How to Calculate Target Cost Expense

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Calculating target cost expense is determining the final cost of a product/service after market analysis and product redesign have been done based on that market analysis. Target cost can be thought of as the maximum amount that can be invested into a product while remaining market viable. As new products/services and their accompanying industries emerge, competition for the delivery of that product/service enters the equation. This calculation of target cost then becomes a central focus of competitors. Take into account the key components of target cost to accurately calculate your own.

Calculating target cost expense is determining the final cost of a product/service after market analysis and product redesign have been done based on that market analysis. Target cost can be thought of as the maximum amount that can be invested into a product while remaining market viable. As new products/services and their accompanying industries emerge, competition for the delivery of that product/service enters the equation. This calculation of target cost then becomes a central focus of competitors. Take into account the key components of target cost to accurately calculate your own.

Set a market price that is market-focused and market-driven. Base the target price on the company’s market share or company standing in the market. Look at market penetration potential.

Establish percentage parameters to help establish whether a product is viable or not.
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Gauge the competition and their ability to respond with competitive pricing. Consider demand fluctuation and study that particular market niche. Use the data from this market research to work your way through a target cost worksheet to calculate the target cost.

Construct your cost worksheet to include these factors. Based on market considerations, set a “Manufacturer’s Suggested Retail Price” per unit, say $500. On the next line, deduct 30% from the $500 to account for dealer/retail markup. Subtract $150 (30%) from the $500 and get $350, as your cost to retailer figure.

Account for every direct cost on your way to establishing target cost expense.
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Deduct $15 from the $350 cost to retailer price for shipping and handling the product, and get $335 as the selling price to the retailer. Subtract an additional 15% ($50.25) for distribution cost to bring the figure to $284.75. Deduct a flat rate of $18 for shipping/distribution costs bringing the new cost to $266.75.

Figure in an 8% profit margin on the product, and subtract $21.34 from the $245.41. Subtract warranty costs at 2% ($4.90) from the $245.41 and get $240.51. Subtract corporate set asides at 10% or $24.06 to get $216.45.

Look to general overhead and development costs to reduce production expenses.
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Subtract an additional 12% or $25.95 for general administrative overhead, to get the new running total of $190.50. Take away another $8 for development costs to arrive at $182.50.

Deduct a final 50% for overhead costs for a final cost of $91.25. This is the direct target cost for this hypothetical product/service. This figure must include the total for all costs, meaning all labor and all materials, to produce this product/service per unit, and remain doable within the market constraints.

Conduct appropriate research to determine whether the $91.14 cost per unit is realistic and still retain the required product quality for it to sell successfully. Explore ways to reduce any amount of the costs listed through these steps.

Tips

  • Consider alternate designs and other cost cutting measures to reduce the final production figure.

Warnings

  • Be especially diligent when studying market viability for any new product or service.

References

Resources

About the Author

Chuck Brown is a freelance writer and former teacher and athletic coach. He has held professional stints as a business owner, personal fitness trainer, curriculum designer, website designer, market trader and real estate investor. Brown holds a bachelor's degree in English and a master's degree in Christian counseling.

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