Strategic Cost Management for Product Life Cycles

12/4/2020 Strategic Cost Management| AE 23| BSAIS, BSIA, BSMA - FIRST CITY PROVIDENTIAL COLLEGE
Strategic Cost Management| AE 23| BSAIS, BSIA, BSMA

Cost Planning for Product Life Cycle
Lesson Presentation
Cost Management for Product Life Cycle
Life Cycle costing
Product life cycle is consideration in each of two aspects.
1. a) The cost life cycle

2. b) The sales life cycle
Cost life cycle
It is the sequence of activities within the firm that begins with research and development, followed by design, manufacturing, marketing/distribution
and customer service.
Sales life cycle
It is the sequence of phases in the product’s or service’s life in the market – from introduction of the product or service to growth in sales and finally
maturity, decline and withdrawal from the market.
1. Cost Management for the Product Life-Cycle
Life-Cycle Costing
Management technique used to identify and monitor the costs of products or services throughout its life cycle.
Sub-components
Upstream costs
Research and development

Design: prototyping, testing, concurrent engineering and quality development
Manufacturing costs
Purchasing
Direct manufacturing costs
Indirect manufacturing costs
Downstream costs
Marketing and distribution

Service and warranty
https://firstcityprovidentialcollege.neolms.com/student_lesson/show/1942120?lesson_id=9816112&section_id=33203973 1/9
Critical success factors at the design stage:
1. Reduced time-to-market.
2. Reduced expected service costs.
3. Improved ease-of-manufacture.
4. Process planning and design.
Common Design Models
1. Basic Engineering
This is a method in which product designers work independently from marketing and manufacturing to develop a design from specific plans and
specifications.
2. Prototyping
This is a method in which functional models of the product are developed and tested by engineers and trial customers.
3. Templating
This is a design method in which an existing product is scaled up or down to fit the specifications of the desired new product.
4. Concurrent engineering
It is also known as simultaneous engineering. It as important new approach in which product design is integrated with manufacturing and marketing
throughout the product’s life cycle.
Characteristics of the Four Design Methods
Illustrative Problem 1
Star Communications Technologies, Inc. has introduced a new phone so small that it can be carried in a wallet. Star invested PhP400,000 in research and
development for the technology, and another PhP800,000 to design and test the prototypes. Star predicts a four-year life cycle for this model and gathered
this cost data for the wallet phone.
Monthly Fixed Cost Variable Costs
Manufacturing costs PhP25,000 PhP20
Marketing costs 20,000 5
Customer costs 3,000 8
Distribution costs 5,000 15
Sales Prediction:
For price of PhP150 – average annual sales of 80,000 units
If the price of the wallet phone is PhP225, Star will have to increase the research and development costs by PhP100,000 and the prototyping costs by
PhP4000,000 to improve the model for higher price. Fixed customer service costs also would increase by PhP500 per month and variable distribution costs
would increase by PhP5 per unit to improve the customer level of PhP150, fixed marketing costs would reduce by PhP5,000 per month because of low price
would be the principal selling feature.
Required:
1. Determine the life-cycle costs for each pricing decision.

2. What price will produce the most profit for Star for the wallet phone’s life cycle?
Cost Management Over the Sales Life Cycle
Sales Life Cycle
The sequence of phases in the product’s or service’s life in the market from the introduction of the product or service to growth in sales and finally,
maturity, decline and withdrawal from the market.
Phases of the Sales Life Cycle
1. Phase 1: Product Introduction
There is little competition, and sales rise slowly as customers become aware of the new product or service.
Costs are relatively high because of high R&D expenditures and capital costs for setting up production facilities and marketing efforts.
Prices are relatively high because of product differentiation and the high costs at this phase.
Product variety is limited.
2. Phase 2: Growth
Sales begin to grow rapidly and product variety increases.

The product continues to enjoy the benefits of differentiation. There is increasing competition and prices begin to soften.
3. Phase 3: Maturity
Sales continue to increase but at a decreasing rate.

