Life-Cycle Costing: Cost Estimating Relationship and Engineered Cost Estimate Methods

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Table of Contents

Introduction
Life-Cycle Costing Approach
Design-to-cost (DTC) Changes
Role of Cost
Problematic Elements of Cost-Reimbursement Contracts
Reference List

Introduction

Cost estimating relationship (CER) is a common term in business. As the name suggests, the concept uses an established independent variable to estimate prices or costs of items. The other general term is the life cycle cost (LCC), which is the cost of a product, asset, or part of the two as it is undergoing its cycle life while still serving the desired functions.

Total ownership cost is a concept used in management accounting and manufacturing industries. This assay uses an example of a large business with strong capabilities to take an idea from the concept phase to its full production within a very short window due to the use of robotics in the machinery department. The business is ready to expand by competing for government contracts for unique products.

The essay uses the organization to analyze the differences between the Cost Estimating Relationship (CER) method and the Engineered Cost Estimate method in the effort to determine, which approach to Life-Cycle Costing (LCC) approach will be the best for the business. It also evaluates the design-to-cost (DTC) changes while analyzing the role of cost as a key independent variable in the production of unique products. The aspects of cost-refund treaties that create the largest predicament for particular businesses are also analyzed.

Life-Cycle Costing Approach

Engineering cost estimate is one of the ways of estimating the cost of a project. It is very crucial to have an approximate budget of the resources that the project will need in the effort to curb any unnecessary inconveniences such as delays because of lack of money, equipment, or workforce. This cost is calculated through the estimation of all the activity costs, adding all of them, and including the overheads to produce detailed cost estimation.

The method is also frequently referred to as the bottom-up cost estimation method (Hofmann, 2007). Although this method is detailed and useful in the engineering industry, there are disadvantages that exist to make it unreliable in cost estimation. The use of this method has been described as useful where the design of a project has reached technical maturity (Ramachandra, 2006).

Cost Estimating Relationships (CER) and parametric cost estimation methods that exist between the bottom-up and the top-down methods are useful in cost estimation (Ramachandra, 2006). The method uses mathematical formulae and expressions to calculate the cost and variables in a production process.

According to Hofmann (2007), CER links price as a dependent element to the price-running elements that are selected based on their autonomy. The vulnerability of costs in a project to past forces is assumed to be the same for the future costs, and hence the use of the method to evaluate the relevant total cost of a project (Ramachandra, 2006).

The two methods of cost estimation are relevant in the described project. Both have advantages for the application. A bottom-up approach may lead to the overestimation of costs in the project. It would thus make it difficult to acquire government contracts because the organizations’ costs will be higher than for the other bidders. The CER method is the best suited for the organization. The result will be a competitive pricing to enable contract wins.

Design-to-cost (DTC) Changes

Design to Cost (DTC) management technique is one of the techniques used by organizations and their interactions with the government (Chris, 1987). In this technique, the cost is controlled using a specific goal in the design in hardware development (Ramachandra, 2006).

The elements of a design-to-cost approach include the understanding of the costumers’ ability to afford the products and the pricing required by the key participants. The allocation target costs must also be established to a level where the costs can be effectively managed in the process.

The main changes in the government DTC policies include the pricing of the different commodities and services that are required. The government has put a minimum price for the various commodities and the tendering process that should be followed. Therefore, the business is required to demonstrate the ability to cover the costs of the whole project before it can undertake the production of the required hardware for the government.

The changes in the DTC in government approach will affect the business in a number of ways. The business will be required to have the exact amount to cover the costs of any project that it intends to carry out for the government. The other effect is that the company will be required to improve in terms of competence by ensuring that it is able to produce the required machinery at a lower cost than most of the other organizations that are in direct competition with the company.

The DTC change also affects the duration of contracts, with the government introducing segmentation of contracts at different stages to ensure competition in the process. This strategy will affect the company since there will be a constant need to update the production process to ensure consistent efficiency.

Role of Cost

Cost is a significant part of any project in an organization. It determines the exact competitiveness of any organizational processes. This section analyses the role of cost as a key independent variable in the production of unique products. Cost can be described as a unique factor in the production process. It can be an independent and dependent factor in the process (Ramachandra, 2006). However, cost is an independent factor in most production process because it influences many of the other factors.

The costs incurred in the production process determine the values of the final product. In the production of new and unique products, the costs of production are usually dynamic (Hofmann, 2007). Production of unique products allows organizations to stay ahead of the competition.

