The diagram shows that by the end of the design phase approximately 80% of costs are committed. For example, the design will largely dictate material, labour and machine costs. The company can try to haggle with suppliers over the cost of components but if, for example, the design specifies 10 units of a certain component, negotiating with suppliers is likely to have only a small overall effect on costs. A bigger cost decrease would be obtained if the design had specified only eight units of the component. The design phase locks the company in to most future costs and it this phase which gives the company its greatest opportunities to reduce those costs.
Conventional costing records costs only as they are incurred, but recording those costs is different to controlling those costs and performance management depends on cost control, not cost measurement.
A numerical example of target and lifecycle costing
A company is planning a new product. Market research information suggests that the product should sell 10,000 units at $21.00/unit. The company seeks to make a mark-up of 40% product cost. It is estimated that the lifetime costs of the product will be as follows:
- Design and development costs $50,000
- Manufacturing costs $10/unit
- End of life costs $20,000
The company estimates that if it were to spend an additional £15,000 on design, manufacturing costs/unit could be reduced.
(a) What is the target cost of the product?
(b) What is the original lifecycle cost per unit and is the product worth making on that basis?
(c) If the additional amount were spent on design, what is the maximum manufacturing cost per unit that could be tolerated if the company is to earn its required mark-up?
The target cost of the product can be calculated as follows:
(b) The original life cycle cost per unit = ($50,000 + (10,000 x $10) + $20,000)/10,000 = $17
This cost/unit is above the target cost per unit, so the product is not worth making.
(c) Maximum total cost per unit = $15. Some of this will be caused by the design and end of life costs:
($50,000 + $15,000 + $20,000)/10,000 = $8.50
Therefore, the maximum manufacturing cost per unit would have to fall from $10 to ($15 – $8.50) = $6.50.
Ken Garrett is a freelance lecturer and author