Role of supply chain management in target costing *

July 2010, Vol.6, No.7 (Serial No.62)

Journal of Modern Accounting and Auditing, ISSN 1548-6583, USA

Role of supply chain management in target costing* Mohammad Talha1, John B.Raja2 (1. Department of Accounting & MIS, College of Industrial Management, King Fahd University of Petroleum & Minerals, Dhahran 31261, Saudi Arabia; 2. Faculty of Business and Law, Multimedia University, Bukit Beruang 75450, Melaka, Malaysia)

Abstract: Standard costing is used as a control for product costing. But with life cycle becoming shorter, costing should be done at the design and development stage of a product. This is achieved through target costing.The implementation of target costing and target pricing is done with the ultimate purpose of cost reduction, cost understanding, continuous improvement, competitiveness, early purchasing and supplier involvement, and improved design and accountability by manufacturers. The study explores the participation of the purchasing and supply chain management’s role in target costing and target pricing process. Supply management plays an active role in monitoring the ongoing cost and performance of suppliers during the early stages of product development. Implementation of target costing and target pricing in various organizations are also explored. Leading Japanese manufacturers have used target costing and target pricing systems to their advantage and the paper also examines the adaptation of the Western companies to these proactive cost management techniques to improve their product development processes. Key words: target costing; supply chain management; product lifecycle costing; target pricing; Kaizen costing

1. Introduction Product life cycles are getting shorter and shorter, quite often one or two years, and sometimes less than one year in high tech industries. Consumers are demanding new and diversified products in short intervals. Due to factory automation, robots and computer controlled manufacturing systems are replacing the conventional production lines. What all these changes mean is the traditional standard costing systems, which emphasize cost control in the manufacturing phase of the product life cycle, are no longer effective. With an one-year product life, controlling costs in the manufacturing phase simply doesn’t accomplish much. Once the product is developed and designed, there is a limit to how much cost cutting companies can do in the manufacturing stage. A new cost management concept has been developed and practiced by world class Japanese manufacturers to deal with the needs in the product design and development phase. The new cost management concept is known as target costing and target pricing approach. The concept of target costing originated in Japan at Toyota Motor Corporation in the 1960s. Since that time it has become recognized as a dynamic, comprehensive system for cost reduction and strategic profit planning. *

Acknowledgement: The authors would like to gratefully acknowledge the excellent research facilities and other support provided by King Fahd University of Petroleum & Minerals, Saudi Arabia and Multimedia University, to carry out this work. Mohammad Talha, associate professor, research coordinator, Department of Accounting & MIS, College of Industrial Management, King Fahd University of Petroleum & Minerals; research fields: financial accounting & reporting, managerial accounting, international accounting, segmental disclosures, merger & acquisition and corporate governance. John B.Raja, professor, Faculty of Business and Law, Multimedia University; research fields: management accounting corporate governance, mutual funds and finance related topics. 46

Role of supply chain management in target costing

Target costing is a program aimed at reducing the life cycle costs of new products, while ensuring customer requirements of quality and reliability. For controlling costs of new products, target costing takes place at the design stage of new product development and considers all ideas for cost reduction during the product planning and research and development process. Traditional methods, or cost-plus approaches, typically estimate design and production costs, then add a profit margin to determine market price. If customers are unwilling to pay the assigned price, cost reduction efforts begin. Some companies employ a conventional Western approach, in which the expected profit margin is unknown. To determine this profit margin, expected production costs are subtracted from the planned selling price. This calculation is made after product functionality and specifications have been determined. In contrast, target costing starts with a market price based on customer research and a planned profit margin based on profit required for long-run firm survival for a product. The difference between the market price and required margin is the allowable cost. If expected costs exceed allowable costs, cost reduction efforts begin, during the product design and development stage, to ensure this allowable cost is achieved.

