Strategic cost management is essential in improving organization performance, efficiency and effectiveness in the operation and increasing profitability of the organization. Strategic cost management techniques are imperative in ensuring the organization achieves a competitive advantage over its competitors.
There are various techniques used in management strategic costing, which include value chain analysis, activity based costing, target costing and business intelligence system. These strategic costing systems ensure that an organization gets a competitive advantage in the global market (Blocher, Stout, & Cokins, 2010). The increasing global competition has led to firms, developing costing and strategic management that facilitate achievement of a competitive advantage. Strategic costing systems and managements facilitate the development of mechanisms that improve efficiency in the operation of the organization and thereby improving profitability in the organization.
In this paper, life cycle costing will be our subject of analysis. An analysis of life cycle costing system will be provided, the implementation process, its applicability in Coca-Cola Company and in other organizations. The implementation process of life cycle costing will be important in this discussion as it provides new insights to decision makers.
Selection of this costing system is based on the need to consolidate all the costs relating from a product from the time the raw materials to the time the product is delivered in the market. Life cycle costing provides a sum of all direct, indirect, recurring, non-recurring and all other costs related to a product. This costing system include all the estimated costs in designing the product, development of the design, manufacturing, operations, support and maintenance of the developed system or product over its anticipated life.
The costing involves amortization of all the costs used in a process. The life cycle costing is important to organizations, which are evaluating the introduction of a new brand in the market or when planning to open foreign branches. The system will aid the organization in evaluating the feasibility of the proposed project and the cost associated to the project to facilitate planning and organization of the required resources. Establishing maintenance cost will be imperative to the organization in determining the sustainability of the proposed project with the resources designed for the project. In summary, life cycle costing will cover all the cost incurred and the estimated costs in all stages of a product life cycle (Blocher, Stout, & Cokins, 2010).
Life cycle costing system is a decision support tool that matches the purpose of the organization rather than the external financial reporting standards that obey special rigidities, guidelines and principles. Life cycle costing system also helps the organization in evaluating its key critical success factors, which it may use to cut cost, increase efficiency and facilitate competitive advantage. However, life cycle costing system should not be used in solitary, rather it should be used with other costing system as activity based costing, target costing and value chain analysis to ensure the right analysis has been done in evaluating a potential investment project (Finkbeiner, 2011).
There are various categories of life cycle costs relating to a project where some are more important and useful than others on a general basis. These costs can be generally categorized into acquisition costs and the cost of sustaining. However, this system of categorizing costs develops problems if there are costs of replacing and procuring equipments.
The system of categorizing costs must consider all types of costs i.e. usual, hidden, liability and less tangible costs in the whole lifecycle of the project. The primary usual cost includes costs relating to capital items, such as buildings and equipments. Expenses costs like labor, supplies, raw materials, utilities and disposals. The usual costs involve all the costs that are accounted in the traditional method of accounting and the traditional method of cost cutting involve cutting of such costs.
They are the major costs in an organization in the development of a new project or sustaining an existing one. Hidden cost is categorized as overhead costs in the traditional cost accounting are allocated proportionately to the direct costs. This has led to cost distortions and wrong allocations of cost have been made. Activity based costing was developed to deal with the shortcomings of overheads allocation to the direct costs (Stark, 2011). Life cycle costing system provides a mechanism through which these costs are identified and eliminated, since they are non value-added costs. Some of the hidden costs are the cost of monitoring equipments, additional technology and expenses relating reporting, training, inspections and testing. Liabilities costs are costs that arise from non-compliance and future potential liabilities. The costs are also referred to as contingent costs, since they are indeterminate.
These costs are categorized as overhead costs or extraordinary costs depending on the type of costs. These costs include the ones relating to employees injury, penalties, and future liabilities that may rise from the customer and natural resource damage. The costs are also categorized as relationship costs and they are difficult to estimate. The importance of contingent costs represents the cost of maintaining corporate social responsibility to the society, as the success of the company is not only defined by profitability but also the costs relating to maintaining a conducive environment.
The cost creates benefits, such as customer loyalty, workers morale, brand name and good stakeholders’ relations. Various costs are quantified in various degrees, depending on whether they are external cost or internal cost. The quantification of these costs has remained difficult, but the external costs are identified as the costs relating to the society, while the internal costs relate the maintenance of the internal operations (Dhillon, 2000).
