The total-life-cycle costing approach is a comprehensive way for managers to understand and manage costs through a product’s design, development, manufacturing, marketing, distribution, maintenance, service, and disposal stages. It refers to the process of managing all costs along the value chain. Using this approach can lead to substantial cost savings. By some estimates, 80-85% of a product’s total life costs are committed by decisions made in the RD&E stage, underscoring the importance of managing all costs along the value chain.
The three major stages of the total-life-cycle costing approach are (1) research, development and engineering (RD&E), (2) manufacturing, and (3) post-sale service and disposal.
Committed costs are those that the organization agrees must be set aside (or committed) to cover product costs through the three major stages of the life cycle. Costs incurred are the actual costs that the organization has paid out over the three major stages of the product life cycle.
The three substages of the RD&E stage are (1) using market research to assess emerging customer needs that lead to idea generation for new products, (2) product design, during which scientists and engineers develop the technical aspects of the product, and (3) product development, during which the company creates the features critical to customer satisfaction and designs prototypes, production processes, and any special tooling required.
During the post-sale service and disposal stage, organizations have to consider both the costs involved in providing service to products as soon as they are in the hands of customers, as well as the costs of ultimately disposing of the product. The following three substages typically occur during this stage: (1) rapid growth from the first time the product is shipped through the growth stage of its sales, (2) transition from the peak of sales to the peak in the service cycle, and (3) maturity from the peak in the service cycle to the time of the last shipment made to a customer; disposal occurs at the end of a product’s life and lasts until the customer retires the final unit of a product.
Target costing is a method of profit planning and cost reduction that focuses on reducing costs for products in the research, development and engineering (RD&E) stage of the total life cycle of a product. It also considers all aspects of the value chain and explicitly recognizes total-life-cycle costs.
The two essential financial elements needed to arrive at a target cost are the target selling price and the target profit margin. The target cost is the difference between the two.
For product development and target costing purposes, customers’ needs or requirements must be translated into product functions or components for engineering. A quality function deployment matrix relates information about customer requirements (that is, features that customers require) to a product’s functions or components. The matrix may also include a competitive evaluation of the product. In this way, the matrix highlights the relationship among competitive offerings, customer requirements, and a product’s design parameters. The matrix is used to compute functional (component) rankings of how important each component is to customers, and these rankings are in turn used to compute a value index (benefit/cost ratio) for each component. If the value index is less than one, the cost exceeds the benefit, and the component is a likely candidate for cost reduction in efforts to achieve the target cost.
Value engineering is a process in which each component of a product is scrutinized to determine whether it is possible to reduce costs while maintaining functionality and performance. Stated another way, value engineering is an organized effort directed at analyzing the functions of the various components for the purpose of achieving these functions at the lowest overall cost...
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