What is Life Cycle Costing?

Life cycle costing is the process of compiling all costs that the owner or producer of an asset will incur over its lifespan. These costs include the initial investment, future additional investments, and annually recurring costs, minus any salvage value. Life cycle costing is more heavily used by businesses that place an emphasis on long-range planning, so that their multi-year profits are maximized. An organization that does not pay attention to life cycle costing is more likely to develop goods and acquire assets for the lowest immediate cost, not paying attention to the heightened servicing costs of these items later in their useful lives - the result can be steadily declining profits, due to the increased servicing costs incurred.

Understanding Life Cycle Costing

The life cycle costing concept applies to multiple areas, including capital budgeting, procurement, engineering, and customer service. We examine these areas below.

Life Cycle Costing in Capital Budgeting

In capital budgeting, the total cost of ownership is compiled and then reduced to its present value in order to determine the expected return on investment (ROI) and net cash flows. This information is a key part of the decision to acquire an asset. In particular, the inclusion of maintenance costs over the full term of an asset’s project life could very well reduce its present value, resulting in reduced project viability, and possibly the decision to not invest in an asset at all.

Life Cycle Costing in Procurement

In the procurement area, the purchasing staff seeks to examine the total cost of ownership of an asset in order to place orders for those items that are the least expensive, in aggregate, to install, operate, maintain, and dispose of.

Life Cycle Costing in Engineering

In the engineering and production areas, life cycle costing is used to develop and manufacture goods that will have the least cost to the customer to install, operate, maintain, and dispose of. Over the long term, this can result in greater customer loyalty, and therefore more repeat sales. Customers may also be more inclined to recommend the company’s products to their associates, which is a free form of marketing.

Life Cycle Costing in Customer Service

In the customer service and field service areas, life cycle costing is focused on minimizing the amount of warranty, replacement, and field service work that must be performed on products over their useful lives. This analysis can lead to more robust products, once management realizes that sturdier products incur lower warranty and field servicing costs.