Life Cycle Costing - An introduction

1. Life Cycle Costing -An introduction Paul Wyton November 2008

2. Life Cycle Management • A life cycle is made up of all the activities that go into making, selling, using, transporting and disposing of a product or service - from initial design, right through the supply chain. Source: http://www.epa.vic.gov.au/Lifecycle/whatis.asp

3. Life Cycle Management • Life Cycle Management (LCM) has been developed as a business approach for managing the total life cycle of products and services. By learning how to more effectively manage this cycle, a company or organisation can uncover a wealth of business, environmental and social value - and make the choice to engage in more sustainable activities and production patterns. • To be a success, Life Cycle Management should not be deployed only as a specific methodology, technique or "add on" • It is a systematic approach, mindset and culture that is embraced throughout the business, where decisions are made that effect both the input and outputs of your product or service life cycle - from corporate strategy development, product design, production, purchasing and procurement, marketing, human resources and more.

4. What is life cycle costing? • Instrumental to Life Cycle Management is Life Cycle Costing (LCC) • Also known as Whole Life Costing (WLC) • The life cost of an item is the sum of all funds expended in support of the item from its conception and fabrication through it operation to the end of its useful life • (White and Ostwald 1976 in Korpi and Ala- Risku 2008) • Introduced within the US Dept. of Defence in 1976 for procurement processes • Though Williams argues that Stone introduced a pre-curser of cost in use to the UK construction industry in the 1960's.

5. What is life cycle costing? • "... a technique which enables comparative cost assessments to be made over a specified period of time, taking into account all relevant economic factors both in terms of initial capital costs and future operational costs" (BS 15686-1, 2000; p.28) • Often driven by Public sector and seen within primarily the construction sector (Woodward 1997) • Sometimes confused with total cost of ownership (TCO) which is used for supplier identification and focuses on transaction costs • (Lindholm and Suomala 2004) • or Life Cycle Assessment (LCA) concentrating on environmental issues • (Emblemsvag 2001)

6. Purpose • Affordability studies • Source selection • Design trade offs • Repair level analysis • Warranty and repair costs • Suppliers sales strategies • (Barringer and Weber 1996) • Cash flow

7. Format of LCC

8. Nature • Is a forecast of the future • Is seen as stochastic (Korpi and Ala-Risku 2008) • Utilises data sourced in a number of ways (Fabrycky and Blanchard 1991) • Estimating by engineering procedures • Estimating by analogy • Parametric estimating Parametric methods are regarded as the most effective though most case studies demonstrate an element of mixed method approach combining parametric and analogy • Should accommodate the time value of money (e.g. discounted cash flows)

9. Nature • Data is hard to find • Time consuming therefore costly • Is future based best guessing • Requires input from a greater number of sources within and outside the organisation • Is often deterministic failing to accommodate sensitivity analysis • is affected by optimism bias

10. Rationale • Detachment between ownership and operation/use • Fragmentation of elements of delivery • Conflicting objectives • Rewards • Training / Education • 95% of LCCs are determined during procurement • All can lead to inappropriate decisions in terms of the whole life of a product or service

11. Sustainability

12. Figure 1: Comparison of relative cost over the life of an office building (from Evans et al., 1998; p.5)

13. Figure 2: Timing of procurement decisions and impact on life cycle costs (Kirk and Dell'Isola, 1995; p.11)

14. Egan • Not specifically around LCC but : • integrate the process and the team around the product: the most successful enterprises do not fragment their operations - they work back from the customer's needs and focus on the product and the value it delivers to the customer. The process and the production team are then integrated to deliver value to the customer efficiently and eliminate waste in all its forms. • The Task Force has looked for this concept in construction and sees the industry typically dealing with the project process as a series of sequential and largely separate operations undertaken by individual designers, constructors and suppliers who have no stake in the long term success of the product and no commitment to it. Changing this culture is fundamental to increasing efficiency and quality in construction. • Rethinking Construction 1998

15. Egan • Design for Construction in Use • in our experience too much time and effort is spent in construction on site, trying to make designs work in practice. The Task Force believes that this is indicative of a fundamental malaise in the industry - the separation of design from the rest of the project process. Too many buildings perform poorly in terms of flexibility of use, operating and maintenance costs and sustainability • the experience of completed projects must be fed into the next one. • designers should work in close collaboration with the other participants in the project process. • design needs to encompass whole life costs, • clients too must accept their responsibilities for effective design.

16. Value for Money (VFM) • Drawing on PFI and other similar procurement models (Swaffield and McDonald 2007) • VFM Defined • Optimum combination of whole life cost and quality (fit for purpose) • (Procurement Policy unit 1998) • Ensuring VFM throughout the duration of the PFI process is fundamental to the profitability (success) of the project - • From a contractors perspective and a clients perspective • LCC as a process is a means to effective management • LCC must be managed as effectively for the significant financial risk to the PFI consortium

17. Makes absolute sense but…..

18. Makes absolute sense but… • Swaffield and McDonald found • QS's within PFI's often do not consider LCC's instead focus on lowest capital cost, this could occur • during exceptionally busy times; • when working with extremely stringent financial budgets for construction costs; • when under pressure from managers to make a procurement decision quickly; • as a result of employing inexperienced or temporary QS staff; • with advanced technical systems where the maintenance requirements and associated costs are not well • on products/elements with a relatively low capital cost that are not considered worthy of a detailed LCC analysis; • where there is a lack of detailed information about the various options, due to poor links with the supply chain, lack of information from trade contractors about actual costs in use or past performance of their products, lack of availability of the people who had prepared the original estimates, and/or failure to fully understand the needs of the client.

19. Further reading Bernard Williams Associates (1996) Facilities Economics, Building Economics Bureau Ltd. Evans, R., Haryott, R., Haste, N. and Jones, A. (1998) The long term costs of owning and using buildings, Royal Academy of Engineers, London Kirk, S.J. and Dell'Isola (1995) Life cycle costing for design professionals, 2nd Edition, McGraw Hill, London Korpi, E. and Ala-Risku, T. (2008) Life cycle costing: a review of published case studies, Managerial Auditing Journal 23 (3) pp 240- 261. OGC (2007) Whole-life costing and cost management, Office of Government Commerce Moussatche, H. and Languell, J. (2001) Flooring materials – life-cycle costing for educational facilities, Facilities, 19(10), p.333-343. Swaffield, L.M. and McDonald A.M. (2007) The contractors use of life cycle costing on PFI projects, Engineering, Construction and Architectural Management, 15 (2) pp 132-148