Target Costing: A Blueprint for Procurement Engineers

Achieving cost efficiency while delivering high-quality engineered solutions is essential for success. Target costing is a strategic approach that integrates cost management into both product design and development, ensuring that products are not only technically sound but also competitively priced. By employing a target pricing strategy from the outset, companies can manage costs more effectively and enhance their overall profitability.

What Is Target Costing?

Target costing strategies ensure that cost management is embedded into the design process from the start. Unlike traditional costing approaches that determine costs after the design phase, target costing begins with the end price in mind. This involves setting a target selling price based on market research and desired profit margins, then working backward to determine the maximum allowable cost that will still enable the desired price and top profit margin.

Formula for Target Costing:

Target Cost = Market Price – Desired Profit Margin

This formula helps businesses align their product design and production costs with the target pricing strategy, ensuring that the final product meets the competitive price expectations and desired profit margins. By setting a target cost early, companies can avoid costly design changes and better manage their production costs throughout the product development cycle.

Target Costing in Engineered Solutions

For engineered solutions, target costing involves a precise focus on balancing cost, functionality, and quality. The target costing process ensures that the final product or service used meets both customer expectations and financial objectives. Here’s how target costing can be applied to engineered products:

Steps in Target Costing for Engineered Products

1. Market Research: Begin by conducting thorough market research to determine the competitive market price and the amount customers are willing to pay for the proposed product. This research helps establish a realistic target selling price that aligns with market conditions and customer expectations.

2. Cost Goal Setting: Using the target selling price and desired profit margin, calculate the maximum cost that the product can afford. This maximum cost serves as a benchmark for design and manufacturing decisions, ensuring alignment with the target pricing strategy and overall profitability goals.

3. Design Optimisation: Engineers must focus on optimising the product design from concept generation to final delivery to meet the target cost without compromising on performance or quality. This might involve Design to Cost (DTC) and value engineering techniques to identify cost-saving opportunities, such as selecting cost-effective materials or simplifying and fool-proofing the design to reduce production costs and errors.

4. Supplier Collaboration: Effective collaboration with suppliers is crucial for achieving the target costs for components and materials. By working closely with suppliers, companies can negotiate better terms, identify cost-saving opportunities, and ensure that components meet both quality and cost requirements.

5. Continuous Monitoring: Throughout the design and development cycle, it is essential to monitor costs regularly to ensure that the project remains within the target cost. This involves tracking expenses, evaluating cost-saving measures, and making adjustments as needed to stay aligned with the final target cost. An often-overlooked area in cost control is tail spend – those low-value, one-off purchases that collectively impact budgets.

Incorporating Target Costing into Product Development

Integrating the target price into the product development cycle involves several key considerations:

1. Design Phase: During the design phase, target costing requires engineers to balance technical requirements with cost constraints. This may involve iterative design adjustments to ensure that the product meets both performance and cost objectives.

2. Value Analysis and Value Engineering: Implementing value analysis and value engineering techniques can help identify cost-saving opportunities and optimise product design. These approaches focus on improving the value of the product by enhancing functionality while reducing costs.

3. Life Cycle Costing: Consider life cycle costing to evaluate the total cost of ownership, including initial production costs, maintenance, and disposal costs. This comprehensive approach helps in setting realistic target costs and ensuring long-term profitability.

4. External Factors: Be aware of external factors such as market changes, regulatory requirements, and supply chain disruptions that can impact the target cost. Proactive cost planning and flexibility in design can help mitigate these risks.

Case Study: Fractory’s Role in Engineered Solutions and Target Cost Contracts

Fractory’s advanced digital manufacturing platform provides customers with a valuable tool for managing target costing in engineered solutions and contracts. By leveraging Fractory’s capabilities and expertise, companies can streamline cost management and achieve their target pricing goals more effectively.

Case Study: AIE’s Success with Fractory

Advanced Industrial Engineering, an industrial machinery manufacturer, faced challenges meeting target costs for a bespoke production line project. They required a solution to manage production costs efficiently and align the price of their offering with customer expectations.

Solution:

AIE adopted Fractory’s platform to enhance their target costing process. Fractory offered several key benefits:

1. Real-Time Cost Analysis: Fractory’s instant quoting system enabled AIE to quickly assess the cost implications of design changes. This real-time Design for Manufacturing (DFM) feedback facilitated timely adjustments to stay within the target cost.

2. Optimised Production Processes: Fractory’s account managers, who are experienced mechanical engineers, helped AIE select the most cost-effective production methods and materials. They considered factors such as tolerances, material availability, and part quantities to ensure alignment with target pricing strategies while meeting the expected lead time. This approach delivered high-quality results while keeping costs in check.

3. Enhanced Supplier Selection & Communication: Fractory’s expertise in matching projects with specialised manufacturers ensures that each step of the project is handled by the most qualified and cost-efficient supplier. In the case of AIE, the project was split between three manufacturers: one for laser cutting and bending, another one for welding, and a third for powder coating. Each manufacturer focused on their area of expertise, improving cost management and product quality. Fractory acted as the sole point of contact, significantly reducing the time and complexity of managing multiple suppliers.

Outcome:

With Fractory’s support, AIE successfully achieved its target cost while streamlining their procurement process. The platform’s real-time cost analysis, optimised production processes and enhanced supplier collaboration not only helped the business to meet its target pricing objectives but also accelerated the project’s expected completion time, providing the business with a significant competitive advantage.

Case Study: Cutting Procurement Costs - Advanced Industrial Engineering

Target Costing in Contracts

Target costing can also be effectively applied to contractual agreements, known as target cost contracts. These contracts establish a target cost before the agreement is finalised, representing the expected expense for delivering the agreed-upon product or service. Here’s how target pricing and cost contracts function:

How Target Cost Contracts Work:

1. Negotiation: Before signing the contract, the contractor and client agree on a target cost based on detailed cost estimates and project requirements. This target cost becomes the pricing benchmark for the contract, setting expectations for cost management and delivery.

2. Cost Management: During the project, the contractor works to deliver the product or service within the target cost. Any cost savings realised below the target cost are often shared between the contractor and client through a predefined profit-sharing arrangement, which incentivises cost control and efficiency.

3. Adjustments: If actual costs exceed the target cost, the contractor may be responsible for covering the additional expenses, depending on the contract terms. This arrangement encourages proactive cost planning and effective cost management to avoid overruns and maintain financial performance.

Conclusion

Target costing is a crucial strategy for managing costs in engineered solutions and contractual agreements. By setting a target selling price from the beginning and working closely with suppliers, companies can ensure that the prices of their products meet both financial and market expectations.

Fractory’s cloud manufacturing solutions play a significant role in supporting target costing efforts, offering real-time cost analysis services, streamlined production processes, and enhanced supplier integration services. For procurement professionals and engineers looking to optimise their cost management and achieve their pricing goals, Fractory provides invaluable tools and insights.

Explore how Fractory can support your target costing initiatives to reduce costs and drive success in your company’s engineered solutions.