UNIT – III VALUE ENGINEERING TECHNIQUES

CREATIVITY
The Creative Phase is an opportunity for the team to use their creativity and produce alternate means
of performing the functions associated with the product, service or project. The goal is to generate as
many ideas as possible in a short period of time. This can be accomplished through Function-based
Brainstorming.

Creativity is the development of ideas new to the individual, not necessarily new to someone else. It
is the one basic element in the value methodology that singles out effective VE performance by
bringing one closer to the attainment of optimum value. It takes creativity to discover alternate
designs, methods, systems or processes that will accomplish the basic functions that need to be
performed. In organisational context individuals and groups must create but on schedule. This
challenge seems overwhelming. Fortunately, innate creative ability can be developed and improved
through training and practice.

There are two general approaches to problem solving - the analytical and the creative. An analytical
problem is one that frequently has only one solution that will work. "Find the cause of the failure" is
an analytical problem. One pursues the problem through a progression of suppositions to be proved or
disproved by experimentations and tests until the problem is successfully narrowed to a cause for
each failure. Once the cause is ascertained, that problem is solved.

The creative approaches appropriate when there appears to be either no solution or more than one
solution to a particular problem The creative approach is an idea-producing process specifically
intended to generate a number of solutions, any of which will solve the problem at hade. Although all
solutions will work, one is the optimum among them.

The creative process is a mental process in which past experience is combined and recombined
(frequently with some distortion) lo form a new combination which will satisfy some needs
eventually. The creative process is that process which the mind normally follows in seeking a
solution.
It involves the following steps:
There are a number of creativity techniques available for problem-solving situations. The ground
rules to be followed when using a specific creative technique are as follows:

(a) Do not attempt to generate new ideas, and to judge them at the same time. Separate these aspects
by time, by place, and by different personnel, if possible.

(b) Generate a large quantity of possible solutions. As a goal, multiply the number of ideas produced
in the first rush of thinking by 5 or even 10.

(c) Seek a wide variety of solutions that represent a broad spectrum of attacks upon the problem.

(d) 'Watch for opportunities to combine or improve ideas as they are generated. Be careful, however,
not to judge ideas when doing this -just hitch-hick on them.

(e) Before closing the book on possible solutions, allow for subconscious operation on the problem
while consciously performing other tasks. Value Engineering

(f) Consider all ideas, even the most impractical. Do not ridicule any idea.

THE BRAINSTORMING TECHNIQUES

In 1938, Alex F. Osborn, an advertising executive, invented the process of “organized ideation” in a
company he headed. The early participants referred to their attempts as “brainstorm sessions,” in the
sense that they were using the brain to storm a problem.The term brainstorming has now become the
accepted way of referring to group attempts to solve specific problems or develop new ideas by
amassing spontaneous, unrestrained contributions by members.

Osborn (1979) credited the origin of the process to Hindu teachers in India, who have used the
method of Prai- (outside yourself) Barshana (question) for over 400 years. During such a session,
there is no discussion or criticism; evaluation of ideas takes place at later meetings of the same group.

Brainstorming can be used to generate possible solutions for simple problems, but it is unrealistic to
expect it to accomplish most problem-solving or planning tasks. The technique is of value as part of a
larger effort that includes individual generation of information and ideas and subsequent compilation,
evaluation, and selection. Brainstorming can be used to generate components of a plan, process,
solution, or approach and to produce checklists.

Osborn (1948) saw the value in a session that was designed solely to produce a list of ideas that could
be used later in problem solving or other creative processes. The key to the success of the process is
that no evaluation or judgment is made of the ideas as they are being generated. Because of this,
creativity is not stifled, it is increased. The objective is to generate as many ideas related to the
specific topic or question as possible. Studies have shown that the ideas generated by the group tend
to get better as the group gets warmed up.
The value of the process is that more good ideas are produced in less time than would be produced in
a typical meeting or conference. Discussion, evaluation, and selection occur at a later time.

One of the reasons why brainstorming works is that ideas generate further ideas through the power of
association—a process that has been called “hitch-hiking” or “piggybacking.” Also, the technique of
“free association” is more powerful when one is working in a group than when one is working alone.
Reinforcement is another factor that leads to increased creativity. In the idea-generation phase of
brainstorming, all suggestions are rewarded by being received and listed—a positive reinforcement.
Nothing is criticized; there is no negative reinforcement.

THE GROUP
The optimum size for a brainstorming group seems to be six to twelve members, and the optimum
group consists of women as well as men. Brainstorming is a total-group effort. Breaking into smaller
groups would defeat the purpose of the brainstorming session.
BEGINNING
Prior to the actual session, group members should be provided with a one-page memorandum that
states the problem to be considered and outlines the brainstorming procedure.
At the beginning of the actual session, if group members are not already acquainted with one another,
they should be introduced (a getting-acquainted activity can be used for this). It is a good idea to
conduct a warm-up activity, with the group members directed to brainstorm solutions to a simple
problem that is unrelated to the topic of the actual session.

THE PROCESS
The leader begins the work session by stating the problem or topic in specific, not general, terms. The
problem should be simple rather than complex, so that the group can focus on a single target. The
leader should have a list of categories, classifications, or leads (new uses, adaptation, modification,
increase, decrease, substitute, rearrange, combine) that can be suggested to the group members if they
seem to be getting off track. The leader also can have a few ideas about solutions ready to throw in
when the group seems to lag.
It seems to work best if one idea at a time is offered by any one member. This allows all members the
space to participate and encourages “piggybacking” on previous ideas.

A recorder (not necessarily the leader) lists all ideas (but not who suggested them) on newsprint as
soon as they are generated. This list is positioned so that all members can see it. The session also may
be tape recorded to make sure that no ideas are lost.
The Rules of Brainstorming

The following criteria are essential to the idea-generation phase of a brainstorming session (Adams,
1979):

1. There is no criticism, evaluation, judgment, or defense of ideas during the brainstorming session.
The purpose of brainstorming is to generate as many ideas related to the topic as possible in the
time allowed. Evaluation, judgment,and selection of ideas are the purposes of subsequent sessions.

2. Free wheeling and free association is encouraged. Group members are asked to voice any
solutions they can think of, no matter how outrageous or impractical they seem. There is no limit on
“wild” or “far-fetched” ideas. Every idea is to be expressed. It is easier to tone down an idea and to
select out later than it is to think up new and creative possibilities.

3. Quantity is more desired than quality. Group members are encouraged to contribute as many ideas
as they think of. The greater the number of ideas generated, the more likely it is that there will be
several useful ideas.

4. Building on ideas is encouraged. Combining, adding to, and “piggybacking” on ideas is part of
the creative process. Members can suggest improvements,variations, or combinations of previous
ideas.

Stimulating Creativity

Osborn stressed the need for the leader or group to keep the process open. No one should be allowed
to comment on the ideas of others unless the comments are totally positive (“that’s great,” “right,
right, and . . . .”). In addition, the sessions should be informal: members should be advised to dress
comfortably, and meals, if included, also should be informal. A playful atmosphere is most conducive
to creativity; often “crackpot” ideas turn out to have a great deal of potential. If it is difficult for the
members to loosen up, it may help to create an atmosphere of safety if the norm is established that
“no one will comment on who suggested what” outside the brainstorming session.

