Toyota Motor Corporation uses target costing. Assume that Toyota marketing personnel estimate that the competitive selling price

Toyota Motor Corporation uses target costing. Assume that Toyota marketing personnel estimate that the competitive selling price for the Camry in the upcoming model year will need to be $28,000. Assume further that the Camry’s total unit cost for the upcoming model year is estimated to be $23,200 and that Toyota requires a 20% profit margin on selling price (which is equivalent to a 25% markup on total cost).

a. What price will Toyota establish for the Camry for the upcoming model year?

b.  What impact will target costing have on Toyota, given the assumed information?

Answer:

a. The price will be set at the estimated market price required to remain competitive, or $28,000. Under the target cost concept, the market dictates the price, not the markup on cost. 

b. The required profit margin of 20% of the estimated $28,000 price implies a $22,400 target product cost as follows: 

Target Product Cost = $28,000 – ($28,000 × 20%) 

Target Product Cost = $28,000 – $5,600 

Target Product Cost = $22,400 

Since the estimated manufacturing cost of $23,200 exceeds the target cost of $22,400, Toyota must reduce $800 from its total costs in order to maintain competitive pricing within its profit objectives. 

The method assumes that the company may not be able to successfully add a markup to its costs because the resulting price may be too high in the marketplace. For example, merely adding the 25% markup on the $23,200 product cost would result in an uncompetitive price of $29,000. The target cost concept moves backward by taking the price as given and then determining the cost that is required for a given profit objective.