LIFE CYCLE COSTING

DEFINITION

Life-cycle Costing is a technique to identify and monitor the costs of assets and products
throughout its entire life cycle. Life-cycle costing helps management plan for the long-term effect
of costs against revenue. It considers costs associated with:

(1)​ Research and Development

(2)​ Design
(3)​ Production
(4)​ Marketing
(5)​ Sales and Service

For example, a poorly designed product will cost less than a fully developed one but may incur
higher costs in later stages, impacting overall profit throughout the product’s lifetime. Life-cycle
costing is often broken down into three components: upstream costs, which are costs of
development, manufacturing costs, which are costs to produce, and downstream costs, which
are costs to sell.

COST LIFE CYCLE

Cost Life Cycle

The cost life cycle refers to the overall cost involving the product and includes every expense
incurred during each of the phases, which are: research and development, followed by design,
manufacturing, marketing, distribution, and customer support.

The sub-components of these costs follow:

Upstream costs

-​ These are expenditures incurred before manufacturing begins and are usually related
with the Development Phase of the cost life cycle.

Downstream costs

-​ These are expenditures spent after manufacturing begins and include the Market &
Distribution, Operation & Use, and End-of-Life phases. These costs relate to selling,
sustaining, and disposing of the products.

Phases of Cost Life Cycle

1.​ Product planning and Design stage

-​ It entails deciding what and how a product will be developed. This phase focuses
on research and development and design.

2.​ Manufacturing and Sales stage

-​ This stage exhibits both growth and maturity in sales. All manufacturing,
marketing, selling, and distribution expenses are incurred at this point.

3.​ Service and Abandonment stage

-​ Expenditures incurred at this period include all after-sales service expenditures,

such as the provision of spares and expert services, as well as costs associated
with product abandonment and disposal.

Stage 1: Research and Development

-​ Innovation, product development, and long-term competitiveness are all fueled by

research and development (R&D). In order to create new goods and technologies,
research must be done. Concepts must then be tested and improved upon before being
ready for sale to consumers.

Stage 2: Design

-​ The subsequent stages of manufacturing, maintenance, and customer satisfaction will

be determined by the design choices made here (materials, features, and complexity).

Why Design is Important

Making decisions throughout the design phase is crucial. Decisions at the design stage are
crucial because they lock in the majority of the remaining life-cycle costs, even if the
expenditures incurred then may be negligible compared to the overall costs over the course of
the full life cycle.

The critical success factors at the design stage include:

1.​ Reduced time-to-market

 2.​ Reduced expected service costs
3.​ Improved ease-of-manufacture
4.​ Process planning and design

Reduced time-to-market

A company's ability to remain competitive depends on how quickly it develops new

products, delivers them, and works to shorten time-to-market.

Reduced expected service costs

Expected service costs can be decreased by using modular or interchangeable

components and a thoughtful, straightforward design.

Improved ease-of-manufacture

To lower production costs and speed up production, the design needs to be simple to
make.

Process planning and design

The manufacturing process plan should be adaptable, utilizing concurrent engineering,

computer-aided design, and computer-integrated production to enable quick setups and
product changes.

Common Design Models

a.​ Basic engineering

b.​ Prototyping
c.​ Templating and
d.​ Concurrent engineering

Basic engineering

A method where product designers work independently from marketing and

manufacturing to develop a design based on specific plans and specifications.

Prototyping

This is a method in which engineers and trial customers develop and test functional
models of the product.

Templating

This is a design method which involves scaling up or down of an existing product to meet
the specifications of the desired new product.

Concurrent engineering

Also known as simultaneous engineering, is an important new approach in which

product design is integrated with manufacturing and marketing throughout the product’s
life cycle.
Characteristics of the Four Design Methods

Design Method Design Speed Design Cost Effect on Downstream Costs

Basic Fast Depends on desired Can be very high; as

engineering complexity and marketing and production are
functionality; should be not integral to the design
relatively low process

Prototyping Slow Significant; materials, Potentially a significant

labor and time reduction in downstream
costs

Templating Fast Modest Unknown; can have costly

unexpected results if the
scaling does not work in
the market or in production

Concurrent Continuous Significant; design is an The best method for

engineering integral, ongoing reducing downstream costs
process

Stage 3: Production

-​ The manufacturing phase, in which the product is manufactured at scale, includes raw
materials, labor, energy, equipment depreciation, and overheads. Efficient manufacturing
procedures save costs and waste.

