4.6 Total Life Cycle Cost and Product Pricing
The Total Life Cycle Cost (TLCC) is a critical determinant in setting the price of a product. Unlike traditional pricing strategies that focus primarily on production costs, TLCC encompasses all costs incurred throughout the product’s life span—from research and development to end-of-life disposal. This comprehensive approach ensures that pricing decisions not only cover all associated costs but also secure a sustainable profit margin.
Illustrative Example: The “Ultra Coffee Pot”
Consider a manufacturer developing a high-end commercial coffee maker, the Ultra Coffee Pot, intended for use in cafés. The product is designed with a 5-year lifespan, and the following cost structure is projected:
- Research and Development (R&D): $500,000 (one-time)
- Production Volume: 1,000 units over 5 years
- Per Unit Costs:
- Materials: $200
- Labour: $100
- Overhead: $50
- Support Costs: $40 per unit (2-year warranty and customer service)
- End-of-Life Costs: $20 per unit (recycling/disposal)
Step 1: Calculating Total Life Cycle Cost (TLCC)
| R&D Cost/unit | $5,00,000 / (1000unit* 5 years) | $100/unit |
| Material | ||
| Labour | ||
| Overhead | ||
| Total Manufacturing Cost | $350/unit |
| Marketing | ||
| Distribution | ||
| Total M&D COST | $80/unit |
| Support&Warranty COST | $40 x 2yrs = | $80/unit |
| Recycling and Disposal | $20/unit | $20/unit |
| TLCC | $630/unit |
Step 2: Determining Minimum Selling Price
To achieve a 25% profit margin, the minimum selling price is calculated as:
[latex]\text{Minimum Price} = \frac{\text{TLCC}}{1 - \text{Profit Margin}} = \frac{630}{1 - 0.25} = \$840[/latex]
This price falls within the competitive market range of $800–$1,000 for similar high-end commercial coffee makers.
Step 3: Strategic Pricing Decision
The manufacturer may choose to price the product at $899, which is near the midpoint of the market range. This decision has several implications:
- Cost Coverage: The price of $899 fully covers the TLCC of $630.
- Profit Margin:
[latex]\text{Profit} = 899 - 630 = \$269[/latex]
[latex]\text{Profit Margin} = \frac{269}{899} \approx 29.9\%[/latex]
- Competitive Positioning: The product remains competitively priced while ensuring a healthy return.
Strategic Implications of TLCC-Based Pricing
- Long-Term Viability: By accounting for all lifecycle costs, the firm ensures financial sustainability and product support throughout its operational life.
- Customer Value Proposition: The price can be justified by emphasizing the product’s durability, quality, and included services (e.g., warranty and support).
- Sensitivity Analysis: TLCC-based pricing allows for proactive adjustments in response to cost fluctuations. For instance:
- A 10% increase in material costs raises the TLCC to $650, requiring a new price of: 650/1−0.25 =$867
- If support costs rise to $50 per unit, TLCC again becomes $650, necessitating similar pricing adjustments.
