COST PLANNING FOR

PRODUCT LIFE CYCLE: LIFE-

CYCLE COSTING AND LONG-
TERM PRICING; TARGET
COSTING AND THEORY OF
CONSTRAINTS
CHAPTER 8
Life Cycle Costing
This chapter focuses on the time dimension of cost
management. Consideration is given both to (1) the effect of
the timeliness of operations on total costs and (2) the way in
which costs change over the life cycle of the product.
Product life cycle is consideration in each of two aspects:
a) The cost life cycle
b) The sales life cycle
Cost life cycle is the sequence of activities within the
firm that begins with research and development,
followed by design, manufacturing,
marketing/distribution and customer service.

Sales life cycle is the sequence of phases in the

product's or service's life in the market - from the
introduction of the product or service to growth in sales
and finally maturity, decline and withdrawal from the
market.
The methods helpful in analyzing the cost life cycle
are:
A. Life-Cycle Costing
B. Target Costing and
C. Theory of Constraints
Life-Cycle Costing is used throughout the cost life
cycle to minimize overall cost.

Target Costing is used for managing costs primarily

in the design activity.

Theory of Constraints is a method for managing

manufacturing costs.
A.COST MANAGEMENT FOR THE PRODUCT
LIFE-CYCLE

Life-Cycle Costing is a management technique used to

identify and monitor the costs of product or service
throughout its life cycle. It provides a long-term
perspective of product costs and product or service
profitability.
The sub-components of these costs follow:
Upstream costs
- Research and development
- Design (prototyping, testing, concurrent engineering and quality development)
Manufacturing costs
- Purchasing
- Direct manufacturing costs
- Indirect manufacturing costs
Downstream costs
- Marketing and distribution (packaging, shipping, samples, promotion,
advertising )
- Service and warranty (recalls, service, product liability, customer support)
The critical success factors at the design stage include:
Reduced time-to-market. The speed of product development and the
speed of delivery and efforts to reduce time-to-market are critical for a
business firm to sustain its competitiveness.
Reduced expected service costs. By careful simple design and the use
of interchangeable or modular components can reduce expected
service costs.
Improved ease-of-manufacture. The design must be easy to
manufacture in order to reduce production costs and speed production.
Process planning and design. The plan for the manufacturing process
should be flexible, allowing for fast setups and product changeovers,
using computer-integrated manufacturing computer assisted design
and concurrent engineering.
Common Design Models/ Model
Basic engineering. This is a method in which product designers work
independently from marketing and manufacturing to develop a design
from specific plans and specifications.
Prototyping. This is a method in which functional models of the product
are developed and tested by engineers and trial customers.
Templating. This is a design method in which an existing product is
scaled up or down to fit the specifications of the desired new product.
Concurrent engineering. Concurrent engineering or simultaneous
engineering, is an important approach in which product design is
integrated with manufacturing and marketing throughout the product's
life cycle.
COST MANAGEMENT OVER THE SALES LIFE
CYCLE

The sales life cycle is the sequence of phases in the

product's or service's life in the market from the
introduction of the product or service to growth in sales
and finally, maturity, decline and withdrawal from the
market. Sales are at first small, then peak in the
maturity phase and decline thereafter.
Phases of The Sales Life Cycle
Phase 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. Process are relatively high because
of product differentiation and the high costs at this phase. Product
variety is limited.
Phase 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.
Phase 3: Maturity Sales continue to increase but at a
decreasing rate. there is a reduction in the number of
competitors and of product variety. Prices soften further, and
differentiation is no longer important. Competition is based
on cost, given competitive quality and functionality.
Phase 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. In the first phase, the focus of management is on design,
differentiation, and marketing. The focus shifts to new product development and
pricing strategy as competition develops in the second phase. In the third and fourth
phases, management's attention turns to cost control, quality and service as the
market continues to become more competitive.

