Target costing and life-cycle costing answer two different but connected questions:
Target costing: what is the maximum cost the market will allow if the organisation is to earn its required profit?
Life-cycle costing: will the product or service earn an acceptable return after all costs from initial idea to final withdrawal are included?
Together they move cost management away from “make it, calculate the cost, add a profit and hope it sells.” They begin with customers and the market, then manage cost across the whole life of the offering.
Current PM scope: the September 2026 to June 2027 syllabus requires target-cost derivation in manufacturing and services, difficulties in services, ways to close a target-cost gap, life-cycle costs and profits, and the benefits of life-cycle costing.
1. Cost-plus pricing versus target costing
A traditional cost-plus approach works forward:
Estimated cost + profit mark-up = proposed selling price
The weakness is that customers may not accept the resulting price. Competitors may offer a better combination of price, quality and features, or the proposed product may contain expensive features customers do not value.
Target costing works backwards:
Target cost = competitive selling price − required profit
The organisation then compares the target cost with the estimated cost of the current design:
Target-cost gap = estimated current cost − target cost
A positive gap means the current design is too expensive to earn the required profit at the market price.
2. Be precise about margin and mark-up
Many target-cost errors are percentage errors.
A profit margin is profit as a percentage of selling price.
A profit mark-up is profit as a percentage of cost.
If the selling price is $240 and the required profit margin is 25%:
Profit = $240 × 25% = $60; therefore target cost = $180.
If the selling price is $240 and the required mark-up is 25% on cost:
Cost is 100% and selling price is 125%; therefore target cost = $240 × 100/125 = $192.
Common trap: never apply a mark-up percentage directly to selling price. Write the percentage relationship—cost 100%, profit 25%, price 125%—before calculating.
3. The target-costing process
Understand the market. Identify customer segments, valued features, competitor offerings and an achievable selling price.
Set the required profit. This may be a margin, a mark-up, a return on investment or another strategic profit requirement.
Derive the target cost. Deduct required profit from market price.
Estimate the current design cost. Include the resources expected to be consumed by the proposed design and process.
Calculate the cost gap. Compare current cost with target cost.
Redesign before costs are locked in. Use cross-functional teams, value engineering, supplier involvement and process improvement.
Review continuously. Confirm that cost reduction has not damaged customer value, safety, quality or long-run performance.
4. Closing a target-cost gap
The objective is not simply “cut every cost.” The organisation should remove cost that does not support the value customers are willing to pay for.
Approach | Possible action | Risk to watch |
|---|---|---|
Value engineering | Change the design, materials, components or production method while preserving the required function. | A cheaper design may damage quality, reliability or customer perception. |
Functional analysis | Ask what each feature does and whether customers value it. | Removing “non-essential” features without proper research can reduce demand. |
Standardisation | Use common parts, fewer variants and simpler specifications. | Too much standardisation can weaken differentiation. |
Supplier involvement | Negotiate prices, redesign components jointly or change sourcing arrangements. | Lowest purchase price may increase defects, lead times or supply risk. |
Process redesign | Reduce set-ups, waste, movement, inspection, rework or cycle time. | One-off implementation costs and disruption must be considered. |
Scale and learning | Use realistic volume discounts and learning effects. | Do not assume demand or efficiency improvements without evidence. |
Profit review | Accept a lower required return if strategically justified. | This closes the accounting gap without reducing cost; the lower return must be deliberate. |
Use value, not indiscriminate cost cutting
Use value is the product’s ability to perform its purpose. Esteem value is the status, appearance or experience customers obtain from ownership or use. A perfume bottle may add little to the liquid’s technical function but contribute greatly to esteem value. Removing it may reduce demand more than it reduces cost.
5. Target costing in service organisations
The same basic formula can be used for a service, but estimating a stable cost per service unit can be more difficult. ACCA’s recent PM examiner guidance highlights four service characteristics:
Intangibility: the service is an experience rather than a physical object, so its precise components can be hard to define.
Simultaneity: production and consumption often occur together, leaving less opportunity to inspect and redesign a finished output before delivery.
Heterogeneity: customer needs and employee interactions vary, so the service and its resource use may not be uniform.
Perishability: unused capacity cannot be stored for later sale, making demand, capacity and unit-cost estimates less predictable.
