FM Issue: Life Cycle Cost Analysis: An Asset Management Strategy
By Jeff Cryder
Published in the October 2009 issue of Today’s Facility Manager
In an economic climate that remains challenging despite signs of an upturn, experts agree that a full recovery is a long way off. Consequently, facility professionals would do well to continue managing their buildings with an eye toward ensuring they are leveraging every aspect in a manner that contributes to the business. This includes managing the building as an asset of the business.
Commercial building owners spend hundreds of millions of dollars on energy each year, according to the U.S. Department of Energy (DOE), Energy Information Administration (EIA). In 2003—the most recent data available—building owners spent approximately $107.9 billion on major fuels. HVAC systems comprise approximately 33% of a typical commercial building’s energy use, according to the 2007 Energy Data Book from the DOE’s Office of Energy Efficiency and Renewable Energy.
Planning and implementing an HVAC project in the same manner as managing a large maintenance expense ignores two key issues:
- HVAC upgrades, which will likely remain in place for 20 to 25 years (or more), are capital investments made within an organization’s fixed asset management program.
- A facility that is comfortable in terms of temperature, humidity, air quality, noise level, and energy consumption plays a mission critical role in occupants’ satisfaction and their ability to concentrate and function productively.
For these reasons, facility managers (fms) should bring a more strategic asset management focus to new HVAC investments.
Changing The Paradigm
Traditionally, bids for HVAC upgrades are solicited on a first cost basis. In these cases, the RFPs ask vendors to present their lowest possible pricing for the initial acquisition and installation of their recommended equipment.
Using a first cost basis to determine the bid outcome on the purchase of supplies or commodities is fine and acceptable. But a major HVAC project is a capital asset; the installation will likely see several decades of service, represents a substantial investment, and the upfront cost often represents only 5% of the overall funding in terms of total cost of ownership over 20 or more years.
Despite this fact, many organizations continue to purchase HVAC upgrades on a first cost basis. Only recently has the paradigm begun to shift, with commercial building managers maximizing efficiency and saving money by evaluating their HVAC projects in view of their life cycle cost.
The Life Cycle Cost (LCC) of an asset is defined as the total discounted dollar cost of owning, operating, maintaining, and disposing of a building or a building system over a period of time, according to The National Institute of Standards and Technology (NIST) Handbook. An LCC analysis (LCCA) examines a capital project’s total cost of ownership by comparing initial, maintenance, repair, and operating costs over the life of the system.
In this era of ever tightening budgets, a low priced system is initially bound to appear attractive. However, it’s important to consider that a lower priced system might use energy inefficiently, have excessive lifetime operational costs, or have a shorter usable life, causing the fm to replace it long before a new system should have been needed.
Fms should consider all of these factors in order to make the most effective, efficient choices for their facilities. That’s the benefit of the LCCA.
A well executed LCCA will result in one of the three following outcomes:
- Acquiring equipment and systems that are outstandingly durable and therefore pay off their higher initial costs with lower operational and maintenance expenses.
- Equipment and systems with lower initial costs and satisfactory, if not optimal, performance.
- Equipment and systems that raise the cost of construction and operations but increase the facility’s performance (and profitability, in the instance of the private sector) to such a degree that it justifies the additional cost.
An LCCA differs from a number of other analytic methods that have been employed in the past, simply because it takes into consideration this wide variety of factors. For example, the payback method only evaluates how quickly the initial investment can be recovered without any measure of long-term performance or consideration of the system’s lifetime. An LCCA, however, takes into account the system’s lifetime as well as a number of unpredictable factors, such as the behavior of the equipment’s materials, the use of the facility, environmental conditions, and energy costs, all of which can affect a system’s overall costs.
As a complex analysis, the LCC evaluation method requires an in-depth understanding of the process in order to ensure the best results. But fms will find the rewards are well worth the time and effort.
How To Get Started
Timing can be important to an organization’s ability to reap the greatest cost benefits from an LCCA. HVAC system decisions can be affected by issues like building design and siting, so it’s important for fms to get an LCCA as early as possible in the design process. Of course, for renovation or replacement of an HVAC system, the timing will be slightly altered to fit the project’s specifications.
An RFP is the first step. Rather than basing the bid process on a “first cost” RFP, fms should look for a more strategic and long-term asset management-based alternative. In other words, any RFP should require each bid to include an LCCA.
Bid processes that incorporate an LCCA help fms determine the best value among the alternatives. The goal is to create a system that can operate at peak efficiency throughout its lifetime, eliminate system shutdowns, and make use, when necessary, of non-corrosive materials in harsh environments.
The Cost Variable: Initial Expenses
There are three variables to consider when breaking down the LCC equation: the cost of ownership; the period of time over which the costs are incurred; and the discount rate that is applied to future costs to equate them with present day costs.