It is important that the brainstorming session continue after the “first wave” of enthusiastic
contributions. Often the most innovative ideas are produced when the group members are forced to
push themselves to think of something new.

Subsequent Ideas

It is likely that members will continue to think of ideas for several days after the brainstorming
session is held. Some mechanism by which the individual members can get in touch with the leader
or recorder after the session will help to ensure that no ideas are lost. In fact, experience indicates that
the most valuable ideas are generated after members of the brainstorming group have “slept on” the
problem. This process can be facilitated by sending the group members a printed, triple-spaced list of
all the ideas that have been generated by the group, with the ideas classified according to categories.
A certain amount of time can be allowed for them to fill in additional ideas and return the list.

Only after the group has exhausted its supply of ideas does the brainstorming session move into the
idea-evaluation phase. Only now can ideas be criticized as the group strives to reach consensus on a
few workable solutions.

EVALUATION AND SELECTION OF IDEAS

There is controversy over whether the group that later evaluates the ideas should be the members of
the original brainstorming group. One side argues that it is negative human relations to ask the first
group to generate the ideas and then cut them off from the rest of the process. It also may generate
negative reactions if they know that others will be critiquing the ideas and deciding which are to be
discarded. If the members of the brainstorming group are sufficiently familiar with and interested in
the problem to perform their initial task, they are probably qualified to continue the process. This
creates a linkage between generation of ideas, evaluation, and development (use of the evaluated
ideas) and ensures commitment to the final solution or plan.

On the other hand, some believe that the evaluation should be done by persons who are better aware
of feasibilities and who are more objective. It is also recommended that the final evaluation be done
by those who are directly responsible for the problem. For several reasons, this may or may not be
those who were selected to generate ideas. If the latter course is chosen, however, it is imperative that
the members of the brainstorming group be informed of the final disposition of their ideas.

Before it actually begins to consider the list of ideas, the evaluation group (whether it makes final
decisions or recommendations only) should establish criteria by which to examine each of the ideas.
Such a checklist might include questions about feasibility,complexity, costs, human factors, timing,
quality, improvement, resources, safety, work flow, and other pertinent factors.

In many cases, the ideas will pass through several groups before final decisions are made. For
example, the critique and evaluation group may be composed of functional managers who make
recommendations to higher management. This level of management may consider the
recommendations and make decisions or it may select plans to be reviewed and commented on by a
cross-section of customers. The ideas may be treated as a springboard for the development of more
in-depth plans. Testing may need to be done. In most cases, the nature of the topic or problem will
determine how the ideas are handled subsequently.
INDIVIDUAL BRAINSTORMING

Brainstorming can be conducted on an individual basis as well (Hayes, 1981). One can write down
possible solutions to a clearly outlined problem, forcing oneself to keep the ideas flowing from the
pen without stopping. This use of brainstorming is effective at stopping one of the strongest drains on
creativity: self-criticism or negative self-talk. People tend to criticize themselves, their thoughts, and
their actions far more than they praise themselves. A person whose every idea is accompanied by the
thought, “What a stupid idea; they’ll just laugh at me if I tell them,” is not very likely to share ideas
with others. Because the brainstorming process encourages the continual production of uninhibited
ideas, it can be an effective exercise in creativity.

Reviewing one’s list when ideas are slow to come may spark new ones. Then, just as in a group
session, the individual can consider the list and select those ideas that seem to best solve the problem.

An individual brainstorming session also can be effective when one is trying to write. Just as the idea-
generating phase may produce the solution to a problem, it also may help an individual to overcome
writer’s block and the inhibitions felt when faced with a blank page.

GORDON TECHNIQUE

The Gordon Technique is a variation of brainstorming, having one basic difference. No one, except
the group leader knows the exact nature of the problem under consideration.

This technique is closely related to brainstorming, in that it is a group conference method in which an
unevaluated free-flowing discussion is encouraged. But in its pure form, there is one basic difference.
No one, except the group leader. Knows the exact nature of the problem under consideration. One of
the principal reasons for keeping the rest of the group in the dark, so to speak, is to avoid "solution
arrived at too soon".

The first and most difficult step in running a session of this type is selecting the topic for discussion.
The subject must be closely related to the problem at hand. But its exact nature must under no
circumstances be revealed. Usually this subject will be a physical principle which is related to the
problem that must be solved. For example, if the problem is of seeking solutions of parking problem
of a large city the group leader might have the group discussing ways to "store things.
 MORPHOLOGICAL ANALYSIS

It is a comprehensive way to list and examine all of the possible combinations of ideas that might be
useful in solving a problem. The procedure is as follows:

 State the problem as broadly and as generally as possible.

 Define the independent parameters that the solution must meet.
 List all alternative ways of fulfilling each parameter. These alternatives can be entered on a
chart to aid in visualizing the possible combinations.

Morphological analysis was developed by Fritz Zwicky, who was based at the California Institute of
Technology. While morphology had been in use before Zwicky’s seminal work (Zwicky, 1967)
during the 1940s and 50s, he matured the ideas into a rigorous method to address “all relevant
interrelations among objects, phenomena and concepts by means of methods which are based on the
utmost detachment from prejudice and carefully refrain from all prevaluations” (p. 273). Among his
notable body of work he employed his morphological method on topics as diverse as jet engines,
astronomical instruments, and law in space (Zwicky, 1947, 1948, 1963).

Morphological analysis breaks down a problem into key dimensions, restructures it, and provides a
framework in which people can consider various solutions. The approach systematically explores the
range of possible combinations of various attributes or dimensions of the problem. During the
exploration, it offers a method of presenting a multidimensional problem in a more simple two-
dimensional space to help understanding. Typically, morphological analysis takes place with a small
group of subject-matter experts through a series of workshops, and there are many examples of it
being used successfully in practice1 . A definition of morphological analysis that encapsulates its
generic status as a problem structuring method is that it is a method for systematically structuring and
examining all the possible relationships in a multidimensional, highly complex, usually non-
quantifiable problem space. The basic idea is to identify a set of variables and then look at all the
possible combinations of these variables […] This exercise [morphological analysis] reduces the
chance that events will play out in a way that the analyst has not previously imagined and considered.
(Heuer & Pherson, 2011, p. 108)

Initially, morphological analysis was applied in the area of technology within engineering design
purposes before being used as a creativity and ideation method (Majaro, 1988). Morphological
analysis has been applied to futures and socio-economic fields and in a more generalised approach
targeting the broader aspect of “wicked problems” and “messes” (Ackoff, 1974; Coyle, 2004;
Funtowitcz & Ravetz, 1994; Godet, 2001; Rhyne, 1995, 2003; Ritchey, 2011; Rittel & Webber,
1973).
MORPHOLOGICAL ANALYSIS AS A PROCESS

A process for Morphological Analysis is shown in Figure 1-1: Outline Process for Morphological
Analysis. .

Step 1: First, the problem which is to be solved must be exactly formulated and be encapsulated in the
form of a focus question. All of the parameters that might enter into the solution of the given problem
must be characterized.2

Step 2: The states at which the parameters might exist need to be captured.3

Step 3: Then a “morphological table” or multidimensional matrix is constructed which contains all of
the solutions of the given problem.

