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.
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.