Performance Management · Target costing

Target Costing vs Cost-Plus Pricing and Evaluation

Updated 11 October 2026 · Fact-checked

Target costing starts with the price the market will pay, subtracts the required profit, and sets a target cost the product must meet. Cost-plus starts with cost and adds a margin to get the price. Target costing is market-led and suits competitive markets, but it needs strong cross-functional cooperation.

Understand Target Costing vs Other Costing Approaches and Evaluation

Traditional cost-plus pricing works from the inside out. You work out the cost of the product, add a mark-up, and that gives the selling price. The weakness is that the market may not accept that price. It also gives no push to reduce costs, because any cost increase is simply passed on in the price.

Target costing works from the outside in. You start with the price customers will pay, which comes from market research. You deduct the profit the business needs. What is left is the target cost. If the current estimated cost is higher, the difference is the target cost gap. The business must close it before launch, or drop the product.

The gap is closed in the design stage, by value engineering, cheaper materials, fewer components, better processes and negotiation with suppliers. Most of a product's cost is locked in at design, so this is where savings are largest. The work needs design, production, marketing, purchasing and finance to work together.

Life cycle costing is different but related. Target costing focuses on the cost of making a product to hit a price. Life cycle costing tracks all costs over the whole life, from design to disposal, so it also covers costs after launch. Target costing can be applied across the life cycle, and a target cost can be set for the whole life of the product. Both stress that costs are committed early.

Target costing also works for services. A hotel, bank or airline can set a price the market accepts, deduct the required margin and design the service to fit the cost. Services are harder because they are intangible, vary each time, and have a high share of overheads and labour that are difficult to cut without hurting quality.

Key rules to remember

Target cost: Target cost = Target selling price − Target profit; Target profit may be a margin on price or a mark-up on cost. Read the question to see which.
Target cost gap: Cost gap = Estimated cost − Target cost; A positive figure means the cost must be reduced. Zero or negative means the target is already met.
Cost-plus price: Price = Full cost + (Full cost × mark-up %); Mark-up is on cost. A margin is on selling price. Do not mix them.
Margin to mark-up: Profit margin of m% on price equals a mark-up of m ÷ (100 − m) on cost; For example, a 20% margin on price equals a 25% mark-up on cost.

How to solve Target Costing vs Other Costing Approaches and Evaluation questions

Questions usually ask you to calculate a target cost and gap, or to discuss target costing against another approach. Use this order.

1Read what is asked: calculation, comparison, advantages and limitations, or suitability for a given business.
2For a calculation, find the target selling price from the market information given.
3Deduct the required profit. Check whether it is a margin on price or a mark-up on cost.
4Compare the target cost with the current estimated cost to find the cost gap.
5For discussion, state the direction of each method: market to cost for target costing, cost to price for cost-plus.
6Use the scenario facts to support each point. Link to the business type, competition, product complexity and design flexibility.
7Finish with a clear conclusion on suitability, and mention actions to close any gap.

Quickest way: Price minus profit, then compare

When to use it: Use this for objective test questions asking for the target cost, the gap, or which statement about target costing is true.

Write the target price.
Convert profit to a figure in currency per unit. If it is a mark-up on cost, divide the price by (1 + mark-up) to get cost.
Target cost = price − profit.
Gap = current cost − target cost.
For statements, test them with one rule: target costing starts from the market price, cost-plus starts from cost.

Common mistakes in Target Costing vs Other Costing Approaches and Evaluation

Treating a profit margin as a mark-up on cost.
Both are percentages of profit and look the same.
Fix: A margin is a percentage of price. A mark-up is a percentage of cost. Re-read the wording and convert if needed.
Saying target costing starts with the cost of the product.
Students are used to full-cost pricing.
Fix: Remember that the price comes first. Cost is the result, not the starting point.
Listing advantages and limitations without using the scenario.
Students memorise generic lists.
Fix: Tie each point to the business given, such as its competition, product life or ability to redesign.
Saying target costing cannot be used by service organisations.
It is mostly taught with manufacturing examples.
Fix: Say it can be used, with difficulties: intangibility, variability, and heavy reliance on labour and overheads.
Confusing target costing with life cycle costing.
Both stress early cost commitment.
Fix: Target costing sets a cost to meet a market price. Life cycle costing measures all costs across the product's life. They can be used together.
Ignoring that the gap may not be closable.
Students assume the answer is always to cut cost.
Fix: If the gap cannot be closed without harming quality or value, the product may be abandoned or the price or profit target reviewed.

