Target Costing The president of Houston Electronics was pleased with the company
ID: 2557634 • Letter: T
Question
Target Costing The president of Houston Electronics was pleased with the company's newest product, the HE Versatile CVD. The product is portable and can be attached to a computer to play or record comput- er programs or sound, attached to an amplifier to play or record music, or attached to a television to play or record TV programs. It can even be attached to a camcorder to record videos directly on compact disks rather than on tape. It also can be used with a headset to play or record sound. The proud president announced that this unique and innovative product would be an important factor in reestablishing the North American consumer electronics industry Based on development costs and predictions of sales volume, manufacturing costs, and distri bution costs, the cost-based price of the HE Versatile CVD was determined to be $425. Following a market-skimming strategy, management set the initial selling price at $525. The marketing plan was to reduce the selling price by $50 during each of the first two years of the product's life to obtain the highest contribution possible from each market segment. The initial sales of the HE Versatile CVD were strong, and Houston Electronics found itself adding second and third production shifts. Although these shifts were expensive, at a selling price of $525, the product had ample contribution margin to remain highly profitable. The president was talking with the company's major investors about the desirability of obtaining financing for a major plant expansion when the bad news arrived. A foreign company had announced that it would shortly introduce a similar product that would incorporate new design features and sell for only $350. The president was shocked. "Why," she remarked, "it costs us $375 to put a complete unit in the hands of customers. REQUIRED How could the foreign competitor profitably sell a similar product for less than the manufactur- ing costs to Houston Electronics? What advice do you have for the president concerning the HE Versatile CVD? What advice would you have to help the company avoid similar problems in the future?Explanation / Answer
ANSWER:
The foreign competitor might have designed the product and process of production for meeting a target cost based on a target selling price minus a desired profit. The proactive cost management of the competitor during such preproduction stages lead to reduction in nonvalue-added activities and in selection of low-cost materials and design and manufacturing alternatives.
The best advice for the president concerning the HE Versatile CVD is to check if the process reengineering and partnerships with distributors and vendors can permit Houston Electronics to continue the production of the product and profitably market it at a significantly reduced price. It must immediately start work on the Enhanced HE Versatile CVD, or certain other same product, to regain the lead in technology. Moreover should follow a different strategy for the development and marketing the next generation of products.
Houston Electronics management must price it's products in way to achieve significant market penetration, instead of following a market skimming strategy. Afterwards it should determine a target cost for the product and design the product and procedure of manufacturing in an approach that products can be produced at lesser cost than the target cost. Moreover can form partnerships with suppliers and vendors to gain ideas of others and thus encourage all entities along the value chain of product to recognize that they are in business together.
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