2. Research problem Implementation of target costing and target pricing is done with the ultimate purpose of eliminating all unnecessary activities and continuously seeking to reduce the cost of production by the management team. Target costing and target pricing represents one of the most important areas where marketing and accounting overlap. It requires managers or manufacturers to make a series of decisions that include defining the customer needs, ascertaining the economics required for profitability, allocating targets to components and identifying the gap between target prices and initial projections of manufacturing costs. The research problems are summarized as below: (1) Lack of awareness on the implementation of target costing and target pricing by manufacturers; (2) Lack of understanding on the use of target costing and target pricing approach to improve supply chain management; (3) Understanding the difference between Japanese and Western manufacturing practices and management accounting methods using the target costing and target pricing approach.

3. Objectives of the research The objectives of the research are: (1) To explore the implementation of target costing and target pricing and to provide an overview of target costing and target pricing approach; (2) To analyze the role of supply chain management in the target costing and target pricing process; (3) To discuss the benefits of implementing target costing and target pricing in organizations; (4) To explore the adaptation of Japanese manufacturing and management costing techniques by the West.

4. Scope of the study Target costing and target pricing is an approach that considers all ideas for cost reduction during the product design and development stage. The study explores the participation of purchasing and supply chain management’s role in target costing and target pricing. The benefits of implementing this approach are also discussed in the study.

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The study also focuses on the adaptation of Western manufactures to Japanese costing techniques such as target costing and target pricing.

5. Survey of literature Gagne & Discenza (1993) analyzed the important factors that determined Japanese approaches to world class manufacturing and it has become necessary to reexamine the management accounting systems currently in use. They commented that a way of doing this is to contrast the US management systems with Japanese methods of cost accounting, which include such concepts as target costing, value engineering, and functional analysis. Japanese cost management departments take a team oriented approach and use direct performance indicators extensively, including production set up times, number of times materials are moved, or number of units scrapped. Japanese cost accountants must compute 100% of product cost in the planning and design stages. Standard costs are steadily reduced by continuous improvement efforts toward the target cost. After the target cost is set, each department implements value engineering activities in cooperation with each other. In functional analysis, the cost information available for each product is used to consider the cost reduction implications of several alternatives. The authors also stated that in the late 1960s and early 1970s, Japanese firms in assembly-oriented industries, such as electronics and automobile manufacturing, began producing high quality products at very competitive prices. These products had short life cycles and were produced in a wide variety of models and sizes. They were the result of a manufacturing environment that used new methods and concepts such as just in time (JIT), total quality management (TQM), continuous improvement (CI), and employee involvement (EI). They emphasized customer service by providing quality, timely delivery, and low cost production. The shortcoming of this article is that the author elaborated more on the Japanese methods of cost accounting instead of comparing equally between the US and Japanese accounting system. Yasuhiro & John (1993) examined kaizen costing, a critical means of ensuring continuous improvement activities used by Japanese auto makers, supports the cost reduction process in the manufacturing phase. Kaizen costing as compared to standard costing aims at reducing costs in a very aggressive manner. The authors commented that Japan’s kaizen costing calls for the establishment of a cost reduction target amount, and its accomplishment through kaizen activities such as continuous improvement in operations. They also define kaizen costing activities as those that sustain the current level of the existing production costs, and further reduce it to the expected level based on the company plan. These cost improvement activities are very specific with respect to each department and each accounting period. The periodic cost improvement process is preceded by the annual budgeting process, or short-term profit planning process. The authors stated that kaizen costing is implemented outside the standard cost accounting system and is not limited by the financial accounting. The strength of kaizen costing comes from its close link with the profit planning process of the whole company. This consistent connection with the overall planning and budgeting process ensures that the company can monitor its progress toward the long-term goals without being confined to the tasks of meeting cost standards and investigating variances in conventional cost control systems. Brausch (1994) summarized target costing as a strategic management tool that seeks to reduce a product’s cost over its lifetime. He overviewed the portfolio of Culp Inc., which identified that cost management was one of the most strategically imperative areas of the firm. It combines the efforts of marketing, operations and accounting and presumes a relationship of working knowledge of each to be successful. The company implemented three

