ELSEVIER
Information & Management 28 (1995) 261-269
Applications
A design and implementation model for life cycle cost
management system
Nazim U. Ahmed
*
Department of Management, Ball State University, Muncie, IN 47306, USA
Abstract
Design-to-cost is a management philosophy that emphasizes the selection and design of a system based on
minimizing life-cycle cost. In some instances, systems alternatives are evaluated using such analysis, but actual
implementation of design-to-cost philosophy throughout the entire system life is an exception rather than the rule.
Management's lack of planning makes it difficult to implement this important philosophy. This paper analyzes and
identifies the issues and provides a framework for design and implementation of a life-cycle cost management
system.
Keywords: Design-to-cost; A-B-C classification; Life-cycle cost; Cost break down structure; System life-cycle; Critical
success factor; Cost database
1. Introduction
American businesses have experienced many
fundamental and structural changes within the
last decade. Many of the major corporations who
once had virtual monopoly, now have to face
tough competitions. This is also true about
medium-sized and small businesses. One of the
major ingredients of being competitive is to lower
the costs of production and or service delivery.
Design-to-cost philosophy states that all procurement decisions should be based on cost
spread over the entire life of the system [5]. The
goal is to minimize the total life-cycle cost. Lifecycle cost includes research and development,
* Corresponding author. Phone: 317-285-5302
installation, and operation throughout the entire
system life. This concept has a long history of use
in the U.S. Department of Defense for evaluating
new weapons system. Non-defense related industries also apply this concept to their major procurement decisions. However, often in both defense industries and also in the private sectors
the cost goals are not achieved due to lack of
proper planning and control of management tasks
at different stages of the life-cycle.
For a complex system it is easy to loose sight
of many of the cost elements to be incurred in the
future. Also, for simplicity, managers may assume
that there is no significant differences between
the ownership cost of alternative systems. Another reason for life-cycle costing being not effectively used is the short term view of the management in the United States. Generally, the managers are rewarded for saving money on an imme-
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Nazim U. Ahmed / Information & Management 28 (1995) 261-269
diate basis, ignoring significant potential expenses
in the long run.
Recently, because of competitive environment
many companies are trying to streamline their
production and service delivery systems by investing billions of dollars in technologies like robotics,
C A D / C A M [22], group technology, flexible manufacturing system, artificial intelligence [8] and so
on. In many instances, the decisions for procurement of new system or modification of existing
systems may be based on initial cost or costs to be
incurred in the very near future. This approach
even though convenient may be not be economically competitive in the long run.
It is only logical that any major procurement
decision should be based on life-cycle cost analysis. However, selection of a system based on
life-cycle cost alone is not enough. It is important
that the cost goals are achieved through proper
planning, and execution of management activities. Various cost models such as parametric cost
estimating models [3,11], replacement model [16]
and others [1,7,10,13,23,24] exist that attempt to
analyze and integrate different life-cycle cost fac-
Establishing
I design-tocost goals
I/
Acquisition [/
Phase
1\
Policy
I Devel°ping
I cost database,
initial IS &
I eStarfig?tatingc°st
Strategic
Acquisition
Operational
I ~
]
I
Identifyingthe
critical success
factors
Policy
Operation
Strategic
] ofgy n
\
Operation
Phase
] \lo ratio.
cm°srring
?I
Fig. 1. A planning frameworkfor design-to-costphilosophy.
Operational
263
Nazim U. Ahmed / Information & Management 28 (1995) 261-269
search and development, to design and installation. Operation phase includes all the activities
during the actual operation of the system. The
major management tasks in the acquisition phase
involve establishing the design-to-cost goals, developing the initial information system and estimating cost targets, and identifying the critical
success factors [6,12,14]. The major management
tasks in the operation phase include modification
of the IS and operations cost monitoring and
control. The IS and database developed in the
acquisition phase can be used, with some modifi-
tors analytically. Problems arise during the actual
design, implementation, and operation of the system as many of the design-to-cost goals are not
met. This paper describes a framework for implementing the design-to-cost philosophy by achieving cost goals at different phases of the systems
life.
