Total Ownership Cost - Essay Example

Total Ownership Cost Total Ownership Cost Cost estimation is an important process carried out in various areas in within organizations. For example, cost estimation is crucial during project planning of an organization in a number of ways. First, cost estimation enable the project manager or organization’s management to determine resources required in undertaking a project. It also ensures that projects are undertaken efficiently since materials and items required are available. Therefore, we need to carry out a cost estimation process to determine the costs of various materials and equipment necessary for expansion of the business. There are various methods of estimating and evaluating costs. Some of these methods are analogy, engineering estimate, cost estimating relationship and actual costs. However, we will analyze two main methods that are available to use and decide on the most appropriate method to the organization. These methods are the Engineered Cost Estimate method and the Cost Estimating Relationship (CER) method. The two methods are applicable and appropriate for use, but we need to apply the best and the most appropriate one among them. First, the Cost estimating relationship method is also known as the parametric cost estimating method. It is a mathematical equation that expresses cost as the dependent variable that relies on one or more independent variables. It is a method used widely in estimating prices or costs using a well-established relationship with a given independent variable. This method involves the use of regression or other statistical method to determine the relationship between cost and an independent variable. The independent variable may be a cost, a product, a process or a service. The cost estimating relationship equation can be either simple or complex according to the information available and the nature of the relationship. The basic aim of the cost estimating relationship method is to identify and determine various parameters of a project or a product that explains the cost of the product or project. Secondly, the method concentrates in finding some historical information the show similar cost value with the desired cost of the project or product. Lastly, the cost estimating relationship focuses on identifying mathematical equations that can incorporate the historical data and estimate various future costs of a project or a product (International Society of Parametric Analysts, 2008). The cost estimating relationship method has several advantages over other estimation methods. First, the method provides valid and appropriate information about a product or a project. The cost estimations provided by the cost estimating relationship method are valid since data is gathered from various sources, and relevant historical information is used. Secondly, the methodology is highly accurate and effective in the estimation of cost than other methods. However, the cost estimating method has some weakness. For instance, it is highly dependent on the historical data. Absence of historical data will result to failure of the cost estimating relationship method in estimating the future costs of products and projects. Sometimes the method is so simplistic to estimate future cost that it may provide unreliable information. Therefore, another estimation method should be used in the presence of detailed information (Stuparu & Vasile, 2012) Engineering cost estimate method is also important in the estimation of future costs. This method is also known as the bottom-up cost estimate. Cost estimation in Engineering cost estimation method are based on measuring and evaluation of task and then pricing the work done in the task (McGraw-Hill, 2011). The cost estimation is also based on labor and material costs used to produce and develop various elements. This occurs mainly at the lowest WBS possible level (Wertz & Larson, 1996). Unlike the cost estimating relationship method, engineering cost estimation method involves the breakdown of the work structure into small activities. These activities are separately estimated and, appropriate overhead costs added. For instance, estimation of a task is broken down into activities such as direct labor, material cost, transport cost and other costs. Engineering cost estimate requires extensive and detailed information and understanding of the entire production system or process carried out by an organization. Therefore, each level of work flow must be clearly identified, carefully tracked and measured. Summation of the outputs should be done in order to establish the estimation point of the product or project. The engineering cost estimate method is beneficial in various ways. The first benefit found in estimation method is the ability to determine the cost estimate of a product and identification of possible overlooks. This makes the engineering cost estimate method reliable to users especially in the production sector. Secondly, the estimation method is only applicable to a program, project, product or manufacturer. The engineering cost estimate method gives clear information and estimation of major cost contributors due to the breakdown of activities. The estimation results obtained by the engineering cost estimate method can be transferred to similar programs easily and efficiently. However, there are several shortcomings of using the engineering cost estimate in the estimation of costs of products or projects. First, implementation of the estimation method is relatively expensive than other methods of cost estimation. Therefore, many small organizations are unable to apply the estimation method into their cost estimation process. The engineering cost estimation method is time consuming and tiresome to use. This arises for its nature of breaking down the work structure in small activities. Therefore, this method is inappropriate if results the period of estimation is short. Thirdly, the estimation method is not flexible enough to handle what-if questions. This means that the estimation method is not flexible to drastic changes. For the estimation to be efficient, specifications of the product must be well known. According to the above analysis of the two cost estimating methods, the most appropriate approach that would work best in the organization in Life-Cycle Costing (LCC) is the cost estimating relationship approach. This method is recommendable for the business because the approach is reliable, confidential, accurate and less costly as compared to the engineering cost estimate method. The cost estimating relation is fast to use as well as flexible to changes in cost due to inflation or tax. In addition, the approach is easily