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strategies namely recognizing the differences between managerial and financial accounting, producing accurate product costing and going from the accuracy school to target costing. The author believes that the target costing program at Culp Inc., did not have an impact on how costs product, but rather has affected the way in which the costing information already available through cost management efforts. The author viewed target costing as the pricing decision, which becomes the focal point of the efforts and not the product’s cost. The author concludes that this information was readily available because the product’s perceived value (selling price) is easily determined based on the look of the product. The author views that medium to long-term profit planning must be in place to incorporate target costing. The author failed to give more details on the implications of cost management efforts in determining the product’s cost. Lee (1994) summarized that product life cycles get shorter and shorter and traditional standard costing systems are no longer effective. The author believes that a new cost management concept, target costing, has allowed companies to win considerable amounts of market shares. Based on the price down, cost down strategy, target costing places emphasis on the firm’s relative position in the market and product leadership. Because it is closely linked with the firm’s long-term profit and product planning process, target costing allows the company to focus on profit and product in an integrated strategy that does not discriminate against high quality, high price, high margin products that require high costs. The main theme is what a product should cost, not what it does cost. The desired profit is determined based on the company’s desired return on sales (ROS), rather than ROI. The author suggested that manufacturers need a variety of products in low volumes to survive and calculating the profitability of each of those products in ROI is impossible. The limitation to this article is that the author did not elaborate or provide enough explanation on the ineffectiveness of the traditional standard costing system compared to target costing. Gagne & Discenza (1995) examined the use of target costing for new product development. Their discussion concentrates on determining costs for a product during the planning and design stage. They also discussed on the use of cross functional teams made up of industrial marketers, cost accountants and others critical to the design and manufacturing decisions required for determining the price and features with which a product is most likely to appeal to potential buyers are also described. After deducting the desired profit margin from the projected selling price, planners develop estimates of each product element that make up a product’s costs for design, manufacturing, sales and marketing. The limitation of the article is that the author did not elaborate in detail on how design and manufacturing decisions are required for determining the price of a product. Schmelze, George, Rolf & Thomas (1996) highlighted the experience of ITT (International telephone and telegraph corporation) automotive, which is used as an example of successful implementation of target costing. The authors stated that, intense competition and pressure from customers to reduce prices has forced many companies to reduce their costs to survive. These companies have found that most costs are committed once production begins, and therefore, the costs must be reduced earlier in the product life cycle, particularly while the product is in the planning and designing stages. The authors stressed that the target costing philosophy requires aggressive cost management in the product planning stage, the product design stage, and the production stage. By designing lower costs into the product, companies realize the best sources of cost savings before the product reaches the production stage. In order for target costing to be successful, integration is needed in the form of cross functional teams comprising engineering, product design, production, purchasing, sales, finance, cost accounting, cost targeting, and in many cases customers and suppliers. The authors believe that by establishing the target price and target margin at ITT Automotive, price is generally set externally, either by competitive pressure or by the 49

