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Contracts & Pricing

Target Costing

Target costing is a method that sets a maximum allowable cost for a product or service by working back from a competitive market price and required margin.

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Instead of pricing from cost upwards, target costing starts with the price the market will bear, subtracts the margin the business needs, and treats the remainder as the cost the product must be delivered within. Design, sourcing and suppliers then work together to engineer the item so it meets that target without sacrificing required quality or function.

In procurement, target costing shapes negotiation and supplier collaboration: buyers share the cost target and challenge suppliers to help reach it through material choices, design tweaks or process efficiencies. It pairs naturally with open-book pricing and should-cost analysis, giving objective grounds for discussing where cost can realistically be removed.

Key points

  • Works backwards from market price and required margin to a cost ceiling.
  • Drives design and sourcing to deliver within the allowable cost.
  • Pairs well with should-cost analysis and open-book pricing.

Frequently asked questions

What is target costing?
Target costing sets a maximum allowable cost by starting from a competitive market price, subtracting the required margin, and requiring the product or service to be delivered within what remains.
How is target costing different from cost-plus pricing?
Cost-plus adds a margin on top of whatever the cost turns out to be, while target costing fixes the allowable cost first and drives design and sourcing to meet it.

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