Strategic Cost Management · Pricing Decisions and Strategies

Target Pricing and Target Costing for CMA Final

Updated 11 October 2026 · Fact-checked

Target costing starts with the price the market will pay. You subtract the profit you want to get the target cost: Target cost = Target price − Target profit. If current cost is higher, the difference is the cost gap. You close it through value engineering and other cost reduction.

Understand Target Pricing and Target Costing

Traditional cost-plus pricing works from inside out. You add up cost, add a markup, and hope customers pay that price. Target pricing works from outside in. You first ask what price customers will accept and what competitors charge.

Target costing takes that market price and works backwards. The company decides the profit it needs, deducts it from the price, and the balance is the target cost. The product must be designed and made within this cost. Cost becomes a constraint, not a result.

Often the current or estimated cost is above the target cost. The difference is the cost gap (or cost reduction target). You cannot close it by simply pressing suppliers. The work is done at the design stage through value engineering: you study each function of the product, remove features customers do not value, and find cheaper materials, processes or designs without hurting quality.

Target costing is used mostly where competition is strong, products have short lives and most cost is locked in at design. Teams from design, production, purchasing, marketing and accounts work together. Suppliers are often involved too.

In short: Cost-plus says price = cost + profit. Target costing says cost = price − profit. The arithmetic is the same equation, but the direction of thinking is reversed.

Key rules to remember

Target cost: Target cost = Target selling price − Target profit; Target profit may be given as an amount per unit, a percentage of sales, or a return on investment.
Target profit on sales: Target profit = Target price × Profit margin % on sales; If profit is a markup on cost, then profit = Target cost × markup %, so Target cost = Price ÷ (1 + markup %).
Target profit on investment: Target profit = Capital employed × Required return %; Divide by units to get profit per unit when the return is on total investment.
Cost gap: Cost gap = Current (estimated) cost − Target cost; A positive gap means cost must be reduced. A negative gap means the product already meets the target.
Cost-plus price (for contrast): Price = Cost + Markup; Target costing reverses this: Cost = Price − Profit.

How to solve Target Pricing and Target Costing questions

Use this order for any target costing question. It keeps you from mixing the price, profit and cost bases.

1Identify the target selling price. It may be given directly, or derived from market research, such as a price that gives a stated volume.
2Work out the required profit. Check the base carefully: per unit, % of sales, % of cost, or return on capital employed.
3Calculate target cost = target price − target profit, per unit and in total if volume is given.
4Find the current or estimated cost per unit. Use the full cost basis the question uses, not only variable cost, unless told otherwise.
5Compute the cost gap = current cost − target cost, and express it also as a percentage of current cost if asked.
6Split the gap by cost element (materials, labour, overheads) if data is given, and show where value engineering savings come from.
7Check whether proposed savings close the gap, and state the shortfall or surplus.
8Give a clear recommendation: launch, redesign, or drop the product if the gap cannot be closed.

Quickest way: Three-line target cost check

When to use it: Use when the question gives price, margin and current cost and asks only for target cost and gap.

Write Price, then subtract profit to get Target cost. Do it in one line.
Write Current cost − Target cost = Gap.
Compute Gap ÷ Current cost for the percentage reduction, then compare with the savings listed in the question.

Common mistakes in Target Pricing and Target Costing

Treating profit margin on sales as markup on cost.
Both are called 'profit %' and students apply it to the wrong base.
Fix: Read the base. For margin on sales, profit = % × price. For markup on cost, target cost = price ÷ (1 + markup).
Adding profit to cost to get the target price.
Habit from cost-plus pricing.
Fix: In target costing the price is given by the market. Always subtract profit from price.
Computing the cost gap the wrong way round.
Students subtract current cost from target cost and get a negative number they do not interpret.
Fix: Gap = current cost − target cost. A positive result means cost must come down.
Mixing per-unit and total figures.
Capital employed and volume are given in totals, but price is per unit.
Fix: Convert total required return into per-unit profit by dividing by units before subtracting from price.
Using only variable cost as current cost.
Relevant costing habits from decision-making topics.
Fix: Target cost covers the full cost of the product (including fixed costs) unless the question states otherwise.
Giving no recommendation after finding the gap.
Students stop at the arithmetic.
Fix: State whether the proposed value engineering closes the gap and what management should do.

Worked examples

Example 1

Sunrise Appliances Ltd plans a new mixer. Market research shows customers will pay ₹4,000 per unit. The company needs a profit of 20% on selling price. The estimated current cost is ₹3,500 per unit. Find the target cost, the cost gap and the percentage cost reduction required.

Show the solution

Target price = ₹4,000.
Target profit = 20% × ₹4,000 = ₹800.
Target cost = ₹4,000 − ₹800 = ₹3,200.
Cost gap = ₹3,500 − ₹3,200 = ₹300.
Reduction required = ₹300 ÷ ₹3,500 = 8.57% of current cost (approximately).

Answer: Target cost ₹3,200 per unit; cost gap ₹300 per unit, a reduction of about 8.57% of current cost.

Example 2

Bharat Motors Ltd will launch a scooter component at a market price of ₹1,500. It plans to sell 20,000 units and needs a return of 15% on an investment of ₹1,60,00,000. Current estimated cost is ₹1,300 per unit. Value engineering is expected to save ₹40 on materials and ₹30 on labour per unit. Calculate the target cost and say whether the savings close the gap.

Show the solution

Required total profit = 15% × ₹1,60,00,000 = ₹24,00,000.
Profit per unit = ₹24,00,000 ÷ 20,000 = ₹120.
Target cost = ₹1,500 − ₹120 = ₹1,380.
Current cost is ₹1,300, which is below target cost of ₹1,380.
Cost gap = ₹1,300 − ₹1,380 = −₹80, so there is no gap to close; the product already beats the target by ₹80.
Expected savings of ₹40 + ₹30 = ₹70 would add to the margin of safety, taking cost to ₹1,230.

Answer: Target cost is ₹1,380 per unit. Current cost of ₹1,300 is already ₹80 below it, so no cost reduction is needed. The product can be launched; value engineering savings of ₹70 per unit would only improve profit beyond the target.

Exam tips

Underline the profit base in the question before calculating. Margin on sales, markup on cost and return on investment give different answers.
Show the three numbers clearly: target price, target cost and cost gap. Marks are given for each.
If the question asks about value engineering, link each saving to a cost element and test whether the total closes the gap.
For theory parts, contrast target costing with cost-plus pricing using the direction of the equation: cost = price − profit.
End numerical answers with a one-line recommendation. Case-based answers lose marks without it.

Practice questions from Pricing Decisions and Strategies

Target Pricing and Target Costing: frequently asked questions

How do I calculate target cost from target price?

Subtract the required profit from the target price. If profit is a percentage of sales, multiply price by that percentage first. If it is a return on investment, convert the total required return into profit per unit.

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

Cost-plus pricing adds a markup to cost to arrive at the price. Target pricing starts from the market price and subtracts the profit to find the cost that must be achieved. One is cost-driven, the other is market-driven.

How are target costing and value engineering linked?

Target costing sets the cost goal and shows the cost gap. Value engineering is a main tool used to close that gap by redesigning the product or process so that required functions are delivered at lower cost.

What if the target cost cannot be achieved?

Management can review the target price, accept a lower profit, change product features or drop the product. The decision depends on strategic importance and how far the cost gap is from being closed.