Step 4: All of the solutions are closely analysed and evaluated through a cross-consistency matrix
with respect to the purposes to be achieved.

Step 5: The best solutions are selected and executed, provided that the necessary means are available.

The first output of a morphological analysis, after step 3, is a morphological table; an example is
shown in Table 1-1: Morphological Table for AFSC.
A morphological table illustrates how a problem is broken down into components. The first row of
Table 1- 1: Morphological Table for AFSC.

Shows the parameters of the problem; under each parameter are potential states, which give different
value options for each parameter. In this instance, the table is intended to represent a problem space
for Alliance Future Surveillance and Control Capability (AFSC).

Typically, morphological analysis uses a workshop format to derive parameters and states from a
group of experts on the topic under scrutiny. It is desirable that parameters be orthogonal in the sense
that it should not be possible to define one parameter from a combination of two or more other
parameters. The set of states for each parameter should be exhaustive, so that for the purposes of the
topic, all possible values of a parameter should be captured. Such “stretching” of the states conforms
to Zwicky’s idea that morphological analysis should allow for “totality research”. Formulating a
novel problem takes time. Consequently, it works best when the morphological table can be limited to
a reasonable number of parameters and states. When a workshop format is used, it is typical that the
constraint is “7 × 7 × 7”: seven experts, seven parameters, each with no more than seven states. For
example, the table in Table 1-1: Morphological Table for AFSC.
CROSS-CONSISTENCY ASSESSMENT

Step 4 in the morphological analysis process is to eliminate non-valid combinations of states though
the principle of contradiction and reduction. Using a cross-consistency matrix, each state is compared
in a pairwise fashion with all the other states, see Table 1.2. In the comparison, the idea is to reduce
the number of valid configurations by identifying those that are inconsistent with each other. By
eliminating inconsistent pairs, the number of combinations to consider reduces considerably. It is not
uncommon to reduce the number of combinations by 90% or more (Ritchey, 2011).

Sometimes, it is necessary to classify an inconsistency. Three classifications of inconsistency are

used.

− Logical Contradictions: A logical contradiction between two or more statements.

− Empirical Inconsistencies: A practical incompatibility or discrepancy between two or more

conditions or statements about the observed world.

− Normative Constraints: An incompatibility or discrepancy between two or more conditions based

on social norms, ethics, and standards.

SOLUTION SPACE

The final step in the morphological analysis process is to discuss the remaining valid combinations as
potential solutions to the problem. A solution is a scene that is consistent across all of the parameters.
Table 1.3 highlights a potential example of a solution space for AFSC.
 ABC ANALYSIS

Introduction to A.B.C.

ABC is a selective inventory control technique which stand for Always Better Control.

ABC analysis is a technique for prioritizing the management of inventory. Inventories are categorized
into three classes - A, B, and C. Most management efforts and oversights are expended on managing
A items. C items get the least attention and B items are in-between (moderate).

All three refer to categorization of various items, products and services into three groups depending
upon their importance and significance so that their handling is done accordingly.

Explanation of A.B.C.

This ABC analysis is based on economic principle of economist Vilfredo Pareto which state that
most of the economic productivity comes from only a small parts of the economy

i.e. in any large group there are “significant few” and “insignificant many”.

As I have discussed above, ABC analysis technique involves the classification of inventory

items into three categories A, B & C. This ABC analysis can be explained with the help of following
Table-1 & Table-2
 Figure 1: Table-01

The annual consumption value is calculated by the formula: (Annual demand) × (item cost per unit)

Figure 2: Table-02

Both of the above tables demonstrate that a few high usage value items constitute a major part of the
capital invested in inventories, where as bulk of items in inventory having low usage value constitute
insignificant part of capital.

Classification of items Under A.B.C.

Category ‘A’
Most valuable and costly items are classified under ‘A’ category. Such items have large investment
but not much in number. For example 10 percent of items account for 70 percent of total invested in
inventory. So, more careful and strict control is needed for such items. This category will be the
smallest category in quantity but largest in monetary terms.
Category ‘B’
Category ‘B’ represents the middle parts of products between Category ‘A’ and Category ‘C’. They
are larger in number than category ‘A’ but smaller in monetary term. These items having average
consumption value. 20 percent of the item in an inventory account 20 percent for total investment.
These ‘B’ items have less importance than ‘A’, so moderate control is needed for them.
Category ‘C’
The items placed under category ‘C’ have the lowest consumption value.But, nearly 70 per- cent of
inventory items account only for 10 percent of the total invested capital. So, these are “trivial many”
items which do not catch much strict management attention i.e. loose control is needed for such
items.
Now, this ABC analysis can be demonstrated with help of following graphs:

Why A.B.C. Analysis:

• Ensures control over the costly items.
• Reduction in the storage expenses.
• Resource allocation.
• Increased economy.
Limitation of A.B.C. Analysis:
• ABC Analysis does not permit precise consideration of all relevant problem of inven- tory
control.
• If ABC Analysis is not updated and reviewed periodically the real purpose of control may be
defeated.

• Periodical consumption value is the basis for ABC classification not the unit value.

PROBABILISTIC APPROACH

The probabilistic method is an efficient technique to prove the existence of combinatorial objects
having some specific properties. It is based on the probability theory but it can be used to prove
theorems which have nothing to do with probability. The probabilistic method is now widely used
and considered as a basic knowledge. It is now exposed in many introductory books to graph theory.

MAKE OR BUY DECISIONS

The Make or Buy decision applies to both goods and services. Businesses compare the cost and
benefits of producing the goods or services within the company and the cost and benefits of getting an
outside supplier to supply the goods and services into consideration. The value here must include all
the fees associated with manufacturing (including material, labor, cost of machinery and space),
storing, moving, taxes, etc. and the corresponding benefits must include benefits in terms of increased
margins (for in-house production) or low capital requirement (for outsourcing).

Let’s discuss the analysis of make or buy decisions.

 Under quantitative analysis, businesses consider all the costs associated with producing the
product or service in-house. These costs include buying and maintaining equipment, cost of
the premises (lease, etc.), raw material cost, conversion cost, cost of fuel and electricity, labor
cost, warehousing or storage cost, shipping cost, and the cost of capital. The benefits include
higher margins from in-house production.

 The cost associated with outsourced production includes the product and service,
transportation, warehousing, and storage and labor costs for managing the logistics.

 The decision becomes a little straightforward if the company does not have an idle capacity to
produce the product or service. In this case, the management can opt to hire an outside
supplier considering that it is not of critical importance, and the firm’s intellectual property is
not endangered.
  Considering the company has the idle capacity, and it is already incurring a large part of fixed
expenses, it can choose to manufacture in the house if the marginal cost of manufacturing is
less than what it will cost to buy from outside suppliers.

Factors
The make or buy decision should be taken with utmost care keeping the long-term and short-term
benefits into consideration. There are pros and cons to both making and purchasing; however,
generally, businesses tend to outsource functions where they do not have a core competency or when
the cost of procuring the components or services from outside suppliers is significantly cheaper.
There are multiple factors that make individuals, entities, and economies assess what option would be
better for them – to make themselves or to buy from other manufacturers. When the entities decide to
make a product or offer a service themselves, they inspect various aspects and assess the cost
involved in conducting the manufacturing or production procedure. If the expenditure seems worthy
of the benefits and usage frequency of items, the countries decide to do it by themselves.