Strategic Pricing Strategy. The strategic pricing approach changes over the life cycle
of the product or service. In the first phase, pricing is set relatively high to recover
development costs and to take advantage of product differentiation and the new
demand for the product. In the second phase, pricing is likely to stay relatively high
as the firm attempts to build profitability in the growing market. Alternatively, to
maintain or increase market share at this time, relatively low prices might be used. In
the latter phases, pricing becomes more competitive, and target costing and life-
cycle costing methods are used, as the firm becomes more of a price taker rather
than a price setter and makes efforts to reduce and downstream costs.
Cost Management System. Together with the change in
strategy and pricing, there is a change in the cost
management system. At the introduction and into the growth
phases, the primary need is for value chain analysis, to
guide the design of products in a cost-efficient manner. As
the strategy shifts to cost leadership in the latter phases, the
goal of the cost management system is to provide the
detailed budgets and activity-based costing tools for
accurate cost information.
B. TARGET COSTING
Target costing is a technique in which the firm determines
the desired cost for the product or service, given a
competitive market price so the firm can earn a desired
profit.

Target Cost = Competitive Price - Desired Profit

Target costing is a very useful way to manage the needed

trade-off between increased functionality and higher cost.
Steps in Implementing a Target Cost Approach
1. Determine the market price.
2. Determine the desired profit.
3. Calculate the target cost at market price less
desired profit.
4. Use value engineering to identify ways to reduce
product cost.
5. Use kaizen costing and operational control to
further reduce costs.
ROLE OF VALUE ENGINEERING
Value engineering is used in target costing to reduce
product cost by analyzing the trade-offs between (1)
different types and levels of products functionality and (2)
total product cost. An important first step in value
engineering is a consumer analysis performed during the
design stage of the new or revised product. The consumer
analysis identifies critical consumer preferences that define
the desired functionality for the new product.
COST REDUCTION APPROACHES
Design Analysis is the common form of value
engineering for products in group two, industrial and
specialized products. The design team prepare several
possible designs of the product, each having similar
features that have different levels of performance and
different levels of performance and different costs. The
design team works with cost management personnel to
select the one design that best meets customer
preferences while not exceeding the target cost.
Cost tables are computer-based databases that
include comprehensive information about the
firm's drivers. Cost drivers include, for example,
the size of the product, the materials used in its
manufacture, and the number of features.
Group technology is a method of identifying similarities in
the of parts products a firm manufactures, so the same
parts can be used in two or more products, thereby
reducing costs. A point of concern in the use of group
technology is that, while manufacturing costs are
reduced, service and warranty costs might be increased if
a failed part is spread over many different models, with
the result that a product recall will affect many more
customers.
TARGET COSTING AND KAIZEN COSTING
The fifth step in target costing is to use kaizen costing and
operational control to further reduce costs. Kaizen costing occurs
at the manufacturing stage, so that the effects of value engineering
and improved design are already in place; the role for cost
reduction at this phase is to develop new manufacturing methods
(such as flexible manufacturing systems) and to use new
management techniques such as operational control, total quality
management and the theory of constraints to further reduce costs.
Kaizen means “continual improvement," that is, the ongoing search
for new ways to reduce costs in the manufacturing process of a
product with a given design and functionality.
C. THEORY OF CONTRAINTS
Theory of constraints is a process of identifying and
managing constraint in the making of products or in
the providing of services. It also describes methods to
maximize operating income when faced with some
bottleneck and some non-bottleneck operations. This
section presents one of the methods to improve
speed, Theory of Constraints (TOC) a technique used
to improve speed in the manufacturing process and
thus speed.
The Theory of Constraints defines three
measurements:
1. Throughput Contribution:
Revenues – Direct Materials and Cost of Goods Sold

2. Investments:
Sum of materials costs in direct materials, work-in-
process, and finished goods inventories; R&D costs;
and costs of equipment and buildings.
3. Operating Costs:
All costs of operations (other than direct materials)
incurred to earn throughput contribution. Operating
costs include salaries and wages, rent, utilities and
depreciation.