Examples of Target Costing | Cost Accounting

The following points highlight the two main examples of target costing. The examples are: 1. Tata Rs 0.1-Million Car 2. Tata Rs 0.1-Million Car- Potential Competition.

Example # 1. Tata Rs 0.1-Million Car:

On 11 March 2003 Business Standard reported the following:

Ratan Tata, chairman of India’s second-largest and longest-established conglomerate, said, he is pressing ahead with a project to bring to market a $2,000 car (Rs 1 lakh), which he believes could revolutionize personal transport in India and some other Asian countries.

He conceived the idea several years ago- to use components from the region’s large scooter and motorcycle industries to create a basic four-seater, four-door car to which the region’s millions of scooter and motorcycle riders, plus 3-wheeler users could aspire. (Emphasis added)

‘It is my dream to make the car a reality within the five years I remain as Tata chairman,’ said Tata. The project has become more ambitious as it has entered trial engineering phases—most notably with the cutting of the target retail price by one-third from the originally envis­aged $3,000. Total material costs for the vehicle are claimed to have already been pared down towards the $1,200 mark. (Emphasis added)

The vehicle might not be acceptable to Western consumers but ‘it would not need to be a poor substitute for a car,’ he said. ‘It will look like a car and have proper seating-stretched, canvas seats would not, e.g., be acceptable. It would be all right for it to be a bit noisier than an ordinary car, but it has to be both simple and safe. (Emphasis added)

Despite the projected price being less than half that of the cheapest car on the Indian market, a basic Suzuki model, Tata said it was not unrealistic and would not need to be subsidised. The vehicles would be produced primarily in kit form for assembly at several places around India, to create local employment.

They have a potential market in other Asian countries such as Vietnam, Malaysia and Indonesia, said Tata, in addition to bridging the gap for 2 million to 3 million Indians between powered two-wheelers and cars. (Emphasis added)

The engine capacity of the car will be 667 cc of power, which is not much more than the 500 cc powering Royal Enfield’s Machismo motor cycle. The car will be petrol driven. Diesel version may follow within six months of the launch of the petrol driven car. The seating capacity will be four (including the driver). It will comply with the emission and safety standards of the country in which it will be introduced, including India. The company (Tata Motors) expects to sell 0.25 million cars per annum and target sale of one million cars.

On 15 February 2006 DWS Review (dot) com reported the following:

However, the company has pointed out that it is not looking to strip down a traditional car, but rather, ‘start with a clean sheet of paper for designing and conceptualizing this vehicle. It will not be a stripped down version of a car, but there will also be nothing too fanciful about it.’ (Emphasis added) In addition, the car would be made such that upgrades would be possible, indicating that add-ons after the car has been sold would be possible.

According to sources, the project (code named Project X3) is aiming to become finan­cially viable by reducing inventory costs to zero or close to zero. The company is aiming to centralize the high-volume parts production, and decentralize the final assembly. Ratan Tata said, in an interview to McKinsey Quarterly, ‘We’re looking at small satellite units, with very low break-even points, where some of the cars could be assembled, sold, and serviced.'(Emphasis added)

Chances of the Tata’s cheap car for the masses will depend significantly upon how well it is marketed. Despite its low cost, a completely no-frills and staid car is unlikely to appeal to the status-sensitive Indian consumer. An affordable car that meets safety standards but also looks stylishly adorable is probably Tata’s best bet at cornering the market with its ‘people’s car’. (Emphasis added)

In December 2007, a report says ‘Market analysts are expecting that upcoming car might become a huge challenger to auto-rickshaw manufacturers as it would become a cheaper alternative to taxi drivers’.

On 19 December 2007, Economic Times reported:

Talking on the potential of economics of this car, the top-notch scientist (R A Mashelkar, who is an independent director on the board of Tata Motors) said- ‘It will create a paradigm shift in low-cost transport and the whole world is looking forward to a car that efficiently runs 25 km on a litre of petrol and offers international specifications. These kinds of fuel- efficient cars will be in demand as pollution is on the rise, climates are changing and fossil fuels are running out. People are looking at a new global eco-car and I have a feeling that this can be the new eco-car not only in the country but elsewhere—in other countries. I feel a sense of pride that it will be manufactured in India.’

