Target costing: starting with the price to determine the cost
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Schedule a meetingLearn about our pricing strategy consulting servicesTarget costing (or target-based pricing) starts with the selling price the market will accept, subtracts the target margin, and then derives the maximum allowable cost of the product. It reverses the logic of cost-based pricing: the price is no longer a consequence of the cost; rather, the cost becomes the constraint. In retail, the term “target-based pricing” is also used when a retailer sets targets (margin, price index, revenue) and allows prices to be calculated based on those targets.
The Essentials in 6 Questions
Target cost = target selling price − target margin.
Buyers, private-label product managers, management control, and pricing teams.
From the moment a product is designed or listed, before negotiations begin.
In markets where the price is dictated by competition or by a psychological threshold.
Ensure a profit margin without exceeding the price the customer is willing to pay.
Set the target price, subtract the margin, and negotiate or adjust until the acceptable cost is reached.
Target costing, target pricing, target-based pricing: What are the differences?
All three terms start with a target, but they do not refer to the same variable: cost, price, or a performance metric.
| Term | What is determined first | What we can conclude from this |
|---|---|---|
| Target pricing | The selling price the market will accept | The potential margin at the current cost |
| Target costing | The target price and the target margin | The maximum allowable cost |
| Target-based pricing | KPI targets: margin, price index, revenue | Prices for each item |
FranceTerme uses the official equivalent “target costing method” (MCC) for “target costing.”
The method originated in Japanese industry, particularly at Toyota, before spreading to the consumer goods and retail sectors. It is the opposite of cost-based pricing, which uses cost as the starting point for setting a price, and the natural complement to value-based pricing, which is used to estimate the price a customer is willing to pay.
How do you calculate a target cost?
Start with the target selling price (excluding tax), subtract the target margin: what remains is the purchase price or cost price that must not be exceeded.
| Formula | Usage |
|---|---|
| Target cost = target selling price (excluding tax) × (1 − target margin rate) | Margin expressed as a percentage of the selling price (markup). |
| Gap to be closed = current cost − target cost | Effort required through negotiation, reformulation, or logistics. |
The margin rate used here is a markup rate (margin as a percentage of the selling price): confusing it with a rate calculated based on cost skews the target cost by several percentage points. For the basics of the calculation, see our guide to calculating sales margins.
Real-world example: a private-label product sold for €2.49
To sell an item for €2.49 (including tax) on the shelf with a 30% margin, the purchase price must not exceed €1.65.
Target retail price excluding tax (€2.49 including tax; 5.5% VAT).
Eligible purchase cost with a 30% mark-up rate.
Difference to be made up if the manufacturer offers 1.78 €.
Fictitious figures, rounded to the nearest cent, to illustrate the method.
The retailer does not raise its price to absorb the 13 centimes; instead, it works with the manufacturer to adjust the specifications (weight, packaging, and logistics) until the target cost is reached. This is the day-to-day approach of private-label brands, whose prices are positioned primarily in relation to national brands (see “Private Labels and National Brands: Two Pricing Strategies”).
Target-Based Pricing Applied to a Retail Product Line
At the department level, the target is no longer a cost but a metric: the retailer sets the margin or target price index by category, and prices are derived from that.
- Traffic Categories (KVI):Price index target relative to the benchmark competitor, with a minimum margin.
- Core portfolio: margin rate target, within an acceptable index range.
- Margin categories (impulse, premium private label): higher margin target, less restrictive index.
This is what we call target-based pricing: a simulation engine generates pricing scenarios that meet the target while adhering to constraints (psychological thresholds, price chaining, product line consistency). Details of the method can be found in our article , “Target-Based Pricing: Pricing by Target in Retail.” Our pricing strategy consulting service helps set these targets by category role.
3 Mistakes to Avoid When Setting a Target Cost
Setting a target price without market data, confusing margin rates, or treating the target as a fixed number.
- An internally determined target price: without tracking competitors' prices or measuring price sensitivity, the target is based on intuition (seeprice elasticity).
- Confusing the markup rate with the gross margin rate: the target cost varies by several cents depending on the basis for calculation.
- Lock in the target: When market prices or material costs change, the target price and cost must be recalculated.
Frequently Asked Questions
Short answers to the most frequently asked questions about target costing and target pricing.
What is target costing?
Target costing is a management method that starts with the selling price accepted by the market, subtracts the desired margin, and derives the maximum allowable cost of a product. Cost becomes a constraint that must be met, rather than the starting point for pricing.
How is a target cost calculated?
Target cost = target selling price excluding tax × (1 − target markup rate). For example, a product sold for €2.36 excluding tax with a 30% markup rate has a target cost of €1.65.
What is the difference between target costing and target pricing?
Target pricing sets the target selling price based on the market. Target costing goes a step further: based on that price and the target margin, it sets the maximum allowable cost. The two are used together.
What is target-based pricing in retail?
This is the retail application of the same logic: the retailer sets targets by category (margin rate, price index, sales) and the prices for each SKU are calculated to meet those targets, subject to business constraints.
Is target costing a recent method?
No. It originated in Japanese industry, particularly at Toyota. What is more recent is its application to retail pricing on a large scale, made possible by pricing software that simulates thousands of scenarios.
Key Takeaways
- Target costing:target cost = target price − target margin.
- Price is determined by the market; cost becomes the constraint.
- In retail, target-based pricing sets margin or index targets by category.
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Target-based pricing starts with a target set by the market or by the company (selling price, margin rate, price index) and deduces the rest, instead of starting from the cost.
Its traditional form, target costing, is calculated as follows: target cost = target selling price (excluding tax) × (1 − target margin rate).
In retail, the method is applied at two levels: product listing (especially for private-label products) and department management, with margin or price index targets set by category role.
Goal-based pricing starts with the target outcome (margin, revenue, category competitiveness) and lets AI calculate the prices needed to achieve it, rather than piling on rules one product at a time.
The engine simulates thousands of scenarios by factoring in business constraints, purchasing behavior, and product cannibalization; if the objective is unattainable, it identifies the best compromise.
For retailers supported by Booper: a margin increase of 1 to 3 points in just a few months and a 70% to 90% reduction in pricing preparation time. The pricing manager retains the final decision.
Private labels and national brands have different cost structures and roles on the shelf. Private labels will account for 45.5% of volume in France in 2025 (35.6% by value, NielsenIQ), but national brands will regain momentum in 2026 (+1.9% in units vs. +1.8% for private labels). Managing both with the same margin thresholds distorts the profitability picture; the cross-elasticity between the two should be measured, not assumed.