A business incurs numerous costs over its life cycle. Different approaches are used in long-term planning for the business, profits, costs, and other departmental matters.
A contemporary approach of life cycle cost is becoming more common for capital budgeting, price setting, engineering, design costs, etc.
Unlike conventional costing, life cycle costing encompasses all the aspects of costs from the idea to the disposal of a product, service, or object.
The main idea behind the life cycle costing is to find every possible cost incurred before, during, after the production or sale of the product.
Life cycle costing is more like the economic analysis of the present and future costs. It is a more realistic approach to calculate the actual cost of production and set economic prices accordingly.
In this article, we’re going to discuss life cycle costing, how its better than conventional costing, its characteristics, benefits, process, and an example of life cycle costing?
What Is Life Cycle Costing?
Life cycle costing or LCC is defined as,
Life cycle costing is a costing approach that considers all the possible costs that will be incurred from the idea stage to the disposal of the product.
Life cycle costing is also called whole life costing. The business takes into accounts all the costs that will be paid during the lifespan of the product.
In the business, the product life cycle commonly has four stages: introduction, growth, maturity, and disposal.
When we say life cycle costing, it will add up all the costs. It includes costs of market research, designing the product, marketing it, selling, operating costs, after-sale costs(warranties), and safe disposal.
Life cycle costing is most commonly used by businesses as a method of manufacturing cost control.
It also helps in the analysis of the long-term profitability of an investment or acquiring an important asset. The discounted values are used for the analysis and finding the ROI.
The capital budgeting techniques extensively employ life cycle costing for the comparison of different alternatives. It helps identify the best option with the least cost and most profit in the long run.
Components Of Life Cycle Costing
Let’s talk about the characteristics or components of the life cycle costing. We will explain each cost that is incurred over the life cycle of a typical consumer product.
Here are the components or costs over the life cycle of a typical consumer product.
Before even the vague image of the product is made, market research is conducted to identify the problem that most consumer faces. After identifying the problem, the solution of the problem is sought by extensive analysis and research.
Data is collected, analyzed, results and findings are shared. All the costs incurred on the product’s market research are also part of the total cost.
Design and Development
The next stage is to design the product prototype, identifying the marketing budget, manufacturing costs, time to market, after-sale services.
In other words, the design and development stage includes all the decision-making, prototyping, and planning of the product’s future.
Now comes the manufacturing costs. It typically includes the material, labor, and overhead costs. The scope of manufacturing costs is from tooling to material procurement and finally making the finished product.
Tooling refers to the installation of any facility required for production.
Procurement is purchasing raw materials, and production starts. All these costs are part of the manufacturing stage.
Operating cost is a set of different costs incurred on the product once it is out of the manufacturing plant. These costs include selling costs, storing costs, distribution costs, and after-sale product support.
The final stage or the end of the product life is disposal. The disposal does not only involves the disposal of product but also decommissioning of the plant and facility.
After the product is discontinued from the market, the manufacturing facilities are disposed of and sold as scrap.
Process Of Life Cycle Costing
Now let’s come to the process of life cycle costing. The process of the life cycle costing relates to the stages of the product life cycle. The product life cycle costing process is performed at the design and development stage of the product.
It includes all the costs incurred for introducing the product to market, increased direct costs when the product is in the growth stage, maturity, and finally, the product discontinues. If we list down the steps involved in the life cycle costing, they’re as follow:
Step 1: The product life cycle is estimated, and its life is divided into different operating cycles. This step is also called operating profiling.
Step 2: The second stage is to identify the utilization factors. The utilization factors will dictate how the product will be used and the operating procedure.
For instance, it refers to all the stages involved in the product’s life cycle. It relates back to the components of the product life cycle costing we discussed above.
Step 3: The next step is to compute all related operations costs and identify cost-related parameters.
Step 4: The costs are discounted back to the present value for accurate calculation.
Step 5: All the costs are added, and the total life cycle cost of the product is output.
Let’s understand the operating procedure of the life cycle costing by taking a numerical example into account.
Company ABC has found a market gap for a consumer product. They’re planning to launch a product to solve the pertaining problem. After completing marketing research, the marketing team concluded that they should sell 10000 units at $25 per unit.
The company is expecting a markup of about 45% on the product cost. The lifetime costs of the stages of the product life cycle are estimated as follow:
Design and Development Stage Costs: $55000
Manufacturing Costs: $11/ unit
End of life costs: $22000
After the extensive analysis and discussion, the product development team estimates that an additional $10000 in design can reduce the manufacturing cost by $2 for each unit.
Let’s find out the original life cycle cost of the product:
Original life cycle cost per unit = ($55,000+(10,000 X 11)+22000) / 10,000 units
Original life cycle cost per unit = $18.7 per unit
However, if we look at the markup estimate of 40%, the product cost should not exceed $17.85 per unit. Therefore, the product is not worth manufacturing.
The design and development team suggested an additional cost of $10000 to reduce costs. The cost of design and end life cost,
= (55,000+10,000+22000)/10000 = $8.7
What will be the maximum cost per unit?
The manufacturing cost per unit will fall from 18.7$ to
$17.85- 8.7 = $9.15
Life Cycle Costing Vs. Conventional Costing
The existence or use of life cycle costing does not rule out the conventional costing approach. Both approaches are useful in business organizations.
However, the use of one approach might be more beneficial in a specific scenario.
Here are some of the differences between life cycle costing and traditional costing.
1. Conventional costing accounts for the costs and profit on a monthly, yearly, or quarterly basis. Whereas the life cycle is costing accounts for the cost for longer periods. It spreads to numerous calendar years.
2. Conventional costing is done periodically; therefore, it considers every event. As a result, profit is calculated periodically. Whereas the life cycle costing considers profit only after the end of the product’s economic life.
Benefits Of Life Cycle Costing
Here are some of the benefits offered by life cycle costing.
- It enables the business to take timely action for reducing costs and revenue generation.
- By use of life cycle costing, the company can decide either to plan a launch of the product or not. It gives a more accurate view of the costs and profitability over the complete life cycle.
- The concept is ideal for long-term planning.
- The life cycle costing enables the estimation of the incremental costs over a product’s life cycle.
Use Of Life Cycle Costing In Different Industries
What is the use of life cycle costing in different industries and departments of a business organization?
Life cycle costing supports different decisions diversely.
Capital budgeting encompasses life cycle costing to analyze different investment options. It helps in the identification of the best option with the lowest cost and higher return on investment.
Therefore, a business organization can decide to purchase an asset, invest in a project, etc.
The procurement department of any business also uses life cycle costing while finalizing the procurement order.
It takes into account the total cost of owning the supplies or products. The costs include installation, operating, Maintainance, and disposal costs in general. The least expensive option is chosen then.
Engineering And Production
We’ve already discussed the product life cycle costing. This aspect is most used in the engineering and production areas.
All the costs of designing, manufacturing, selling, customer services, and disposal are aggregated to decide the production of a product.
We have tried to comprehend the concept of life cycle costing. Its comparison with the counter approach, its uses in different industries, and why businesses should choose life cycle costing is also discussed.
We hope that you’re now more informed and educated about the purpose of life cycle costing. 😊