Target costing
Target costing starts from an uncomfortable truth: by the time a product reaches the factory floor, most of its cost is already decided. Eighty to ninety per cent of what a product will cost is locked in at the design stage, long before the first unit is made. So target costing moves the cost discipline upstream, into development, where the decisions that drive cost are actually taken. Its Japanese name, genka kikaku, captures the idea exactly: genka is cost, kikaku is planning. Cost is planned, not merely recorded.
The logic also inverts the usual direction of pricing. Rather than adding a margin to whatever a product happens to cost, target costing lets the market set the price first, subtracts the profit the business needs, and treats what remains as a cost the design must hit. That allowable cost becomes a constraint the development team works back from, using value engineering, cross-functional teams and close supplier involvement. This profile sets out where it came from, how the mechanics work, and where it fits.
Target costing, known in Japanese as genka kikaku (cost planning), is a method that designs cost into a product during development rather than controlling it afterwards. The formula is target cost = target price minus target profit: the market sets the price, the business subtracts its required profit, and the remainder becomes the allowable cost the design must meet. This inverts cost-plus pricing. Because roughly 80 to 90 per cent of a product's cost is locked in at the design stage, target costing relies on value engineering, cross-functional teams and supplier involvement to close the gap before launch. Kaizen costing then continues the cost reduction once the product is in production. ---
Where it came from
Target costing emerged in post-war Japan during the 1950s and 1960s as manufacturers sought to build cost discipline into product development rather than chase it on the line. Toyota is generally credited with pioneering its implementation from roughly the late 1950s and early 1960s, with cost planning embedded in product planning by the mid-1960s. The lineage is often traced to Toyota's Product Planning Office, established in 1965, and to the adaptation of weight-budgeting logic from aviation, where a target weight is allocated across components, to the budgeting of cost in the same disciplined way. By the early 1990s, adoption had reached roughly 80 per cent of assembly firms in Japan.
The method was documented for Western readers from the late 1980s into the 1990s. Michiharu Sakurai wrote "Target Costing and How to Use It" (Journal of Cost Management, 1989). Yasuhiro Monden set out the production-phase companion in "Cost Reduction Systems: Target Costing and Kaizen Costing" (Productivity Press, 1995). Robin Cooper and Regine Slagmulder examined the design-stage discipline in "Target Costing and Value Engineering" (Productivity Press, 1997). Together these works carried genka kikaku from the Japanese assembly plant into Western practice.
How it works
The arithmetic at the heart of target costing is simple, and that simplicity is the point.
Target cost = target price - target profit
The market sets the target price first. This is top-down and market-driven: it is the price the customer will actually pay, not a figure derived from internal cost. The business then subtracts the profit it needs to earn, and what remains is the allowable cost. That allowable cost is not a forecast to be reported against later; it is a constraint the design must satisfy before the product is approved for launch. This inverts cost-plus pricing, which starts from incurred cost and adds a margin on top.
Hitting the target is the work of design. Because roughly 80 to 90 per cent of a product's cost is committed at the design stage, that is where the effort concentrates, through value engineering: systematically examining each function and component to deliver what the customer values at the lowest cost. Cross-functional teams, drawing in engineering, purchasing, marketing and finance, work alongside suppliers, who are brought in early to help design cost out of the parts they will supply.
Target costing does not end at launch. Kaizen costing is its production-phase complement, driving continuous cost reduction after the product enters production. The two fit into one integrated cost-management system: target costing in development, kaizen costing in production, and cost maintenance to hold the gains, all closely tied to lean and the Toyota Production System.
A worked example
Consider an illustrative company, CaP, designing a new product. The team begins not with its own costs but with the market.
All figures below are illustrative.
| Step (illustrative) | Amount |
|---|---|
| Target price (what the customer will pay) | EUR 200 |
| Required profit margin (25%) | EUR 50 |
| Allowable target cost | EUR 150 |
| Current estimated design cost | EUR 175 |
| Cost gap to close | EUR 25 |
The market price is EUR 200 and the business requires a 25 per cent margin, so the target profit is EUR 50. That leaves an allowable target cost of EUR 150. The current design, however, is estimated at EUR 175, which means there is a gap of EUR 25 to close. Under cost-plus thinking, the firm might simply price the product at EUR 175 plus a margin and hope the market accepts it. Under target costing, the EUR 25 gap is a design problem to be solved through value engineering before the product is allowed to launch, not a number to be passed on to the customer.
- Controls cost where it is actually determined, at the design stage, rather than after it has been committed.
- Keeps pricing aligned to the market, because the price the customer will pay is the starting point.
- Protects the profit margin by construction, since profit is reserved before cost is set.
- Drives design innovation and supplier collaboration, turning the cost target into a creative constraint.
- Is customer-needs oriented throughout, since value engineering asks what the customer actually values.
- Complex and time-consuming, demanding heavy cross-functional coordination and a good deal of data.
- Carries the risk of cutting quality or features simply to hit the target, if the discipline tips into corner-cutting.
- Can strain or damage supplier relationships when the cost pressure passed down the chain is unrealistic.
- Fails if the underlying price or volume estimate is wrong, because the whole target is built on that market assumption.
- The literature notes the pressure target costing can place on development teams, with sustained demands to meet aggressive targets.
Where it fits
Target costing suits assembly-oriented discrete manufacturing, where a product is built from many components and design choices have a clear, traceable effect on cost. It is most strongly associated with the automotive sector and with consumer and precision electronics, industries where competitive pricing and frequent new-product development make upstream cost discipline essential.
It is less suited to process industries, where output is continuous and cost is driven more by yield and throughput than by discrete design decisions. The method remains closely tied to Japanese manufacturing and to lean, which is both its heritage and the environment in which it works best.
FAQ
What is target costing in simple terms?
It is a way of planning cost into a product during development. The market sets the price, the business subtracts the profit it needs, and the remainder is the cost the design must hit. Cost becomes a design target rather than something measured after the fact.
What does genka kikaku mean?
Genka kikaku is the Japanese term for target costing. Genka means cost and kikaku means planning, so the phrase translates literally as cost planning, which is exactly what the method does: it plans cost before the product is made.
How is target costing different from cost-plus pricing?
Cost-plus pricing starts with incurred cost and adds a margin to set the price. Target costing reverses this: the market sets the price first, the required profit is subtracted, and the result is the allowable cost. Price drives cost, not the other way around.
What is the difference between target costing and kaizen costing?
Target costing applies during development, designing cost into the product before launch. Kaizen costing applies during production, driving continuous cost reduction once the product is being made. They are two phases of one integrated cost-management system.
Which industries use target costing most?
It is most common in assembly-oriented discrete manufacturing, especially automotive and consumer or precision electronics. It is less suited to process industries, where cost is driven more by yield and throughput than by discrete design decisions.