Mr Mashelkar said- ‘The way their engineers have been able to design it and style it to meet specifications—it is abso­lutely incredible.

The story of the Tata Rs 0.1 -million car is quite fascinating. It is a very good example of target costing approach. The idea was conceived much before the year 2003. The company had a clear idea about the market segment of this product and also of the functionality and quality that will be successful in that market segment.

Keeping in view the market pricing dynamics, the target price was established, and the development and design team was given the mandate to design the car in a manner that it can be produced at the target cost. It is not that innovation was required only in product design, but well thought out manufacturing strategy was also formulated and target costs are given to component sup­pliers to keep the cost low.

In response to a question, Mr Ravi Kant, MD, Tata Motors said:

I think costs have been kept under control on account of three factors. First, the design of the car itself. Second, the kind of materials you use while ensuring the car is safe. Third, the various incentives and tax breaks that we are availing of like any other manufacturer. I must also point out that early vendor involvement in the designing of the car helped us to bring the cost down.

Without the collaboration efforts of our partners, suppliers and vendors, this would not have been possible. So many people have come forward, including many well-known multinationals, who have taken up this challenge of creating solutions for this car. They would guide us on ways to cut costs while at the same time improving quality and performance.

In order to cut cost, the company plans to adopt the distributed manufacturing sys­tem. Under this, a completely knocked down kit of the car will be built at three Tata- owned plants. The kit will then be ferried to warehouses across the country, where they will be assembled by dealers.

The idea is that the dealer will have a warehousing terminal to house the semi-knocked down kits, an assembly plant, and a sales office where a few vehicles will be displayed. As soon as customer will place a firm order, the dealer will with­draw the kit from the warehouse, assemble it at his plant and deliver it to the customer.

This is an innovation in the supply chain and distribution. The idea is similar to assembling home furnishing at home with little help from the manufacturer. The system will be viable because the company expects that each dealer will handle large volume.

The Tata Rs 0.1-million car story clearly brings out an important advantage of target costing—it leads to innovation.

Example # 2. Tata Rs 0.1-Million Car- Potential Competition:

E.g., Financial Express on 26 March 26 2007 reported the following:

Fearing erosion in two-wheeler sales, once Ratan Tata’s dream Rs 1 -lakh car is launched, the country’s second largest two-wheeler manufacturer Baja Auto is seriously considering entering the passenger car market. Hero Honda, the country’s top bike maker has already said it would foray into the four-wheeler market.

‘The JD power study says that it (Tata’s one lakh car) will affect the two-wheeler market. If that happens, then we would also manufacture cars for the market,’ Bajaj Auto chairman Rahul Bajaj said on the sidelines of the eighth annual convocation ceremony of Indian Institute of Management (IIM), Indore. Bajaj Auto, which was earlier essentially a scooter manufacturer, shifted gears and got into the motorcycle segment when the market preference moved to the latter from scooters.

Bajaj had earlier said it would launch a goods-carrier version of a light commercial vehicle in the first half of 2009. It is also expected to a launch passenger carrier version a little later. The proposed vehicle will be fitted with a 500—600 cc engine and will be available in diesel, petrol, and compressed natural gas (CNG) versions.

International consultancy firm JD Power had said early this week that the Tatas’ people’s car would severely affect the top-end motorcycle segment in which Bajaj is the market leader with Pulsar. Tata Motor’s proposed car is likely to be launched in the third quarter of 2008.

The country’s largest car manufacturer Maruti Udyog Ltd’s (MUL) True Value initiative has already dented the domestic high-end motorcycle market. Under True Value, Maruti dealers sell used car certified by the company at a considerably lower price compared with a new one. Maruti sells around 75,000 used cars a year under this initiative.

Kolkata-based Global Automobiles, which recently entered the two-wheeler market, has also tied up with China’s Guangzhou Motors, to roll out a low-cost (sub Rs 1 lakh) car.

Tata Motors will be required to recover the cost from the first model and its variations.

Mr Ravi Kant, MD, Tata Motors, in his interview with the Business World said:

Now that people see that the car is a possibility, the thought is going to cross somebody’s mind—if he can do it, why can’t I? I will not like to say anything about different competi­tors, apart from the fact that we are quite conscious that people will come and, therefore, we will have a window of opportunity for a few years. Hopefully, we have the first mover advantage.