On the other hand, if entities or nations find out that the benefits and usage frequency do not require
them to invest so much into the production or manufacturing of items, they find it better to have an
external source hired for the items.

Make Decision
The following are the major factors considered while deciding to make the good or service in-house.
 Cost concerns are one of the most important factors. If the businesses find it too expensive to
outsource the manufacturing or production activities, they skip the buy idea and manufacture
the products themselves.

 Their desire to enhance the manufacturing focus inspires them to manufacture their own
products.

 Most businesses fear their intellectual belongings being roped. Such concerns disallow them
to outsource processes.

 Many times, businesses are not sure of the quality the outsourcing company would offer. Any
tampering with the quality directly hampers a business’ image or a nation’s image. The
quality concerns, therefore, forbid them to buy from others.

 Not all suppliers are reliable. This is a reason enough to not trust a third party.

 The need for direct quality control over the product. When there is another unit working on
the manufacturing of the products, the main business loses supervision control, which may
affect the quality of the products and services offered.

 The absence/shortage of competent suppliers can be yet another reason.

  The volume of product required might not be significant enough for a prospective supplier to
take orders.

 When the shipping and transportation costs are reasonable enough to handle, companies prefer
making products rather than buying them from an external business.

Besides the above-mentioned major reasons, there can be other factors too affecting the make or buy
decision. Such factors include environmental determinants, political reasons, etc.

Buy Decision
The following are the major factors considered when deciding to buy the goods or service from an
outside supplier.
 The first and foremost reason that makes a business or nation opt for buying products and
services from external sources is their own lack of expertise in manufacturing those categories
of products and services. They know they cannot yield the best. Hence, they connect with the
best providers for their consumers.

 When companies decide to outsource their manufacturing process, they do thorough research
to check who’s the best provider of the required products and services. The research and
specialized know-how of the supplier better than the buyer is what inspires them to delegate
their manufacturing service to other brands.

 Cost considerations are always one of the main concerns. If the businesses or nations find that
it is less costly for them to buy the products and services from an external source than to
produce themselves, they consider the former option and hire a third-party service.

 There are situations where a business is incapable of manufacturing an item itself. This is
when they have to look for some other entity that could look after its manufacturing
obligations.

 When the goods are not required in large numbers, the businesses find it worth having an
external source of production of the products. This is because there is no use in devoting much
time and effort to arranging everything from scratch for producing an insignificant volume of
goods. Hence, they prefer outsourcing services.

Besides the above-mentioned reasons to consider buying products from external sources, the
company may also think that a particular product category is not much important to the firm’s
strategy. Hence, they prefer outsourcing the production of the same. Plus, they may have a personal
liking for the brand that inspires them to outsource the manufacturing to that particular external
brand.
 FUNCTION COST WORTH ANALYSIS (FCWA)

The functional cost analysis is a value engineering method that aims to increase the difference
between the cost and the value of a product. The cost is the amount that is incurred in the production
and delivery of the product. This expense can include the price of parts, labor, overhead (e.g.,
building, power), packaging, shipping, and advertising, among others. What the product is worth in
the eyes of the customer is considered the value. When completing a functional cost analysis, this
definition of value is extremely important. The design team may not perceive a certain product
feature to be valuable, however if it is important to the customer, then that feature must be regarded
as valuable.

FAST is a powerful analytical process that enables people with different technical backgrounds to
communicate and work together on problems that require an interdisciplinary approach.

FAST identifies those functions, which clearly serve a purpose in the goals of the system. It
distinguishes between the functions that are necessary to the purposes of the system, and other
activities that exist simply as a consequence of the way in which the purposeful functions are carried
out. It also analyses functional interdependencies through a disciplined reasoning process that uses an
inclusive logic methodology, which allows all stakeholders in the system to work together in its
development, thus ensuring as wide a consensus as possible.

A Component Function Cost Matrix or Value Analysis Matrix is prepared to identify the cost of
providing each function by associating the function with mechanism or component part of a product.
Product functions with a high cost-function ratio are identified as opportunities for further
investigation and improvement.

STEPS IN FCWA
Function Cost Analysis is a team activity with from four to seven employees from different areas of
the business such as design, engineering, management accounting, marketing, production and
purchasing . One of the great strengths of functional cost analysis is that it has a structured approach a
specific objective to which all analysis is that it has a structured approach to achieve a specific
objective to which all team members can contribute. Function Cost Analysis is carried out in the
following steps:
Select product for FCWA and decide specific objectives
For new products, the FCA can be integrated into the design process. For existing products the
criteria when selecting products are very complex or very heavy or very bulky with relatively high
cost. Other objectives could include the following:
 Increase the quality of the product without increasing the cost,
 Reduce the weight of the product without increasing the cost,
  Increase the function of the product without increasing the cost,
 Develop new patents.
Collect Information
The information collected would include the following:
 existing design;
 existing specifications for product;
 details of production process;
 material, labor and overhead cost data;
 scrap data;
 marketing data about the product.
List the separate components of the product, and identify the function served by each
component

The first analytical step in the method is to strip a product down to its separate components - either
literally and physically, or by producing an itemized parts list and drawings. However, parts lists and
conventional engineering drawings are of limited value in understanding and visualizing the
components, the ways in which they fit together in the product overall and how they are
manufactured and assembled. So if an actual product, or a prototype version, is not available for
dismantling, then something like exploded diagrams of the product are helpful in showing
components in three- dimensional form and in their relative locations or assembly sequences.

It is important that the team thinks about the functions rather than the parts of the product. The
function could be assigned by type as:

 Basic function - the primary purpose(s) for which the item or service was designed when it is
operating in its normally prescribed manner. This function must be accomplished to meet the
purpose of the product, structure, or service. A product or service may have more than one basic
function.

 Secondary functions are ones that support the basic function (and, hence, are sometimes referred
to as “support functions”). They result from a specific design approach to achieve the basic
function. If the design changes, the need for existing secondary functions may be modified or
even eliminated. To enhance the analytical an evaluation process some practitioners break
secondary functions into a sub classification of “required” (by the current design), “aesthetic,”
and “unwanted”. The distinction between what is needed (basic functions that provide value) and
what is not needed (secondary functions that have no value or even have a negative value) is vital
to the successful functional cost study. Elimination of unnecessary cost is dependent upon it.
Creating a FAST model

For best results, a multidisciplinary team of experts should carry out the FAST process. Firstly, the
team must agree the objectives and motivation for developing the system, or product, and then
secondly, determine the functions that will be required to achieve these objectives. At this stage the
team is concerned with analyzing the problem rather than developing solutions, and therefore it is
important to distinguish between function and process.
A function is some necessary phenomenon that enables a particular purpose to be achieved, whereas
a process may be just one possible way of performing that function. In the FAST process a function
is described using an Active-Verb and a Measurable-Noun. The second stage of the FAST process
leads to the production of a FAST diagram that describes the relationships between a purpose and
the functions necessary to achieve it. In this diagram the relationship between functions are not time-
constrained and can only be described using a HOW-WHY-WHEN Logic, as shown in Fig. 1.

