This life cycle cost concept truly links the “Assets” on the Balance Sheet to the “Operating Costs” on the Income Statement.
So, what is the big deal about life cycle costs? LCC is important because the acquisition value of an item plays only a small part in relation to the true costs associated with owning and oper- ating said item.
Stated another, simple way on the Successful Delivery Kit: “The cost of ownership of an asset or service is incurred throughout its whole life and does not all occur at the point of acqui- sition.”
The website continues: “There are 4 major benefits of LCC analysis:
evaluation of competing options in purchasing;
improved awareness of total costs;
more accurate forecasting of cost profiles; and
performance trade-off against cost.”
Maybe an example is in order …
According to a University of Michi- gan study, a 1991 Ford Escort Wagon listed at a manufacturer’s suggested retail price of $7,994.90;7 this study found that, at the optimal replacement interval of 17 years, there was a total cost of over $47,000, almost six times the acquisition value!
TCO is a fundamental decision support tool that presents a holistic view of costs across the enterprise, over time. It includes the people and process costs, in addition to the technology costs”.5
(It is interesting to note that the vast majority of Internet references to TCO involve IT assets. Thus it certainly appears that the IT establishment has bought into the concept.)
The Department of Defense, as a significant purchaser of goods and serv- ices, should have some good words on the subject and it does. The Defense Acquisition Handbook states: “Both DoD Directive 5000.1, The Defense Acquisition System, and DoD Instruction 5000.2, Operation of the Defense Acquisition System, make reference to Lifecycle cost and total ownership cost. This section of the Guidebook explains the meaning of each these terms. The
terms are similar in concept, but signifi- cantly different in scope and intent. For a defense acquisition program, Lifecycle cost consists of research and develop- ment costs, investment costs, operating and support costs, and disposal costs over the entire Lifecycle. These costs include not only the direct costs of the acquisition program, but also include indirect costs that would be logically attributed to the program. The concept of total ownership cost is related, but broader in scope. Total ownership cost consists of the elements of Lifecycle cost, as well as other infrastructure or business process costs not necessarily attributable to the program. Subsequent sections more carefully define and describe these concepts.6
Let’s stipulate that LCC is at least roughly analogous to TCO, and, to avoid confusion, use LCC throughout this article.
Why would someone spend $47,000 on an $8,000 vehicle? Hope- fully, the vehicle provides some sort of value justifying the expenditure. Per- haps the vehicle transports the owner to a job, where money is earned. Or, the owner may transport goods from point to point for some sort of consideration. In either case the owner feels justified in the investment of much more than the acquisition value over the life of the vehicle, hoping that the vehicle will provide reliable transportation for sever- al years.
This simple example demonstrates two very important, distinctly separate yet closely related concepts: purchase price versus life cycle costs.
These two concepts are usually depicted on two widely used and accepted documents that define the overall financial health of an organiza-
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