Fig. 1 provides an outline of the framework
developed in this paper. The stages of the system
life-cycle are condensed into: (1) the acquisition
phase and (2) the operation phase. Acquisition
phase includes all the activities ranging from re-
I
Initial
Cost
ComputerSystemLCC
Operation
Cost
I
C)
l
Disposal
Salvage
Value
Disposal
Cost
I Feasibility
~t~' II Training II Purchase
Initial I I Installation
¢
[I
Vendor
Installation
I OperatorsII ManagerII Programmer/Analyst
Hardware
II
Pilot
I Software
I
** ~¢
SoftwareModifications
I
Fig. 2. An exampleof a cost breakdownstructure.
System I
Testing
264
Nazim U. Ahmed / Information & Management 28 (1995) 261-269
cation, in the operation phase. It should be emphasized that the management modules should
be in place before the actual start of that phase.
For example, the information system for acquisition phase should be in place before the initiation
of the acquisition phase.
been simplified. All cost items and their relationship may not be known by a single person. If it is
large then it is impossible. A satisfactory framework may be obtained through an interdisciplinary and iterative process. In the cost break
down structure, it should be possible to isolate
the costs in different categories for management
reporting and control purposes.
2. Acquisition phase
3.2. A-B-C analysis of cost break down structure
The major management tasks in this phase are
described below.
3. Establishing design-to-cost goals
Design-to-cost goals consist of the target minimum for different categories of cost spread over
the entire service life. The important vehicle for
establishing the cost goals is the cost break down
structure (CBS) [4]. The process involves developing a satisfactory CBS and then the CBS framework is analyzed in terms of importance of cost
items using a technique called A-B-C analysis
[221.
3.1. Developing the cost breakdown
framework
structure
The idea is to breakdown the total system
life-cycle costs into hierarchical cost categories.
These are generally established on the basis of
functional activity areas, major element of a system, classes of common cost items, etc. A cost
break down structure should satisfy three major
requirement.
(1) identify major items or significant activities
and be well defined having the same meaning
throughout the entire organization.
(2) be designed in such a manner that it is possible to identify the impact of cost change in a
particular area without affecting the other
areas.
(3) be compatible with the data requirements for
management cost reporting and control.
Fig. 2 shows a hypothetical cost break down
structure for a computer system. The cost break
down structure in this example is general and has
A-B-C analysis is a technique frequently used
in the operations management and quality control. It is derived from a simple but very important concept called the " p a r e t o " principle. A
manager should identify and distinguish between
the "vital few" and the "trivial many" items. For
attaining efficiency and profitability, one should
put more emphasis on the "vital few" items. The
" A " items are those that are few in number but
critical, in the sense that they constitute a significant portion of the costs. " B " items number more
than " A " items and are moderately critical. "C"
items may number in the hundreds but together
constitute a minor portion of the total cost.
In the illustration, " A " items are marked with
. . . . . . . , " B " items are marked with . . . . . . while
" C " items are not marked. The A-B-C analysis
should be done at a level of cost break down
structure where the costs are specific. For example, initial cost, and operation cost are extremely
important, since they are at the top of the cost
break down structure. However, classifying them
as " A " items will not reveal useful information
for cost control purposes. Thus, hardware and
software costs were designated as " A " items, but
not all of their child necessarily will be "A".
Once the cost break down structure is analyzed,
it is important to design the management control
and reporting system so that the " A " items are
most emphasized and the " C " items least.
4. Developing cost database and initial information system
It is extremely important to develop a cost
database [21] and management information sys-
Nazim U. Ahmed / Information & Management 28 (1995) 261-269
t e m for cost m o n i t o r i n g a n d control. T h e cost
b r e a k d o w n s t r u c t u r e is an e x t r e m e l y i m p o r t a n t
i n p u t for t h e d e s i g n o f a cost i n f o r m a t i o n system.
