Actual statistics for component X
1.5 LIFE CYCLE COSTING -INTRODUCTION
(iv) Each phase of the product life-cycle poses different threats and opportunities that give rise to different strategic actions.
(v) Products require different functional emphasis in each phase-such as an R&D emphasis in the development phase and a cost control emphasis in the decline phase.
(vi) Finding new uses or new users or getting the present users to increase their consumption may extend the life of the product.
1.5.4 Various stages of product life cycle
Typically the life cycle of a manufactured product will consist of the following stages :
(i) Market research : Before any investment in made the investor must believe that what the company proposes to make can be sold at a price which will permit a profit to be made. This usually means that market research will establish what product the customer wants, how much he is prepared to pay for it and how many he will buy.
(ii) Specification : When market research has established what is to be made, it will be necessary to turn the general statement of requirements into a detailed specification which will tell the designer and manufacturing engineer precisely what is required. The design specification will give such details as required life, maximum permissible maintenance costs, maximum permissible manufacturing cost, the number required, the delivery date, the required performance of the product.
(iii) Design : With a precise specification, the designers can produce the drawings and process schedules which define the geometry of the product and some of the manufacturing processes.
(iv) Prototype manufacture : From the drawings it will be possible to manufacture a small number of the product. These prototypes will be used to develop the product and eventually to demonstrate that it meets the requirements of the specification.
(v) Development : When a product has been made for the first time, it is necessary to prove that it meets the requirements of the specification. In fact, when a product is first made it rarely meets the requirements of the specification and changes have to be made until it does. This period of testing and changing is ‘development’. Development can be very expensive and often generates a large negative cash flow before any products have been sold and hence, before any positive cash flows have been generated.
(vi) Tooling : When a product is shown to meet the requirements of the specification and if calculations suggest that it will be profitable, the decision will be made to make it to sell.
This is not a decision that will be taken lightly because, in many cases, the decision to make a product for sale is commitment to tool up for production. Tooling up for production can mean building a production line costing several lakhs of rupees, building expensive jigs, buying special purpose machine tools or, in some other say, making a very large initial investment.
(vii) Manufacture : The manufacture of a product involves the purchase of the raw materials, the purchase of bought out components, the use of labour to make and assemble the product, and the use of supervisory labour.
(viii) Selling : When the product is fit to sell and available, it may be necessary to spend money on a campaign to sell the product.
(ix) Distribution : In the process of selling the product, it must be distributed to the sales outlets and to the customers.
(x) Product support : When the product has been bought, the customer will expect it to be supported. The manufacturer or supplier will have to make sure that spares and expert servicing are available for the life of the product. The manufacturer or the supplier may even have to offer free servicing and parts replacement during the early life of the product.
(xi) Decommissioning or Replacement : When a manufacturing product comes to an end, the plant used to build the product must be re-used, sold, scrapped, or decommissioned in a way that is acceptable to society.
1.5.5 Product life cycle costing
It is an approach used to provide a long term picture of product line profitability, feedback on the effectiveness of life cycle planning and cost data to clarify the economic impact of alternatives chosen in the design, engineering phase etc. It is also considered as a way to enhance the control of manufacturing costs. The thrust of product life cycle costing is on the distribution of costs among categories changes over the life of the product, as does the potential profitability of a product. Hence it is important to track and measure costs during each stage of a product’s life cycle.
1.5.6 Features of product life cycle costing
Product life cycle costing is important due to the following features :
(i) Product life cycle costing involves tracing of costs and revenues of each product over several calendar periods throughout their entire life cycle. Costs and revenues can be analysed by time periods, but the emphasis is on cost and revenue accumulation over the entire life cycle for each product.
(ii) Product life cycle costing traces research and design and development costs etc., incurred to individual products over their entire life cycles, so that the total magnitude of these costs for each individual product can be reported and compared with product revenues generated in later periods.
Life cycle costing therefore ensures that costs for each individual product can be reported and compared with product revenues generated in later periods. Hence the costs are made more visible.
1.5.7 Benefits of product life cycle costing
The benefits of product life cycle costing are summarized as follows :
(i) The product life cycle costing results in earlier actions to generate revenue or to lower costs than otherwise might be considered. There are a number of factors that need to the managed in order to maximise return on a product.
(ii) Better decisions should follow from a more accurate and realistic assessment of revenues and costs, at least within a particular life cycle stage.
(iii) Product life cycle thinking can promote long-term rewarding in contrast to short-term profitability rewarding.
(iv) It provides an overall framework for considering total incremental costs over the entire life span of a product, which in turn facilitates analysis of parts of the whole where cost effectiveness might be improved.
Illustration
A company is considering the purchase of a new machine for Rs. 3,50,000. It feels quite confident that it can sell the goods produced by the machine so as to yield an annual cash surplus of Rs.
1,00,000. There is however some uncertainly as to the machine’s working life. A recently publish Trade Association Survey shows that members of the Association have between them owned 250 of these machines and have found the lives of the machines vary as under:
No. of year of Machine life 3 4 5 6 7 Total No. of machines having given life 20 50 100 70 10 250 Assuming a discount rate of 10%, net present value for each different machine life is as follows :
Machine life 3 4 5 6 7
NPV (Rs.) (1,01,000) (33,000) 29,000 86,000 1,37,000 You are required to advice whether the company should purchase a new machine or not.
Solution
Computation of NPV of an asset considering the prob. of life of machine.
Year Probability NPV Expected value
Rs. Rs.
3 20/250 (-1,01,000) (8,080)
4 50/250 (-33,000) (6,600)
5 100/250 (29,000) 11,600
6 70/250 (86,000) 24,080
7 10/250 (1,37,000) _5,480
26,480
1.6 VALUE CHAIN ANALYSIS