Most organisations have costs associated with each stage of the production process, which means they can benefit from a costing method that accounts for the full lifecycle. This is known as lifecycle costing.
The phases of lifecycle costing
There are four key production phases, each of which has its own associated costs. These are design, manufacture, operation, and end of life.
Design: At this stage, there are costs associated with the research and development of the product to be created, as well as the cost of designing the product.
Manufacture: The manufacturing phase involves the costs of the material and labour associated with the product, as well as overhead costs.
Operation: The operation stage includes costs related to bringing the product to market. During this phase, there are distribution costs as well as advertising costs.
End of life: The final end of life phase is the disposal and decommissioning costs associated with the removal of the product.
Why use lifecycle costing?
More conventional costing methods tend to focus solely on the resources used during the manufacturing stage, including materials, labour, and variable overheads. However, it is difficult to determine true profitability without taking into account both total revenue and total costs, and so the costs that arise at every stage of the lifecycle need to be considered.
Companies that do not consider each of these stages when costing products risk missing out on the overall profit required, as there are costs they haven’t anticipated.
Using lifecycle costing not only helps organisations to better determine profitability, but also enables the kind of decision-making that results in higher profitability. With conventional costing, it can be easy to overlook the costs of things like research and disposal, meaning that total costs can creep higher than revenue. But with lifecycle costing, the organisation is always aware of the costs at every stage, and can address inefficiencies and overspending more effectively.
For example, a small toy manufacturing business might not take into account the cost of the 100 hours of research that goes into developing a new toy. Whether the research is carried out by a salaried staff member or someone hired externally, employing someone for this amount of time is a considerable cost.
Acknowledging this cost allows the business to determine whether this amount of research is profitable, and if not, to identify ways of reducing it for better profitability.
The benefits and drawbacks of different types of costing are covered in depth on our accounting courses.