There are four main ways of performing life cycle costing depending on resources available, time available, degree of accuracy and availability of data. There are benefits accruing to each type of the method. These methods include analogy, parametric, engineering cost method and cost accounting. Analogy method involves identification of similar products or component and adjusting its costs for differences. This approach is used when the massive factors relate to cost. This method simply classifies the costs historically, classifies, and scales them according to the most important costs.
The method has been largely used in the energy sector and in shipbuilding since extensive historical data is available. Such projects have large cost drivers, which form the basis of this analogous. Without these dominant cost drivers, there would be no basis for analogous formation. Parametric models method on the other hand is advancement of the analogous method and it is based on predicting the cost of a product or a component either in total or in disintegration into various components. It use models to explain the relationship between costs and products, process or the related parameters various variables are used in the prediction, these variables include the complexity of the manufacturing process, familiarity with the design, performance and compression of the schedule.
The difference between analogous method and the parametric method is that the analogous method is based on one cost driver while the parametric method is based on several cost drivers or variables. Analogous model also assumes a linear model of linear regression while parametric model assumes a non-linear model of linear regression. Engineering cost method of linear regression involves direct estimation of particular cost element by examining asset component (Emblemsvag, 2003). It is referred to as industrial engineering and it commonly used in engineering and development projects.
The model has led to development of the concept of just-in-time production, which uses time as a basis of cost absorption. It encourages manufacturing only when the there is demand for the product and stoppage of production if there is a problem with quality or demand of the product. Target costing has been developed from the concept of balancing the needs of the customer with the organization goal of maximizing profits. It is a system of profit planning and management of cost to suit price and customer design, which initiates management of cost in the early stages of product designing and development. It is applied throughout the lifecycle of the product and involves active use of the value chain.
Coca cola has been facing stiff competition from other non-alcoholic beverages companies such as Pepsi. This has led to rethinking of developing of the existing products non-popular brand and development of new products to counter the alarming rate of awareness about health issues related to consumption of carbonated drinks. To develop sustainable products the company will require evaluating the life cycle costs of introducing such products. The management costing methods are used collectively to ensure that the sound decisions are made by the organization (Venkataraman & Pinto, 2008). The application of the life cycle has been done due to an increasing trend in resource limitations.
Organizations need to optimize the available resources, and life cycle costing system helps the organization identify the life cycle costs involved in production. The inflation levels have been increasing and the organizations need to evaluate and estimate the future costs of generating the product. A well-structured life cycle costing system establishes the cost, including all the costs that may arise due to inflation. There has been an increased focus by organizations to reduce the costs involved in the production and operating costs. Establishment of the life cycle costs will aid the company in establishing and identifying the various methods and costs that can be minimized. The increasing competition by firms has led to firms developing strategic activities that will facilitate the firms to gain a competitive advantage.
Life cycle analyses the costs relating to a product and helps the organizations in procurement strategy. Life cycle costing also helps the organization to establish the dominant cost drivers in the organization. Strategic decision is made to ensure that the organization gains a competitive advantage, life cycle costing as a decision making tool provides the organization with strategic information that facilitates achievement of a competitive advantage (Boussabaine & Kirkham, 2004). Life cycle costing is also important in when the firm is selecting among various options assessing the available technology and providing the objectives that can be used to control the program. It provides an important tool to facilitate the forecasting of future budgetary needs of the organization. The system also facilitates in ensuring optimal training needs of the staff on the requirements of the new projects.
Life cycle processing helps the organization when evaluating competing projects of the organization. Life cycle costing facilitates selection of competing bidders and long range planning. It is useful in establishing controls over the existing products and decisions relating to replacement of depreciated equipments. However, lifecycle costing has various challenges such as lack of data that are used in the analysis. There are challenges also involved in use of historical data and the conditions surrounding it.
Errors in the estimation process may lead to gross mistakes by the management by making decisions relating to the firm based on the estimation bound with errors. The life cycle costing has its complexities and can only done by skilled personnel. For example, the industrial engineering model requires experts to implement. Many organizations lack the mechanisms and frameworks of collecting and storing of data that can effectively be used in the life cycle costing. It involves the use of large amounts of data in the analysis, which can lead to distortions, the establishment of relationships between various cost and conditions can lead to distortions which pose potential danger to the decision making process (Dhillon, 2000).