T h e e s s e n t i a l c o m p o n e n t s o f t h e initial IS a r e
t h e cost d a t a b a s e a n d cost d a t a d i c t i o n a r y [17]
t h a t s u p p o r t s t h e t h r e e i n f o r m a t i o n m o d u l e s (IM).
T h e p r o c u r e m e n t I M s h o u l d p r o v i d e o n - l i n e infl)rmation a n d g e n e r a t e r e p o r t on p r o c u r e m e n t
cost, l e a d time, v e n d o r i n f o r m a t i o n a n d o t h e r
related information. The planning and scheduling
I M s h o u l d g e n e r a t e i n f o r m a t i o n r e l e v a n t to p l a n ning a n d s c h e d u l i n g o f acquisition activities. T h e
cost m a n a g e m e n t I M s h o u l d e n h a n c e m a n a g e m e n t d e c i s i o n s u p p o r t by i n c o r p o r a t i n g m o d e l s
a n d t e c h n i q u e s for cost analysis, s i m u l a t i o n , fut u r e cost a n d v a r i a n c e forecasting, etc.
T h e d a t a d i c t i o n a r y a n d d e s i g n o f cost d a t a b a s e
a r e critical. T h e d a t a b a s e d e s i g n s h o u l d s u p p o r t
t h e p l a n n i n g activities in r e l a t i o n to t h e CBS. T h e
p u r p o s e o f the d a t a d i c t i o n a r y is to p r o v i d e d o c u m e n t a t i o n o f d a t a s t r u c t u r e s a n d s e m a n t i c s with a
b r i e f d e s c r i p t i o n o f use, p o s s i b l e r a n g e s o f values,
265
sources etc. This will p r e v e n t c o n f u s i o n of the
m e a n i n g o f t h e terms.
F i n a l l y t h e IS should: (1) p r o v i d e s u m m a r y
i n f o r m a t i o n to t o p m a n a g e m e n t , (2) p r o v i d e routine r e p o r t s to d e p a r t m e n t a l m a n a g e r s , 3) continuously m o n i t o r critical cost c o m p o n e n t s a n d p r o vide e x c e p t i o n r e p o r t s .
5. Establishing cost targets
Cost b r e a k d o w n s t r u c t u r e is t h e m a i n vehicle
t h a t i d e n t i f i e s d i f f e r e n t cost c o m p o n e n t s a n d t h e i r
r e l a t i o n s h i p s . Cost t a r g e t s a r e t h e a c t u a l value o f
t h e cost c o m p o n e n t s in t h e f r a m e w o r k . D e v e l o p ing t h e cost p r o f i l e s (i.e., p r o j e c t i n g costs over t h e
life-cycle) involves t h e following steps:
(1) W i t h i n e a c h cost c a t e g o r y in t h e cost b r e a k
d o w n s t r u c t u r e , e s t a b l i s h t h e cost e l e m e n t t i m e matrix. T h i s is t h e p r o j e c t i o n o f cost for
e a c h cost e l e m e n t over the life-cycle.
(2) F o r e a c h cost c a t e g o r y e s t i m a t e r e l e v a n t fac-
Table 1
Examples of mapping of CSF's at policy, strategic and operational levels
Phase/level
Policy
Strategic
Acquisition
1.0 Acquisition cost variation
should be less than 1%.
1.1 Construction cost variance
should be less than 1%
1.2 No construction delay
should be allowed
Operation
2.0 First two year cost
should be within budget
2.1 Monthly cost variance
should be less than 2%
2.2 No quarterly cost overrun
in "A" items
Operational
1.1.1 Monitor vendor purchase
cost weekly
1.1.2 Monitor construction cost
weekly
1.1.3 Report exception and take
immediate action
1.2.1 Compare progress with
schedule weekly
1.2.2 Project future monthly
schedule
1.2.3 Report exceptions and
anticipated actions
2.1.1 Monitor departmental cost
weekly
2.1.2 Project cost on a monthly
and quarterly basis
2.1.3 Report exceptions, anticipated
exceptions and actions
2.2.1 Review cost of "A" items
weekly
2.2.2 Project cost of "A" items
on a monthly and quarterly basis
2.2.3 Report exceptions and
actions
266
Nazim U. Ahmed / Information & Management 28 (1995) 261-269
tors for such variables as inflation, effects of
learning curves, discount rate etc., and adjust
the cost projection accordingly.
