Final answer:
Target costing is a business strategy where a company deducts its desired profit from a competitive market price to set the target cost for a product. This method ensures that the product can be sold for a price that meets the company's profit objectives.
Step-by-step explanation:
The concept of target costing is pivotal in a business setting, as it forms the foundation for pricing strategies that ensure a product's viability in competitive markets. Target costing is a pricing method used primarily by businesses to manage costs and secure profitability in the face of market constraints. It involves setting a target cost by subtracting a desired profit margin from a competitive market price, which will then guide the cost management process during the product development phase. In other words, it helps a company determine the maximum cost it can incur while still achieving a desired level of profit when selling a product at the competitive market price.
With target costing, the competitive market price sets the ceiling for what can be charged for a product. From this predetermined market price, a firm will deduct its desired profit margin to arrive at the target cost for producing the product. If the actual cost of production exceeds this target cost, the company must find ways to reduce costs through process improvements, cheaper materials, or other cost-saving measures. The ultimate aim is not just to earn a small profit or break even, but rather to meet the specific profit objective that the company has set.