The Possibilities of Life Cycle Costing in Outsourcing Decision Making

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RESEARCH PAPER

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The Possibilities of Life Cycle Costing in Outsourcing Decision Making,

Changes in supply chains have an influence on both suppliers’ and customers’ business. In addition to pure products, the suppliers of machines and equipment offer different services to customers throughout products’ life cycles, which aims at securing long term revenues .The literature of life cycle costing is mostly conceptual in nature and there is little information about how the concept is applied or about the extent of its use. The paper is based on literature and on empirical evidence about the current practices of life cycle costing. The empirical data were gathered through two web surveys, which were supplemented by interviews. The literature review focused on life cycle costing and outsourcing.

Objective of the Study

  1. To find out what kind of information life cycle costing can provide in an ideal case.
  2. To find out what kind of information is needed in outsourcing decision making.
  3. To describe the present state of life cycle costing on the basis of two web surveys, supplemented by a series of interviews.
  4. To discuss the possibilities of life cycle costing in outsourcing decision making.

Methodology

Research process

The study of the present state of life cycle costing is based on two web surveys, which are supplemented by a series of interviews. The present state of life cycle costing in a rail transport supply chain was examined in the first study.

The study was carried out in autumn 2003 and the data were gathered using an interview study and a web survey. The interview study consisted of 16 interviews. 8 of the interviewees represented transport operators, 8 represented suppliers of rolling stock and subsystems and two of the interviewees represented other industries.

The web survey was aimed at European transport operators and suppliers of rolling stock. Separate questionnaires were aimed at both groups of respondents. A need for a further study of the present state of life cycle costing emerged on the basis of the study done in the rail transport supply chain.

The data were gathered in spring 2004 using a web survey. Separate questionnaires were aimed at the representatives of both the users and the suppliers of products. The perspective in both questionnaires was life cycle costs incurred in the operational phase of an asset. The issues dealt with in the survey were the definition of life cycle costing, life cycle costing in the purchase phase, monitoring of costs during the life cycle, problems and requirements for development in life cycle costing and the trend of outsourcing.

The design of the questionnaires might also have affected the results. Because the questionnaires consisted mainly of closed-ended questions, the answer choices might have led to particular answers. In addition, it is unlikely that the sample used in these studies captured the whole spectrum of practices related to life cycle costing. This is because earlier field studies have shown that, typically, LCC practices have not really spread throughout organizations but there are often only few individuals who actually are responsible for LCC. Thus, caution is needed in generalizing the results of this study.

Outcome of the Study

On the basis of the study, customers are quite interested in life cycle costs of products in the purchase phase. However, the studies indicate that the interest towards life cycle costing is smaller than the interest towards life cycle costs among customers. The situation is somewhat different in different parts of the rail transport supply chain, and customers are very interested in LCC calculations. Provision of LCC calculations to customers at the purchase phase is rare in other industries since LCC calculations are provided to customers always or quite often in 20.4 % of the companies, sometimes in 34.7 % of the companies and, in 44.9 % of the companies, calculations are usually not provided or they are not provided at all in the purchase phase. While estimating of life cycle costs is not quite common, in almost all cases the length of a product’s life cycle is estimated in some way in the purchase phase. The life cycle is determined on the basis of running time, calendar time or travelled distance, depending on the product.

LCC information does not play a crucial role compared to other factors in the purchase phase of products. The table below presents the most important factors affecting the purchasing decision. The table shows that the purchase cost is the most important factor in over half of the cases, even if the life cycle costs can be many times the initial purchase cost.

Factor Proportion of the cases (%)

Purchase cost 52.8

Performance of product 20.8

Something else 17.0

Life cycle costs 9.4

The defects related to reliability and validity of the results of the LCC calculations were considered to be the key reasons for why life cycle costs do not usually have an effect on purchasing decisions. The LCC calculations, which have been done by the suppliers of rolling stock, have an important role in the purchase contracts.

Conclusion

Decision of any kind made in business, affects the costs. Cost management is a challenging task due to a number of reasons thereby affecting he decisions *taken by a decision-maker. The decision-maker has to consider all the dimension of costs. The financial effects of outsourcing cannot be observed on the spot; as a portion of costs may occur during a longer period of time.

One of the main objectives of outsourcing is cost reductions and in a longer term, the utilization of cost management in outsourcing is quite rare. Due to this, companies generally don’t know the financial effects of outsourcing. As a result, companies do not usually know the costs associated with their operations of product, activity or process level. If the company is not aware of the costs, it is difficult to assess the economics of outsourcing and the cost effectiveness of a supplier or a customer company. This becomes important as the outsourcing trend continues. When companies outsource, indirect costs will transform partly into direct costs, which creates an illusion that costs become transparent. But this does not happen if we do not understand the cost behavior deeply. In other words, what is behind the price and what drives costs in a long run.

Life cycle costing is a tool for outsourcing. It can be used when the decision is being made. Also, it can be used after the decision has been made. Life cycle costing is not only forecasting but also monitoring the present situation. Outsourcing aims at long term cost reductions. Also, it identifies long term costs. Outsourcing is a means to achieve optimal cost effectiveness.

In contrast, the studies that focused on the present state of life cycle costing gave a more different impression. The potential that seems to exist cannot be utilized fully because of the problems with life cycle costing practices. The biggest problems include scarce data collection, insufficient collaboration between supply-chain which is due to the reason life cycle costing relies on few individuals even in big organizations.

The practical obstacles can be removed but this requires a lot of work. Both cost management tools and practices, and business processes have to be considered to gain benefits of LCC in outsourcing decisions.

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