Strategic Cost Management · Target Costing

Principles and Features of Target Costing

Updated 11 October 2026 · Fact-checked

Target costing starts with the price the market will pay, subtracts the profit the firm needs, and treats the result as the maximum allowable cost. The product and its processes are then designed to meet that cost. You answer questions by linking each principle to a design action.

Understand Principles and Features of Target Costing

Traditional costing works forward. You design a product, add up the cost, add a profit margin and then hope customers pay that price. Target costing works backward. It begins with the market.

The core idea is price-led costing: Target cost = Target selling price − Target profit. Cost is not a result to be reported. It is a limit to be met. If the expected cost is above the target cost, the gap must be closed before the product is launched.

The main principles are these:
- Customer focus: the price and features come from what customers value and will pay for. Features customers do not value are removed.
- Product and process design focus: most of a product's cost is locked in at the design stage, so savings are sought there, not on the shop floor after launch.
- Cross-functional teams: design, production, purchasing, marketing, finance and sometimes suppliers work together from the start.
- Life-cycle view: the target covers cost over the whole life, including purchase, use, service and disposal, not only production cost.

Other features: the target is set top-down and is demanding, suppliers are involved in cost reduction, and the process continues after launch through continuous improvement.

Target costing works best where competition is strong, products are complex and the design stage is long. It works poorly where prices are fixed by regulation or the firm is a price-maker with no real rivals.

Key rules to remember

Target cost: Target cost = Target selling price − Target profit; Target profit may be given as an amount or as a percentage of selling price or of cost. Read which.
Cost gap (cost reduction required): Cost gap = Expected (current) cost − Target cost; A positive gap means cost must be reduced. The team must close it through design changes.
Target profit on sales: Target profit = Selling price × Required margin %; If margin is on cost, profit = Cost × margin %, and selling price = Cost × (1 + margin %).

How to solve Principles and Features of Target Costing questions

Use this method for both numerical and descriptive questions on principles and features.

1Identify what is asked: a list of principles, a comparison with traditional costing, advantages and limitations, or conditions for success.
2For each principle, state it in one line and then explain why it matters in cost terms.
3Link the principle to the case: name the product, the customer need or the department in the scenario.
4If numbers are given, compute target cost = price − profit, then the cost gap against the current cost.
5Say how the gap can be closed: redesign, fewer components, cheaper materials, supplier help or process change.
6Add a balanced view: one or two advantages and limitations, and a condition for success.
7End with a clear conclusion or recommendation, such as go ahead, redesign or drop the product.

Quickest way: Four-word recall: Price, Customer, Design, Team

When to use it: Use it for 5-7 mark theory parts and for short case-based questions.

Write Price-led: Target cost = price − profit, cost is a limit.
Write Customer: price and features are driven by customer value.
Write Design: costs are mostly locked in during design, so act early.
Write Team: cross-functional and supplier involvement, plus life-cycle view.
Add one advantage, one limitation and one condition, then link each to the case.

Common mistakes in Principles and Features of Target Costing

Describing target costing as cost plus profit equals price.
Students carry over the habit from cost-plus pricing.
Fix: Always write the direction: price first, then subtract profit to reach the cost.
Saying cost reduction happens mainly during production.
Confusion with kaizen and continuous improvement.
Fix: State that target costing focuses on design. Savings after launch are limited because most cost is already committed.
Ignoring the life-cycle view and counting only manufacturing cost.
Numerical questions usually show only production cost.
Fix: Mention purchase, use, service and disposal costs when the question asks for principles or features.
Listing principles without linking them to the case.
Students rely on memorised points.
Fix: Add one case-specific example per principle, such as the team members or customer features in the scenario.
Giving only advantages and forgetting limitations.
The method sounds so sensible that drawbacks are overlooked.
Fix: Include limitations such as team pressure and morale, longer development time, and risk of cutting quality to meet the target.

Worked examples

Example 1

A Pune firm plans a new water purifier. Market research shows customers will pay ₹8,000. The firm needs a profit of 25% on selling price. The current design costs ₹6,400. Find the target cost, the cost gap and state what the team should do.

Show the solution

Target profit = 25% × ₹8,000 = ₹2,000.
Target cost = ₹8,000 − ₹2,000 = ₹6,000.
Cost gap = ₹6,400 − ₹6,000 = ₹400 per unit.
The gap is 6.25% of the current cost (400 ÷ 6,400).
The team should close the ₹400 through value engineering, fewer parts, supplier price cuts or process changes, without removing features customers value.

Answer: Target cost is ₹6,000 and the cost gap is ₹400 per unit. Launch only after design changes close the gap.

Example 2

Explain the main principles of target costing and state two conditions needed for it to succeed.

Show the solution

Price-led costing: the market price sets the cost limit, so target cost = price − profit.
Customer focus: features and price come from customer value.
Product and process design focus: most cost is fixed at design, so savings are sought there.
Cross-functional teams: design, production, purchasing, marketing and finance work together, often with suppliers.
Life-cycle view: the target considers the cost over the whole life of the product.
Condition 1: top management support and a clear, achievable target, with reliable market information.
Condition 2: good supplier relationships and a working cost database so that the team can find savings.

Answer: Target costing is price-led and customer-focused, works through design and cross-functional teams, and takes a life-cycle view. It succeeds with management support, reliable market data and supplier cooperation.

Exam tips

Open any theory answer with the formula: target cost = price − profit. It shows the direction at once.
For advantages and limitations questions, give a balanced list with at least two points on each side.
In case questions, name the cross-functional team members and customer features from the scenario.
In numerical questions, read whether profit is on cost or on selling price before you calculate.
Close with a recommendation on whether the product should proceed.

Practice questions from Target Costing

Principles and Features of Target Costing: frequently asked questions

What are the main principles of target costing?

They are price-led costing, customer focus, design focus on product and process, cross-functional teams, and a life-cycle view. Supplier involvement and continuous improvement are often added as features.

How is target costing different from traditional costing?

Traditional costing builds cost first and adds profit to get the price. Target costing takes the market price, subtracts the required profit and treats the result as the cost limit. It also focuses on design rather than production.

What are the limitations of target costing?

It can put heavy pressure on teams and suppliers. It can lengthen development time and may lead to quality cuts if the target is set too tight. It also needs reliable market information.

What conditions help target costing succeed?

You need strong competition or clear market prices, top management support, cross-functional teamwork, supplier cooperation and a reliable cost database. Targets must be challenging but achievable.