Measuring and Managing
Life-Cycle Costs
Chapter 8
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Total-Life-Cycle Costing
Total-life-cycle costing (TLCC) is the approach
companies use to understand and manage all costs
incurred in:
Research, development and engineering cycle
Manufacturing cycle
Post-sale service and disposal cycle
Also known as managing costs from the cradle to
the grave
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Total-Life-Cycle Costing
Each part of a companys value chain is typically
managed by a different organizational function
Companies need a total-life-cycle perspective that
integrates the tradeoffs and performance over time
and across functional units
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Research, Development, and
Engineering (RD&E) Stage
The RD&E Stage has three substages:
Market research
Product design
Product development
By some estimates, 80% to 85% of a products
total life costs are committed by decisions made in
the RD&E stage of a products life
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Manufacturing Stage
This stage offers little opportunity for engineering
decisions to reduce costs since most costs have
already been determined during the RD&E stage
Methods to help improve product costs include:
Product and process costing
Facilities layout
Kaizen
Benchmarking
Just-in-time manufacturing
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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 products 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
substages:
Rapid growth
From the first time the product is shipped through 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 products 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 products 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
RD&E
Manufacturing
Service and Disposal
Average Years in Life
Cycle
Combat
Jets
Commercial
Aircraft
Nuclear
Missiles
Computer
Software
21%
45%
34%
20%
40%
40%
20%
60%
20%
75%*
*
25%
30
25
2 to 25
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Target Costing
An approach that considers manufacturing costs
early in the design decisions
Helps engineers design new products that meet
customers expectations and that can be
manufactured at a desired cost
An important management accounting method for
cost reduction during the design stage that helps
manage total-life-cycle costs
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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
Project engineers attempt to design costs out of the
product before design and development end and
manufacturing begins
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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Target Costing Method
Engineers set an allowable cost that enables the
targeted product profit margin to be achieved at a
price customers are willing to pay
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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Target Costing Method
Once the total 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 of value engineering are usually
needed before the final target cost is achieved
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Target Costing Method
Two other differences characterize the process:
Throughout the entire process, cross-functional
product teams made up of individuals representing
the entire value chain guide the process
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. Perform a functional cost breakdown
3. Determine the relative importance of customers
requirements
4. Relate features to functions
5. Develop relative functional rankings
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Conduct Value Engineering
Value engineeringorganized 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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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 and function enhancement
ideas
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Concerns about 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
projects 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 design
and development process 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 the competition
so that higher sales can be earned sooner to repay
the product development investment
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Innovation Measures on the
Balanced Scorecard
Examples of financial measures:
Target cost
Percentage of sales from recently launched
products
Gross margins from new products
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Innovation Measures on the
Balanced Scorecard
Examples of nonfinancial measures:
Market Research and Generation of New Product
Ideas
Number of new projects launched based on
customer input
Number of new value-added services identified
Design, Development, and Launch of New
Products
Number of patents
Total RD&E time: from idea to market
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Environmental Costing
Environmental remediation, compliance, and
management have become critical aspects of
enlightened business practice
Environmental costing involves:
Selecting suppliers whose philosophy and practices
in dealing with the environment match the buyers
Disposing of waste products during the production
process
Incorporating post-sale service and disposal issues
into management accounting systems
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Controlling Environmental
Costs
Activity-based costing can be easily applied to the
measurement, management, and reduction of
environmental costs
Identify the processes that cause environmental
costs
Assign the organizational costs associated with
these processes
Assign those costs to individual products,
distribution channels, and customers
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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
Environmental costs fall into two categories:
Explicit costs
Implicit costs
2012 Pearson Prentice Hall. All rights reserved.
2012 Pearson Prentice Hall. All rights reserved.