Fig. 1. Basic FAST model

Determine the cost of each component

It is not always easy for a company to determine the exact costs of components used in products. This
explains why many companies employ specialists in cost estimating. It is not sufficient to merely
determine the cost of the individual components and estimate the labor involved. A number of other
factors must be considered and included. Some of these factors are:
 Cost of parts including the purchase price as well as any associated shipping costs.
 Cost of consumables that are used in the fabrication of the product (e.g., glue, cleaners).
  Labor costs for assembly as well as for any modification or finishing to parts.
 Equipment or tooling costs.
 Handling and inventory control.
 Packaging and shipping costs.
Equipment or tooling costs are items that may require some calculation since there is not a one- to-
one ratio between the unit of equipment and unit of product. Therefore, it may be necessary to
calculate equipment costs based on projected volumes.

Very detailed cost calculations may also include indirect or overhead costs. These involve facility
costs (e.g., heat, hydro, taxes), non-direct labor (e.g., finance, human resources, marketing), or any
other cost that cannot be directly tied to a product. There are a number of different methods by which
companies apply overhead costs to products.

It is important not to ignore low-cost components, particularly if they are used in large numbers (e.g.
screws or other fasteners). Even a relatively small cost reduction per item can amount to a substantial
overall saving when multiplied by the number of components used.

Once the costs have been determined for each component or sub-assembly in relation to the
function(s) they support, the total cost of the component or sub-assembly is determined. The total
product cost is calculated by summing the totals for all components. This total is then used to
calculate the percentage of the total cost that each part represents.

Determine the cost of each function

Components often contribute to several different or related functions, and hence the cost of a
particular function is often spread across several components. The kind of component/function cost
matrix shown in Fig. 2 allows the designer to analyze in detail these often complex relationship.
This matrix displays the components of the product, and the cost of those components, along the left
vertical side of the graph. The top horizontal legend contains the functions performed by those
components. When a component contributes to more than one function, it may be difficult to break
down its overall cost into precise part-cost per function. Approximate but well-informed estimates
then have to be made.

The cost of each function can be calculated by adding all of the costs attributed to a specific function.
As with the component costs, the percentage of the total cost that each function represents is
calculated. If desirable, the cost sequence can be determined where the functions are numbered, with

(1) representing the most costly function.

A powerful analysis method is created when FAST is used in conjunction with QFD (Quality
Function Deployment) method . QFD enables the uses of Value Analysis Matrix. It is powerful in
two ways. First, it associates functions back to customer needs or requirements. In doing this, it
carries forward an importance rating to associate with these functions based on the original customer
needs or requirements. Functions are then related to components, the same as with the Function-Cost
Matrix. Components are related to functions as either strongly, moderately or weakly supporting the
given function. This relationship is noted with the standard QFD relationship symbols. The associated
weighting factor is multiplied by customer or function importance and each columns value is added.

Consider the value of functions

This is a critical step and bring the customers views into the costing system, so the value of product
functions must be those as perceived by customers, rather than by designers or manufacturers.
Although values will be interpreted in different ways by different customers, its common
characteristic is a high level of performance, capability, emotional appeal, style, etc. relative to its
cost. This can also be expressed as maximizing the function of the product relative to its cost:
Value = (Performance + Capability)/Cost =Function/Cost (1)

The goal would be to achieve a ratio of 1.

If a certain function is not perceived to be valuable to the customer and the function is determined not
to be necessary for reasons such as performance or reliability, then perhaps that function should be
simplified or eliminated. Having added functionality in a product that is not perceived valuable by the
customer can actually hurt the sale of the product. The market prices of different products can
sometimes provide indicators of the values that customers ascribe to various functions.

Generate alternatives of reducing cost without reducing value, or of adding value without
adding cost
This is the really creative part of functional cost analysis where all the team member make suggestion
for improvement. Attempts to reduce costs usually focus on components and on ways of simplifying
their design, manufacture or assembly, but the functions performed by a product should also be
looked at critically, because it may be possible to simplify them, reduce their range, or even eliminate
them altogether if they are of limited value to the purchaser.
There are some general strategies which can be applied in order to direct the search for ways of
reducing costs. The first is to concentrate on high-cost components, with a view to substituting lower-
cost alternatives. The second is to review any components used in large numbers, since small
individual savings may add up to a substantial overall saving. A third strategy is to identify
components and functions which are matched as high-cost/high-value, or low-cost/low-value, since
the aim is to achieve high-value functions with low-cost components.

Cost-reduction guidelines are:

There is a whole class of value attributes related to aesthetics. This includes not only the appearance
of a product - colour, form, style, etc. - but also aspects such as surface finish and feel to the touch.

Evaluate alternatives and select improvements

The application of functional cost analysis should result in a number of alternative suggestions for
changes to the product design. Some of these alternatives might well be incompatible with each other,
and in fact all suggestions should be carefully evaluated before selecting those which can be shown to
be genuine improvements.
Implement alternatives and audit results

It is obviously important to implement the chosen alternative and ensure that the predicated results
are actually achieved in practice.

FUNCTION ANALYSIS SYSTEM TECHNIQUE (FAST)

The Function Analysis System Technique (FAST) helps thinkingabouttheproblem objectively and in
identifying the scope of the project byexhibitingthe logical relationships between functions. The
organization of thefunctionsinto a function-logic, FAST diagram enables participants to
identifyofalltherequired functions.

Objectives of FAST
The objectives of FAST diagram are
 to verify if, a proposed solution achieves the needs
 illustrate how to achieve the needs of the project, and
 to identify unnecessary, duplicated or missing functions.

Function Analysis
Functional analysis is similar to VA/VE analysis. The basic difference is that the VE focuses on the
development stage of a new product, but FAST uses the functions of a product (or service) as the
basis for cost management.
Definitions
“Functional analysis is concerned with improving profits by attempting to reduce costs and/or by
improving products by adding new features in a cost effective way that are so attractive to customers
that profits actually increase”.
“Functional analysis is an analysis of the relationship between product functions, their perceived
value to the customer and their cost provision”.