Role of supply chain management in target costing

customer’s target costing system. The authors agreed that although the setting of the targets is a cross functional procedure, the ITT Automotive team believes that it is critical for someone who is independent to first set the targets. The shortcoming of this article is that the authors did not elaborate on the negative implications of cost reduction in the planning stages. Omar (1997) examined the rigorous cost management technique used by UK based car manufacturers, which helps prevent the senior managers from launching low margin cars, which do not generate enough returns on investment. He highlighted that most car manufacturers in the UK employ the logic of target costing as a marketing management tool to determine the prices of new car models. Target pricing drives motorcar development strategy that focuses the design team on the ultimate customer and on the real opportunity in the market. Evidence suggested that leading Japanese motorcar manufacturers have used target costing to their advantage, and have introduced it in the UK. For manufacturers to gain and hold market leadership, they have to design the cost out of their cars. They set initial levels of quality and functionality and calibrate the car performance to an identified price niche. The author stressed that senior managers need to approach new car development controlling for future costs and target costing process must be highly transparent throughout the organization. He also pointed out that the requirements for motorcar functionality must be articulated clearly so that nobody tries to achieve the target cost by reducing model functionality below acceptable levels. He also concluded that it’s not good to reduce costs by short changing customer’s car performance demands. Evidence from this study suggests that the UK based Japanese car manufacturing firm uses target costing system to keep prices constant while adding as much functionality as possible to each new generation of vehicles. Bayou & Reinstein (1998) provided an overview of the three alternative routes that target costing projects could pursue to reach their goals namely total cost management, cost cutting and cost shifting. They expressed that the basic strategies of comprehensiveness, integration, flexibility, dynamic and long term continuity form the strength that total cost management needs to reach the targets. Total cost management can be diverted into cost cutting and cost shifting practices. They commented that target costing affects the management accounting profession. The authors summarize the contributions of this paper to: Developing three possible routes that target costing can pursue to reach its objectives; Identifying and explaining the basic strategies shaping the critical and suggestive nature of cost improvement through total cost management and demonstrating how the weaknesses in applying these strategies can divert total cost management into assertive cost cutting or evasive cost shifting practices. The authors argued that the cost improvement, which refers to the costing elements of total cost management, has a critical nature, which necessitates a suggestive mode for its conduct and communication. This criticality stems from the strategies of comprehensiveness, integration, flexibility, dynamic functioning and long term continuity. The authors pointed out that those strategies face many practical problems, including forecasting in the face of ever changing global conditions such as model complexity, limits to continuous cost improvement, conflicts with decentralization and the emergence of secrecy as a fundamental constraint. Jones, Munday & Brinn (1998) debated on the role of the UK management accountant as a barrier to the adoption of Japanese management accounting techniques, highlighting professional and cultural differences, which could make UK management accountants reluctant to convert to Japanization. The authors argued that such reluctance in a key functional area might, in turn, hinder the importation of closely related Japanese production techniques and adversely impacting the competitiveness of UK manufacturing. This conclusion has a wider pertinence because the critiques of Japanese cost and management techniques show their pivotal and supportive role in the successful development of Japanese production systems. The authors highlighted that if UK 50

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manufacturing organizations are unable to adopt Japanese management accounting methods, then the importation of interconnected Japanese production techniques such as JIT and kaizen will be inhibited, adversely affecting UK manufacturing competitiveness. The authors agrees to the suggestion that the successful Japanization of production will occur only in conjunction with extensive organizational redesign, particularly in the management accounting functions which have some self interest in the vertical transmission of historical financial data rather than the horizontal dissemination of information supportive of cost management and kaizen. However, the authors hypothesized that UK management accountant’s act as a barrier to the mediated Japanization of management accounting but failed to provide an empirically based research to robustly test these arguments. Cooper & Slagmulder (1999) argued that with the emergence of the lean enterprise and global competition, companies around the world are facing increasing challenges in developing products that deliver the quality and functionality that customers’ demand, while generating the desired profits. The authors highlighted that one way to ensure that products are sufficiently profitable when launched is to subject them to target costing. Target costing achieves this objective by determining the life cycle cost at which a company must produce a proposed product with specified functionality and quality if the product is to be profitable at its anticipated selling price. The authors commented that market analysis plays a critical role in shaping the market driven costing section of target costing by determining so called allowable costs. Their discussion assumed once a company establishes product level target costs, it decomposes them to the component level, thus transmits its cost pressures to its suppliers. Thus, component level target costing helps discipline and focus supplier’s creativity in ways beneficial to the buyer. The limitation of this article is that the authors fail to provide suggestions on cost reduction techniques of new products and did not elaborate how this would gain market share and experience economic success. Shank & Fisher (1999) examined a case study that demonstrates the relevance of target costing techniques for a process industry plant built in the 1890s that had been making the same products for 50 years. According to the authors, the firm’s managers had used a standard cost system for many years and due to competitive realities, the management necessitated a major strategic change that employed target costing as an important ingredient in cost-reduction efforts leading to strategic revitalization. The authors further discussed on the cost reduction efforts taken by the plant management to achieve ideal manufacturing cost such as no waste, no scrap, no inefficiency, no delays, perfect formulations and perfect plant layout. The authors highlighted that target costing did not receive any attention. The study illustrates the potential of using target costing as a proactive cost reduction tool in place of standard costing. Ellram (2000) described that target costing became a critical tool for purchasing at the Vancouver Division of Hewlett Packard in order to better understand and manage their costs and supply base. The author highlighted the benefits of using target costing and its responsibility for opening a dialogue with its suppliers that addresses both the justification and need for cost reduction. The author commented that target costing is driven by the program team as practiced in Hewlett Packarding. The author concluded that target costing has worked from the supplier’s perspective and this makes Hewlett Packard rewards suppliers who cooperate in target costing with more business. The limitation of this article is that the author fails to provide examples of how the program team drives the target costing process. Ellram (2000) examined the participation of the purchasing and supply management function in the process of target costing. The author addressed four primary issues namely, why do organizations undertake target costing? Is there a common pattern of participation for the purchasing and supply management function in target costing? What should the role of purchasing and supply management be in the target costing process? How can purchase 51