Worked examples

Example 1

A company plans a new product. Market research says customers will pay $60 per unit. The company requires a profit margin of 25% on selling price. The current estimated cost is $48 per unit. Calculate the target cost and the cost gap, and state what cost-plus pricing would suggest if the company added a 25% mark-up on cost.

Show the solution

Target profit = 25% × $60 = $15.
Target cost = $60 − $15 = $45.
Cost gap = $48 − $45 = $3 per unit.
Cost-plus price = $48 × 1.25 = $60.
So the cost-plus price equals $60 here, but only because the estimated cost is accepted as it is. Target profit on a 25% margin is $15, while the mark-up approach gives a profit of $12 at that cost.

Answer: Target cost is $45 and the cost gap is $3 per unit. Cost-plus gives a price of $60 with a profit of $12, but target costing requires cost savings of $3 per unit to earn the $15 profit.

Example 2

A hotel group is considering target costing for its room and restaurant services. Evaluate whether target costing is suitable and how it differs from cost-plus pricing.

Show the solution

Difference: cost-plus adds a margin to the cost of the service. Target costing starts with the rate guests will pay and requires costs to fit within it after the required profit.
Suitability, in favour: the hotel market is competitive and prices are visible, so market-led pricing is relevant. Services can be redesigned, for example check-in processes, menu design and staffing patterns.
Suitability, against: services are intangible and vary by guest, so costs and quality are hard to specify. Many costs are fixed overheads and staff, which are hard to cut quickly.
Risk: cutting cost may reduce service quality, harming reputation and repeat business.
Link to life cycle costing: a refurbishment or new hotel has major costs set at design, so a target can be set for its whole life cost.

Answer: Target costing is suitable if applied with care. It makes the hotel work from the market rate, unlike cost-plus, and design choices can close the cost gap. However, difficulty in measuring service costs and the risk to quality limit its use.

Exam tips

In a comparison question, state the direction of each approach first. It is the clearest mark-earning point.
Check whether profit is given as margin or mark-up before you calculate.
For suitability questions, use the scenario: competition, product complexity, flexibility to redesign and the product's life length.
For advantages and limitations, give balanced points, then a conclusion. Do not only list.
In objective tests, remember that wrong answers score zero, so eliminate options that start from cost when the question is about target costing.

Practice questions from Target costing

Target Costing vs Other Costing Approaches and Evaluation in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Target Costing vs Other Costing Approaches and Evaluation: frequently asked questions

What is the difference between target costing and cost-plus pricing?

Cost-plus starts with the cost and adds a margin to set the price. Target costing starts with the market price, deducts the required profit and sets the cost the product must achieve. Target costing is market-led, while cost-plus is cost-led.

What are the advantages and disadvantages of target costing?

Advantages include a focus on customers and the market, cost reduction at the design stage, and teamwork across functions. Disadvantages include the time and effort needed, pressure on staff and suppliers, and a risk of reducing quality to meet cost. It also works poorly where the product cannot be redesigned.

Can target costing be used in service industries?

Yes, but with difficulty. Services are intangible, vary between customers and have high labour and overhead costs that are hard to reduce. It can still help where competition sets the price and the service can be redesigned.

How does target costing differ from life cycle costing?

Target costing sets a cost to meet a market price and profit. Life cycle costing measures all costs over a product's whole life, including development and disposal. They support each other because both focus on controlling costs early.

When is target costing most suitable?

It suits competitive markets where the business is a price taker and has some freedom to redesign the product or process. It is stronger for products with short lives, many components and costs that are set at the design stage.