adaptable by the organization. According to Kenneth Crow, Design-To-Cost is a strategy in management that normal support different methodologies in order to produce affordable products through treatment of the desired cost as an independent parameter necessary in the development of a product. He also insisted that design-to-cost philosophy is vital in management of costs of products efficiently. Design-to-cost is an important management tool that assists in monitoring costs where new and innovative product is in the design phase (Beck & Partner KG, 2013). It is a famous technique of costs control. The method controls costs by developing goals and objectives of costs at every level of work breakdown structure. The method then requires the business or project to make trade options in order to meet the goals of the system. Design-to-cost tool that functions as a benchmark that helps in determining the progress of the development. The design-to-cost tool also plays a significant role in identifying possible areas requiring additional creativity to solve some problems if the project’s progress is bad. The design-to-cost method enabled the government to identify and consider our business for contracts due to the robotics in the machinery department of the business. The design-to-cost model has high impact in the development of business’ ability to compete for government contracts. For instance, the business can determine the profit of the government contracts through the use of the design-to-cost model. Cost as an Independent Variable (CAIV) is a well-established strategy for supporting and acquiring various defense systems. This involves setting and managing achievable, aggressive, and realistic objectives of the cost for new acquisition and field systems. Cost plays a significant role as an independent variable especially in the production of unique products of the business. First, it assists the management of organization in carrying out strategic management process. This involves activities such as the establishment of the mission area allocation of resources. CAIV ensures that resource allocation process in effectively done according to the demand of business commodities. It also helps in establishing realistic and aggressive cost targets for products or projects undertaken by the business. Cost as an independent variable determines various requirements required to meet the business objectives. These requirements may be labor, material or capital. For instance, the business will require extra capital and more labor to produce unique products and compete for the government contracts. CAIV also recognizes that resources are limited and utilizes the available resources to execute the targeted task within profitability projected limit (Wertz & Larson, 1996). Cost as independent variable contributes in risk management process. This happens through careful risk analysis and establishment of incentives. As a part of strategic management, cost as an independent variable determines various opportunities of cost reduction in the production process and trade-offs to meet business goals and objectives. It is also important in developing metrics, plans and provisions for the purpose of managing program execution. In the business venture, cost as independent variable ensures that the business has a continuous life cycle. In addition, it contributes to the value addition process and improvement of products and processes. Cost-reimbursement contract is a relationship between the government and the contractor where the contractor’s payment comprises of allowed expenses up to a set point, and additional payment inform of profit. The cost-reimbursement contract may also involve financial incentives to the contractor or the seller. There are three main types of cost-reimbursement contracts. These are Cost-Plus Fixed Fee (CPFF), Cost-Plus Award Fee (CPAF) and Cost-Plus Incentive Fee (CPIF). According to Philpot, the cost-reimbursement contract is a risk contract that is highly risky to the government of the company offering the contract. Through cost-reimbursement contract, there is no accurate estimation of the cost of the contract. This is because the government or the company offering the contract does not put a fixed price on the contract. Therefore, many companies are abandoning the cost-reimbursement contracts, and they are now offering other types of contracts such as fixed-price contracts. Cost-reimbursement contracts are risky because the contractor may overestimate the payment, use resources carelessly without consideration of resources or even estimate false figures. This contract is highly exposed to frauds such as mismanagement of funds and corruption since there is no clear estimation of the cost of the contract. There are few reasons why cost-reimbursement contract is risky and harmful to companies and to the government. First, there low monitoring level of the contract owner on progress of the contract. This gives the contractor or the seller an opportunity of overestimation and overvaluation of the cost of the contract. In addition, the contractor may misuse the resources and materials since they are sure of the compensation and profit. Secondly, there is no fixed cost of the contract. This poses a risk to the government or the owner of the contract since the contractor would regulate the payment. This may result to high level of expenditure on the government or a company owning the contract. Therefore, cost-reimbursement contracts are inefficient, expensive and unreliable. In conclusion, proper method and approach of cost estimation should be selected after evaluation of the available resources necessary to carry out an activity or a project. The cost estimation method that should be used in our business venture should have the following features. It should be relatively cheap and affordable to use in the business organization. It should also be realistic and flexible in nature. Lastly, it should enhance proper and minimum resource utilization. Work cited International Society of Parametric Analysts (2008). Parametric Estimating Handbook. Vienna. Retrieved from ISPA_PEH_4th_ed_Final.pdf. Wertz, J & Larson, W (1996). Cost Estimation Module. Reducing space mission cost. Torrance, Calif. Microcosm Press. Beck & Partner KG (2013). A management method for innovations and product development. Brandmayerstr. Retrieved from pdf. McGraw-Hill (2011).Cost Estimation. The McGraw-Hill Companies. Retrieved from 18.Cost_Module_V1.0.ppt. Stuparu, Dragos & Vasile, Tomita (2012). Elementary statistical techniques used in cost estimating relationship (CER”s) development. University of Craiova. Retrieved from 065.Stuparu, Tomita.pdf Read More