Plain definition
Target costing starts with the price customers will pay and subtracts the profit the business requires. The remainder is the allowable cost of delivering the offer. It reverses the usual sequence of designing a product, adding its cost, and hoping the market accepts the resulting price.
The target is a design constraint, not a reason to cut quality, safety, or contractual obligations. When expected cost exceeds allowable cost, the team must change product scope, process, supplier terms, volume, or the price proposition—or decide not to launch.
Illustrative example
Monetary examples use Saudi riyals (SAR). The same principles apply in other currencies.
Suppose research supports a selling price of for a device and the business needs of contribution to cover fixed costs and profit. Allowable unit cost is . If the current design costs , the gap is per unit.
A manager cannot solve the gap by calling the original cost “efficient.” The decision is whether to redesign the device, negotiate component cost, reduce features customers do not value, or reject the launch.
| Market-supported selling price | |
|---|---|
| Required contribution | |
| Allowable unit cost |
Target costing works before most cost is committed; late cost-cutting often removes value customers notice.
Why it matters
It connects commercial reality to engineering and procurement choices before a product becomes expensive to change.
Practical consequence
Document the evidence behind the target price and the required contribution. Build a cost table by component and process, assign owners to each material gap, and separate true cost reduction from cost shifted to warranty, service, or another team. Re-test the customer value after each design change.
Try your own numbers
Separate profit per unit, margin on selling price, markup on cost, and a target-margin price.
Margin and markup