Target costing can still help where the service can be specified and repeated—such as a standard subscription, diagnostic package or transaction-processing service. The answer should explain the particular difficulty in the scenario rather than claim target costing is impossible for every service.
6. What life-cycle costing adds
A current-period product cost can omit costs that are essential to the product’s overall success. Life-cycle costing accumulates costs and revenues over the entire commercial life of the product or service.
Life-cycle stage | Examples of cost |
|---|---|
Research, concept and design | Market research, development, prototyping, testing, product design and tooling. |
Launch | Promotion, training, distribution setup and initial production preparation. |
Production and delivery | Materials, labour, energy, overhead, quality control, logistics and support. |
Use and after-sales | Warranty, repairs, customer support, upgrades and operating commitments. |
Withdrawal and end of life | Decommissioning, disposal, environmental restoration, recycling and contract closure. |
Life-cycle cost per unit = total costs across the life cycle ÷ total life-cycle units
Life-cycle profit = total life-cycle revenue − total life-cycle costs
7. Committed costs versus incurred costs
A cost is committed when a decision has made the future expenditure difficult to avoid. It is incurred when the resource is actually used and the cost is recorded.
Interactive cost-commitment lab
Change the five cumulative percentages. The design-stage gap is recalculated in the title. Predict how an earlier design decision changes management’s remaining freedom before moving an input.
Three quick experiments: delay cost commitment until launch, accelerate spending into design, then make the two lines almost coincide. Which situation leaves most scope for effective cost reduction?
The greatest opportunity to control cost is often early. Once a design specifies ten components, a particular material and a complex assembly process, future purchase, production, warranty and disposal costs are largely committed. Negotiating a small component discount later may save less than designing the product to use eight components in the first place.
8. Worked example combining both techniques
A company plans a new product. Market research indicates lifetime sales of 10,000 units at $21 each. The required profit is a 40% mark-up on cost. Expected life-cycle costs are:
design and development: $50,000;
manufacturing: $10 per unit; and
end-of-life costs: $20,000.
Management could spend an additional $15,000 on design to reduce manufacturing cost.
Step 1: calculate the target cost
With a 40% mark-up, cost is 100%, profit is 40% and selling price is 140%:
Target cost per unit = $21 × 100/140 = $15
Target total life-cycle cost = 10,000 × $15 = $150,000.
Step 2: calculate the current life-cycle cost
Total cost = $50,000 + (10,000 × $10) + $20,000 = $170,000
Life-cycle cost per unit = $170,000 ÷ 10,000 = $17
The current design has a target-cost gap of $17 − $15 = $2 per unit, or $20,000 over the life cycle. It would still report an overall profit at the proposed price, but it would not achieve the required 40% mark-up. That is more precise than simply declaring that the product is “not worth making.”
Step 3: assess the additional design proposal
If the extra $15,000 is spent, non-manufacturing life-cycle cost becomes:
($50,000 + $15,000 + $20,000) ÷ 10,000 = $8.50 per unit
To keep total life-cycle cost within the $15 target:
Maximum manufacturing cost = $15 − $8.50 = $6.50 per unit
The extra design expenditure is worthwhile for target-cost purposes only if it can reduce manufacturing cost from $10 to $6.50 or below without unacceptable effects on customer value, risk or quality.
9. Benefits of life-cycle costing
It prevents early and late costs from disappearing behind period-based manufacturing reports.
It supports realistic pricing and product-profitability decisions.
It encourages management to control cost when it is committed, especially during design.
It reveals trade-offs: higher design or training cost may reduce production, warranty or disposal cost.
It improves accountability for environmental and end-of-life obligations.
It can be applied to services, contracts and projects as well as physical products.
10. CBE method and exam traps
Identify whether the profit percentage is a margin, mark-up or return measure.
Calculate target profit and target cost separately.
Calculate the current estimated cost on the same basis.
State the cost gap and its direction.
Suggest specific ways to close it without destroying customer value.
For life-cycle costing, include pre-production, operating, after-sales and end-of-life costs.
Explain the result: does the product earn the required return, and when can the cost be controlled?
Common mistakes: confusing margin with mark-up, excluding development or disposal cost, assuming every cost cut is desirable, calling an estimated current cost the “target cost,” and describing service difficulties without applying them to the scenario.
11. Continue studying PM
In a nutshell: target costing sets the cost ceiling from the market; life-cycle costing makes sure every relevant stage is inside that ceiling.