Life-Cycle Costing

Too frequently the simple, short-term view of looking at the price only results in a purchase that ends up costing much more over a period of time than the original price tag. What’s more, the entity doing the buying may be pulled back to revisit that purchase multiple times if the item fails prematurely, turns out to be less efficient than expected, requires more time to install or maintain than anticipated, or some other, unanticipated problem comes up.

In the 1960s, life-cycle costing (LCC) became popular as a means to evaluate the true cost of something over its entire useful lifetime. LCC seeks to quantify all costs associated with ownership. In addition to the initial cost, LCC commonly attempts to weigh factors such as the cost to install, maintain, repair, operate, replace, even dispose of an item, and depending on how comprehensive the analysis is intended to be, the list can include many more factors. As this shows, the final cost of an item is almost always much more than its purchase price.

But alas, LCC is not a precise process—its calculation can become so complex that it involves factors as scary as scientific calculations using probability theory, risk assessments and statistical analysis. The degree of use depends on how precise the LCC calculation must be. This is probably one of the reasons LCC fell out of favor. However, that attitude is changing; in this time of tight budgets and the need to wring every bit of value out of each dollar spent, there’s renewed interest in LCC.

Fortunately, LCC as a concept can be applied without having to deal with much of the complexity, which is what this article seeks to do. Those who want to complete a “true” life-cycle cost analysis, the way such analyses have traditionally been done, can find ample source material on the Internet to help them and provide guidance. Those who choose this path can search some of the following terms:

• Life-cycle cost
• Life-cycle cost analysis
• Life-cycle cost summary
• Life-cycle cost calculator
• Water distribution life-cycle cost
• Water system life-cycle cost

However, before deciding to engage in this comprehensive LCC analysis with all its complexities, the following concepts about LCC should be understood:

LCC is not an exact science. Despite the many scientific principles and calculations that can be involved, the result itself is almost always only an estimate. That’s because the only part of the LCC equation that is well-known and clearly defined is the procurement cost. All other data is estimated or assumed, with no guarantees that one factor will behave exactly the same as another when trying to quantify things such as performance or repair histories. LCC estimates, by the very nature that they are estimated, lack hard accuracy.

A detailed LCC analysis can require costly procedures to obtain needed data. The more accurate the LCC calculation needs to be, the more cost and time involved to develop the input data.

Although LCC can call for volumes of data, typically only limited data will exist.

LCC for a given item that comes from different sources, such as from a seller versus an end user, can differ significantly. This is because each party has a bias when selecting or establishing the input data.

“Something” is almost always better than “nothing.”

Despite these realities, including LCC concepts in the procurement process can result in a more cost-effective purchasing decision. Even when a comprehensive analysis is not done, it is good practice to inject LCC into the discussion for no other reason than to push the various purchasing influences towards a team-like approach to the procurement process. In other words, considering only the initial cost without LCC:

• Designers or engineers might cut back on an item’s performance variables to meet a capital budget constraint that only considers initial cost.
• The purchasing department might focus on the lowest cost thinking as the desired goal, when in fact operating and other costs might mushroom once a less capable item is put into service.
• The operations department might assume an item will perform at 100% of its capacity and last forever when in fact almost nothing lasts that long.
• The maintenance department might plan an optimistic maintenance or repair program to reduce preventive maintenance costs and meet short-term management goals.

Including LCC principles in discussions and planning can push out each party’s cost horizon and encourage a more realistic assessment of potential costs over a longer period of budget years.

WHAT’S MY REAL COST?

Even before you enter the purchase price for an item on a purchase order, you need to consider at least some of the following factors that can bring on added expense:

The supplier’s reputation for service before, during and after the sale. A problem at any of these points in the procurement process that is not addressed in a timely manner can result in unexpected project delays, system downtimes, penalties, claims and other things that can bring on added cost.

The availability of a supplier’s local representation to address problems during installation or while the product is in service. Again, a supplier who is not available when needed can mean undue delays. Additional damage to systems or property may result if a failure is not corrected as quickly as possible by someone located nearby.

Availability of local stock, especially repair parts and accessories. Without this availability, downtimes can be extended, cutting into production revenue or increasing maintenance costs.

Supplier’s financial viability, which provides assurance of long-term support and honoring warrantees. Evaluating agents, representatives or any other entity that stands between operations and the manufacturer can have a detrimental effect on whether or not a warranty will be honored by that manufacturer. Often an item purchased outside a manufacturer’s authorized distribution channel will be refused warranty service or cause additional cost for repair or replacement.

Quality and professionalism. How the entire supply channel supporting an item acts can have an enormous effect on the level of customer service and support provided the end customer, especially over the long term.

The manufacturer’s commitment to a market segment. If the manufacturer’s focus is on another market or geographic area and its staff is not versed in the concerns and needs of the purchaser, the best product may not be selected.

Many of the foregoing considerations cannot be assigned a dollar value. Yet if a shortfall occurs in any one of them, it is almost assured that an unintended cost results. The old adage, “Pay me now or pay me later” tends to ring true in such circumstances, as does “if it sounds too good to be true, then it probably is.”

Note that the foregoing considerations do not do much to help a purchaser arrive at a meaningful cost comparison for one item versus another. However, constructing a matrix to rate all the brands to be considered, and then placing the items in order of likelihood that item will cost more over the long haul, gives a sense of true cost.

In constructing such a matrix, brands being considered could be one axis, while the other axis might list key words that represent each parameter to consider. In addition to the parameters suggested above, the list also might include:

• Supplier’s reputation for products/services that last or perform with minimal attention.
• Supplier’s reputation for products/services that are easy to install or apply with minimal training.
• Supplier’s reputation for products/services that save energy or lead to more efficiency in an application.
• The degree to which the product/ service is proven in years of field use—or lacking this, the reputation of the supplier’s products/services to last for extended periods of time relative to other brands.

After creating such a matrix, the next step would be to assign a number for each brand/parameter combination, such as “1” if the judgment on that consideration is low likelihood, poor or some other negative.” If “1” is the negative number, “3” might be high, excellent, very likely or similar. Then, “2” would be used for neutral performance or when a conclusion cannot be reached (though using that number should be kept to a minimum because it injects a degree of “benefit of a doubt” that might penalize other brands.) The last step would be to add up the numbers for each brand and arrange the brands from the highest score to the lowest.

Notice the initial cost is not factored into such a matrix. This is because an inferior product can sometimes hide behind a low initial cost. By including the initial cost in the matrix, whether that price is high or low, an otherwise high-scoring product could be penalized or a low-scoring one could be given an undeserved boost. Instead, an item’s purchase price should be evaluated in light of its ranking in the matrix.

The resulting matrix and scores can provide a procurement team a means to conduct more meaningful and insightful discussions to arrive at the best purchasing decision. While this approach might not have the precision and mathematical complexity of a true LCC analysis, its validity as a decision-making tool is much closer to evaluating the true cost of a product than initial cost alone.

ROBERT J. ABBOTT is director of corporate marketing communications,Mueller Co., Chattanooga, TN. Reach him at RAbbott@muellercompany.com.