To start, the costs of ownership variable can be broken down into two categories—initial costs and future costs. Initial costs are those incurred prior to installation of the HVAC system. Future costs are those incurred after the system is in place.
The capital costs for the HVAC system and controls are included in the initial costs category. Because controls are an important factor in maintaining a high performance HVAC system in a building, they need to be flexible. Fms should consider how easily controls handle the following tasks:
- Centralizing commands;
- Monitoring temperature and humidity;
- Changing settings;
- Controlling critical functions; and
- Testing and balancing equipment.
Construction expenses also fall into the initial costs bucket. Detailed estimates of construction costs are not a necessary part of preliminary analyses of building systems. These estimates are usually not available until the design process is rather far along and the opportunity for cost reducing design changes has been missed.
LCCA can be repeated throughout the design process if more detailed cost information becomes available. Initially, construction costs are estimated by reference to historical data from similar facilities. Several government and private sector cost estimating guides and databases also are available.
The Cost Variable: Future Expenses
All other expenses that will occur after the new HVAC system is in place fall into the future costs category. This includes energy, water, and other utility costs, non-fuel operating costs, along with maintenance and repair (OM&R) costs
Many future costs, like energy prices, are difficult to predict, so determining the exact value of expenses in each cost category can be tricky. A variety of energy modeling software programs can help analyze the building’s projected use, occupancy rates, schedules, and other factors that can predict energy consumption.
Energy prices fluctuate from time to time, but despite these occasional changes, the cost of energy will continue to rise over the long term. But, a good LCCA will factor in an energy price projection as well as the rate type, the rate structure, summer and winter differentials, block rates, and demand charges to obtain an estimate as close as possible to the actual energy cost, according to the NIST’s guide on LCCA.
Utilities, such as water usage, can be treated similarly to energy. For example, in terms of water, the analysis must take into account usage and disposal.
The future costs included in the LCCA should account for maintenance and frequency as well as preventive maintenance including: non-labor intensive system tracking and monitoring, options for cost-effective outsourcing, service calls and parts, and availability of skilled technicians.
OM&R costs often are more difficult to estimate than other building expenditures because operating schedules and standards of maintenance vary widely from building to building. Even between buildings of the same type and age, there is great variation in these costs. Therefore, it’s especially important for fms to apply engineering judgment based on a particular building and use projections when estimating these costs. A full service agreement may help to mitigate cost and risk in this area as well as ensure uninterrupted services.
The fm and and a building consultant can decide which costs are applicable to the project and produce a realistic LCC comparison of alternatives. For example, will there be renovation costs associated with a system upgrade? Or will the new system simply reside where there is an existing unit?
The Time Variable
Time is the second component of the LCC equation. The study period for an LCC is the length of time over which the preparer will evaluate ownership and operations expenses. Typically, the study period will range from 20 to 40 years, depending on the fm’s preferences and the intended overall life of the facility. However, it’s important for professionals to note the study period is generally shorter than the intended life of the facility.
Similar to the way LCCA costs are broken down, the NIST approach divides the study period into two phases: planning/construction and service. The first phase is the time from the start of the study to the date the new HVAC system becomes operational (the service date). The second phase begins on the service date and lasts until the end of the study.
The Discount Rate Variable
The third and final piece of the LCC equation is the discount rate. This is the rate applied to future costs to equate them to the present.
The discount rate can be viewed as the number that would make fms indifferent as to whether they receive some (perhaps small) payment now or a greater payment later. As the economies change, so does the discount rate. However, fms can refer to organizations like the DOE to see what happens when a discount rate is updated annually.
An LCCA can be performed in constant dollars or current dollars. Constant dollar analyses exclude the rate of general inflation, and current dollar analyses include the rate of general inflation in all dollar amounts, discount rates, and price escalation rates. Both calculations result in identical present value life cycle costs.
An LCCA is a valuable assessment to help fms design, build, and maintain their facilities as assets, not commodities. A number of other considerations can further extend facility investments, such as:
- Financing programs that can help manage the total cost of renovation by guaranteeing energy savings that will finance HVAC systems improvements;
- Energy modeling software that helps fms more accurately model building performance and compare reduced energy usage to optimize Energy Policy Act tax deductions as approved by the U.S. Internal Revenue Service; and
- Systems that provide optimum efficiency with a smaller footprint, allowing fms to reduce the use of resources (water and energy), thus saving on costs and minimizing the negative impact on the environment while increasing the amount of useable volume within the building.
There isn’t a definitive, objective method to quantify some of the costs and benefits that result from an LCCA. One non-monetary effect of upgrading an HVAC system could be the benefit derived from a particularly quiet HVAC system. Though non-monetary effects are external to the impact of the LCCA, they should still be considered in the final investment decision.
Cryder is the controls contracting leader for St. Paul, MN-based Trane. During a 28-year career, Cryder has earned a reputation for excellence within the controls and building services industry.