An Example of Functional Analysis

This case refers to the days of telecoms industries at the forefront of telephone manufacture, sales,
and inventing new telephones and telephone exchanges. When a new telephone was developed, and
before production took place, a target cost exercise was undertaken by the marketing team to establish
what the customer would be willing to pay, and working backwards, the company could establish a
target cost. At this stage a functional analysis exercise was undertaken. A complete breakdown was
made of the product, in particular, listing all the functions the telephone would perform, and a second,
more detailed research investigation was undertaken to establish and identify the importance the
customer attached to each feature/function of the telephone. It was pointless including “nice to have”
features that customers did not value, did not use, and were not prepared to pay for. When the
exercise was completed the unnecessary features were removed and an overall target cost was
calculated. What the company was doing was establishing a ‘use value’ as opposed to simply catering
for the few customers who were prepared to pay the higher price for ‘esteem value’. The company
was placing a cost of the provision the customer wanted and valued. As with value analysis, a
systemic approach needs to be followed by a company adopting a functional analysis exercise.
Procedure of Functional Analysis
The technique could involve:
Step 1: Select the object of analysis (Product/Service or Overhead)
If it is not a new product, the better is to choose a high volume product with a complex design and
relatively large production cost. Other reasons for selecting a particular product might include
apparently high cost, low yield rates, manufacturing problems, market demand (such as remodelling
required) or a need for a more compact design. The product selected will determine the precise
objective of the analysis exercise (reduce weight by 25%, reduce cost by 30% while maintaining the
existing level of quality).
Step 2: Choose members for the team.
There no hard and fast rule for the number of members in the team. Less than five members is too
less for obtaining sufficient number of ideas and also suffers myopic judgment. More than ten is too
large and decision making becomes difficult. It resembles an octopus for moving further. So, usually
it is better to form a group with six to eight (6 to 8) members fromanumberofdifferent departments
(such as accounting, production, purchasing, engineering,design and marketing).
Step 3: Collect information.
This stage is the spine of the analysis. At this step, the informationfrombothsides (i.e. inside and
outside) of the organization is collected. Theinformationand data that are collected often constitute
the following.
Information from inside the organisation:
 detailed design,
 material specification
 material properties
 manufacturing process and
 marketing information) and
Information from outside the organization
 information about new technologies,
 market survey report,
 customer complaints
 trends and changing environment
Step 4: Define the functions of the object.
The various functions of the product should be defined in terms of averbandanoun.
For example:
A mobile smart phone
The major function: The main function can be described as talktothepeoplefar away from any place.
So, it is now stated as
The Main Function:
‘To talk to the people far away’
The Supporting Functions:
These, in turn are many. However, these may be classified into secondary, tertiary and so on. One
such way is given below.
Secondary Functions:
Photography (camera), messaging, mailing, data storage, money transfer, etc.
Tertiary Functions:
Calculator, watch, timer, alarm, data transfer, data search, news and information flow, chat etc.
Step 5: Draw a functional family tree.
The functions identified in step 4 should be arranged in a logical ordering family-tree diagram. A
table illustrating the relationship between the functions and the parts of the product, as well as
relevant existing costs, should also be drawn up. The improved version of this exercise is known as
FAST diagram. We shall discuss about the FAST Diagram in the next section after understanding the
procedure of functional analysis.
Step 6: Evaluate the functions.
Estimate or calculate the relative value of each function to a total target cost from the customers’
point of view (either using market research or by each member of the team placing values and a
consensus being reached for each function). These relative values provide a target cost for each
function. Those functions where the actual cost is greater than the assigned target cost should be
highlighted as potential problem functions. Of course, the absolute amount of money involved should
also be taken into consideration.
Step 7: Suggest alternatives and compare with the target cost.
Alternatives might include the use of new materials or parts, a different method of manufacturing,
suggestions for completely new products or new product functions, modifications to the functions of
the product, the combination of different functions or even the elimination of certain functions.
Step 8: Choose the alternatives for manufacturing.
Various alternatives obtained from the evaluations in above step, it is the most important point that
counts on decision making. Assessing the alternatives and choosing which to implement is not an
easy task as those of the earlier tasks because this activity unlike the others, is filled with more
responsibility and accountability. Therefore, it should have a judicious thinking and backed up by the
evidential support or proper justification.
Step 9: Review the actual results.
After taking a decision and implementing the best suitable alternative, it should be given sufficient
time to produce results. An audit or review of the changes implemented should be conducted
promptly and findings reported to senior management. It should not have any prejudices. Moreover,
this will prevent over-optimistic assessments of the functional analysis exercise and provide feedback
to improve future functional analysis.
Finally, the functional analysis exercise can result in a cost-effective design and will ultimately
produce in an improved competitive advantage. As 90% of a product’s life cycle cost is determined at
the decision stage of the product, it is essential that the tightest control is exercised at the design
stage.

Applicability
As a general rule, this exercise can be conducted with the principles of
 value engineering and function analysis for new products
 value analysis for existing products

Further, the three most important messages for companies providing products or services are:

1. Do not produce a product/service that the customer does not want

2. Do not include features that are not required

3. Do not produce in the hope that someone will buy.

FUNCTION ANALYSIS SYSTEM TECHNIQUE (FAST) DIAGRAM

It is a graphical representation showing the logical relationships between the functions of a project,
product, materials, process or service based on the appropriate questions of the 5W1H analysis
(What, Who, When, Where, Why, and How). The questions of ‘Who’, ‘What’ and ‘Where’ are
already answered at the problem selections stage while the remaining three questions that aretobe
answered are:
 How?
 Why?
 When?

These are considered important here. Refer figure 13.2, which helps in describing the logical
relationships during the 5W1Hanalysis.
 Fig. 13.2: Logical relationship diagram to develop 5W1Hanalysis

The Function Analysis System Technique (FAST) diagramis usuallypreparedin a workshop setting
and led by someone with experience in preparingFASTdiagrams. Input for the diagram is received
from workshop participants. Three key questions addressed in a FAST Diagramare:

 How do you attain the functional objective? Or,

 Howdoyouachievethis function? Why do you perform this function?
 When you perform this function, what other functions must youdo?

The following diagram illustrates how a function is expandedin"How"and"Why" directions in a

FAST diagram.

Fig.13.3: Developing a FAST Diagram

Steps in constructing the FAST Diagram

Start with the Functions as identified using Function Analysis (explained the previous section) and
then referring the above diagram Fig no. 13.3, follow the procedure prescribed below:
 Expand the functions in the "How" and "Why" directions:
  Build along the "How" path by asking 'how is the function achieved'? Place the answer to the
right in terms of an active verb and measurable noun.
 Test the logic in the direction of the "Why" path (right to left) by asking 'why is this function
undertaken?'
 When the logic does not work, identify any missing or redundant functions or adjust the order.
 To identify functions that happen at the same time, ask "when this function is done, what else
is done or caused by the function?"
 The higher order functions (functions towards the left on the FAST Diagram) describe what is
being accomplished and lower order functions (functions towards the right on the FAST
Diagram) describe how they are being accomplished.
 "When" does not refer to time as measured by a clock, but functions that occur together with
or as a result of each other.

Example Fast Diagram: Mouse Trap

Observe the following FAST diagram for a mouse trap using the how and why logic as described
above.

BENEFITS OF FAST
The development of a FAST diagram is a creative thought process which supports communication
between team members. The development of a FAST diagram helps teams to:
 Develop a shared understanding of the project.
 Identify missing functions.
 Define, simplify and clarify the problem.
  Organize and understand the relationships between functions.
 Identify the basic function of the project, process or product.
 Improve communication and consensus.
 Stimulate creativity

DRAWBACK OF FAST
The basic drawback of the FAST diagram is that, there is no‘perfect’or'correct' FAST diagram, but
there is a valid method of representing the logics in a diagram. The validity of a FAST model for a
given situation depends on knowledge and scope of the workshop participants. The FAST diagram
aids the team in reaching consensus on their understanding of the project.

