Life-cycle, target and kaizen costing

Take the product's whole economic life into account

A profitable production month does not prove that a product earns an adequate return over its life. Development, launch, service and withdrawal can create costs before and after the units appear in the production report. Life-cycle costing connects those commitments with the revenue expected from the entire offering.

This topic uses Harbour Display Co., a fictional supplier developing a fold-flat exhibition-display kit. All descriptions and figures are original illustrative assumptions. They are a learning model, not forecasts for a real product. Amounts exclude tax and financing unless stated otherwise.

The commercial stages of introduction, growth, maturity and decline help managers think about demand and investment needs. They are not a timetable every product follows. Demand may stop early, a redesign may extend use, and obligations to support customers can continue after new sales end. Forecast both the planned path and credible alternatives.

Concept sources: ACCA, Target costing and life-cycle costing — costs before, during and after production belong in an overall product assessment.

Distinguish cost commitment from cost incurrence

A design decision can determine future costs well before the resources are used. Harbour's choice of connector, packing dimensions and repair method influences later materials, assembly, freight and support. Changing those decisions after tooling and supplier arrangements are established may be expensive.

Cost commitment here means that earlier choices constrain future resource requirements; it is broader than the date an invoice arrives. Cost incurrence concerns resources consumed or obligations arising. Cash payment is another timing question. Keep these distinctions clear rather than assuming all three occur together.

There is no universal percentage of product cost fixed at one design milestone. The practical lesson is to investigate while alternatives remain feasible. A more expensive component can lower later support costs; a cheap design can impose repeated work throughout the product's life. The decision must compare the complete consequence.

For an existing product, a whole-life record remains useful for learning. However, costs already irreversibly spent are not made avoidable by placing them in that record. A decision to continue or withdraw should evaluate future consequences and relevant commitments, not attempt to recover a sunk cost through an uneconomic action.

Build a complete, consistent cost baseline

Assume Harbour expects to sell 5,000 kits at $240 each over three years. The initial life-cycle estimate is:

Revenue is $1,200,000, expected profit is $250,000, and average life-cycle cost is $190 per kit. The production figure of $128 alone would omit $62 per kit of other costs. It would therefore answer a different question from total product profitability.

Use one consistent boundary. Here the dedicated tools are counted once as a whole-life cost, without adding depreciation again. The closure estimate is net of any recovery proceeds included in it. In a real forecast, document dates, cost behaviour and uncertainty; avoid counting the same resource in both direct costs and overhead allocations.

Work backwards from price and the required return

Target costing asks what cost the offering can support at a credible selling price and desired profit. It does not establish that customers will buy or that the cost is achievable. Market evidence and a feasible design must support those assumptions.

Suppose Harbour requires a 25% profit margin on sales:

Be careful with the denominator. A 25% markup on cost gives target cost of $240 ÷ 1.25 = $192 and profit of $48. That is a 20% margin on the $240 price. Treating margin and markup as interchangeable would change Harbour's target by $12 per kit.

Keep the target separate from the forecast. The $180 ceiling expresses the desired economics; $190 is the initial estimate. Relabelling estimated cost as $180 does not remove the gap. Different service requirements, price points or sales volumes require a new consistent calculation.

The same logic can apply to a service. If Harbour offers an exhibition-planning support package, define what assistance and response level the customer receives before estimating staff time, systems and follow-up costs. Different customer requirements can make a single average misleading. Clear information and better scheduling may reduce avoidable work; removing necessary advice or quality checks changes the service rather than simply making it cheaper to deliver.

Preserve function while investigating the gap

Value engineering examines how the required function can be delivered economically. It involves understanding use, performance and alternatives, rather than simply buying the cheapest component. Harbour's kit must remain suitable for display, practical to assemble and dependable during use.

Concept sources: US Federal Highway Administration, The Value Engineering Process and Job Plan — function, alternatives, life-cycle costs and verification inform value engineering.

For an original proposal, the team investigates compatible packing, a more durable replaceable connector and a simpler assembly fixture. The connector costs more, but may reduce support work. Prototype tests and supplier quotations are needed; projected savings are not proven by a spreadsheet.

The revised estimate is $890,000, or $178 per kit. Making and packing falls to $118 per kit; support falls to $6; upfront development rises to $100,000. All other baseline assumptions remain unchanged. Expected profit becomes $310,000, a margin of about 25.8%, leaving $10,000 of cost headroom against the target.

The proposal improves total cost while deliberately increasing one component cost. Confirm that savings are feasible, independent and not double-counted. Do not treat a reduction in allocated overhead as a purchased-service saving. The $7 here is explicitly assumed to reduce the assembly contractor's charge.

Check demand and implementation assumptions

Harbour's revised forecast has $200,000 of costs treated as fixed for this illustration: development $100,000, tools/preparation $60,000 and closure $40,000. The other costs total $138 per kit: $118 making/packing, $14 selling/delivery and $6 support.

