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Life-Cycle Costing: What You Need to Know

When talking about costing, we often first think about classical cost accounting concepts or marginal costing. However, there are other forms of cost concepts a management accountant should know of. One of them is life-cycle costing.

Definition of life-cycle costing

Life-cycle costing can be described as the accumulation of costs for all activities that occur over the entire life-cycle. Such costs include all initial investments, future expenditure later on as well as annually recurring costs.

There are two main areas of application. Firstly, product life-cycle costing is where we consider all the costs related to develop and market a product. Secondly, customer life-cycle costing is related to all expenses of acquiring and maintaining a customer. We now look further into both areas.

Product life-cycle costing

The CIMA official textbook mentions three factors that need to be considered to maximize a product’s return. Since we are dealing with a costing model, maximizing profit is meant in terms of generating low costs. These factors are:

  • design costs of a product
  • time to market
  • the length of the product life cycle

If a product life-cycle costing approach is applied, management information systems should be designed in a way to enable accounting for these three areas.

Graphic showing the product life-cycle

The design and development costs of products are typically a large proportion of all expenses that occur in the life-cycle. These costs would be minimized while not compromising on the quality.

Companies should aim at a short time to market. This not only reduces costs but also gives them a long time on the market with no or less competition. This is especially true for products related to new technologies.

The length a product stays on the market should be maximized. Doing this, the market can be served with relatively low costs as the design and development costs already occurred. A way to increase the product life-cycle is through market expansion, e.g. serving additional geographical areas or other customer segments.

Customer life-cycle costing

Another common approach is customer life-cycle costing. Here lies the focus in all the costs invested in gaining and maintaining a customer. This approach can often be seen in the service industry where no physical products are developed.

As an example, we could take a mobile phone provider. They aim to acquire and maintain customers while minimizing the costs related to all these activities. The lower the costs, the higher the profits will be.

Adrian

I'm Adrian, a chartered management accountant with many years of practical experience. I studied strategy, financial controlling and entrepreneurship in Switzerland and England.

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