Whole Life Costing

When you are buying products and services for your organisation it is important to know how much it is going to cost.

This is not as straight-forward as it sounds, because you need to take into account many factors. It is not just about the actual purchase price, as we shall explain here.

In procurement, organisations use a number of methods to look at the cost of supply of products and services, depending on their own requirements. These include:

Whole Life Costing (WLC): This is also known as Life Cycle Costing. It includes financial, environment and social costs, from planning and design to replacement and disposal.

Total Cost of Ownership (TCO): This is the total amount you pay to obtain and operate the product or service through to its disposal. 

Total Cost of Acquisition (TCA): This is the total amount you pay to obtain a product or service. It may include shipping costs, duties and taxes.  People sometimes use the term landed cost, which includes the price of the product, transportation fees, customs, duties, taxes, tariffs, insurance, currency conversion, crating, handling and payment fees.

 
To demonstrate how these methods apply we can look at the breakdown of costs as they occur in a typical lifecycle of a product. The diagram below shows how these costs are incurred over time:

The black line shows the quantities sold throughout the life of the product

The green line represents investment and eventually profit.

The product life cycle describes the stages a product goes through from the moment it is created until it is finally removed from the market. The true cost needs to be calculated through the whole cycle. There are six stages:

1. Research and development: researching and developing a product before it is released in the market. During this stage decisions are made about what materials to use and whether these materials are capable of being recycled. Are they toxic and harmful to the environment? Can we design the product so that it is easier to disassemble at stage 6. Can we make it more energy efficient and safe to operate?
2. Introduction: launching the product into the market
3. Growth: when sales are increasing at their fastest rate
4. Maturity: sales are near their highest level but growth is slowing.
5. Decline: final stage of the cycle, when sales begin to fall
6. Disposal: this is the stage when the product is disassembled and broken down for disposal.

What is important to remember is that you must consider all possible costs connected to the product or service you are buying. For example, the cheapest product on offer can turn out to be more expensive if you end up spending more on repairs and maintenance.

The costs you need to take into account can be split into the following groups: 

• Cost of acquisition
• purchase price
• delivery charge
• installation and commissioning
• training and support

• Cost of ownership
• fixed costs like tax and insurance for a car
• finance costs, such as interest on a loan
• depreciation and amortisation (writing off the initial cost of the asset as it ages)

• Cost of operation
• labour
• materials
• consumables
• energy supply and consumption
• contract and supplier management
• transaction costs
• environmental costs
• cost of change, for instance, a decision to use alternative materials

• Cost of maintenance
• specialist labour and tools
• spare and replacement parts
• reduced output with age
• frequency of maintenance
• recommended downtimes, including loss of earnings
• service and inspection requirements

• Cost of disposal
• re-sale
• ongoing liabilities
• decommissioning
• removal for sale or scrap
• re-instatement of land or buildings for alternative use

Calculating the total cost of products and services has a number of benefits.

• It will help your organisation to select the supplier who offers the best value for money over the life of the product or service.
• It will help you to build the case for investment. This might be important if the investment is big or if there are competing demands for money.
• It will help you to decide whether to buy or lease or, in some cases, to manufacture your own products. Other options might include outsourcing or sharing a product or service with another organisation.
• It will make your organisation more efficient and more competitive by identifying ways in which savings can be made.

You also need to be aware of limitations and disadvantages.

• Getting the information can be time-consuming and involve some cost.
• The information is not always available or is based on estimates that require certain assumptions to be made. For example, sales forecasts might be too optimistic.
• Working out the cost becomes more speculative when it involves products or services that have longer life cycle.

Whole Life Costing is favoured when an organisation is buying capital equipment. These usually have a high cost, are one-off purchases and are likely to involve a close, ongoing relationship with the supplier, particularly for maintenance. Contract documentation is usually complex. An example in healthcare is an MRI (magnetic resonance imaging) scanner.

A good rule to follow is that the bigger the investment, the greater the benefit of Whole Life Costing to your organisation.