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and supply management be most effectively involved in the target costing process? The author stressed that the implementation of target costing is for cost management reasons such as reducing costs, improving understanding of the supplier’s cost structures, improving internal cost management, improving cost monitoring and increasing cost accountability. The author pointed out that, purchasing and supply management is involved from very limited involvement to being the driver of the process and being accountability for results, is the key to the long-term success of target costing. The author concluded that it would be beneficial to study a broader sample of service organizations for which purchasing and supply management plays an active role in target costing. The limited sample of service organizations in this research demonstrated some patterns in purchasing and supply management’s participation in target costing in the service sector. Lastly, the author did not discuss on the applicability of target costing and the role of purchasing and supply management in the nonprofit and governmental sectors. Lockamy & Smith (2000) examined the use of target costing as a means to improve the management of supply chains. They commented that the concept of target costing is used as a mechanism in determining the total supply chain cost that meets the requirements of the customer. With regard to these aspects, the authors agreed that a sound supply chain strategy is needed which is aligned with the target market as well as with the firm’s competitive and product strategies. They also discussed the traditional and activity based cost management approaches to supply chain management, which provides the basis for exploring the use of target costing within supply chains. The authors described the customer requirements and supply chain relationships as the key criteria for selecting the most appropriate method of target costing for supply chains. Hibbets, Albright & Wilfried (2003) concluded that target costing is intimately linked to an organization’s competitive strategy. This study investigates the relationship between competitive environment and strategy for target costing firms. Preliminary evidence conducted by the authors, through interviews with managers from twelve US and German based target costing adopting companies, shows product differentiators are more likely to implement target costing than firms pursuing other competitive strategies (i.e., cost leadership or confrontational strategies). The authors employ Classification and Regression Trees (CART), an unique statistical technique for categorizing data. This study also contributes to the general area of strategic management accounting literature by explicitly pursuing and investigating links between company strategy and target costing. The authors concluded that future research should explore the relationships of strategy and competitive environment with a larger sample size and should include a control sample of non target costing adopters as a comparison. Ellram (2006) used case study approach to execute this research. The case study method is becoming more accepted in operations and supply management research. The use of target costing is not widespread among organizations in the US economy (Cooper & Slagmulder, 1999). Under the present circumstances, more relevant data can be gathered using the case method. Of course, the most compelling reason for using the case study method is that it best supports the research objective of this study. The study is done in firms in US from the perspective of operations management. 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. The author found that the target costing process as employed here has benefits and linkages beyond cost management.

6. Research methodology The emergence of target costing and target pricing is divided and discussed into four sections as discussed

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below. (1) Implementation of target costing and target pricing in various organizations; (2) The role of supply chain management; (3) Benefits of implementing target costing and target pricing; (4) Finally, explore the adaptation of Western manufacturers to Japanese manufacturing techniques. The information and data were gathered from various sources. The Internet search engine like Goggle, Yahoo and AltaVista offered excellent search for locating on-line articles. Sources of secondary data include journal articles published in magazines and downloaded from the Internet Websites including Emerald, EBSCO and ProQuest online databases. References were also made on the research topic from various chapters of relevant accounting and financial textbooks. The research methodology framework is developed in Figure 1 as below.

