Summary by Steve Barnier
Master of Accountancy Program
University of South Florida, Summer 2001
Life cycle management (LCM) has been developed to make life cycle costing a reality. It combines advanced cost management techniques, new performance measures, and the portfolio concept of investments. The goal is to provide more useful information about an investment throughout its life.
The components of an LCM approach include; the life cycle model, a balanced set of performance measures, advanced cost management systems, and the portfolio theory. The life cycle model incorporates the seven stages of the life cycle. The analysis, start-up, entry, build, maturity, decline, and withdrawal stages make up the life cycle of any industry, investment, or product. The performance measures are linked to critical success factors, and are constantly monitored. An advanced cost management system in the context of the LCM differs from ABC or ABM, because they are based on a process view of business. This means that costs are aggregated as much in terms of processes as they are in terms of activities. This information can be linked to the various operational functions, and then to the life cycle model. The portfolio theory allows managers to evaluate investments as a whole rather than individually. This results in investment decisions being made with an understanding of the effect on the entire company.
The LCM provides a framework that is connected to the original planning, targeted toward monitoring those activities with greatest impact on investments, and standardized around key performance measures.
Currently, Management uses a "go" or "no go" process to make investment decisions. Investment approval involves identifying the expected ROI, timing of cash flows, and net impact of cash flows in terms of business processes. Another aspect of current investment planning is the use of "investment kickers". The basic idea with these is to strategically use a technological innovation, new investment use, or other techniques to extend the life of an investment. Kickers usually do require additional investment, but will result in a rise in revenues.
The problems with the current practices described above include, losing track of investments, comparability of actual vs. planned expenditures, problems in data collection and comparability, and determining between outcomes as a result of original planning and kickers. Once investments become integrated into the company the ability to directly monitor and evaluate the effects of the investment on the company cannot be achieved. LCM will allow managers to budget investment resources, track resources, and measure the impact on the organization.
LCM realizes that an investment provides different levels of present and future benefits throughout its life. Therefore, evaluation of the investment must be different at each stage of the life cycle.
An important contribution of LCM is the definition of critical success factors. These are factors identified in the implementation strategy of an investment by analyzing the competitive environment. Examples include time, customer satisfaction, target pricing, resource requirements, continuous improvement, etc. These factors change in the different stages of an investments life. Managers have to weight the importance of the different critical success factors at each of the stages of the investments life.
After weighting the success factors, management must design performance measures to capture the information needed to manage them. The importance of the performance measures is in the balance between measuring processes and results. Process measurements reflect the performance and variability of a process. Results measurements evaluate specific performance indicators after the fact. By linking the performance indicators to the original planning, a company can eliminate the possibility of evaluating an investment on criteria not useful in obtaining the investments objective.
Once the performance measures have been established, an activity based advanced cost management (ACM) system will provide the link between the budgeted process and the reporting process. The ACM system is a method of translating the life cycle concept into quantifiable requirements for both processes and functions. Companies will be able to more accurately plan and evaluate investments, because they will have captured actual results of an investment through performance indicators designed directly from the original plan for the investment. An ACM system also gives information that can help managers make decisions about whether to lengthen or shorten various stages of an investments life cycle to maximize performance. It will tell managers what it would cost to shorten periods of negative cash flows or additional costs to lengthen period of profitability.
Portfolio management is the last aspect of the LCM to be evaluated. This is basically the way management identifies how the company’s ability to generate cash compares with the demands of the various investments. The goal is to smooth the peaks and valley’s of the investment cycle. This approach allows managers to see the impact of each investment on the organization. They can see how profitable investments are offsetting cash-using investments, that will later provide cash flows. The aggregation of all the different investment life-cycle curves provides a picture of the cash position of a company. Managers can use this information to make decisions about new investments or changing the mix of current investments. When making these decisions management must balance the use of resources involved in each investment to obtain an ideal cash-flow that not only maximizes current needs, but takes into account future needs and cash-flows. Once the trade-off decision has been made, the impact on the processes is determined, and the information is available for functional budgeting.
Functional budgeting is when the departmental managers plan for the needed resources to meet the requirements of each investment in the portfolio. When management changes aspects of a particular investment, the life cycle curve of that investment will be different, and this must be carried through to the budgeting process of the organization. Once a company has an understanding of its investment portfolio, it can manage whether it is consistent with the overall strategy. This gives a consistent focus for each decision, and allows an organization to track the contribution of each investment toward the overall goal of the company.
The continuous improvement philosophy is enhanced with a LCM. Because the investment decisions are integrated with the budgeting process through functional budgeting, LCM enhances the continuous improvement of processes by establishing achievement goals for productivity, cost, quality, and time. LCM helps the managers locate where they need to focus their efforts. The impact of process improvements and functional budget improvements will eventually affect the product cost. By measuring the changes in the discounted cash flows of investments over their life cycles as a result of specific improvements or failures, the effect of the changes being made can be measured. Management can use this to make future decisions on the investment as they make small changes to improve their processes.
The technology for a LCM approach requires transaction-based software that can perform complex data manipulations. It must either replace or become integrated with existing cost accounting systems. This software must be able to translate small changes in a process into effects based on an investments life cycle. This information will be useful in both tactical and strategic decision making. The hardware existed, and the software was being developed to handle this when the article was written.
Managers are unable to monitor an investments impact on an organization once it has been implemented. LCM will provide current information about investments after conception. Managers will be able to better deal with changes in the markets, and respond quicker to ensure a continuous improvement in the process involved.
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