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Toyota Motor Corporation: Target Costing System
Estimating Difference Costs
Rather than adding together all of the costs for a new model, Toyota added the differences in cost between new and current models. These differences were determined at the major function level. Thus, cost planning could begin even before blueprints for the first test model were drawn. Also, estimating the total difference instead of the total cost tended to be more accurate because the typical new model was heavily based upon existing designs. (Trying to estimate the cost of a new vehicle from scratch would, in management’s opinion, introduce more errors than using existing data and modifying it accordingly.) And it helped the related divisions understand cost fluctuations. The approach was more helpful to the design divisions because it highlighted the areas of the new model that were different from existing designs. New designs required most of the work in the design divisions. Thus, the estimated cost of a new model was the cost of the current model plus the cost of any design change. Thus, for every increment in the functionality of a new model there was an estimated incremental price and cost. This approach allowed the firm to measure the incremental profitability of each new function it built into a new model. A full model change required many design modifications. Consequently, the cost of the design change was broken out into the costs of a number of different design modifications. The design team analyzed each modification and assigned it an estimated cost. The sum of these cost estimates had to equal the cost planning goals for the new model. Estimating differences helped clarify the cost-planning goal and showed accurately how much was accomplished through cost planning. Cost planning focused on new model design. Its effectiveness was measured as the amount of cost reduction achieved through design. Therefore, other factors that affected cost, including wages and fluctuations in indirect costs incurred by related divisions, had to be eliminated from overall cost reduction in order to identify the portion due to cost planning. By fixing the cost of the current model and calculating the differences between the current and new models, Toyota's system dealt only with cost changes resulting from changes in design and production volume. Without actual drawings for the new model, the estimate often began with just an idea. Since rough sketches provided by the design division were often the only sources of information, estimates were made under the guidance of the cost planning division rather than the accounting division. Toyota’s 20 design divisions designed each major function of the new vehicle, including the engine, transmission, air conditioner, and audio system Because the people at the design and cost planning divisions had the latest in-house basic research, they were best qualified to estimate the costs from the sketches. Applying the results of basic research to product design was helpful both for improving product performance and for attaining the cost-planning goal. Cost planning tested the company's design capabilities. If the new model had the same functionality as existing models, then the initial cost estimates were assumed to be unchanged. A full model change inevitably required a large investment in equipment. The amount invested in terms of depreciation affected the cost of the new model. Depreciation charges for a new model were based upon the capital equipment dedicated to the new model and the expected production volume. If the new model required a considerable amount of new equipment, then the capital associated with the new model, as well as the depreciation charge, would be higher than if existing equipment was used. For this reason, an outline of equipment investment was often provided at the product-planning stage, but the budget for equipment investment was not officially set until after the product plan was approved. Equipment Investment and Depreciation
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