Benefits derived from target

Implementation of target

costing and target pricing

costing and target pricing Target pricing and target costing development and control The role of supply chain management in target costing and target pricing

Figure 1

Adaptation of Japanese manufacturing and management techniques by the West

The research methodology framework

7. Discussion, analysis and finding 7.1 Overview of target costing and target pricing and its implementation 7.1.1 Target costing Under this approach, a company employs market research to determine the price at which a product will sell. It then subtracts an estimated profit margin to yield the target cost. Finally, engineers and cost analysts work together to design a product that can be manufactured for the allowable cost. Activity-based costing (ABC) can help in target costing, as well as in cost plus pricing methods, because the focus on activities assists in eliminating cost distortion. Target costing relies on value engineering, which utilizes information collected about a product’s design and production processes, subsequently identifying areas that need improvement. The target costing process begins by establishing a selling price, based on market research, for the new product. From this target selling price, the desired target profit is subtracted to determine the target cost. In all likelihood, this target is below the company’s current manufacturing cost. Teams from many departments then perform functional cost analysis in an attempt to reach the target cost. If the current cost estimate is at the target,

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the firm must decide whether or not to introduce the new product. If the current cost estimate is above the target, functional cost analysis is used to make changes and prepare another cost estimate. Marketing plays a crucial role in the determination of the target cost. 7.1.2 Target pricing Target pricing is a pricing arrangement whereby the buyer determines the price they are willing to pay for a particular product or service from a supplier. The buyer examines the supplier’s pricing structure and, leaving labour and material costs along with the profit margin alone, recommends supplier cost reductions which they can take in the overhead and general and administrative costs areas which will allow the supplier to meet the buyer’s target price. The major influences on target pricing decisions are: customer demand competitors’ costs and political, legal, and image-related issues: Target cost = Target price－Desired profit 7.1.3 The role of supply management chain in target costing and target pricing There are specific roles and relationships for supply chain management throughout the target costing process. One sentiment echoed by the organizations studied is that in order for supply chain management to make a substantive contribution to the target costing process, it needs to be involved early, during the idea conception stage. This is necessary to identify and qualify good suppliers on time and to have the ability to influence specifications of the major cost drivers for new products and services. Ideally, supply chain management should become actively involved in target costing during the first step of the process, when the product or service concept is being developed. Another key role and relationship in successful target costing is a close working relationship between supply chain management and design engineers. This is because design drives supplier requirements, which, in turn, drive the cost and have a direct impact on the ability of a product or service to meet the target cost. The specific roles for supply chain management in the classic approach to target costing includes identifying capable suppliers, facilitating early supplier involvement, as well as qualifying suppliers and verifying their capabilities and performance history. Supply chain management plays a key role in identifying new suppliers and new technologies for the research and development department to investigate. The primary role for supply chain management is to lead the negotiation and the development of long-term agreements with suppliers. The negotiation and long-term agreement development should ideally begin in the first step of the target costing process, giving the firm the maximum flexibility to design around a supplier’s capabilities if warranted. Another important role for supply chain management throughout the process is to work closely with the supplier to develop cost breakdowns, to gather market data to assess the reasonableness of supplier cost estimates, and to determine what the costs should reasonably be. The product or service and design are often in great flux at this stage as all parties work toward trying to achieve the quality and functionality goals while meeting the target cost. The ideal situation for target costing is a supply chain wide effort that includes value engineering, value analysis, and early supplier involvement. However, not all organizations have the resources and the company wide support required to make integrated, institutionalized target costing a success. In this case, the best role for supply chain management is as a member of a cross functional team, involved throughout the entire product or service life cycle, from ideal conception to end of life. However, target costing is a very resource intensive process. To be truly effective, it requires a team effort, generally involving varying degrees of participation by supply chain management, marketing, accounting, research, design, and manufacturing. It also requires relationship built with suppliers in order to reap the benefits of early supplier involvement and design participation. Top management 54