Life cycle costing is an important tool in decision, and the implementation process is critical in ensuring the validity of the system. There are various steps involved in the life cycle costing, which include development of the representative cost structure of the product or the project. The cost structure of the project involves determination of all the costs involved in the current period and the costs relating to future. These include all the contingent costs and costs arising due to inflation.
After determining the cost structure, data is collected to support the cost structure and cost-estimating relationships are developed from the cost data. Data collected may involve historical data and the various methods used in forecasting can be used to provide analyzes on the future costs (Stark, 2011). Estimation of the relationship between various costs involves the establishment of the behaviors of cost due to various changes in the conditions and factors that affect cost. This facilitates formulation of a complete lifecycle costing system, which is used to estimate the whole life cycle of the product costs.
The major cost drivers in the project are identified, which are instrumental in development of the model. If there is only one dominant cost driver, the analogous method may be used. However, if the dominant variable is more than one, the parametric method will be useful. Determination of the model to be used depends on availability of data and the decision-making process of the organization. Various strategic costing methods are also important in evaluating and determining the variables, which are critical in the decision making process. This model is then validated to establish its validity and accuracy in estimating the life cycle costs of the product. This information is represented in the table below (Finkbeiner, 2011).
The model above shows the various steps that can be used in the implementation of the life cycle costing system. The implementation process of the life cycle faces various challenges. There are uncertainties about the cost driving activities during the project life cycle. The estimations of the cost drivers are uncertain, due to the various business conditions and legal environment. The government can change the regulations regarding the invested project, which can lead to gross changes in the cost (Dhillon, 2000).
The expected costs involved in the implementation process are uncertain and keep changing from one period to the other depending on the economic conditions and the efficiency of the internal processes. In the implementation process of a brand new product life cycle costing there are no historical data relating to the products. This brings uncertainty on the market viability of the product and the estimation process that can be used to predict the demand for the product. The sustainability of the product and the maintenance requirements such as operating and support facilities of the product are uncertain.
However, for an existing product the life cycle costing management method can be an efficient strategic cost management, due to the availability of historical data, which can be used in the life cycle costing. The level of accuracy depends on the complexity of the integrated methods used with the cost increasing and an increase in complexity. For example, more accuracy will be achieved if an analysis is done on a larger amount of data.
The cost involved in the collection of a large amount of data may be high. In addition, the cost of analyzing large amount of data will be high since they involve the use of complex methods of analyzes operated by experts. The model used in the implementation process should include all the dominant cost drivers in the project and develop an appropriate scheme that can be used to structure.
In the implementation process, there are various methods that can be used to classify the costs, which include cost accounting, cash flow method and work breakdown system. The cost method of classification is based on the phases of the project life cycle of the project, this cost are classified according to phases, while the cash flow method involves all the cash that have been paid out in the implementation process. The model used in the implementation relates to cost components as a function of some explanatory decision variable (Finkbeiner, 2011).
Application of Life Cycle Costing Method in Government Agencies
Life cycle costing has been an important tool in some government agencies in the formulation of policies that ensure accurate cost estimation and effectiveness of the projects. For example, there are certain Acts and regulations that are in force and they require government agencies to conduct life cycle costing analyses on all major projects. These include large expenditure projects such as highway constructions.
The life cycle costing analyses is conducted in the initial stages of the project and the level of accuracy should always be consistent with the level of expenditure. For example, in the ministry of roads there are requirements to conduct a life cycle costing on all major constructions (Boussabaine & Kirkham, 2004). The process involves the development of rehabilitation, maintenance and repairs strategies for the period of analysis. The life cycle costing should also establish the expected life of the roads and an evaluation of the maintenance and rehabilitation strategies. The life cycle costing analyses should evaluate all the costs involved in the construction maintenance, rehabilitation and repairs of the road.
The user and non-user costs relating to the project should be identified in the model and estimated. The analyses should also develop the expenditure streams and compute the present value of the future estimated costs. The results of the project are analyzed using a deterministic or a probabilistic approach to evaluates and validate the strategies used in the project. The evaluation should identify the effectiveness of the strategies used in the project and recommend new strategies. The primary purpose of life cycle costing analyses is to quantify the long-term economic consequences of the initial construction decisions. There are various rehabilitation and maintenance strategies employed in the in the analysis of the project life.
