From early on, the Japanese recognized that the most efficient way to keep costs down was to design them out of their products, not to reduce them after the products entered production. This realization reflects a fundamental reality of cost management in Japan; the majority of a product’s costs (as much as 90 to 95%) are “designed in.” Consequently, effective cost control programs in a Japanese business typically focus heavily on the design process (rather than on the production process) for a particular product. This is done primarily using a concept known as target costing, as well as value engineering (VE). Target costing is used to determine what the market is willing to pay for a product. Using the target market price (i.e., the price required to win the customer’s business), the manager then subtracts the target profit to arrive at the target cost. After the target cost is determined, VE then is used to design the product in order to achieve the targeted level of costs. Thus, target costing manages costs by effectively designing into the products and processes the required costs in order to achieve the desired profit.
What do you think is the effect of target costing and VE on the use of variances? Specifically, will materials usage variances and labor efficiency variances be more or less important to a firm that strictly uses target costing and VE versus a traditional firm that is more focused on controlling daily production processes?