Engineering Economics vs. Cost Modeling

Engineering economics treats the analysis of the economic effects of engineering decisions and is often identified with capital allocation problems.  Engineering economics provides a rigorous methodology for comparing investment or disinvestment alternatives that include the time value of money, equivalence, present and future value, rate of return, depreciation, break-even analysis, cash flow, inflation, taxes, and so forth. Cost modeling is a different beast.

While traditional engineering economics is focused on the financial aspects of cost, cost modeling deals with modeling the processes and activities associated with the manufacturing and support of products and systems, i.e., determining the actual costs that engineering economics uses within its cash flow oriented decision making processes.

Cost modeling is one of the most common business activities performed in an organization.  But what is cost modeling, or maybe more importantly, what is it not?  The goal of cost modeling is to enable the estimation of product or system life-cycle costs.  Cost analyses generally take one of two forms:

•       Ex post facto (after the event) – Cost is often computed after expenditures have been made.  Accounting represents the use of cost as an objective measure for recording and assessing the financial performance of an organization and deals with what either has been done or what is currently being done within an organization, not what will be done in the future.  The accountant’s cost is a financial snapshot of the organization at one particular moment in time.

•       A priori (prior to) – These cost estimations are made before manufacturing, operation and support activities take place.

Cost modeling is an a priori analysis.  It is the imposition of structure, incorporation of knowledge, and inclusion of technology in order to map the description of a product (geometry, materials, design rules, and architecture), conditions for its manufacture (processes, resources, etc.), and conditions for its use (usage environment, lifetime expectation, training and support requirements) into a forecast of the required monetary expenditures.  Note, this definition does not specify from whom the monetary resources will be required--that is, they may be required from the manufacturer, the customer, or a combination of both.