If volume is only 4,000 kits, with the same price and cost behaviour, total cost becomes $200,000 + $138 × 4,000 = $752,000. Average cost rises to $188. Revenue is $960,000 and profit $208,000, about 21.7% of sales. The 25% margin target permits cost of $720,000, so the forecast now has a $32,000 gap.

This does not mean lower volume always has precisely that effect. Capacity commitments, supplier prices and support requirements may also change. The calculation makes one sensitivity explicit. Examine uncertain benefits, implementation delay and customer acceptance as well as demand.

If the gap cannot be closed credibly, management can reconsider the offering, investigate a different value proposition, accept a lower return with explicit justification or decline the launch. Increasing the price on paper is not a solution without evidence of willingness to pay.

Reconcile lifetime profit with the need for early funding

For a simplified cash view of the revised design, assume 1,000, 2,500 and 1,500 kits are sold in successive years. Assume all sales and $138 variable costs are settled in the year shown, the $160,000 development/tools outlay occurs before launch, and the $40,000 closure payment occurs at the end. There is no working-capital balance, tax, financing, residual tool value or additional depreciation charge in this model.

The ending $310,000 reconciles to the revised whole-life profit under these simplified assumptions. It does not remove the early funding requirement or establish an adequate discounted return. A formal investment appraisal must consider timing, risk and the appropriate return, using the methods discussed in Module 4.

Continue improving costs after launch

Kaizen costing focuses on repeated incremental cost improvements during operation. It complements earlier target-cost work; it cannot reliably rescue every weak design after commitments have been made. Staff involvement, observation and testing help turn a reduction target into a practical change.

For a separate later operating review, assume the actual recurring making-and-packing baseline is $118 per kit. Harbour sets a 2% reduction target for the next comparable period: $118 × 98% = $115.64. Required reduction is $2.36 per kit.

The team proposes $0.90 less material waste, $0.70 lower purchased packing work and $0.60 less consumables use per kit, without reducing required quality. These original assumptions total $2.20, giving recurring cost of $115.80. The plan is useful but still misses the target by $0.16 per kit.

At 1,000 kits, the recurring benefit is $2,200. If training costs $1,000 once, the first-period net benefit is $1,200. Cost including that training is $116.80 per kit. Report both the recurring improvement and the implementation effect instead of choosing the more flattering number. These later possibilities are not added retrospectively to the preceding $890,000 launch forecast.

Concept sources: US EPA, Lean & Environment Toolkit, Chapter 4 — improvement work can investigate process-level inputs, waste and practical changes.

Standard costs provide a comparison basis; kaizen costing deliberately seeks improvement in that basis. Confirm actual results, explain unrelated price or volume effects and update methods when improvements are sustained. Repeated arbitrary cuts without a feasible process change are not continuous improvement.

Include returns, recovery and final disposal

The value chain also has reverse flows. Products may return for repair, refurbishment, recovery or disposal. Design and material choices influence whether those activities are practical. Keeping a relationship with users can provide information about failures and recovery opportunities.

Concept sources: US EPA, Sustainable Materials Management Basics — a life-cycle perspective considers resource use, reuse and end-of-life management.

Consider a separate illustrative cohort of 1,000 returned kits. Collection and sorting cost $5 each, or $5,000. Of these, 200 are refurbished for $12 each and sold for $25 each; 400 yield materials sold for $2 each; 400 cost $3 each to dispose of. Total costs are $5,000 + $2,400 + $1,200 = $8,600. Receipts are $5,000 + $800 = $5,800. Net cost is $2,800.

Recovery receipts therefore do not mean the programme is cost-free. This small cohort example illustrates what might inform a closure estimate; it is not an extra $2,800 charge to add to the earlier forecast. Other programme costs, timing and uncertain recovery rates need consideration.

Financial life-cycle costing and environmental life-cycle assessment answer related but different questions. A recovery route with a lower net cost does not automatically have a lower environmental impact. Transport, energy, material condition and safe handling can matter, as can employee and community effects.

Review the decision as evidence changes

Use clear ownership for design assumptions, cost estimates and later reviews. Compare actual defect patterns and service costs with the assumptions that justified the product. Feed what is learned into future designs rather than merely explaining a historical variance.

Self-check: Harbour's revised design costs $178 per kit against a $180 target. Does that establish that the launch will earn the required return?

Answer: It meets the target under the stated 5,000-unit forecast, but demand, price, implementation costs and support outcomes remain uncertain. The 4,000-unit case already shows a target shortfall. Check feasibility, sensitivity, cash timing and required performance before recommending launch. The target-cost result is part of the decision evidence, not a guarantee.

Sources and further reading

Study-guide reading: Strategic Management Accounting, Module 6, printed pages 306, 330–342 and 351–352 — value engineering, life-cycle and target costing, kaizen improvement, reverse flows and wider effects.

Concept sources: ACCA, Target costing and life-cycle costing

Concept sources: US Federal Highway Administration, Value Engineering Process and Job Plan

Concept sources: US EPA, Lean & Environment Toolkit, Chapter 4

Concept sources: US EPA, Sustainable Materials Management Basics