The implementation of target costing in the United States: theory versus practice

Journal of Supply Chain Management, Wntr, 2006 by Lisa M. Ellram

INTRODUCTION

As product life cycles rapidly decrease in many sectors, the attention given to the new product development (NPD) process has increased commensurately. Much research has been done related to how to conduct the NPD process (Fine 1998; Porter 1998; Rusinko 1999; Tatikonda and Rosenthal 2000; Goffin and New 2001), as well as on various methods to enhance the NPD process, such as concurrent engineering and early supplier involvement (ESI) (Ettlie 1997; Maylor 1997; Koufteros, Vonderembose and Doll 2001; Kessler and Bierly 2002), and the importance of speed in NPD (Mendez and Pearson 1994; Hicks 2001). Consideration has also been given to cultural differences in NPD processes (Liker, Sobek, Ward and Cristiano 1996; Wasti and Liker 1999; Lynn 2002). Clearly, most organizations endeavor to create new products and services that have the potential to be profitable. With few exceptions, firms who fail to make money in the long run will not survive. Thus, the cost of an organization's products and services is a fundamental concern of CEOs (Kearney 1998).

However, with notable exceptions (Cooper and Slagmulder 2000; Browning and Eppinger 2002), outside of the accounting literature, limited attention has been given to how to control the costs of products and services during the development process, so that the resultant product or service is created at a cost that will create a profitable product for the manufacturer (Kessler 2000; Lockamy and Smith 2000). This is especially true in the engineering and operations management literatures. There is a literature around product costing and managing the cost of new products in development (also known as target costing) in the field of accounting. Today, it is the domain of proactive management accountants to provide tools and techniques for better managing and running the financial and cost aspects of the business (Shank and Govindarajan 1993; Cooper and Slagmulder 2003).

Should something as important and with as broad implications as cost management during the NPD process be left to any single function (Kopczak and Johnson 2003)? Clearly, there are many objectives in addition to cost management in the NPD process, such as meeting customer needs. However, cost is virtually always a concern.

The current research is part of a larger study that specifically investigated the role of supply management in the target costing process. This view provided a unique perspective for the study, rather than viewing target costing from the lens of accounting, as does most previous reported research (Brausch 1995; Fisher 1995; Ansari and Bell 1997; Cooper and Slagmulder 1997, 1999a, 2003; Partridge and Perren 1997). This study involved multiple respondents across a spectrum of functions within each firm, creating a broad and diverse perspective on target costing application and benefits.

There is a proposed theoretical model of target costing set forth in the accounting literature (Ansari and Bell 1997). This model is widely presented, generally from a managerial standpoint in terms of its application to an individual organization (Newman and McKeller 1995; Dutton and Ferguson 1996; Schmelze, Geier and Buttross 1996), and/or with a focus on large Japanese manufacturing firms (Cooper and Slagmulder 1997, 1999a, b). Target costing is of great interest in part because of its potential to improve the cost and functionality outcomes of the NPD process. But, does target costing work the same way (or at all) in an environment that is not characterized by long-term, ongoing supplier alliances, but rather is an environment that is volatile, competitive and with shifting alliances, as is common in the United States? Prior research indicates that effective business practices in NPD (Lynn 2002) and supplier relationship management (Ellram and Cooper 1993) may be quite different in Japanese firms than in U.S. firms. Yet the Japanese model of target costing dominates our literature and practice.

The major question to be explored in this research is:

        
    
    
    
    
    How should U.S.-based firms adapt the target costing process to fit      the business environment and culture? 

PREVIOUS LITERATURE AND THEORY

This section first presents a brief review of the literature in target costing theory. The target costing process has been most widely noted as a practice to support NPD by keeping constant vigilance on the cost and functionality of products, and establishing methods to close the gaps between current and desired cost and functionality (including quality). Thus, target costing begins by establishing critical product and service functionality. A selling price for the product is estimated based on what the market will bear (Worthy 1991; Gagne and Discenza 1995; Ansari and Bell 1997; Dorjahn 1997). The overall target cost for a product or service is determined using the following formula:

Target Cost = Estimated Selling Price - Desired Profit

The target cost is then apportioned to each of the critical bill of materials elements, taking into account a combination of cost estimates/history, and the constraint of the overall target cost. The target costing process is a very systematic approach for establishing and communicating cost objectives and performance metrics both within the organization and to external suppliers.