Target Costing, Kaizen Costing and Just-in-Time

Chennai Mixers has designed a mixer-grinder that costs ₹2,650 to make. Rivals sell similar ones for ₹3,000. Adding its usual 20% to cost gives ₹3,180, which no buyer will pay. Is the answer to lower the margin, or to lower the cost?

The mixer-grinder. Market price ₹3,000. Desired profit 20% of price = ₹600. Target cost = ₹3,000 − ₹600 = ₹2,400. The first design costs ₹2,650, so there is a gap of ₹250 to be designed out.

If the design could not be changed and the firm sold at ₹3,000, it would earn ₹350, which is only 11.7% of the price against the 20% wanted.

Why use it. When products are alike, competition is strong and customers switch easily, the firm cannot set the price, so it must control the cost. Most of a product’s cost is fixed at the design stage, so the saving must be sought there, not after production has begun.

Objectives. To lower the cost of new products so that the required profit is ensured; to meet the quality, delivery time and price the market needs; and to make everyone in the firm responsible for the target profit.

Benefits. Better profit through lower cost, innovation shaped by what customers want, customer satisfaction, and a leaner production process.

Don’t confuse target costing with cost-plus pricing. Cost-plus starts with cost and adds profit to reach a price. Target costing starts with the price and takes profit away to reach a cost. The first lets inefficiency pass into the price; the second makes the cost bear the pressure of the market.

Where it breaks. A target set too hard may lead designers to cut quality or safety, or to push the cost onto suppliers who cannot bear it. A product with no real market price, such as a new invention, has nothing to start from. The work in design and testing adds cost of its own.

For exams. Know the formula, the contrast with cost-plus, the objectives, the steps and the benefits.

Price first, profit second, cost is what is left.

Chennai Mixers launches at the target cost of ₹2,400. A year later rivals have cut theirs. If cost stays still, the margin shrinks. Kaizen costing keeps cost falling by a little each month.

The mixer-grinder, month by month. The unit cost is ₹2,400. The target is to take ₹20 off every month.

In months 1 and 3 the firm fell short of its target and in months 2 and 4 it beat it. After four months the actual cost is ₹2,310, which is ₹90 below the start. The variance is a prompt to find which waste was removed, and which was not.

Continuous improvement, not re-engineering. Kaizen is small steps taken all the time by everyone. Business process re-engineering is a radical, one-off change. The thinking behind Kaizen is that perfection is never reached, so there is always something to improve, and that improvements from the people who do the work are usually small.

Principles. It does not take the present situation as given. It seeks gradual improvements, not perfection at any cost. It allows managers to use their knowledge and discretion and encourages shared decision-making, on the view that many minds do better than one. Standards are set and then improved continually.

Don’t treat Kaizen as the same as standard costing. A standard cost is a fixed yardstick, and a variance is judged against it. In Kaizen costing the yardstick itself is lowered every period. Kaizen costing is about reducing the cost, while standard costing is about controlling it at the level set.

Where it breaks. Targets that keep falling can run out of room, and employees may feel pressure when no improvement is ever enough. Gains from small steps need a culture that rewards suggestions. Cutting cost without regard to quality can harm customers.

For exams. Give the meaning, the contrast with cost control and with re-engineering, the seven wastes and the principles.

Small cuts, every month, by everyone.

Chennai Mixers holds about ₹12,00,000 of motors, castings and finished goods. At 20% a year for storage, insurance, interest and spoilage, holding it costs ₹2,40,000 a year. What if the goods arrived only when they were needed?

The saving. Suppose JIT cuts the average stock from ₹12,00,000 to ₹3,00,000. Carrying cost falls from ₹2,40,000 to ₹60,000, a saving of ₹1,80,000 a year, and ₹9,00,000 of working capital is freed.

Where it came from. JIT was developed at Toyota, and Taiichi Ohno is usually called its father. It worked only because everyone was committed, the plant was laid out for efficient flow, and quality and production schedules matched demand.

JIT purchasing in steps. Find a reliable supplier. Work out the internal and external lead times. Prepare the bill of materials and the master production schedule against time. Order the items to arrive within the lead times. Move material straight to the shop floor, make or assemble to schedule, and deliver as planned. A small temporary store may be kept if needed. The aim is to remove the warehouse and its carrying cost.

Don’t think JIT only means less stock. JIT needs steady quality, short set-ups, reliable suppliers and a tight schedule. A firm that cuts stock without these simply runs out of parts. The stock was hiding problems, and JIT exposes them, so they must be solved.

Where it breaks. A supply failure stops the line at once, because there is no buffer. Heavy dependence on a few suppliers, long supply routes or sudden demand swings make JIT risky. Some firms now hold a safety stock of critical parts.

For exams. Know the meaning, the slogan ‘inventory is waste’, the origin, the objectives, the four environments and the steps of JIT purchasing.

The right unit, in the right quantity, at the right time.