Target Costing

The president of Houston Electronics was pleased with the companys newest product, the HE Versatile CVD. The product is portable and can be attached to a computer to play or record computer 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 distribution 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 products 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 companys 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 manufacturing 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?