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must make time available and create an internal reward structure that supports target costing across all disciplines within the organization. All of the organizations studied that have implemented well integrated, institutionalized target costing efforts have regular top management reviews of the target costing progress throughout new product or service development. Target costing is an integral part of the new product or service development process, as well as an ongoing approach for monitoring and improving the costs of existing products or services. Thus, while target costing may begin as a supply chain management effort, it is critical to convince other functional areas of the benefits of target costing and to get their participation and commitment. 7.2 Comparison of costing in Japan and West With the introduction of world class manufacturing, it has become necessary to reexamine the management accounting systems currently in use. A way of doing this is to compare Western management systems such as from the US and UK, with Japanese methods of cost accounting. Japanese cost management departments take a team oriented approach and use direct performance indicators extensively, including production setup times, number of times materials are moved, or number of units scrapped. Japanese cost accountants compute 100% of product cost in the planning and design stages. Standard costs are steadily reduced by continuous improvement efforts toward the target cost. After the target cost is set, each department implements value engineering activities in cooperation with each other. In functional analysis, the cost information available for each product is used to consider the cost reduction implications of several alternatives. Clearly, there are shortcomings with traditional cost accounting approaches due to the changing nature of today’s manufacturing environment. Traditional cost accounting has served manufacturers well for a long time. But as factories change, its conventions and premises have become less defensible. Consequently, the internal management accounting system currently provides less than optimal information for helping American manufacturing companies competing in a global environment of rapid technological change and intense competition. A comparison is made between the US management systems and the Japanese methods of cost accounting. Japanese cost management departments take a team oriented approach and include members from other fields (e.g., engineering, purchasing, and manufacturing) as well as accountants. These individuals are typically specialists who have rotated through several departments before taking on a cost planning job. These people have broad perspectives that give them an unique ability to discover ways to reduce product costs. In Japan, because of the highly competitive nature of assembly oriented manufacturing, cost reduction in the planning and design stages is an important management issue. Japanese cost accountants must compute 100% of product cost in the planning and design stages. This is how the concept of target costing evolved. In Japan, standard costs are steadily reduced by continuous improvement efforts towards the target cost. The target cost is established during the design stage, standard costs as well as other cost reduction techniques are used during the production stage to attain the target cost. Thus, the standard costing system tracks progress in achieving the target cost. The Japanese have provided guidance on how management accounting can play a significant role in creating sustainable competitive advantages for the West. The other major aspect of Japanese managerial accounting is functional analysis, which was developed in the US. Under this method, cost information is available for each product function and the cost reduction implication of several alternatives is considered. Cost tables with detailed information are critical for successful functional analysis. For example, modifications to existing functions can be investigated, or functions can be reduced, expanded or combined. Generating higher profit margins is one of the company’s goals, and cost reduction is one way to achieve this goal. Another way is to add functions to the product, which may increase its cost but will 55

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increase its value to the customer even more. Japanese management accounting systems support a top to bottom commitment to continuous improvement in both the process and the product. Performance is judged over time, and progress towards goals is emphasized. When developing a new product in the US, the typical approach is to design it first and then compute the cost using a standard cost approach. Direct material, direct labor and overhead standard costs are summed, and the resulting total is the new product cost. If the cost is too high, the product goes back to design or the company accepts a smaller profit. In the US, the purpose of standard costing is to practice management by exception (i.e., management’s attention is directed towards situations where the actual results differ from the expected results). The expected results are based on standards set relative to the current manufacturing process. Therefore, standard costing reflects existing technologist and fails to motivate improvements in the process. In the US, changes in the focus and methods of production need to be accompanied by changes in management accounting systems.

8. Limitations Based on the above discussion, applying target costing and target pricing must be undertaken. If the supplier is dependent on the customer, then it may be possible to employ the technique. If the supplier can choose its customers, then the likelihood of success is limited .The US buyer-supplier relationship differs from that in Japan. In Japan, suppliers will more readily accept pressures from buyers because of the long-term nature of the relationship. A buyer’s loyalty to the supplier can be counted on in austere periods, as customers do not desert suppliers. The efforts to achieve constant improvement in price have to be rewarded. If there is a sharing of cost reduction, then it is in the seller’s interest to cooperate.

