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Target Costing in Cost Accounting

Target costing is a two-step process to determine the cost of your product when cost accounting. First, you estimate a target price — an estimated price you think your customer is willing to pay based on market conditions. You use the target price information to compute the target cost. You consider

  • Customer perception of the value of your product

  • Customer perception of your product compared with your competitors’

  • Your ability to differentiate your product from the competition

The first point is about the customer’s perception of your product. You can find what it is by asking. Talk to your customers; that’s the easiest and perhaps the soundest method (and you’d be surprised by how many small businesses never ask). If you have a sales force, your sales reps can ask your customers about everything from perceived quality to perceived speed of delivery. Formally, you could conduct surveys and focus groups.

The second point considers how your customers compare you to the competition. Again, just ask and thou shalt receive. People love to be asked. You also might consider paying a firm to perform market research for you. The cost of hiring the firm may be worth the specific customer information it can provide. The more you know about your customers, the better you can serve their needs.

The third point is about differentiation in products. There are numerous ways to see the differences. You can always simply buy a copy of the competitor’s product, but there’s more.

If you’re willing to play detective, there are several great ways to learn about your competitors. The more you know, the better. You may start off just learning about the competition’s product, but when you’re done, you’ll know a lot about the competitor’s business processes and philosophy. That knowledge can make a big difference. The result is that you end up with information to make more accurate comparisons between your product and the competition’s.

You can get competitor information from customers, suppliers, and public information. There are less savory techniques (and you better believe that low-integrity businesses have used them), but let’s not go there.

  • Your customers: Ask your customers if they have done business with your competition. Find out about their whole buying experience: the price they paid, how they were treated, the service they received. That’s great information, and they are likely to be willing to share.

  • Suppliers: A supplier might be tougher, but it’s still worth a try. Suppliers may keep information on current clients confidential, but you might be able to get some data on a competitor who is a former client. A supplier can tell you what your competitor bought, how much, and possibly for what price, and maybe why the competitor stopped buying from them. Essentially, you’re getting data on your competitor’s supply costs.

  • Company publications: Companies publish information for a variety of reasons. In some cases, they provide information to comply with industry rules or regulations. Corporations publish a glossy annual report for shareholders. Publicly traded companies must file Form 10-K with the Securities and Exchange Commission (SEC). This report may contain data that’s helpful to your analysis. Look online.

  • The print media: Many companies issue press releases to announce new products and services. Information appears in the general press and in industry journals. CEOs give interviews, too.

  • The Internet: The Internet is the print media “writ large.” Read company websites. See what analysis, industry experts, and journalists have to say about the company.

  • Reverse engineering: An excellent way to gather information about a competitor and their products is through reverse engineering. You get their product and literally take it apart to see how the product was designed and assembled.

    The auto and high-tech hardware fields do a lot of reverse engineering. The great added value to a car, computer, or a smartphone is the design, so the best way to keep up with your competitors is to pull apart their latest product and see how it works.

    However, you may find surprises that have nothing to do with design. You can see, for example, where printed circuit boards were made or that the product was assembled in China, Indonesia, or Vietnam.

  • Intelligent guessing: My experienced clients can make very shrewd guesses about how competitors are cutting corners to lower cost. A lawnmower manufacturer may say, “Oh, I bet they’re using a low-quality blade.” A restaurant owner may say, “My guess is that they use salad mix from a big bag instead of tearing the lettuce.” Use your experience.

All of the intelligence (also known as the G2 or the MI6, for ex-military folks) can help you price your product intelligently.

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