Analysis 43: Customer Life Cycle Cost Per Unit


HOW TO INTERPRET THE ANALYSIS: The exhibit is presented without numbers. It shows that the customer's most important cost is the cost to Use the product. However, the customer does incur significant costs to Acquire, Maintain and Dispose of the product. The price of the product, itself, would be in the "Use" part of the chart. The price is stated as an amount of money per unit. All other customer costs in Acquire, Use, Maintain and Dispose are also stated in the equivalent of the price, an amount of money per unit. This format allows the you to quantify customer cost savings in the equivalent of the price per unit of the product.

PURPOSE: This analysis calculates the customer's total cost related to the product over the entire time the customer has the product. The "customers" of particular interest in this step are the largest core customers available to the Company. The Company can augment this understanding of the costs of these larger core customers by doing variations of this analysis for the other core customer size segments that the Company would like to serve. The company uses these cost estimates to help direct its performance innovation program as it plans to add something unique in the market.

APPROACH: This analysis totals the customer's life cycle cost with the product and converts these costs into a cost per unit of the product. Using this approach enables the company to determine the value of potential innovations in the customer's total cost structure. The company can then use this value of these innovations both to set priorities for future innovations in the product and service package and to set possible prices for the product after the innovations have been implemented.

A Final customer has four tasks to accomplish over the time that he is involved with the product: Acquire, Use, Maintain and Dispose. These costs are the same whether the Final customer purchases from the producer of the product or from an Intermediary. Each of these tasks entails a cost.

  • Acquire costs include all those activities the customer completes before beginning to use the product. These include all the costs to learn about the product and its potential suppliers, to order it, to put it in place and to learn how to use it. When the Final customer purchases from an Intermediary, these steps include the customer's efforts to evaluate alternative Intermediaries and to locate and travel to the chosen Intermediary's location.

  • Use costs include all the costs a customer incurs in employing the product in its normal application. These costs include the product price, all the operating costs associated with the product, including labor and other purchases, such as energy or other materials needed to use the product. This usually is the largest portion of the customer's life cycle cost. When the Final customer purchases from an Intermediary, Use costs include the Final Customer's efforts to find, choose and pay for the product at the Intermediary's location.

  • Maintain costs include all the costs necessary to keep the product functioning throughout its life. These costs include the costs to obtain maintenance service, parts, and trained labor, plus the costs the customer incurs due to product down time. When the Final customer purchases from an Intermediary, these steps may include the Intermediary's installation of the product at the Final customer's location.

  • Dispose costs include all those costs the customer incurs to disassemble, remove or otherwise get rid of the product after the customer has finished using it. This "Dispose" cost may be positive, meaning the customer receives a net in-flow of cash, if the product has significant resale value.

Intermediary customers also incur four major system costs in connection with the product over its useful life: Obtain, Sell, Guarantee and Return.

  • Obtain steps include all activities preceding the selling of the product. These activities include the costs of identifying potential suppliers and stocking the product.

  • Sell steps are the activities intermediary customers take in selling and delivering the product to their customers. These activities include the Intermediary's recruitment of customers and product delivery to them.

  • Guarantee steps include the activities required for the Intermediary customer to keep the product or service in owrking order for the Final customer. These activities include both problem assessment and correction.

  • Return activities include the work to deliver the product back to the supplier and to receive credit for the returned product.

The first analysis of customer costs should focus on the largest core customer relationship which the company would target. Then, the company may choose to do this analysis for a representative customer in each size segment (i.e. VL, L, M and S) because unit costs can change notably as customers change in size. Once this preliminary analysis is complete, the company should review its estimates with several customers of various sizes to confirm and develop these conclusions.

Once the company has developed some potential innovations that might reduce the core customer's cost, it should analyze how the innovation affects the customer as follows:

  1. Define the situation the customer faces. For example, the customer could be undertaking one of three different activities: a retrofit of the product in an existing system, an expansion of existing capacity, or a new build. Each situation involves different customer costs.

  2. Use the Acquire, Use, Maintain and Dispose approach to the customer application system to set a base case for the customer. This base case should show the customer's natural alternative to the company's product and would include:

    1. Revenues, if the product will have a differential effect on revenues than does the base case product.

    2. Operating costs; and

    3. Investments.

  3. Lay out the company's alternative to the base case using the same categories as above.

  4. Subtract the company's new product/service approach costs for the customer from the base case costs to create cash flows for the beginning year and following years. Then do a discounted cash flow analysis. Note in this analysis that:

    1. In order to make operating costs and revenue differences comparable, the company must multiply the customer's operating margin percentage times the revenues to create a contribution number that would be comparable to the cost savings.

    2. Investments, if they occur only at the beginning of the period, can simply be netted against one another. This happens when the company uses the subtraction method described in this step.

Return to Diagnose Products and Services: Customer Cost Systems

Return to Basic Strategy Guide Step 16

Recommended Reading

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Symptoms and Implications: Symptoms developing in the market that would suggest the need for this analysis.

Perspectives: Conclusions we have reached as a result of our long-term study and observations.