick to it. In this lesson, we'll see how it is more common for companies to do this than you might think.

Definition of Target Costing

Have you ever wondered why whenever a new smartphone comes out that its price is never that different from an old one? For example, you can usually purchase, on a contract, a new top-rated smartphone for around $200. But wait, if technology is always getting cheaper, shouldn't this number budge a little bit?

The fact is that it shouldn't due to target costing. Target costing is the strategy to set a price point for a product and engineer it to that point. In doing so, profit is treated as any other cost. As such, the formula for target costing is that the sales cost of an item should be the anticipated profit plus the cost that has been targeted by the designers. By doing so, a company hopes to offer enough value to still attract customers, while still maintaining a profit. In this lesson, we'll look at how it works, what happens when plans go far, and then see it played out in an example.

Target Costing Steps

There are four major steps when doing target costing. The first of these is simply to figure out what your market is like and what your potential customers expect from a product. A crucial point is to make sure you understand what each aspect costs. From there, you should figure out what the highest cost is that you're willing to pay per device to manufacture them. Keep in mind to leave plenty of room for profit and overhead costs. From there, you create the product, keeping it within the budgetary lines. Finally, remember that many products see their cost lowered as the lifespan of the product continues. At this point, it is wise to try to reduce the production cost of the item to continue to make those price point reductions profitable.

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