Functional Obsolescence

Article byKumar Rahul
Reviewed byDheeraj Vaidya, CFA, FRM

What Is Functional Obsolescence?

Functional Obsolescence is the reduction in the usefulness or desirability of a product or property caused by changes in design, technology, or market preferences. The purpose of understanding it is to help individuals and businesses make informed decisions about the value and usefulness of their assets.

Functional Obsolescence

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It can be a crucial strategy for maintaining competitiveness and profitability. This may involve investing in research and development, redesigning products to meet changing consumer preferences, or renovating properties to improve their functionality and appeal.

Key Takeaways

  • Functional obsolescence is the reduction in the usefulness or desirability of a product or property caused by physical wear and tear, damage, deterioration, or changes in design or consumer preferences.
  • Its comprehension is intended to assist people and organizations in making defensible choices regarding the worth and use of their assets.
  • It can impact the physical or operating performance of products or properties or their market value or competitiveness.
  • Therefore, understanding the types and causes of it is essential for businesses to maintain the importance of their assets.

Functional Obsolescence Explained

Functional obsolescence occurs when an item becomes less valuable or useful over time. This is often due to wear and tear outdated technology, or changes in consumer tastes. It can occur in any product or property, significantly impacting its value and usefulness.

The importance of understanding it lies in the fact that it can significantly impact the value of products and properties. By recognizing the factors contributing to obsolescence, businesses and individuals can make more informed decisions about their assets. This leads to greater efficiency and long-term success.

One of the key benefits of understanding it is the ability to anticipate changes in the market and adjust business strategies accordingly. By recognizing technological trends, consumer preferences, and design trends, businesses can invest in research and development, redesign products or properties, or develop new products. This can help companies to remain competitive and profitable over the long term.

Similarly, individuals who understand obsolescence can make more informed decisions about purchasing or investing in assets. By considering its potential, individuals can evaluate the long-term value and usefulness of products or properties.

Moreover, understanding it may sometimes be complicated, as it can be influenced by many factors and is difficult to predict. Therefore, it is essential to recognize the potential for functional obsolescence. It is also important to balance this with other factors such as cost, functionality, and market demand.

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Types

There are two main types of functional obsolescence.

1. Physical functional obsolescence: Physical functional obsolescence refers to reducing the usefulness of a product or property caused by physical damage. This obsolescence can occur when a product or property is misused or aged beyond its useful life.

For example, a vehicle driven for years and has accumulated many miles may suffer from physical functional obsolescence due to engine wear and other mechanical problems.

2. Economic functional obsolescence: Economic functional obsolescence refers to a reduction in the usefulness or desirability of a product or property caused by market or economic conditions changes. This type of obsolescence can occur when products or properties become less desirable or less competitive due to changes in technology, design, or consumer preferences.

For example, a mobile phone that lacks the latest features may suffer from functional economic obsolescence due to the availability of newer, more advanced models.

Examples

Let us understand it in the following ways.

Example #1

Suppose a company, Amacon Ltd., produces a line of prevalent smartphones among consumers but needs the latest technology, such as 5G connectivity, larger screens, or better cameras. As a result, customers may see these smartphones as less desirable over time and turn to other brands. This is an example of functional economic obsolescence due to changes in technology.

Example #2

There has been growing concern among automakers about the functional obsolescence of internal combustion engine (ICE) vehicles. As more and more countries and cities are pushing towards electric vehicles and implementing stricter emission standards, ICE vehicles are becoming less competitive and desirable. This is an example of functional economic obsolescence due to changes in market demand and government regulations.

Functional Obsolescence vs Economic Obsolescence

Functional and economic obsolescence are two types that can affect the value and usefulness of products and properties. Here are some differences between the two:

  1. Definition: Functional obsolescence refers to a reduction in the usefulness or desirability of a product or property caused by physical wear and tear, damage, deterioration, or changes in design or consumer preferences, while economic obsolescence refers to a reduction in the usefulness or desirability of a product or property caused by changes in the market or economic conditions.
  2. Causes: Functional obsolescence is caused by physical wear and tear, damage or deterioration of products or properties, or changes in design or consumer preferences, while changes in technology, market demand, and government regulations cause economic obsolescence.
  3. Timing: Functional obsolescence can occur gradually over time as products or properties age, while economic obsolescence can occur suddenly as market conditions change.
  4. Reversibility: Functional obsolescence can sometimes be reversed through repairs, upgrades, or redesigns, while economic obsolescence may not be reversible and may require significant changes to the product or property.
  5. Impact: Functional obsolescence can impact the physical or functional performance of products or properties, while economic obsolescence can impact the market value or competitiveness of products or properties.

Frequently Asked Questions (FAQs)

What is functional obsolescence in real estate?

Functional obsolescence in real estate refers to a reduction in the usefulness or desirability of a property caused by features or design elements that need to be updated or more desirable to modern buyers or tenants.

What is functional obsolescence in an appraisal?

It is an essential consideration in real estate appraisals because it can impact the value of a property. This can include things like outdated building materials or design features, a lack of modern amenities, or a floor plan that is no longer practical or efficient.

Which would be a contributing factor toward functional obsolescence?

There can be many contributing factors toward functional obsolescence, including technological advancements, changes in consumer preferences, wear and tear, lack of maintenance, and changes in regulation or standards.

How to calculate functional obsolescence?

It refers to outdated equipment, technology, or processes that reduce efficiency or productivity. Here are some steps that can be followed to calculate it in a business: identify the areas of concern, determine the impact of obsolescence, estimate the cost of upgrading or replacing the equipment or technology, compare the price and potential benefits, and calculate the possible return on investment.

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