(3) Develop a hierarchical cost profile at each
level following the cost break down structure
framework.
For estimating the cost, a Life-cycle cost (LCC)
steering committee should be organized with
managers from each department affected by the
system. They should be knowledgeable in the
appropriate aspects of the system so that they
understand the short term and long term ramifications of the costs. The cost estimation should
ensure that managers:.
Step 1. Understand the cost break down structure in major cost categories.
Step 2. Decide who is responsible for cost estimation, reporting and control and concern with the assignments.
Step 3. Form a team in their own departments
for estimating costs assigned to them.
Step 4. Resolve the responsibility for those cost
elements, that fall into the "fuzzy" areas
by assigning cost to departments that are
closer to that cost centre or devising other
ways to resolve it.
Step 5. Review the " A " and " B " cost items to
see if there are any discrepancies in the
estimate.
Since most of these are future costs, it may be
useful to require three cost estimates for " A " and
" B " items. These estimates are pessimistic, most
likely and optimistic cost estimates similar to
PERT-cost.
level. CSF's for top management emphasize policies and guidelines. CSF's at the middle management or strategic level transforms policies into
strategies. At the operational level, strategies are
transformed into specific actions. Table 1 provides examples of mapping of CSF's. Here the
CSF at the policy level for the acquisition phase
is to keep the cost overrun to less than 2 percent
of the estimated amount. This can be transformed into CSF's at the strategic levels of monitoring construction cost variance and construction
cost delay etc. The CSF's at the operational level
would consists of monthly and weekly review of
construction cost etc.
7. Operation phase
Most of the system cost is incurred during the
actual operation throughout its service life [4]. It
is important that serious planning and control
effort are aimed at attaining the design-to-cost
goals during the operation phase. Basic planning
of the management tasks for this phase should be
done before hand and preferably even before the
system is acquired. This includes establishing the
cost goals, identifying the critical success factors,
cost management and reporting system etc. Also,
the planning and task coordination during the
acquisition phase should be performed by keeping in mind the integration requirement with the
operation phase.
8. Modifying the information system
6. Identifying critical success factors
Critical success factors (CSF) are important
variables [14,15] that can aid in the successful
implementation of a project. The idea was first
introduced by Daniel [9] was refined by John
Rockart [20] for designing IS. According to
Rockart, management should identify CSF before
designing or implementing an IS.
CSF should be established at the top management or corporate level, at middle management
or strategic level and also at lower or operational
The initial IS was geared towards acquisition
activities. However, not all of it should be
scrapped as many of its features could be incorporated into the new IS. Planning for the initial
IS should consider the future requirements. This
would reduce the cost and time of modifications.
The main components that can be retained
with minor modifications are: (a) Database, (b)
data dictionary, and (c) database management
system. It is assumed that the database was developed to be useful for the entire system life-cycle.
Also, the data dictionary should have been based
Nazim U. Ahmed /Information & Management 28 (1995) 261-269
Plan°i°
lj
ceulin
q
Module
Cost
~
Monitoring
And Reporting ~
Module
~
~
items) routinely, on an exception basis, and also
at important milestones of the system life-cycle.
The management decision support module is
important and should be designed in such a way
that managers can use it as a planning and analysis tool for cost management and control.
This decision support [8] should include management science models like linear programming,
scheduling, forecasting, and simulation [22]. Finally, it should track the status of the critical
success factors and project them into the future
to anticipate any problems or opportunities.
9. Cost monitoring and control
r~
Management
Decision
Support
Module
267
~
Once the decision is made to acquire a system
on the basis of design-to-cost philosophy, continuous monitoring and control is necessary to make
sure that different activities progress according to
the scheduled plan of action. To accomplish this,
management must establish proper monitoring
and control procedures which should include: (1)
report generation, (2) tracking of critical success
factors, and (3) establishing an incentive scheme.
