Welcome back to another installment of Whitepaper Wednesday here on the Purchasing Certification Blog. Today, I’ll be reviewing a whitepaper entitled “Best Practices in Target Costing” from the Institute of Management Accountants and BNET.

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This whitepaper focuses on the authors’ lessons learned from studying the target costing practices of companies that they perceived as leaders in target costing: Boeing, Caterpillar, DaimlerChrysler, and Continental Teves. The first page of the whitepaper introduces the reader to “the six key principles of target costing”:

  1. Price-led costing
  2. Focus on customers
  3. Focus on design
  4. Cross-functional involvement
  5. Value-chain involvement
  6. A life cycle orientation

The description of the first principle succinctly defines and explain target cost: “Market prices are used to determine allowable—or target—costs. Target costs are calculated using a formula similar to the following: market price – required profit margin = target cost.” Also noteworthy is the authors’ explanation of what they mean by value-chain involvement: “All members of the value chain—e.g., suppliers, distributors, service providers, and customers—are included in the target costing process.”

A point that is emphasized several times throughout the whitepaper is that if the cost of an innovation or component is greater than the value to the customer of that innovation or component, then that innovation or component should be abandoned. In one of the several good examples used to illustrate the principles taught by the whitepaper, the authors write “One of Boeing’s customers requested heated floors. Before target costing, The Boeing Company was
inclined to provide almost whatever the customer wanted without regard to cost. The company now prices airplane options separately. When this particular customer learned that the price for heated floors was more than $1 million, it reconsidered its request.”

While the whitepaper is not written from a procurement perspective, there are plenty of nuggets that address the procurement role in successful target costing, such as:

  • “[Successful companies] view their supply chains as part of an ‘extended enterprise’ where they share design information, cost information, and establish inter-company teams to meet cost reduction goals”
  • “If a supplier is unable to meet its target costs, Continental might ask to send a team there to view its operations. Continental will then analyze the supplier’s manufacturing processes, tolerances, and material content and generally verify the assumptions in its cost-modeling tool. After negotiations, however, if Continental still believes the
    supplier’s costs are too high, it might consider bids from other suppliers.”

The whitepaper also devotes sufficient ink (or is it pixels?) to sharing an example of how one of the profiled companies broke down their costs into categories and decided how much cost reduction to seek in each category. This is well worth considering as a process to emulate if you need some guidance in getting your own target costing initiative started.

So, as you’ve read, this whitepaper contains a great deal of valuable information and I haven’t even covered it all. So, I suggest that you download your own copy of this whitepaper from BNET’s Web site.


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