BREAK EVEN ANALYSIS

The analysis of cost behaviour is necessary for planning, control and decision making. Analysis of
cost behaviour means analysis of variability of each cost element in relation to the level of output.
Every cost follows some definite behaviour pattern. For example total variable costs varies in direct
proportion to the volume of output but per unit variable cost remains same. Examples of such costs
are direct material, direct labour, packaging expenses, selling commission etc. These costs are called
product costs and are controllable, as they incur only when production takes place. Whereas fixed
costs remains same irrespective to the level of output but per unit fixed cost goes on decreasing with
the increasing level of out put as fixed cost scattered over a large number of units. Examples of such
expenses are rent, rates and insurance, executives’ salary, audit fees etc. These costs are also called
period costs and are uncontrollable. The mixed costs or semi-variable costs have both the elements
variable and fixed. These costs also change in the same direction in which volume of output changes
but this change is less than proportionate change in output. Examples of such costs are power,
telephone, depreciation, etc. Thus the concept of break even analysis is a logical extension of
marginal costing. It is based on the same principle of classifying the costs into fixed and variable.

Semi-variable costs are segregated in fixed and variable components as discussed in the earlier
chapter. Fixed component is added in fixed costs and variable component with variable cost. Thus the
costs are classified into two water tight compartments i.e. fixed and variable.

The cost behaviour play a significant role in decision making. The relationships in volume, cost and
profit shows that if volume increase by 10 per cent (say), then cost will not increase by 10 per cent.
Because only variable cost will increase and fixed costs remain same and unit fixed cost declines.
Consequently, profit will not increase by 10 per cent but more than that and vice versa. The level of
production changes due to many reasons, such as recession or boom, competition, introduction of
new product, increase in demand, scarce raw material etc. The management wants to know the effect
of these changes on profit. The break-even analysis helps the management in decision making in
these situations.

The study of cost-volume-profit relationship is some time called as “break even analysis.” In the
opinion of some, it is a misnomer as break even analysis depicts a point where costs and total sales
revenue is same. Beyond this point, it is called costvolume-profit relationship. Some hold the view,
that break even analysis can be interpreted in two senses – narrow and broad sense. In narrow sense,
it refers to determine the level of output where total costs equal to total revenue i.e. no profit, no loss.
In the broad sense, it is used to determine the probable profit at any level of output.

BREAK EVEN POINT

It is a point where sales revenue equals the costs to make and sell the product and no profit or loss is
reported. In the words of Keller and Ferrara, “the breakeven point of a company or a unit of a
company is the level of sales income which will equal to the sum of its fixed costs and variable
costs.” Charles T. Horngren define it, “the breakeven point is that point of activity (sales volume)
where total revenues and total expenses are equal, it is the point of zero profit and zero loss.”
There are two methods of calculating breakeven point. Mathematical method and Graphical method.

Mathematical Method
The break even point through mathematical method can be found out either by
i) Equation Method, or
ii) Contribution Margin Technique.
Contribution Margins Technique
Contribution per unit means difference between selling price and variable costs
or
Contribution per unit = Selling price per unit – Variable Cost per unit
Total Contribution = Sales Revenue – Total Variable Costs
Breakeven point can be expressed in terms of units to be produced and sold or in terms of value of
goods. At breakeven point, we know
GRAPHICAL METHOD
The break-even point can also be shown graphically. The BEP chart shows the relationships between
cost, volume and profit at various levels of output. Fixed costs, variable costs and sales revenues are
shown on Y-axis and volume of out on X-axis. The break-even point is that point at which the total
cost line and total sales line intersect each other. This point represents “no profit, no loss”.
The following steps are involved in construction of break even chart:

 Sales volume is plotted on x-axis. Sales volume may be expressed in terms of value (rupee),
units or as percentage of capacity.
 Cost and Revenue are depicted in y-axis. Fixed costs remains constant irrespective to the sales
volume. Hence it is parallel to the x-axis and starts from Rs. 90,000. (Data of illustration 1)
Variable cost starts from (0,0) because no sales volume, no variable cost and as the volume
increases variable cost also increases. When a parallel line of variable cost drawn from the
fixed cost line in y - axis, it depicts the total cost line. The sales revenue curve also starts from
(0,0).
  The point of intersection of sales revenue line and total cost line depicts, break even point. It
occurs at a point of 90,000 units on x-axis and Rs. 2,70,000 (in terms of value) on y-axis.
 The area to the left side of break even point depicts loss zone as cost curve is at a higher level
and sale revenue line is at a lower level. The area to the right hand side of break even point is
call profit zone as sale revenue line lies at a higher level than the total cost line.
 The angle formed by the intersection of sale value line and total cost line is known as angle of
incidence. Larger the angle, lower is the break even point and vice versa.

Let us draw a break even chart with the help of the following illustration.
 LIFE CYCLE COST (LCC)

The life cycle of any product commences with the initial identification of a consumer need and
extends through planning, research, design development, production, evaluation, use, logistic support
in operation, retirement and disposal. The concept of life-cycle assumes significance for cost control
purposes because of interdependencies of activities in different time periods.

Life cycle costing is a system that tracks and accumulates the actual costs and revenues attributable to
cost object from its invention to its abandonment. Life Cycle Cost (LCC) of an item represents the
total cost of its ownership, and includes all the cots that will be incurred during the life of the item to
acquire it, operate it, support it and finally dispose it. Life Cycle Costing adds all the costs over their
life period and enables an evaluation on a common basis for the specified period (usually discounted
costs are used).
Thus, product life cycle costing is an approach used to provide a long-term picture of product line
profitability, feedback on the effectiveness of the life cycle planning and cost data to clarify the
economic impact on alternative chosen in the design, engineering phase etc.

Characteristics of Life Cycle Costing:

The important characteristics of life cycle costing are as follows
a) Product life cycle costing involves tracing of costs and revenues of a product over several calendar
periods throughout its life cycle.

b) Product life cycle costing traces research, design and development costs and total magnitude of
these costs for each individual product and compared with product revenue.

c) Each phase of the product life-cycle poses different threats and opportunities that may require
different strategic actions.

d) Product life cycle may be extended by finding new uses or users or by increasing the consumption
of the present users.

Elements of Life cycle cost

A clear picture of life cycle cost can be understood by the following diagram-

Types of Life-cycle costing

There are two types of life-cycle coting:
(a) Product Life-cycle costing

(b) Project Life-cycle costing

A. Product Life-cycle Costing:

The life-cycle of a product or service begins in the following order:
i. Identification of new consumer need or new need of existing consumer.
ii. Invention of a new product and get it patented.
iii. Development of new product to make it saleable.
 iv. Manufacturing/producing the product.
v. Expansion of market with product’s market acceptability.
vi. Entrance of competitors with rival/initiation products and diminishing of product’s
market.
vii. Gradually product is degenerated.

Stages of Product Life Cycle Costing:

Following are the main stages of Product Life Cycle:
i. Market Research: It will establish what product the customer wants, how much he is
prepared to pay for it and how much he will buy.
ii. Specification: It will give details such as required life, maximum permissible
maintenance costs, manufacturing costs, required delivery date, expected performance of
the product.
iii. Design: Proper drawings and process schedules are to be defined.
iv. Prototype Manufacture: From the drawings a small quantity of the product will be
manufactured. These prototypes will be used to develop the product.
v. Development: Testing and changing to meet requirements after the initial run. This period
of testing and changing is development. When a product is made for the first time, it rarely
meets the requirements of the specification and changes have to be made until it meets the
requirements.
vi. Tooling: Tooling up for production can mean building a production line; building jigs,
buying the necessary tools and equipment’s requiring a very large initial investment.
vii. Manufacture: The manufacture of a product involves the purchase of raw materials and
components, the use of labour and manufacturing expenses to make the product.
viii. Selling
ix. Distribution
x. Product support
xi. Decommissioning: When a manufacturing product comes to an end, the plant used to
build the product must be sold or scrapped.

