Using Target Costing as a Competitive Advantage

Today, quality is no longer a competitive advantage, but rather a prerequisite. Cost and time remains a big differentials in a competitive environment. As the competition in the construction industry becomes increasingly intense, a lower cost structure is critical for a company's survival.

The use of target costing can be a promising approach to achieving a more proactive cost management. Developed over the past 40 years by a number of Japanese companies, Target Costing differs from the cost-plus approach traditionally used in the construction industry. The cost-plus approach starts by estimating the costs of production, adds a profit margin and then derives a market price. If the client is unwilling to pay the price, then some activities are put in place, such as lowering specifications, reducing quality, and trimming profit. On the other hand, the target costing approach implies that an allowable cost is determined by a target price less an appropriate profit margin.

Target costing process is divided into three major sections: market-driven costing, product-level target costing, and component-level target costing, as shown in Figure 1.

Figure 1 - Figure 1: Three main elements of the target costing process1

Market-driven costing focuses on customer requirements and uses the concept of allowable cost to transmit the competitive pressure of the marketplace to the company's designers and suppliers. An allowable cost cannot be achieved by sacrificing the features customers desire, lowering the performance or reliability of a product, or by delaying its introduction in the marketplace. Therefore, understanding what is value for the customer and how to use this understanding to guide cost reduction ideas is also essential in the target costing process.

In the second section of the target costing process, designers focus on finding ways to develop products that satisfy customers at the allowable cost. In practice, however, the allowable cost does not reflect the current capabilities of the company and its suppliers, which means it is a simple calculation. It reflects only the market's demands and the company's profit requirements. Therefore, the company should incorporate those capabilities into the definition of an achievable product-level target cost.

Once the target cost is set, the next task becomes finding ways to achieve it. Target costing requires a set of core tools (e.g. value engineering, value analysis, quality function deployment etc.) that work together with systems already available in an organization. Once a company establishes the product-level target costs, it decomposes them to the component-level transmitting its cost pressures to its suppliers.


1. Cooper, R. and Slagnulder, R. 1999 “Develop Profitable New Products with Target Costing”, Sloan Management Review v. 40, no. 4, pp. 23-33.

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