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Life-Cycle Costing For Contract Manufacturers: Why It Matters

Posted by Charing Kam on May 3, 2018 5:30:15 PM
Charing Kam
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Life-Cycle Cost Analysis (LCCA), or Life-Cycle Costing (LCC), is a common concept in the world of procurement and manufacturing: It refers to the need to analyse all ‘costs of production, installation, usage and disposal, aiming at the minimum of the total cost’, as per a 1998 research paper, ‘Product Life Cycle Costing Applied to Manufacturing Systems’.

Instead of focusing on the cheapest cost price, LCC looks at a material’s entire life cycle (hence the term), and the need to include installation, operational, maintenance, and end-of-life costs to the overall buying cost of a material.

Life-Cycle Costing For Contract Manufacturers_ Why It Matters (1)

For example, when it comes to a raw material like steel, the initial purchase price can be higher than alternatives. However, stainless steel is known for its corrosion resistance, low maintenance requirements, and recyclability. These product ownership costs make stainless steel a value-for-money choice in the long run.

Why Is Life-Cycle Cost Analysis Important Now?

There are three main reasons why LCCA has resurfaced as an important factor for contract manufacturers:

  1. Price Wars Are Unreliable

Before the world was interconnected through the advent of the Internet, manufacturers tended to stay within their comfort zone, making price wars a straightforward comparison between a few vendors. Most vendors ended up specialising in their industries, leading to less competition as compared to current day.

Now, you can find anything on the Internet, and with that has come increasing buyer expectations. Contract manufacturers are thus faced with global competitors that will always find ways to produce products cheaper and quicker than them. Even China, the “world’s factory” for more than 10 years, has recently started losing contract manufacturing jobs to other Asian countries like Vietnam and India due to the latter’s lower wages and costs.

There’s a need for contract manufacturers to find another method to reduce costs without relying on pushing their own prices down to get the project.

  1. Low Prices Can Mean Low Quality

Besides the unreliable nature of price wars, competing based on price has also become undesirable for another reason. With the rise of the “world’s factory” in China, there was also an unfortunate increase in the perception that ‘low prices mean poor quality’.

When buyers find an abnormally low price point for a product, instead of rejoicing at their luck, they now wonder if the producer is cutting corners in order to hit those numbers. There’s hence a stigma attached to certain materials that are too low a price.

The effect is that contract manufacturers have the power to quote more profitable prices, but they still have to balance that price with their costs, ensuring that quality fade doesn’t happen.  

  1. Other Unseen Factors To Consider

The classic method to achieve cost reduction is to cut head count. At the same time, in the age of Industry 4.0, there’s an expectation that automation will be used on the factory floor. Both these factors, hence, bring up the age-old panic that workers’ jobs will be lost, either due to cost-cutting or redundancy. And while we don’t think that automation in general will be a threat, we think differently about cutting head count.

In our interconnected world, these voices can band together and make a lot of noise. If contract manufacturers sacrifice talent for the bottom line, that can come back to bite them in the future. Reputation is key when it comes to business, and often, factory locations were built to foster local talent and provide local jobs. By cutting those jobs to save costs, contract manufacturers risk their long-term sustainability in the region.

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That’s why LCCA has become popular again. With a focus on calculating the hidden costs behind product ownership, LCCA has become an alternative to the three issues above. It is cost-effective as the cost-cutting happens in terms of the entire product life cycle, leading to long-term benefits for the business.

How To Implement LCCA: Department Collaboration

Implementing Life-Cycle Cost Analysis can be tough, as it requires buy-in and time investment from each stakeholder. LCCA is a complex process, with the need to project and include factors such as:

  • Material costs
  • Tooling / Fabrication costs
  • Installation Costs
  • Labour costs
  • Inventory costs
  • Maintenance costs
  • Depreciation over time
  • Warranty / Replacement costs
  • Scrap value
  • Plant decommissioning costs

and more.

That will call for input from departments such as purchasing, accounting, production, and more. To sell the product, contract manufacturers will also have to include their sales teams, who will have to help inform stakeholders on the maximum price that customers are willing to pay, as well as the engineering teams, who will have to figure out the optimal configuration for product quality and low costs.

Summary

In the end, the aim of Life-Cycle Cost Analysis is to help choose the most economical materials to produce the most cost-effective product, and in the end, reduce costs as much as possible in the long term.

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With LCCA, there will be more accurate and realistic costing and pricing calculations, which will help contract manufacturers to be more profitable (and competitive) in the long run.

 

Looking for another tool that can help with accurate costing? Watch our CPQ demo video to see other configuration and calculation possibilities!

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Charing Kam

Written by Charing Kam

Charing is responsible for In Mind Cloud's Inbound Marketing initiatives. A content marketing enthusiast, she works to find out how consumers make decisions and aims to help them along the way.

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