Stage 4: Marketing and Distribution

-​ Enables a company to promote their product, generate sales revenue, and maximize
market potentials. These include advertising, promotions, sales commissions, and
distribution costs. These activities are essential for generating sales revenue and
maximizing the product's market potential.

Stage 5: After Sales Service

-​ Encompasses customer service and warranty services along with repairs and
maintenance that are recurring services after the actual sale. The expenses incurred by
the after-sales service are included in the overall life cycle cost of the product, and they
vary according to product complexity, customer expectations, and terms of warranty.
FOUR STAGES OF SALES LIFE CYCLE

Stage 1: Product Introduction

In the first phase there is little competition, and sales rise slowly as customers become aware of
the new product or service. Costs are relatively high because of high R&D expenditures and
capital costs for setting up production facilities and marketing efforts. Processes are relatively
high because of product differentiation and the high costs at this phase. Product variety is
limited.

Stage 2: Growth

Sales begin to grow rapidly and product variety increases. The product continues to enjoy the
benefits of differentiation. There is increasing competition and prices begin to soften.

Stage 3: Maturity

Sales continue to increase but at a decreasing rate. There is a reduction in the differentiation
that is no longer important. Competition is based on cost, given competitive quality and
functionality.

Stage 4: Decline

Sales begin to decline, as do the number of competitors. Prices stabilize. Emphasis on

differentiation returns. Survivors are able to differentiate their product, control costs, and deliver
quality and excellent service. Control of costs and an effective distribution network are key to
continued survival.
Management Focus

The focus of management changes over the sales life cycle, from differentiation in the early
phases to cost leadership in the final phases. This happens as the market continues to become
more competitive over time.

Introduction: Design, Differentiation, and Marketing

Growth: New product development and Pricing strategy

Maturity and Decline: Cost control, Quality and Service

Strategic Pricing Strategy

The strategic pricing approach changes over the life cycle of the product or service.

Introduction: pricing is set relatively high

●​ In order to recover development costs and to take advantage of product

differentiation and the new demand for the product.

Growth: pricing is likely to stay relatively high

●​ As the business attempts to build profitability in the growing market. However,

penetration pricing might be used as an alternative to maintain or increase
market share.

Maturity and Decline: Target Costing and Life-Cycle Costing Methods are used

●​ Businesses become more of a price taker rather than a price setter since pricing
becomes more competitive and they want to reduce upstream and downstream
costs.

Cost Management System

Together with the change in strategy and pricing, there is a change in the cost management
system.

Introduction and Growth:

●​ Primarily need Value Chain Analysis in order to guide the design of products in
a cost-efficient manner
●​ Master Budgets are also used to manage cash flows

Maturity and Decline:

●​ to provide the detailed budgets and activity-based costing tools for accurate cost
information
ADVANTAGES AND DISADVANTAGES

Advantages of Life Cycle Costing

Improve Forecasting

●​ LCC helps predict the total cost of a product or project more accurately. By considering
all costs involved – from acquisition to disposal – managers can better plan budgets and
avoid unexpected financial burdens.

Improve Awareness

●​ It provides management a deeper understanding of what factors contribute to costs. This

includes identifying which resources are required, how external factors affect expenses,
and what actions can reduce long term costs.

Performance Trade-Off Against Cost

●​ LCC doesn’t just focus on minimizing expenses but also it evaluates the value delivered,
such as product quality, durability, and service levels.

Disadvantages of Life Cycle Costing

Time Consuming

●​ Preparing a life cycle cost analysis takes a lot of time. It requires gathering detailed data,
analyzing multiple scenarios, and considering the impact of future changes.

High Costs

●​ The longer the project or product life cycle, the higher the operating cost. This technique
might result in increased upfront analysis expenses to estimate future costs accurately.

Technology Challenges

●​ Technology evolves rapidly; costs estimates might become outdated quickly, requiring
frequent updates to reflect current conditions and technological advancements.