These strategies are analyzed in the process to identify their success and alternative strategies that can be used over the period of the project. In estimating the useful life of the road, data is collected on the roads the selected contractor completed projects and their useful life and the guarantee given by the contractor. The cost involved in the construction involve all the direct cost involved such cost of raw materials, cost of direct labor, the preliminary engineering surveys, contract administration, supervision cost, all maintenance and rehabilitation costs. The analysis should provide the agency with details and information on whether to rehabilitate the existing roads or to construct new roads (Stark, 2011).
This analysis is important in guiding decision making and misinterpretation of data, otherwise, ineffective analyses of the data may lead to poor decision making. Coca Cola Company had ignored this analysis in the earlier years. For example, in 1985 the company did a blind testing and introduced a New Coke, which in their notion was better than the old Coke. There was an error when conducting the market research since preferred the old the old coke to the New Coke. When Coca Cola introduced the new coke in the market, the sales plummeted and the new product was a failure in the market.
According to consumers, the New Coke was like an imitation of the Pepsi Cola and there was a conception in the market that Pepsi was the original drink, while the New Coke was its imitation. This was a gross error in the marketing research and lack life cycle analyses of the product could have saved the company from the losses. The New Coke only lasted in the market for two months after which Coca Cola reintroduced the old coke under the brand classic Coke.
The cost involved in this switching of brands was high, but it served as a lesson to the company (Venkataraman & Pinto, 2008). These costs includes the cost of introducing the brand in the market, loss of profits due to rejection of the brand, cost of advertising in introducing the product, and many other costs involved in the marketing production and phasing out the introduced brand. If the company could have employed the life cycle costing process it could have identified the weaknesses of the strategies used in the introduction of the New Coke.
Life cycle costing method could have aided the company identify the various critical success factors, which could have led to a competitive advantage. The analyses could have enabled the company in the selection of the various alternatives available and analyze each of the alternatives. This could have enabled the company to make a choice of the most beneficial alternative that could lead to profitability.
In the current competitive global market, Coca Cola Company has been facing stiff competition from major brands like Pepsi. There has been an alarming awareness in the global market over the consumption of carbonated drinks due to health issues. These global shifts require the company to be innovative and creative in the introduction of new products through research and various analyses like life cycle costing (Dhillon, 2000).
Life cycle costing will be instrumental to the company in their initiatives to introduce new products and develop the existing products. Coca-Cola Company has a variety of products, which have not fully been established in the global market. To introduce these products in the market successfully the company will require performing various market research and analyses of the market (Emblemsvag, 2003).
Life cycle costing analyses will be imperative to the company if it is to achieve a competitive advantage in the global market. This analyses will be important will be important in structuring the costs involved in development of existing products or in the introduction of new products. The company will be able to identify the major cost drivers involved in the whole phase, starting from when the raw materials are bought to the time the final product is moved to the market.
As a tool of decision-making this analysis will provide coca cola company with information useful in the decision making process. The company should also make use of other management costing techniques such as activity based costing, value chain analyses, which are imperative in ensuring the company achieves a competitive. Life cycle costing will aid the company in making choices between various alternatives to ensure the choice selected facilitates achievement of a competitive advantage. It facilitates identification and classification of costs, which enable the company to identify the various ways it can minimize it costs. It will also facilitate the firm in identifying the dominant cost drivers, which can affect the operations of the company significantly (Emblemsvag, 2003).
In conclusion, strategic management is important in an organization in facilitating achievement of a competitive advantage. The various methods of used in strategic management enhances identification of the critical success factors of an organization. Life cycle costing is among the strategic management costing method, which analyses the cost of a project or a product from the initial stage to the time the product is delivered to the customer.
There are various models used in the life cycle costing, which include analogous model, parametric method and engineering method. There are different steps used in the process of life cycle costing implementation, this facilitates and ensures that the process achieves accurate results used in the process of decision-making. The analysis has been instrumental in various organizations such as the government and any contemporary organization that aim at achieving a competitive advantage. It is used in government agencies in large expenditure projects such as road construction and other decisions relating to large expenditure projects.
It facilitates structuring costs and identification of costs in the current period and in the future. In Coca Cola Company the analyses is important for the organization in facilitating achievement of a competitive advantage through the introduction of new products and improvement of the existing.