There is a reduction in the number of competitors and of product variety.
Prices soften further, and differentiation is no longer important.
Competition is based on cost, given competitive quality and functionality.
4. Phase 4: Decline
Sales begin to decline, as do the number of competitors.

Prices stabilize.
Emphasis on differentiation returns.
Survivors are able to differentiate their product, control costs, and deliver quality and excellent service.
Control of costs and an effective distribution network are key to continued survival.
Management Focus
First phase – design, differentiation, and marketing

Second phase – new product development and pricing strategy
Third and fourth phases – cost control, quality and service
Strategic Pricing Strategy
First phase – relatively high

Second phase – pricing is likely to stay relatively high
In the latter phases – pricing becomes more competitive.
Cost Management System
Introduction and growth phases – value chain analysis, master budgets

Latter phases – detailed budgets and activity-based costing
Problem 2: Sales Life-Cycle Analysis
The management accountant at the Aeron Manufacturing Company has collated these data in preparation for a sales life-cycle analysis on one of its
products, a leaf blower:
Required: Determine what stage of the sales life cycle the leaf blower is in.
Problem 3: Strategic Costing and Pricing:
Optic Care Inc. (OCI) manufactures specialized equipment for polishing optical lenses. There are two models – one principally used for fine eyewear (L-25)
and another for lenses used in binoculars, cameras and similar equipment (BL-10).
Required:
1. Calculate the product cost and product margin for each product.
2. A new competitor has entered the market for lens polishing equipment with a superior product at significantly lower prices – P750 for the BL-10 model
and P550 for the L-25 model. To try to compete, OCI has made some radical improvements in the design and manufacturing of its two products. While
the costing rates have stayed the same, the materials costs and activity usage rates have been decreased significantly:
Calculate the total product cost with the new activity usage data. Can OCI make a profit with the new costs, assuming the OCI must meet the price set by the
new competitor?
3. Why cost management method might be useful to OCI at this time and why?
1. Target Costing
Target Costing
It is a technique in which the firm determines the desired cost for the product or service, given a competitive market price so the firm can earn a
desired profit.
Target Cost = Competitive Price – Desired Profit
How to Reduce Costs to a Target Cost Level
1. Integrate new manufacturing technology using advanced cost management techniques such as activity-based costing and seeking higher productivity
through improved organization and labor relations.
2. Redesign the product or service.
Steps in Implementing a Target Cost Approach
1. Determine the market price.

2. Determine the desired profit.
3. Calculate the target cost at market price less desired profit.
4. Use value engineering to identify ways to reduce product cost.
5. Use kaizen costing and operational control to further reduce costs.
1. Role of Value Engineering
Value Engineering
Used in target costing to reduce product cost by analyzing the trade-offs between (1) different type and levels of product functionality and (2) total
product cost.
Benchmarking
Used to determine which features give the firm a competitive advantage.
Design Analysis
The common form of value engineering for products in industrial and specialized products.
Cost tables
Computer-based databases that include comprehensive information about the firm’s drivers.
Group technology
Method of identifying similarities in the parts of products firm manufactures, so the same parts can be used in two or more products, thereby
reducing costs.
1. Target Costing and Kaizen Costing
Kaizen
Means “continual improvement”, the ongoing search for new ways to reduce costs in the manufacturing process of a product with a given design
and functionality.
Illustrative problem
Required:
1. Calculate the target cost for maintaining current market share and profitability.
2. Can the target cost be achieved? How?
1. Theory of Constraints
A technique used to improve manufacturing process and speed.

