Target, Kaizen and Life Cycle Costing
Strategic Cost Management moves beyond recording and controlling cost (the job of Papers 8 and 12) into actively engineering cost down before and during a product's life — and target costing, kaizen costing and life cycle costing are the three techniques that do this at three different points in that life.
1. Target costing — running the cost-plus formula backward
Traditional cost-plus pricing starts from cost and adds a margin to arrive at price: Cost + Margin = Price. Target costing deliberately reverses this sequence, starting instead from what the competitive market will actually pay:
The target selling price is set by studying the competitive market the product will actually be sold into — not by asking what the company would like to charge — and the target profit margin is set from the company's required return, leaving target cost as the number the product must be engineered to hit, rather than a number that simply emerges from however the product happens to be designed.
The gap between a product's currently achievable cost (estimated from its initial design) and its target cost is called the cost gap, and closing it is target costing's central discipline. This is achieved primarily through value engineering — a systematic review of the product's design, components and specifications, asking of every feature and part whether it delivers value proportionate to its cost, and redesigning or substituting wherever it does not.
This review is carried out before manufacturing begins, while the design is still flexible and change is cheap, rather than trying to cut cost out of a design that has already been frozen and tooled for production.
2. Kaizen costing — continuous reduction after design is frozen
Where target costing does its work before production starts, kaizen costing continues the cost-reduction effort throughout the manufacturing phase, once the design itself is essentially fixed.
It sets a small, incremental cost-reduction target for each period (commonly expressed as a percentage reduction per month or per year against the previous period's actual cost) and pursues it through continuous small process improvements — reducing waste, improving workflow, eliminating minor inefficiencies — rather than through the larger, one-time design changes value engineering uses.
The practical distinction worth holding onto: target costing asks "what should this product cost, given the market price" and acts at the design stage; kaizen costing asks "how much further can we still shave off the cost of what we are already making" and acts continuously during production.
A well-run manufacturer uses both — target costing to get the design cost-competitive from the start, and kaizen costing to keep pushing actual cost down further, period after period, once manufacturing is underway.
3. Life cycle costing — judging profit across the whole life
A product moves through five broad stages — introduction, growth, maturity, saturation and decline — and life cycle costing tracks revenue and cost across this entire span rather than any single accounting period, because a period-by-period view can be badly misleading about a product's true overall profitability.
A product can show large losses during introduction (heavy R&D and marketing launch cost against low initial sales volume) and strong profits during maturity, and judging it a failure from its introduction-year numbers alone, without weighing the full life-cycle picture, is a well-documented management error this technique is built to prevent.
The most important single fact in life cycle costing (introduced at CMA Intermediate level and extended here) is that roughly 80-90% of a product's total lifetime cost is typically committed by decisions made during the research, design and development stage, even though only a small fraction of that cost is actually incurred (cash spent) at that early stage.
This has a direct strategic implication for Strategic Cost Management specifically: since target costing and value engineering both operate exactly at this design stage, they are structurally the right tools to influence the 80-90% of lifetime cost that is committed there — cost-control effort applied later, during manufacturing (kaizen costing's territory), can only influence the smaller remaining share of cost not already locked in by the design.
Worked Examples
Example 1. A company wants to launch a product at a competitive market price of ₹800, and requires a 20% profit margin on selling price. Compute the target cost.
Target Profit = 20% × ₹800 = ₹160. Target Cost = ₹800 − ₹160 = ₹640.
Example 2. The product's current estimated cost, based on its initial design, is ₹720. Using the target cost from Example 1, compute the cost gap, and name the technique primarily used to close it.
Cost Gap = ₹720 − ₹640 = ₹80. Value engineering is the primary technique used to close this gap, by reviewing the design for components or features that can be redesigned, substituted or removed without reducing the value the customer actually pays for.
Example 3. A manufacturer's current actual cost per unit is ₹500. It sets a kaizen cost-reduction target of 2% per month. Compute the target cost for the next month.
Target cost for next month = ₹500 × (1 − 0.02) = ₹500 × 0.98 = ₹490.
Example 4. Explain why a product showing a loss in its first year (introduction stage) should not automatically be judged a failure.
Life cycle costing recognises that the introduction stage typically carries heavy R&D and marketing launch costs against low initial sales volume, which can produce a loss even for a product that will be strongly profitable once it reaches the growth and maturity stages with higher volume and lower incremental marketing cost — judging profitability from a single early period ignores the pattern the full life cycle is expected to follow.
Example 5. A design team is deciding between two component choices at the design stage: Component X (cheaper to source but more failure-prone, driving higher warranty costs later) and Component Y (costlier to source but more reliable). Explain, using the 80-90% committed-cost insight, why this decision deserves more scrutiny than a similarly-sized cost decision made during manufacturing.
Because roughly 80-90% of the product's total lifetime cost — including the warranty cost that will actually be incurred much later — is effectively locked in by decisions made at the design stage, choosing Component X's cheaper-but-less-reliable option now commits the company to a warranty-cost consequence that cannot easily be undone once the design is frozen and manufacturing begins.
A similarly-sized cost decision made later, during manufacturing (kaizen costing's territory), only affects the smaller remaining share of cost not already committed by earlier design choices, so it carries proportionately less long-term consequence.
Example 6. Distinguish the point at which target costing and kaizen costing are each primarily applied.
Target costing is applied primarily before manufacturing begins, at the product design stage, when the design is still flexible enough for value engineering to meaningfully change cost. Kaizen costing is applied continuously during the manufacturing phase, once the design is essentially frozen, pursuing smaller, incremental cost reductions through process improvement rather than design change.
Example 7. A company sets a target selling price of ₹1,500 and a required target profit margin of 15% of selling price. Its design team's initial cost estimate comes in at ₹1,320. Compute the cost gap.
Target Profit = 15% × ₹1,500 = ₹225. Target Cost = ₹1,500 − ₹225 = ₹1,275. Cost Gap = ₹1,320 − ₹1,275 = ₹45.
Summary
Target costing reverses the traditional cost-plus sequence — Target Cost = Target Selling Price − Target Profit — starting from the market price the product must actually compete at, and closes any resulting cost gap primarily through value engineering, applied before manufacturing begins while the design remains flexible.
Kaizen costing continues cost reduction after the design is frozen, pursuing small, incremental percentage reductions per period through continuous process improvement during the manufacturing phase itself, rather than the larger design changes value engineering uses.
Life cycle costing tracks a product's revenue and cost across its full introduction-to-decline span rather than any single period, built around the key insight that 80-90% of lifetime cost is typically committed at the design stage even though only a small fraction of it is actually spent there — which is exactly why target costing and value engineering, both design-stage tools, carry the greatest leverage over a product's eventual total cost.
