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4.6), also emphasises the need for the elimination of costs through design.
This leads to proactive cost management (the new paradigm), as opposed to reducing costs after they have been incurred, which is reactive cost management (the traditional paradigm).
Sakurai (1996:186) holds that the Japanese approach to life cycle costing differs from the approach adopted in the USA. While there is an explicit focus on trade-offs between the cost to the user and the manufacturing cost in the USA, the Japanese have actively tried to cope with the life cycle in the same way as quality costing, in order to improve reliability during the period in which a product or piece of equipment is used.
While Emblemsvag (2003:2) states that the Japanese were the first to use life cycle costing in cost management, Sakurai (1996:186) challenges the view that it is more popular in the USA and failed to take hold in Japan because of cultural differences between the two countries. For the Japanese, it is more important to make reliable, high-quality products than find a cost-benefit trade- off between manufacturing and user cost. It is also difficult to fully understand life cycle cost if the manufacturer and the user are in different organisations.
According to Brown and Yanuck (1980:2), life cycle costing is applied in the USA to every new weapon system proposed or under development. The defence and aerospace industries design their products in terms of life cycle objectives. This practice is known as design to cost. Life cycle costing, included in the frame of capital budgeting, has since been applied to an endless variety of projects and is a decision-making tool used in many businesses.
Life cycle costing will increase in importance in years to come. The post- purchase cost of labour, material and energy is likely to grow as long as inflation resists control efforts and the dependence on scarce energy sources continues. Life cycle costing can also contribute to the conservation of precious fuel supplies (Brown & Yanuck 1980:2-4; Dhillon 1989:introduction;
Emblemsvag 2003:2).
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Since life cycle costing is not suitable for any product or project, its feasibility of application will now be discussed.
2.3.1 Factors that may influence the economic feasibility of applying life cycle costing
Brown and Yanuck (1980:4) identify the following factors that influence the economic feasibility of applying life cycle costing:
Energy intensiveness. When energy costs are expected to be high throughout a commodity’s life cycle, life cycle costing should be considered.
Efficiency. When the efficiency of operation and maintenance cost has a significant impact on overall costs, life cycle costing will be beneficial when savings can be achieved to reduce these costs.
Life expectancy. If a commodity has a long life, costs other than purchase costs are important.
Investment cost. The larger the investments, the more significant life cycle cost analysis will become.
A building will satisfy all four of these criteria. Buildings use a great deal of energy, require many repairs and maintenance, have a long life span and are large investments. Other assets that satisfy these criteria are construction equipment, pollution control equipment, transportation vehicles, heating, ventilating and air-conditioning systems, farm equipment and hospital equipment.
The majority of metallurgical research projects have a duration of more than one year (see sec 5.6.2), require high technical sophistication (see sec 5.6.3) and have a budget of more than R1 000 000 (see sec 5.6.8). Because they are research projects, the efficiency of operation definitely has a significant impact on overall costs. Metallurgical research projects therefore also satisfy the criteria for the use of life cycle costing.
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The development of life cycle costing started during the late 1960s, but for various reasons, the idea took a long time to be applied.
2.3.2 Why life cycle costing took so long to be applied
Prior to the 1970s, fuel costs were insignificant, because resources were considered sufficient to provide unlimited energy at a low cost. In the 1950s and 1960s, inflation was extremely low, (between 1 and 2 %), but increased in the 1970s to between 5 and 9%. Operating and maintenance costs increased in relative importance. A lack of understanding of the concept and methodology of life cycle costing is another significant factor. The difficulty of estimating future cost also makes people reluctant to use life cycle costing.
For any cost management technique, the data necessary for effective analysis need to be identified and collected. When life cycle costing is used, it may be difficult to identify operating costs and to determine the interrelationship between running and capital costs. There may also be estimation problems, since the analysis takes account of costs over time. A lack of historical data may influence the decision to use life cycle costing. Inflation may also be a problem because all costs do not escalate at the same rate (Brown & Yanuck 1980:5; Flanagan & Norman 1983:19).
Two errors committed in the management of project costs, which could be solved by life cycle costing, are thinking that a project is completed before it actually is, and thinking the implementation is perfect when it is not (Taylor 1999:3A).
To determine how effective life cycle costing is, it is necessary to compare it with other cost management techniques.
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2.3.3 Life cycle costing compared to target costing and the value chain
The value chain (see sec 4.3.2) is a basic tool for systematically examining all the activities a firm performs, and the way the firm interacts is necessary for analysing the sources of competitive advantage.
Correia, Langfield-Smith, Thorne and Hilton (2008:50) define the value chain as a set of linked processes or activities that begins with acquiring resources and ends with providing and supporting goods and services that customers value.
The major difference between the value chain and the life cycle is that the former adopts the perspective of a specific company, while the latter follows the product. Many decision makers such as suppliers, producers and customers are involved in the life cycle. Because a longer chain of activities is involved, the time horizon is greater. The life cycle is therefore a more generic less limiting concept than the value chain (Emblemsvag 2003:24).
Garrison et al (2003:792) claim that life cycle costing draws extensively on the techniques of target costing (see sec 4.6). The target cost for a product is computed by starting with a product’s anticipated selling price and then deducting the desired profit. Target costing is more than just a pricing technique. Costs are not only passively measured but also managed. The aim of target costing is to choose product and process technologies that yield an acceptable profit at a planned level of output. Life cycle costing anticipates cost improvements during the manufacturing stage as well as recognising the importance of the design stage. This is sometimes referred to as Kaizen costing (see sec 4.5).
Target costing may reveal an unpleasant view of a company’s internal operations, exposing uncompetitive practices and processes that were hidden by traditional costing techniques. It may also be too time consuming. It may be appropriate in the car industry, which is based on lengthy product life cycles, and mature technologies, but less appropriate in industries such as electronics,
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where the rate of innovation is extremely rapid and time to market minimised.
Life cycle costing assumes a relatively orderly value chain with a dominant customer.
When target costs are specified, it is necessary to incorporate all the product’s life cycle costs (Hilton 2002:671).
When analysing life cycle costing, one should remember that almost every product has a finite cycle during which it has a place in the market before losing appeal as more attractive products appear. These life cycles will now be discussed.