It is the process of identifying and managing constraint in making of products or in providing of services.
Measurements of Theory of Constraints
1. Throughput Contribution
2. Investments
3. Operating Costs
Steps in Theory of Constraints
1. Identify the Binding Constraints

2. Determine the Most Efficient Utilization for Each Binding Constraints
3. Manage the Flows Through the Binding Constraint
4. Add Capacity to the Constraints
5. Redesign the Manufacturing Process for Flexibility and Fast Cycle Time
Problem 4
Basic data on Columbia Industries follow:
Columbia Industries manufactures electronic testing equipment. Columbia also installs the equipment at customer’s sites and ensures that it functions
smoothly. Additional information on the Manufacturing and installation departments is as follows:
Equipment Manufactured Equipment Installed
Annual capacity 400 units per year 300 units per year
Equipment manufactured and installed 300 units per year 300 units per year
Columbia manufactures only 300 units per year because the Installation Department has only enough capacity to install 300 units. The equipment sells for
PhP40,000 unit (installed) and has direct materials costs of PhP15,000. All costs other that direct materials costs are fixed.
Case 1
Columbia’s engineers have found a way to reduce equipment manufacturing time. The new method would cost additional PhP50 per unit and would allow
Columbia to manufacture 20 additional 20 units a year. Should Columbia implement the new method?
Case 2.
Columbia’s designers have proposed a change in direct materials that would increase direct materials costs by PhP2,000 per unit. This would enable
Columbia to install 320 units of equipment each year. If Columbia makes the change, it will implement the new design on all equipment sold. Should
Columbia use the new design?
Case 3.
A new installation technique has been developed that will enable Columbia’s engineers to install 10 additional units of equipment a year. The new method
will increase installation costs by PhP50,000 each year. Should Columbia implement the new technique?
Case 4.
Columbia is considering how to motivate workers to improve productivity. One proposal is to evaluate and compensate workers in the Manufacturing and
Installation departments in the basis of their productivities. Is the new proposal a good idea?
Problem 5. Theory of Constraints
Kable Inc. manufactures a part, XX3, used in automobiles. Three processes are involved in the production of XX3: drilling, inserting and packaging. Each
process performed at a separate workstation and has these performance characteristics:
The drilling function can drill 30,000 parts per hour.

The inserting function can inset 3,000 parts per 5 minutes.
The packaging function can package 10,000 parts per half hour.
How many units of XX3 can be manufactured in a week, and which process is the binding constraint?

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12/4/2020 Strategic Cost Management| AE 23| BSAIS, BSIA, BSMA - FIRST CITY PROVIDENTIAL COLLEGE

Strategic Cost Management| AE 23| BSAIS, BSIA, BSMA

Life Cycle costing

Product life cycle is consideration in each of two aspects.

1. a) The cost life cycle

Cost life cycle

Sales life cycle

1. Cost Management for the Product Life-Cycle

Research and development

Marketing and distribution

Critical success factors at the design stage:

Common Design Models

Characteristics of the Four Design Methods

Monthly Fixed Cost Variable Costs

Marketing costs 20,000 5

Customer costs 3,000 8

Distribution costs 5,000 15

For price of PhP150 – average annual sales of 80,000 units

For price of PhP180 – average annual sales of 60,000 units

For price of PhP225 – average annual sales of 48,000 units

1. Determine the life-cycle costs for each pricing decision.

Cost Management Over the Sales Life Cycle

Sales Life Cycle

Phases of the Sales Life Cycle

1. Phase 1: Product Introduction

Sales begin to grow rapidly and product variety increases.

Sales continue to increase but at a decreasing rate.

Sales begin to decline, as do the number of competitors.

First phase – design, differentiation, and marketing

Strategic Pricing Strategy

First phase – relatively high

Cost Management System

Introduction and growth phases – value chain analysis, master budgets

Problem 2: Sales Life-Cycle Analysis

Problem 3: Strategic Costing and Pricing:

Target Cost = Competitive Price – Desired Profit

How to Reduce Costs to a Target Cost Level

2. Redesign the product or service.

Steps in Implementing a Target Cost Approach

1. Determine the market price.

1. Role of Value Engineering

Used to determine which features give the firm a competitive advantage.

1. Target Costing and Kaizen Costing

A technique used to improve manufacturing process and speed.

Measurements of Theory of Constraints

Steps in Theory of Constraints

1. Identify the Binding Constraints

Basic data on Columbia Industries follow:

Equipment Manufactured Equipment Installed

Problem 5. Theory of Constraints

The drilling function can drill 30,000 parts per hour.

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