Key Takeaways:
- Understand the stages of a product’s life cycle and their impact on cost management.
- Learn how Life Cycle Costing provides a complete view of cost accumulation over a product’s lifespan.
- Discover the principles and practical application of Target Costing for competitive pricing strategies.
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Modern business environments demand a sophisticated approach to controlling and managing costs. As competition intensifies and consumer expectations evolve, organizations must adopt forward-thinking methods to ensure profits and long-term sustainability. Life Cycle Costing and Target Costing have emerged as indispensable tools for cost accountants and managers, enabling them to align costing strategies with overarching business objectives.
Product Life Cycle
a. Stages of Product Life Cycle
Every product passes through distinct phases, each with unique cost and revenue dynamics. Understanding these stages allows companies to anticipate cost patterns and design effective costing systems.
| Stage | Description | Cost Implications |
|---|---|---|
| Introduction | Product launch, high marketing & development expenses. | Heavy initial investments; low sales volume. |
| Growth | Rapid sales increase, market acceptance. | Production scales up, some cost reduction per unit. |
| Maturity | Sales stabilize, competition intensifies. | Focus on cost efficiency; economies of scale peak. |
| Decline | Demand falls, product may be phased out. | Costs may rise relative to sales; need for rationalization. |
Recognizing the life cycle stage helps firms set appropriate cost targets and pricing decisions that support strategic goals.
Life Cycle Costing
a. Concept of Life Cycle Costing
Life Cycle Costing (LCC) is an approach that accumulates all costs associated with a product from inception to disposal. Instead of focusing solely on manufacturing costs, LCC includes research and development, design, production, marketing, distribution, after-sale service, and disposal costs. The aim is to provide a comprehensive view of the total cost incurred throughout the product's life.
Life Cycle Costing ensures that hidden or deferred costs, such as warranty, maintenance, or end-of-life disposal, are incorporated into decision-making. This holistic perspective is especially valuable for products with long-term commitments or significant post-sale expenses.
For example, when budgeting for a new automobile model, a manufacturer must estimate not only the direct manufacturing costs, but also future warranty claims, service costs, and end-of-life recycling costs.
Target Costing
a. Meaning and Formula
Target Costing is a proactive cost management approach that begins with the Market Price and desired profit margin. Rather than calculating costs and adding a profit mark-up, organizations set a target cost that allows them to compete effectively and achieve profit objectives.
The formula is simple but powerful:
Target Cost = Target Price – Desired Profit
Here, Target Price is determined by market analysis and customer expectations, while Desired Profit reflects organizational goals. The resultant Target Cost becomes a benchmark for design, production, and supply chain decisions.
b. Advantages and Application
- Market-Driven Approach: Target costing starts with what customers are willing to pay, ensuring products remain competitive.
- Profit Planning: By fixing profit before cost, management aligns product development and operations with financial objectives.
- Cost Control: The method encourages cross-functional teams (design, engineering, procurement) to collaborate in achieving cost targets from the earliest stages.
- Strategic Pricing: Enables firms to respond rapidly to market changes, competitors' moves, and evolving consumer preferences.
Many Japanese manufacturing firms pioneered target costing to maintain profitability in highly competitive sectors such as electronics and automobiles. Today, it's a standard practice globally for new product development.
Example
Consider a company planning to launch a new gadget. Market research indicates that the maximum price customers will pay is ₹2,000. The company's policy is to earn a profit margin of 25% on sales.
- Target Price = ₹2,000
- Desired Profit = 25% of ₹2,000 = ₹500
- Target Cost = Target Price – Desired Profit
Target Cost = ₹2,000 – ₹500 = ₹1,500
This means the product must be designed, manufactured, and delivered to the customer at a total cost not exceeding ₹1,500. If current cost estimates exceed this figure, the team must find ways to reduce costs whether by redesigning the product, negotiating with suppliers, or streamlining production processes.
Life Cycle Costing vs. Target Costing
| Aspect | Life Cycle Costing | Target Costing |
|---|---|---|
| Focus | All costs over product’s life | Cost control for target profit and price |
| Timing | Used throughout product life | Applied during product design & planning |
| Decision Basis | Total cost minimization | Market-driven price & profit |
| Application | Budgeting, investment decisions | Product design, cost reduction |
Both methods empower managers to make informed, forward-looking decisions. Life Cycle Costing ensures complete cost visibility, while Target Costing keeps products relevant and profitable in fiercely contested markets. Integrating these approaches equips future commerce professionals with the analytical and strategic skills needed for modern business success.