1. Measuring Life-Cycle Costs
Chapter 8
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2. Total-Life-Cycle Costing
Total-life-cycle costing (TLCC) is the name of the process of managing all costs along the value chain
TLCC is also known as managing costs “from the cradle to the grave”
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3. Total-Life-Cycle Costing
A TLCC system provides information for managers to understand and manage costs through a product’s stages
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4. Total-Life-Cycle Costing
Deciding how to allocate resources over the life cycle usually is an iterative process
Opportunity costs play a heightened role in a total-life-cycle cost perspective
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5. Total-Life-Cycle Costing
Numerous life-cycle concepts have emerged in various functional areas of business
A TLCC perspective integrates the concepts so that they can be understood in their entirety
From the manufacturer’s perspective, total-life-cycle product costing integrates functional life-cycle concepts
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6. Research, Development, and Engineering (RD&E) Stage
The RD&E Stage has three stages:
Market research
Product design
Product development
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7. Cost Control in the RD&E Stage
By some estimates, 80% to 85% of a product’s total life costs are committed by decisions made in the RD&E Stage
Decisions made in this stage are critical:
An additional dollar spent on activities that occur during this stage can save at least $8 to $10 on manufacturing and post-manufacturing activities:
Design changes
Service costs
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Manufacturing Stage
After the RD&E stage, the company begins the manufacturing stage
Usually, at this stage there is not as much room for engineering flexibility to influence product costs and product design because they have been set in the previous stage
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9. Cost Control in the Manufacturing Stage
Operations management methods help to reduce manufacturing life-cycle product costs
Companies have begun to use management accounting methods such as activity-based cost management to identify and reduce non-value-added activities in an effort to reduce costs in the manufacturing stage
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10. Post-Sale Service and Disposal Stage
The service stage begins once the first unit of a product is in the hands of the customer
Disposal occurs at the end of a product’s life and lasts until the customer retires the final unit of a product
The costs for service and disposal are committed in the RD&E stage
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The Service Stage
The service stage typically consists of three stages:
Rapid growth
From the first time the product is shipped to the growth stage of its sales
Transition
From the peak of sales to the peak in the service stage
Maturity
From the peak in the service stage to the time the last shipment is made to a customer
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The Disposal Stage
Disposal occurs at the end of a product’s life and lasts until the customer retires the final unit of a product
Disposal costs often include those associated with eliminating any harmful effects associated with the end of a product’s useful life
Products whose disposal could involve harmful effects to the environment, such as nuclear waste or toxic chemicals, often incur very high costs
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Life-Cycle Costs
The following table illustrates four types of products and the percentage of life-cycle costs incurred in each cycle
Combat
Jets
Commercial
Aircraft
Nuclear
Missiles
Computer
Software
RD&E
Manufacturing
Service and Disposal
Average Years in Life Cycle
21%
45%
34% 30
20%
40% 25
60%
2 to 25
75%* *
25% 5
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Target Costing
A method of profit planning and cost management that focuses on products with discrete manufacturing processes
Its goal is to design costs out of products in the RD&E stage of a product’s total life cycle
It is a relevant example of:
How well-designed MACS can be used for strategic purposes
How critical it is for organizations to have a system in place that considers performance measurement across the entire value chain
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15. The Traditional Method
Begins with market research into customer requirements followed by product specification
Companies engage in product design and engineering and obtain prices from suppliers
After the engineers and designers have determined product design, cost is estimated
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Target Costing Method
Although the initial steps appear similar to traditional costing, there are some notable differences:
Marketing research is customer-driven
Costs are managed using concurrent design and engineering
The total-life-cycle concept is used by making it a key goal to minimize the cost of ownership of a product over its useful life
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17. The Target Costing Method
Price-lead costing—used to determine a target selling price and target product volume based on the company’s perceived value of the product to the customer
The target profit margin results from a long-run profit analysis, often based on return on sales
The target cost is the difference between the target selling price and the target profit margin
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18. The Target Costing Method
Once the target cost has been set, the company must determine target costs for each component
The value engineering process includes examination of each component of a product to determine whether it is possible to reduce costs while maintaining functionality and performance
Several iterations usually are needed before it is possible to determine the final target cost
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19. The Target Costing Method
Two other differences characterize the process:
Cross-functional product teams are made up of individuals representing the entire value chain guide the process throughout
Suppliers play a critical role in making target costing work
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Cost Analysis
Cost analysis requires five sub-activities:
1. Develop a list of product components and functions
2. Do a functional cost breakdown
3. Determine a relative ranking of customer requirements
4. Relate features to functions
5. Develop relative functional rankings
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21. Conduct Value Engineering
Value engineering—organized effort directed at the various components for the purpose of achieving these functions at the lowest overall cost without reductions in required performance, reliability, maintainability, quality, safety, recyclability, and usability
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22. Conduct Value Engineering
Two sub-activities:
Identify components for cost reduction by computing a value index (ratio of the value to the customer and the percentage of total cost devoted to each component)
Generate cost reduction ideas
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Target Costing
Some studies of target costing in Japan indicate that there are potential problems in implementing the system
Companies may manage many of these factors
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24. Problems with Target Costing
Lack of understanding of the target costing concept
Poor implementation of the teamwork concept
Employee burnout
Overly-long development time
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Break-Even Time (BET)
BET measures the length of time from the project’s beginning until the product has been introduced and generates enough profit to pay back the investment originally made in its development
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Break-Even Time (BET)
BET brings together in a single measurement three critical elements in an effective and efficient product development process:
BET requires tracking the entire cost of the product so that the company can recover its total investment
BET stresses profitability and encourages cross functional teamwork to meet the customer needs
BET is denominated in time and encourages the launch of new products faster than competition so that higher sales can be earned sooner to repay the product development investment
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27. Environmental Costing
Environmental remediation, compliance, and management have become critical aspects of many businesses
All parts of the value chain, and their costs, are affected by environmental issues
These issues are being incorporated into cost management systems and overall MACS design
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28. Controlling Environmental Costs
Only when managers and employees become aware of how the activities in which they engage create environmental costs will they be able to control and reduce them
The activities that cause environmental costs have to be identified
The costs associated with the activities have to be determined
These costs must be assigned to the most appropriate products, distribution channels, and customers
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29. Types of Environmental Costs
Environmental costs fall into two categories:
Explicit costs
Implicit costs
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