To accumulate the expenses incurred on all the above activities is the essence of product lifecycle
costing. Thus, product life-cycle costs involve the expenses on stages from designing to development
of product/service, on introduction in the market, selling & distribution and finally on its
abandonment from the market.

Purpose of Product Life-cycle Costing

Life-cycle costing in general provides a comprehensive accounting of product’s costs right from its
inception to abandonment and this helps design-makers to understand the cost consequences of
manufacturing that product and also to identify the areas where cost reduction efforts are desirable
and effective. The major purposes of life-cycle costing are as follows.
1. To help in developing a sense of total costs associated with a product; this will help in identifying
as the profits earned during manufacturing phase would cover the costs in development &
decommissioning phase.

2. To identify a product’s environmental cost consequences and to initiate action for reducing or
eliminating such costs.

3. To help in identifying the planning and decommissioning costs during the product and process
design phase, so that costs in that phase be managed and control.

Benefits of Product Life Cycle Costing:

Following are the main benefits of product life cycle costing:
1. It results in earlier action to generate revenue or lower costs than otherwise might be considered.
There are a number of factors that need to be managed in order to maximise return in a product.

2. Better decision should follow from a more accurate and realistic assessment of revenues and costs
within a particular life cycle stage.

3. It can promote long term rewarding in contrast to short term rewarding.

4. It provides an overall framework for considering total incremental costs over the entire span of a
product.

B. Project Life-cycle costing

“Project life-cycle costing includes costs associated with acquiring, using, caring for and disposing of
physical assets.” At the same time costs generated by the acquisition, use, maintenance and
replacement of permanent physical assets in respect of feasibility studies, research design,
development, production, maintenance, replacement and disposal as well as support, training and
operating are also included in project life-cycle cost.

Thus, life cycle costing, or whole-life costing, is the process of estimating how much money you will
spend on an asset over the course of its useful life. Whole-life costing covers an asset’s costs from the
time you purchase it to the time you get rid of it. In contrast to product life-cycle costs, the project
life-cycle costs are incurred for fixed assets. The components of a project cost over its entire life
include the following.

i. Costs of research, design, testing, production, construction or purchase of capital

equipment i.e., cost of acquisition.
 ii. Costs of transportation and handling of capital equipment.
iii. Cost of maintenance of capital equipment.
iv. Costs incurred in operations like, energy costs, various facilities costs and utility costs.
v. Training costs.
vi. Costs of holding spare parts, warehousing etc.
vii. Costs of purchasing any technical data (information).
viii. Retirement and disposal costs at the end of economical life of the capital equipment.

Purpose of Project Life-cycle Costing Analysis

As mentioned, conducting a life cycle cost analysis helps you estimate how much an asset will cost
you over the course of its life. The following are the major purpose of project life-cycle costing
analysis
1. Choose between two or more assets: Using life cycle costing helps you make purchasing
decisions. If you only factor in the initial cost of an asset, you could end up spending more in the long
run. For example, buying a used asset might have a lower price tag, but it could cost you more in
repairs and utility bills than a newer model. Life cycle cost management depends on your ability to
make a smart investment. When you are deciding between two or more assets, consider their overall
costs, not just the price tag in front of you.

2. Determine the asset’s benefits: How do you know if you should buy an asset? Generally, you
weigh the pros and cons of your purchase. But if you only consider the initial, short-term cost, you
won’t know if the asset will benefit your business financially in the long run. By using life cycle
costing, you can more accurately predict if the asset’s return on investment (ROI) is worth the
expense. If you only look at the asset’s current purchase cost and don’t factor in future costs, you will
overestimate the ROI.

3. Create accurate budgets: When you know how much an asset’s total price is, you can create
budgets that represent your business’s actual expenses. That’s way, you won’t underestimate your
business’s costs. A budget is made up of expenses, revenue, and profits. If you underestimate an
asset’s cost on your budget, you are overestimating your profits. Failing to account for expenses can
result in overspending and negative cash flow.

Uses of Project Life-cycle Costing

The concept of project life-cycle costing is now widely accepted. It involves accounting for all costs
relating to capital expenditure decisions which may be incurred during its life-time. Project life-cycle
costing is specifically useful in the following cases:
i. When projects are to be operated in capital intensive industry.
ii. Where projects have sizeable on-going constructing programme.
 iii. Where projects depend on numerous and expensive items of plant with consequent
substantial replacement programmes.
iv. Where projects relate to major expansion.
v. Where projects contemplate the purchase or design or development of expensive new
technology.
vi. Where projects are sensitive to disruption due to down-time.

Life Cycle Costing Process

Life cycle costing is a three-staged process. The first stage is life cost planning stage which includes
planning LCC Analysis, Selecting and Developing LCC Model, applying LCC Model and finally
recording and reviewing the LCC Results. The Second Stage is Life Cost Analysis Preparation Stage
followed by third stage Implementation and Monitoring Life Cost Analysis. The three stages are as
follows-
Stage 1: LCC Analysis Planning:
The Life Cycle Costing process begins with development of a plan, which addresses the purpose, and
scope of the analysis.
The plan should:

i. Define the analysis objectives in terms of outputs required to assist a management decision.
ii. Make the detailed schedule with regard to planning of time period for each phase, the
operating, technical and maintenance support required for the asset.
iii. Identify any underlying conditions, assumptions, limitations and constraints (such as
minimum asset performance, availability requirements or maximum capital cost limitations)
that might restrict the range of acceptable options to be evaluated.
iv. Identify alternative courses of action to be evaluated. The list of proposed alternatives may be
refined as new options are identified or as existing options are found to violate the problem
constraints.
v. Provide an estimate of resources required and a reporting schedule for the analysis to ensure
that the LCC results will be available to support the decision-making process for which they
are required.

Next step in LCC Analysis planning is the selection or development of an LCC model that will satisfy
the objectives of the analysis. LCC Model is basically an accounting structure which enables the
estimation of an asset components cost.

Stage 2: Life Cost Analysis Preparation:

The Life Cost Analysis is essentially a tool, which can be used to control and manage the ongoing
costs of an asset or part thereof. It is based on the LCC Model developed and applied during the Life
Cost Planning phase with one important difference: it uses data on real costs.
The preparation of the Life Cost Analysis involves review and development of the LCC Model as a
“real-time” or actual cost control mechanism. Estimates of capital costs will be replaced by the actual
prices paid. Changes may also be required to the cost breakdown structure and cost elements to
reflect the asset components to be monitored and the level of detail required.

Targets are set for the operating costs and their frequency of occurrence based initially on the
estimates used in the Life Cost Planning phase. However, these targets may change with time as more
accurate data is obtained, from the actual asset operating costs or from the operating cost of similar
another asset.

Stage 3: Implementing and Monitoring:

Implementation of the Life Cost Analysis involves the continuous monitoring of the actual
performance of an asset during its operation and maintenance to identify areas in which cost savings
may be made and to provide feedback for future life cost planning activities.
For example, it may be better to replace an expensive building component with a more efficient
solution prior to the end of its useful life than to continue with a poor initial decision.