Chapter 10: Cost Planning for the Product Life Cycle: Target Costing, Theory of Constraints, and Long-Term Pricing

Summary

The strategic cost management concepts introduced in the preceding chapters are extended here. First, we discuss four cost management methods used to analyze the product or service’s life cycle: target costing, the theory of constraints, life-cycle costing, and strategic pricing. Target costing is a tool for analyzing the cost structure to help management identify the proper design features and manufacturing methods to allow the firm to meet a competitive price. The five steps in target costing are (1) determine the market price, (2) determine the desired profit, (3) calculate the target cost (market price less desired profit), (4) use value engineering to identify ways to reduce product cost, and (5) use kaizen costing and operational control to further reduce costs.

The theory of constraints (TOC) is a tool that assists managers in identifying bottlenecks (constraints) and scheduling production to maximize throughput and profits. TOC analysis has five steps: (1) identify the constraint, (2) determine the most efficient product mix given the constraint, (3) maximize the flow through the constraint, (4) add capacity to the constraint, and (5) redesign the manufacturing process for flexibility and fast throughput.

Life-cycle costing assists managers in minimizing total cost over the product’s or service’s entire life cycle. Life-cycle costing brings a focus to the upstream activities (research and development, engineering) and downstream activities (marketing, distribution, service), as well as the manufacturing and operating costs that cost systems focus on. Especially important is a careful consideration of the effects of design choices on downstream costs. The four common design methods: (1) basic engineering in which engineering is done separately from marketing and production, (2) prototyping in which a working model of the product is developed for testing, (3) templating in which a new product is developed from the design of a similar existing product, and (4) concurrent engineering, that integrates marketing, manufacturing, and design to continually improve a product’s design.

Strategic pricing helps management determine the price of the product or service based on life-cycle costs or in its position in the different phases of its sales life cycle.