9. Conclusion Target costing and target pricing are used as a valuable tool to support an organization’s overall efforts to remain cost competitive. It is a process most effectively undertaken by cross functional teams, in conjunction with other value adding processes such as early supplier involvement, value analysis and value engineering. The reasons for use may be broadly classified as the need to increase competitiveness and the desire to increase communication and early supplier involvement in the new product or service development process. In addition, there are cost management reasons for implementing target costing, such as reducing costs, improving understanding of the supplier’s cost structures, improving internal cost management, improving cost monitoring, and increasing cost accountability. References: Bayou M. E. & Reinstein A.. (1998). Three routes for target costing. Managerial Finance, 24(1), 28-45. Brausch, J. M.. (1994). Target costing for profit enhancement. Management Accounting, 15(4), 44-49. Cooper, R. & Slagmulder, R.. (1999). Develop profitable new products with target costing. Sloan Management Review, 40(4), 23-33. Ellram, L. M.. (2000). Purchasing and supply management’s participation in the target costing process. Journal of Supply Chain Management, 36(2), 39-51. Ellram, L. M.. (2006). The implementation of target costing in the United States: Theory versus practice. Journal of Supply Chain Management, 42(1). Gagne, M. L. & Discenza, R.. (1993). New product costing, Japanese style. The CPA Journal, 12(9), 68-71. Gagne, M. L. & Discenza, R.. (1995). Target costing. Journal of Business & Industrial Marketing, 10(1), 16-22. Hibbets, A. R., Albright T. & Wilfried, F.. (2003). The competitive environment and strategy of target costing implementers:

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Role of supply chain management in target costing Evidence from the field. Journal of Managerial Issues, 15(1), 65-81. Howard, C. & Herbig, P.. (1996). Japanese pricing policy. Journal of Consumer Marketing, 13(4), 5-17. Jones, M. J., Munday, M. & Brinn, T.. (1998). Speculations on barriers to the transference of Japanese management accounting. Accounting, Auditing & Accountability Journal, 11(2), 204-215. LEE J. M., CHEN C. W., CHEN Injazz & CHUNG C. H.. (2002). A target costing based strategic decision support system. The Journal of Computer Information Systems, 43(1), 110-116. LEE Y. J.. (1994). Use target costing to improve your bottom-line. The CPA Journal, 64(1), 68-73. Lockamy, A. H. I. & Smith, W. I.. (2000). Target costing for supply chain management: Criteria and selection. Industrial Management & Data Systems, 100(5), 210-218, Newman, R. G. & Mckeller, J. M.. (1995). Target pricing–A challenge for purchasing. International Journal of Purchasing and Materials Management, 31(3), 13-20. Omar, O. E. (1997). Target pricing: A marketing management tool for pricing new cars. Pricing Strategy & Practice, 5(2), 61-69. Reinstein. A. & Bayou. M. E.. (1997). Product costing continuum for managerial decisions. Managerial Auditing Journal, 12(9), 490-497. Schmelze. G., Geier. R. & Buttross. E. T.. (1996). Target costing at ITT automotive. Management Accounting, 78(6), 26-30. Shank. J. K. & Fisher. J.. (1999). Case study: Target costing as a strategic tool. Sloan Management Review, 18(2), 73-82. Yasuhiro. M. & Lee. J. Y.. (1993). How a Japanese auto maker reduces costs: Kaizen costing drives continuous improvements at Daihatsu. Management Accounting (IMA), LXXV(2), 144-163.

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(continued from Page 45) References: Armstrong, M.. (1999). Personal management. Prague: Grada Publishing. Beazley, H., Boenisch, J. & Harden, D.. (2002). Continuity management: Preserving corporate knowledge and productivity when employees leave. Wiley. ISBN 978-0-471-21906-4. Beazley, H.. (2003, April). Knowledge continuity: The new competitive advantage. Retrieved June 12, 2009, from http://www. asaecenter.org/PublicationsResources/EUArticle.cfm?ItemNumber=11836. Koontz, H. & Weihrich, H.. (1993). Management. Prague: East Publishing. ISBN 80-7219-014-8. Mcknight, C. A.. (2002, November). The effects of audit firm structure and auditor locus of control on auditor acquisition, compensation, performance, and retention. USA , Doctoral Dissertations, ISBN 9780493701776. Mladkova, L.. (2004). Knowledge management in practice. Professional Publishing. ISBN 80-86419-51-7. Sangjae, L. & Kun Chang, L.. (2010, March). The relationship among formal EDI controls, knowledge of EDI controls, and EDI performance. Information Technology and Management, 11(1), 43. Ticha, I.. (2000). The competitiveness: A shift in perception, some measuring instruments and critical comments on them. In: Proceedings of the Scientific Conference: The Agrarian Perspectives VII/1, Faculty of Economics and Management, 324-327.

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