However, the whole process of designing the production line, making the unique product, and marketing it usually consumes financial resources from the organization. The cost in the design process is mainly in the hiring of designers and setting up the automated processes of production for the mechanized production companies such as the one in focus. The design costs are also consumed by the acquisition of the appropriate tools for the production process (Hofmann, 2007).

In the marketing of the new unique products, the costs are also consumed in bulk by the large marketing input. The finance that is available in the production of the unique products determines the level of marketing to be undertaken, with the result being the final cost of the complete products.

The unique products that companies develop are harder to market because they are new to customers (Hofmann, 2007). Therefore, the costs are greater compared to the ones incurred in marketing other products. There are often difficulties associated with the setting up of the costs of the unique products. This means that companies can underestimate the costs or overestimate them based on the initial cost assumptions.

For the company under focus, the intention is to act as a formidable organization that can win contracts from the government and begin the production of any unique products as spelt out in the contract terms. Cost is a major independent factor in this process. It affects all other factors within this organization if it is to engage in the contract.

The cost that the organization is likely to incur includes setting up of the appropriate mechanical production line, the acquisition of the robotics, setting up of a team to oversee the production process, and the acquisition of space for the production line. The costs of all these factors will be crucial in establishing the required production costs.

The cost in this company will be independent in that it will influence all other production processes and the eventual product cost. This means that the efficient use of cost estimation methods ensures that the company can control the costs incurred throughout the production process. The company can reduce the eventual costs of the unique products that it intends to produce through the introduction of efficiency in its production process.

Problematic Elements of Cost-Reimbursement Contracts

Cost repayment agreements are types of treaties where suppliers are given all the permissible operating expenses of the agreement to a certain acceptable maximum, including imbursement of additional overheads to allow the supplier to make an income (Ramachandra, 2006).

One of the problematic elements of this type of contract is the estimation of the final cost of the project and the contract that may be difficult to establish. In this type of contract, the contractor is allowed a cost that is predicted by the government by using the prevailing economic conditions and costs of the appliances at that point in time.

Despite the government allowing for the provision of extra funds towards the projects being undertaken by the contractor, the final costs may surpass these costs (Hofmann, 2007). If these are not considered and/or more funds are availed, the contractor may end up making little if any profit in the contract. The government may also have to increase the funds available for the project.

The problem of cost estimation in cost-reimbursement contract also has an effect on the overall quality of the contract and the output of the company (Chris, 1987).

The measures that can be taken to reduce the effects of the changes in the duration of the contract to prevent large disparities between the stated cost and the final cost include the thorough estimation of the production costs. Companies can achieve this goal through the contracting of economic experts who can quantify the various inputs to be used and the likely changes in their value.

Another problematic element of a cost-reimbursement contract is the additional oversight that is required to design incentive of award fees (Chris, 1987). The extra oversight or administration required to oversee the design of the incentive fees is often a liability for the two sides involved in the contract (Chris, 1987).

The contractor has the responsibility of ensuring that he or she adequately controls the overhead costs of the production process and that the payments he or she receives are only for the permissible costs of the contract (Hofmann, 2007). On the government side of the contract, the administration has to ensure that the right company with the appropriate market cost is considered for the contract. It also has to exercise oversight over the contractor to ensure that it does not add extra costs in the contract.

It is the role of the government to protect the contractor from the unforeseen costs of the contract (Hofmann, 2007). However, in some instances, the contractor may engage in covering the extra costs incurred in the contract because of poor statement of the costs of the contract.

The result of this act is that the company may incur losses occasioned by the inability to cover the unforeseen costs. For the company on focus, the right procedures should be followed to ensure that any contract that it undertakes with the government has all the costs being accurately calculated, with an overestimation made for some of the most dynamic costs.

As opposed to fixed-price contracts, a cost-reimbursement presents little incentive to the contractor to be efficient in the production process because of the assurances in costs that they have. Efficiency in this type of contract may be increased through the introduction of a strict oversight in the respective organs and/or the introduction of an oversight authority for the side that awards the contract (Hofmann, 2007).

The other way that the problem may be solved is through the setting of limits for contractors in various projects. A contract should be shared by several contractors, with each of the parties being compared against the other. This strategy will lead to direct competition within the contracts since the companies seek to win future contracts or get contract renewals.

Reference List

Chris, K. (1987). An Empirical Validation of Software Cost Estimation Models. Communications of the Association for Computing Machinery, 30(5), 416-429.

Hofmann, P. (2007). Psychology of decision making in economics, business and finance. New York, NY: Nova Science Publishers.

Ramachandra, K. (2006). Business economics. New Delhi: New Age International (P) Ltd., Publishers.

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