Quality Management

by A. Blanton Godfrey




Life-Cycle Costs

Many companies lack a simple,
useful model of life-cycle costs.

A frequently talked about but far too rarely used concept is life-cycle costs. Even some leading companies, widely and justly praised for their advanced quality thinking, seem to have only vague ideas and weak practices when it comes to life-cycle costs. Yet this is one of the most basic and easily understood concepts of modern quality management.

Understanding life-cycle costs entails no more than understanding the actual costs of a decision during the life of the decision. A common use of life-cycle costs is making purchasing decisions based on price and estimates of the costs of purchasing, using, maintaining and, finally, replacing the item under consideration. You then try to make the decision that minimizes total costs.

Almost everyone understands this idea instinctively and applies it daily in his or her own life. And yet, corporations often behave quite differently. Each of us can remember many examples where our companies have made decisions that minimized short-term costs but were financially harmful in the long term.

There seem to be three root causes for this behavior: lack of a useful model, lack of understanding and an unwillingness to act.

Many companies, even those with sophisticated quality systems, lack a simple, useful model of life-cycle costs. Without a model, these companies don't have an easy way of making life-cycle cost decisions.

A second problem is that many companies have such simplistic models that they do not include many of the major costs that should be considered.

The third problem is models that are too complex. A few companies have created life-cycle cost models that include every imaginable cost. Many of these costs are quite difficult to measure and require special investigations. The models appear so daunting that they are never used.

Many companies do not have the necessary levels of understanding within the organization to use life-cycle costs in their decisions. With no clear models or missing needed data for the models, they just continue flying blind.

Of course, some companies have all the technical skills they need. They have detailed life-cycle cost models and world-class databases containing information from research and development, purchasing, production, distribution, sales, field service and other functions. Their training courses contain beautiful examples of how to apply these models in a variety of situations. And yet they still don't act.

There are three key reasons for this. First, some companies are just starting their quality journey and do not have the structure, training, tools and information systems in place to make major changes easily.

A second reason is lack of accountability. No one is really responsible for minimizing life-cycle costs. Purchasing is trying to minimize costs per item purchased. Production is trying to minimize labor costs. Field service people are trying to reduce their labor costs.

The third reason is company structure, policies and tradition. Many ways we traditionally managed our companies just don't work today. A company CEO told me a painful story about turning down a recommendation of a quality improvement team because the solution required a capital investment of about $1 million. The team had conclusive evidence that this investment would generate more than $2 million in savings the first year. But the company did not have an extra million dollars in that year's capital budget for that division.

The team soon returned to talk with the CEO. They offered to personally buy the machine if they could have the $2 million. They were willing to take out second mortgages on their houses because they were so sure of the results. The CEO was dismayed. He asked me how his company could have possibly gotten trapped in such absurd practices that prevented them from getting two-to-one returns on investment. Why were his employees so much smarter than the company?

We need to create the understanding necessary to act. First we create a reasonable and useful life-cycle cost model, apply it to several important decisions to develop clearly understood applications to use as striking examples and then integrate the teaching of the model and application into relevant orientation and basic management, quality and project management courses.

Next we change the accountabilities for total costs. Using process-oriented measurements, activity-based costing or other estimates, we assign clear responsibilities for minimizing total costs. We make these part of management responsibilities. One by one, project by project, we start making the changes necessary to reap the savings. Finally, it becomes the standard practice.

This isn't easy. Sometimes even knowing that the $14 light bulb will last 10 times as long and use $52 less electricity, we will still buy the 99¢ one.

About the author

A. Blanton Godfrey is chairman and CEO of Juran Institute Inc. in Wilton, Connecticut. Questions or comments about this column can be sent directly to him at godfrey@netaxis.com.