The practical aspects of whole-life costing
Published: 14 May, 2005
JOHN LANGMAID puts the concept of whole-life costing into context against other evaluation processes that need to be undertaken during the design phase of a project.
hole-life-costing (WLC) has been around for many years. I first used it in the early 1960s when working for the (then) GPO to provide and economic analysis of various telecommunications civil-engineering schemes. In those far-off days the process was known as ‘PV of AC’ (present value of annual charges) — an acronym that still has the ability to stir the heart of many an old timer.
Another misconception about WLC is that this process of economic evaluation will provide data for input to budgets; it will not, and it cannot. Most certainly, the data collected for input to WLC calculations is eminently valuable for budgets once the scheme with the lowest whole-life cost has been selected.
As with any prediction of the future, whole life cost analysis is a guess — an educated guess most certainly, but a guess none the less.
The analysis calculations depend on the prediction of future interest rates and future costs, so it is easy to see why there is little certainty in the outputs and why those outputs cannot be used for budget formulation. Because the real purpose of WLCA is economic comparison, variations in interest rate are minimised, as the same variations will apply across all alternatives being considered.
The choice of the discount rate (interest rate) used can have a dramatic effect on the outcome of the analysis. As an example, an annual energy bill of £100 000 over 30 years will have a present value of around £1.7 million if a 3.5% interest rate is taken, but only £600 000 at 15%.
The change from 6% to 3.5% for the standard rate to be used (dictated by HM Treasury) in April 2004 will have upset many project calculations — although it is doubtful if any retrospective action has been taken.
The only criterion used in whole-life-cost analysis is that the scheme which meets all client required functional requirements and which has the lowest whole-life cost, is the preferred solution. No other or further adjudication is needed.
Whole life costing is one of three evaluation processes that need to be undertaken during the design phase of any project. The other two are technical evaluation and environmental evaluation. The final choice of scheme will be a compromise between these three. BS ISO 15686 shows these in context.
Whole-life value is more important than value for money, for one simple reason. WLV represents the long-term value for the money invested; VFM tends to represent the immediate spend against the functions provided by the technical solution (which may or may not meet the client’s business needs).
Before a WLC analysis can be undertaken — with a view to achieving the highest WLV — it is essential that a value-engineering exercise is undertaken, and repeated as necessary, to remove all unnecessary functions from the technical specification — leaving only those functional requirements which fully meet the client’s business needs.
Once the value engineering has been completed, the designer has the task of matching several technical means of achieving those functional requirements. Each solution must meet all the stated requirements and, ideally, not provide any others.
Estimated current costs for equipment supply, installation, and commissioning are relatively simple to acquire and apply, but those for ongoing operations and maintenance can be more complex and difficult to ascertain. In too many instances, the replacement schedule for equipment is given as a range in time, with no context regarding the quality of installation, commissioning, operation, maintenance, or environment.
The maintenance regime to be employed must be decided before moving into whole-life-cost analysis. This process will assist with the definition of the recurring costs of maintenance mantime, spares, replacement and renewal. Part of this exercise must be the evaluation of the environment in which the equipment will operate.
These activities are not part of whole-life-cost analysis. They are, instead, part of service life planning (SLP), and there is confusion between the two.
The purpose of WLCA is to provide an economic assessment that considers all projected significant and relevant cost flows over a period of analysis, expressed in monetary value.
The purpose of SLP is to consider the likely performance of the building over the whole of its life under the environmental conditions applicable to it.
In other words, SLP provides data for use in WLC, and WLC provides economic analysis of SLP alternatives
The ‘life’ data supplied by the manufacturer must then be modified to suit that environment. For example, a water pump operating in a hard-water area is likely to require more maintenance and is less likely to last as long as the same pump operating in a soft-water area. This assumes that it is possible to find out what environment is applicable to manufacturers’ data and what definition of ‘life’ has been applied.
The same pump in a soft-water area but with minimal maintenance will likely fail earlier than if the pump were operating in hard-water but had extensive and regular maintenance.
The life of the equipment is another area where misunderstanding is rife. There are many types of equipment life. Here are two suggested by Kirk and Dell’Isola.
• Economic life is the estimated number of years until that item no longer represents the least-expensive method of performing the functions required of it Technological life is the estimated number of years until technology causes an item to become obsolete.
• Useful life is the estimated number of years during which an item will perform the functions required of it in accordance with some pre-established standard.
Which definition will apply to the project under evaluation will alter the replacement schedule and hence is likely to modify the outcome of the whole-life evaluation. For example, CIBSE quotes the life expectancy of a shell and tube boiler as 20 to 25 years. If we assume a capital replacement cost of that boiler of £100 000 and a discount rate of 6%, the Present value of a replacement in year 20 and one in year 25 will be around £31 000 and £23 000, respectively. That substantial difference could easily reverse the selection of the scheme with the lowest whole-life cost.
The same difficulty applies to predicting future mantime costs, although these are likely to have a lesser effect on the overall totals.
To define the input data for WLCA, it is as well to understand the deterioration mechanisms which will affect the installation so that more accurate predictions can be made of the timing and extent of the interventions which will be required.
It is therefore important that the facility or maintenance manager be involved in the data acquisition process early in the design phase and that the relevant schedules and costs be estimated as accurately as possible.
There are a number of errors usually made by practitioners when carrying out a whole life cost analysis.
• Omission of data.
• Lack of a systematic structure or analysis.
• Misinterpretation of data.
• Wrong or misused estimating techniques.
• A concentration of wrong or insignificant facts.
• Failure to assess uncertainty.
• Failure to check work.
• Estimating the wrong items.
• Using incorrect or inconsistent escalation data.
The value of whole-life costing — and, hence, whole-life value — depends on several elements.
• The ability of the designer to find alternatives which fully meet the functional requirements.
• The acquisition of accurate input data.
• The documentation of all assumptions that must be made due to the lack of accurate information.
Of these the most difficult will be the accurate input data — it simply isn’t there.
John Langmaid is a principal consultant with BSRIA Ltd, Old Bracknell Lane West, Bracknell, Berks RG12 7AH.
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