9.1. Report generation
Fig. 3. Operations information system.
on the content of the database. The criteria on
which the database management system was selected in the acquisition phase should also be the
same for the operation phase.
Some modifications need to be made in the
initial IS as its requirements will change for the
operation phase. For example, the procurement
information module may not be necessary if the
procurement decisions are routine and not very
complex. The schematic of the information system for operation phase is shown in Fig. 3.
The planning and scheduling module in this
phase should be different from that of the acquisition phase. This module should generate information about manpower planning, equipment
planning, maintenance planning, etc.
The cost monitoring module should generate
information about major cost items ( " A " and " B "
Administering life-cycle cost activities is very
complex. It involves managers of several departments. Necessary reports include (1) cost items in
the cost break down structure, (2) those for the
departments, (3) those for major cost components, (4) summaries for top management, (5)
exception reports for departments and top management, (6) comparison statistics, and (7) projection reports [19].
9.2. Tracking critical success factors
Critical success factors are important barometers to judge the success of the system in terms of
attainment of design-to cost goals. Each one
should be associated with one or more performance measures [18]. The IS should be able to
generate statistics on these performance measures. Based on these statistics, managers should
take appropriate action for achieving the cost
goals.
268
Nazim U. Ahmed / lnformation & Management 28 (1995) 261-269
9.3. Establishing incentive s c h e m e
Two types of incentive systems should be designed for implementing the design-to-cost philosophy. The internal incentive system should not
necessarily concentrate on immediate cost saving.
Some long term factors should also be incorporated so that managers do not try to achieve short
term saving at the expense of long term gain.
Sometimes a significant portion of the life-cycle
cost is incurred through outside personnel or
organizations. The external incentive system
should be based on negotiations between the firm
and the outside contractors. For well established
systems, fixed price contracting procedures are
common. For newly developed systems, contracts
can be relatively flexible and cost reimbursing
agreements may have to be negotiated.
One c o m m o n method of contract payment is
incentive contracting [2]. According to this, a
sharing ratio is negotiated between the firm and
the contractor. For example, a 4 0 / 6 0 sharing
ratio means that in case of cost savings from the
target, 40 percent of the savings will go to the
firm and 60 percent of the cost savings will got to
the contractor. This will be true about the cost
overrun also.
I0. Conclusion
Design-to-cost is a m a n a g e m e n t philosophy
that emphasizes the selection of a system based
on total minimum life-cycle cost. Even though,
this seems logical, the traditional acquisition decisions are still biased towards initial price. There
is a sizeable body of literature which attempts to
analyze the cost relationships for complex systems. Problems arise during the actual management of the life-cycle cost.
This p a p e r provides a conceptual framework
for design and implementation of a life-cycle cost
m a n a g e m e n t system. The life-cycle is condensed
into two major phases. The acquisition phase
includes the activities from research and development, design, up to the installation of the system.
The operation phase includes the activities during the actual use of the system.
The IS developed for the acquisition phase
should be modified to generate relevant information for the operation phase. This includes routine and exception reports to be generated for
departments and top management. Also, the decision support module of the IS should provide
important planning information by generating
scenarios for different decisions and situations.
Tracking the CSF is also important as it provides
the necessary information to devise strategies for
achieving design-to-cost goals. Finally, an incentive scheme should be established both for internal personnel and external contractors.
References
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Dr. Nazim U. Ahmed is currently a
professor in the Department of Management at Ball State University. He
obtained his Ph.D. degree from Texas
A&M University. His primary teaching interests are in the areas of Operations Management and Information
Systems. Dr. Ahmed's publications
have appeared in International Journal of Production Research, Journal
of Operations Management, Transportation Research, Journal of Business Research, Information and Management, Computers and
Industrial Engineering, Production and Inventory Management, Journal of the Academy of Marketing Science and also
in other journals.