What is target costing?

Target costing is a pricing strategy that starts with determining the market-driven selling price of a product and then works backward to establish the allowable cost of production that will yield a desired profit margin. This approach is particularly important in competitive markets where maintaining a reasonable price point is crucial for profitability and market share.

In this method, once the selling price is set based on what the market can bear, the company then calculates the maximum cost it can incur in producing the product to still achieve that price and desired profit. This often leads to innovations in production processes or changes in design to reduce costs without compromising the quality or functionality of the product.

This concept does not merely focus on production costs independent of market conditions, nor does it involve adjusting costs after pricing has been set. Instead, it directly links the selling price to the cost structure from the outset, ensuring that the cost to manufacture aligns with what customers are willing to pay. The emphasis is on aligning product development and manufacturing with customer expectations and competitive pricing, making it a proactive approach to cost management.