Target Cost Gap for a Smart Meter
Surya Electronics is developing a smart meter for a market where the selling price is expected to be ₹4,800 per unit. The company requires a margin of 22% on selling price. At a planned volume of 50,000 units, the current estimated cost is ₹4,050 per unit: direct materials ₹2,100, direct labour ₹650, variable overhead ₹300, fixed overhead ₹500 and warranty/installation ₹500. The value-engineering team proposes three changes: replace the metal casing with a polymer casing, saving ₹280 per unit but increasing expected warranty claims by ₹90 per unit; reduce installation steps, saving ₹120 per unit; and renegotiate a component contract, saving ₹150 per unit but requiring a one-time tooling payment of ₹18,00,000. The sales team warns that the price may fall to ₹4,500 if competitors launch early. The company uses target costing and life-cycle costing, and the finance manager insists that one-off tooling be reflected in the unit cost used for the target-cost decision.
1. Compute the target cost per unit at selling prices of ₹4,800 and ₹4,500, and the current cost gap at each price.
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Target cost = selling price × (1 − required margin percentage). Required margin is 22% of selling price, so the target cost ratio is 78%.
At ₹4,800: target cost = ₹4,800 × 0.78 = ₹3,744. Current cost = ₹4,050. Cost gap = ₹4,050 − ₹3,744 = ₹306 per unit.
At ₹4,500: target cost = ₹4,500 × 0.78 = ₹3,510. Cost gap = ₹4,050 − ₹3,510 = ₹540 per unit.
Thus the current design misses the target by ₹306 at the expected price and by ₹540 if the price falls. The company needs cost reduction, value engineering or a product redesign before launch.
2. Evaluate the three proposed changes and compute the revised unit cost and the cost gap or surplus at both selling prices. Treat the tooling payment over the planned 50,000 units.
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Casing change: saving ₹280 − extra warranty ₹90 = net saving ₹190 per unit. Installation change: saving ₹120. Component change: saving ₹150 − tooling per unit (₹18,00,000 ÷ 50,000 = ₹36) = net saving ₹114. Total net saving = ₹190 + ₹120 + ₹114 = ₹424 per unit. Revised cost = ₹4,050 − ₹424 = ₹3,626.
At ₹4,800, target cost is ₹3,744, so revised cost gives a surplus of ₹3,744 − ₹3,626 = ₹118 per unit. At ₹4,500, target cost is ₹3,510, so there is still a gap of ₹3,626 − ₹3,510 = ₹116 per unit.
Conclusion: the proposals close the gap at ₹4,800 but not at ₹4,500. Further value engineering or a price premium is needed if the lower price is likely. The casing change must be validated for quality and warranty risk, not accepted on cost alone.
3. The purchasing team proposes treating the ₹18,00,000 tooling payment as a period cost so that unit cost appears lower. Advise. Also state how an additional end-of-life recycling cost of ₹60 per unit would affect the decision.
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Treating the tooling payment as a period cost would make the revised unit cost appear as ₹4,050 − (₹190 + ₹120 + ₹150) = ₹3,590, which is ₹36 lower than the ₹3,626 that includes tooling. That is not appropriate for a target-cost decision: the tooling is caused by the component change and is part of the product’s life-cycle cost. It should be spread over the planned 50,000 units unless it has a reliable residual value or alternative use. Excluding it overstates the saving and may lead to accepting a design that does not meet the target.
An additional recycling cost of ₹60 per unit would reduce the component saving further: ₹150 − ₹36 tooling − ₹60 recycling = ₹54 net. Total saving would be ₹190 + ₹120 + ₹54 = ₹364, giving a revised cost of ₹3,686. At ₹4,800 the surplus falls to ₹58; at ₹4,500 the gap rises to ₹176. The recycling cost should be included because life-cycle costing considers post-purchase and end-of-life costs, not only factory cost.