How to use “Target pricing” and „Target costing” in procurement and what is the difference?

All of you already have experienced the difference between cost and price. Before and after the holiday weekend the fuel price is significantly different while the cost stayed the same. In procurement we deal with supplier prices every day, but is there any value for us to investigate the potential price of our product? The following article will elaborate on the difference of cost and price and how we need to use it in our daily procurement world.

Target Price

Let’s start to investigate the “target price”. What does it mean for you in the procurement context? The target price for a product is the price at which the product is competitive in the market. There is no sense to complain about that price; either you meet it, or you will not sell your product. The “target price” serves as a clear orientation during the product development. The team needs to understand that this price is not negotiable and additional features which do not add customer value will not be honored with a relaxed target price.

Key takeaway I: “Target price” defines a price at which the product is competitive.

Target Costing

“Target Costing” describes the process where specific cost targets for the whole product and then sub-components are developed and these cost-targets guide the development team to meet the “target price”. Why do I talk about “guiding” the team?

The “target price” defines the maximum cost which can be spend to manufacture / assembly a product to be competitive on the market (“target price” = “target cost” + profit). A bottom up costing for your first design drafts identifies for you the gap between the “allowed cost level” and the “expected cost level”.  To identify by how much you need to reduce the cost of each component, you could just break-down the cost gap with a hair cut approach. Imagine you are 10% above you “cost target”, you could assign now for each individual component a cost-target which is 90% of the currently forecasted component cost. If each component meets at the end this cost-target the overall cost-target would be met as well.

So far so good. This approach is easy and transparent for everybody, but comes with some shortcomings as

  • this approach ignores that cost-out is for each component on a different difficult level
  • mistakes or shortcomings in the bottom up costing / cost forecast for the design concept leads to wrong cost-targets
  • components which generate customer value and differentiate the product are treated the same way as “auxiliaries”

A much smarter approach is to identify upfront, with the help of the bottom up cost calculation, the different potentials for components regarding cost-out. So higher the potential so more you should expect in terms of cost-out. Focusing on smart cost-targets ensures that that you maximize the cost-out outcome with the give resources. We have discussed how to assess the cost-out potential through “global value sourcing” in one of our recent articles.

Key takeaway II: Use individual cost-targets for your components to achieve the overall target price for your product. Individual cost-targets are the key to maximize the outcome with given resources.

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