Cost Planning for the Product Life Cycle

Blocher,Stout,Cokins,Chen, Cost Management 4e The McGraw-Hill Companies 2008

The Cost Life Cycle

Cost life cycle refers to the following sequence
of activities:
R&D Design Manufacturing (or providing the service) Marketing/distribution Customer service

It is the life-cycle of a product or service from the

viewpoint of costs incurred
Blocher,Stout,Cokins,Chen, Cost Management 4e The McGraw-Hill Companies 2008

The Cost Life-Cycle (continued)

R&D

Design

Manufacturing

Marketing and Distribution

Customer Service

Upstream Activities

Downstream Activities

Design decisions account for much of total product life cycle costs
Blocher,Stout,Cokins,Chen, Cost Management 4e The McGraw-Hill Companies 2008

The Sales Life-Cycle

Sales life cycle is the sequence of phases in the
products or services life:
Introduction of the product or service to the market Growth in sales

Maturity
Decline Withdrawal from the market

It is the life-cycle of a product or service from the viewpoint of sales volume achieved
Blocher,Stout,Cokins,Chen, Cost Management 4e The McGraw-Hill Companies 2008

The Sales Life-Cycle

Important strategic cost management issues arise in each stage of the life-cycle.

Sales

Growth

Maturity Decline

Introduction

Time
Blocher,Stout,Cokins,Chen, Cost Management 4e The McGraw-Hill Companies 2008

Life-Cycle Costing
Life-cycle costing provides a more complete perspective of product costs and profitability
Managers need to be concerned with costs outside the manufacturing process because upstream and downstream costs can account for a significant portion of total life-cycle costs

The most crucial way to manage these costs is at the design stage of the product and the manufacturing process
Blocher,Stout,Cokins,Chen, Cost Management 4e The McGraw-Hill Companies 2008

Life-Cycle Costing (continued)

Decision-making at the design stage is critical because Decisions at this point commit a firm to a given production, marketing, and service plan, and lock in most of the firms life cycle costs
Blocher,Stout,Cokins,Chen, Cost Management 4e The McGraw-Hill Companies 2008

Life-Cycle Costing (continued)

Four common design methods:
Design Method Design Speed Design Cost Depends on desired complexity and functionality; should be relatively low Significant; materials, labor and time Modest Significant; design is an integral ongoing process Effect on Downstream Costs Can be very high because marketing and production are not integral to the design process Potentially can reflect a significant reduction Unknown; can have costly unexpected results if the scaling does not work in the market or in production Can result in greatest reduction
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Basic Engineering Fast

Prototyping

Slow

Templating Concurrent Engineering

Fast

Continuous

Blocher,Stout,Cokins,Chen, Cost Management 4e

Life-Cycle Costing Example

According to the traditional product-line statements below, ADI-1 appears to be the more profitable product

Product Line Income Statements Analytical Decisions, Inc. ADI-1 ADI-2 Total Sales $ 4,500,000 $ 2,500,000 $ 7,000,000 Cost of sales 1,240,000 1,005,000 2,245,000 Gross margin $ 3,260,000 $ 1,495,000 $ 4,755,000 R&D Selling and service Income before taxes
Blocher,Stout,Cokins,Chen, Cost Management 4e

2,150,000 1,850,000 $ 755,000

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Life-Cycle Costing Example (continued)

However, when upstream and downstream (i.e., life-cycle) costs are considered, ADI-2 is actually more profitable
Life-Cycle Costing Analytical Decisions, Inc. ADI-1 ADI-2 $ 4,500,000 $ 2,500,000 1,240,000 1,005,000 $ 3,260,000 $ 1,495,000 1,550,000 1,450,000 $ 260,000 600,000 400,000 495,000

Sales Cost of sales Gross margin R&D Selling and service Income before taxes

Total $ 7,000,000 2,245,000 $ 4,755,000 2,150,000 1,850,000 $ 755,000

Blocher,Stout,Cokins,Chen, Cost Management 4e

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Strategic Pricing
Strategic pricing decisions require information from: a) The cost life-cycle b) The sales life-cycle

The cost information for pricing is commonly based on one of four methods:
Full manufacturing cost plus markup Life-cycle cost plus markup Full cost and desired gross margin percent Full cost plus desired return
Blocher,Stout,Cokins,Chen, Cost Management 4e The McGraw-Hill Companies 2008

Strategic Pricing (continued)

Strategic pricing depends on the position of the product or service in the sales life-cycle
Phase 1 Intro.
Phase 2 Growth Phase 3 Maturity Phase 4 Decline

Pricing is set relatively high to recover development costs and take advantage of new-product demand
Pricing is likely to stay relatively high as the firm attempts to build profitability The firm becomes more of a price taker than a price setter and attempts to reduce upstream and downstream costs The firm is ready to scrap the product

Blocher,Stout,Cokins,Chen, Cost Management 4e

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Item

Sales LifeCycle

Use of Sales Life Cycle

Critical Success Factors Differentiation, innovation, performance Develop of financial resources and manufacturing capacity to sustain growth; development of distribution channels and marketing Effective cost control, quality, service; development of new product features Control of costs and effective distribution;reduction of capacity; timing of R&D Expenditures are very Price is set high to develop relatively high differentiation, because of demand innovation, and and differentiation performance Expenditures are high to maintain As above differentiation, innovation, and performance Target costing is used; price is set by a competitive market Value engineering is used to determine value/cost relationships through target costing None Strategic Pricing

Z300

Intro.

Y300

Growth

X300

Maturity

W300 Decline

Low price is set

Blocher,Stout,Cokins,Chen, Cost Management 4e

The McGraw-Hill Companies 2008

Chapter Summary
Target costing determines the allowable (i.e., target) cost for a product or service, given a competitive market price and a target profit The target costing approach involves five steps:
Determine the market price Determine the desired profit Calculate the target cost (market price less desired profit) Use value engineering to reduce cost Use kaizen costing and operational control to further reduce costs
Blocher,Stout,Cokins,Chen, Cost Management 4e The McGraw-Hill Companies 2008

Chapter Summary (continued)

Life-cycle costing provides a more complete perspective of product costs and product or service profitability because it considers the entire cost life cycle of the product or service Management accountants prepare information from both the perspective of the cost life-cycle and the sales life-cycle to help management make strategic pricing decisions
Blocher,Stout,Cokins,Chen, Cost Management 4e The McGraw-Hill Companies 2008