LifeCycle Costing Project Report April 2008 (2)

8/6/2019 LifeCycle Costing Project Report April 2008 (2)

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AAMCoG LifeCycleCostAnalysis(LCCReport)

Life Cycle Cost Analysis

(LCCA)

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The Australian Asst Management Collaborative Group (AAMCoG)

The Australian Asset Management Collaborative Group (AAMCoG) was formed in August 2006

by the CRC for Integrated Engineering Asset Management (CIEAM). AAMCoG is acollaboration of several of Australias peak bodies interested in work programmes in asset

management. AAMCoGs mission - Facilitate collaboration between interested organisations to

promote and enhance asset management for Australia.

Members of AAMCoG aim to:-

Collaborate nationally on asset management strategies between all asset managementgroups

Coordinate transfer of technology and knowledge sharing of asset management R&D Promote skills development in asset management Host the annual National Forum for Asset Management Act as a communication channel between member bodies Inform asset owners/custodians of the critical aspects of whole of life asset management

For further details, please refer to the AAMCoG Website www.aamcog.com

Acknowledgments

The CRC for Integrated Engineering Asset Management (CIEAM) would like to acknowledge the

financial support from the Commonwealth Governments Cooperative Research Centres

Programme and the contributions from our industry, government and university participants.

CIEAM would also like to acknowledge the following contributions to this report;

Dr Lyle Turner Research Fellow QUT

Mr Peter Way - Chair - IPWEA-NAMS.AU

Dr Nick Hastings CIEAM Training Facilitator

This project was undertaken under the guidance of Professor Joseph Mathew chair of AAMCoG

and Professor Kerry Brown, Executive Officer, AAMCoG.

Confidentiality

In accordance with Australian freedom of information legislation, all information collected as

part of this study will be retained for seven years in a safe and secure environment. Paper-based

data will be stored in a locked filing cabinet, and electronic data will be encrypted and stored at

CIEAM Head Office, Brisbane.

Disclaimer

AAMCoG members make use of this report or any information provided by CIEAM at its own

risk. CIEAM will not be responsible for the results of any actions taken by members or third

parties on the basis of the information in this report, or other information provided, nor for any

errors or omissions that may be contained in this report. CIEAM expressly disclaims any liabilityor responsibility to any person in respect of anything done or omitted to be done by any person in

reliance on this report or any information provided.Enquiries

Communication Officer/ Jane Davis

CRC for Integrated Engineering Asset

Management

Level 7, O Block, QUT Gardens Point campus

GPO Box 2434

BRISBANE QLD 4001

Phone: +617 3138 1471

Fax: +617 3138 4459

Email: [email protected]

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http://www.aamcog.com/http://www.aamcog.com/mailto:[email protected]:[email protected]:[email protected]://www.aamcog.com/


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CONTENTS

TheAustralianAsstManagementCollaborativeGroup(AAMCoG)...........2

Acknowledgments......................................................................................2

Confidentiality............................................................................................ 2

Disclaimer................................................................................................... 2

Enquiries..................................................................................................... 2

Introduction................................................................................................... 4

LifeCycleCostAnalysis.................................................................................. 5

Discussion...................................................................................................... 9

Recommendations.......................................................................................14

Appendix...................................................................................................... 18

Engineeringcostmethod..........................................................................18

Analogouscostmethod............................................................................18

Parametriccostmethod...........................................................................18

Probabilisticestimationmethod..............................................................18

References:.................................................................................................. 19

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Towards a Unified LCC Framework

IntroductionLife Cycle Cost Analysis (LCCA) is a method applied by a business or government entity

in the management of its asset base. As a tool, it is used to aid in a variety of situations

where a decision must be made, such as in the acquisition of one of a number of assets, orin the continued upkeep of a portfolio of existing assets. LCCA is primarily concerned

with the cost of ownership over the life of an asset, and as such, provides a valuable

framework for the analysis and allocation of all related expenses that will be incurred.

Given the ability of LCCA to be used to capture important information related to the

management of an entitys assets, and the improvements in decision making capabilitywhich it provides, it may be somewhat surprising that in general these benefits are not

reflected in the real world where there is a distinct lack of attention paid to LCCA.

Indeed, recent studies such as those commissioned by the Building Research

Establishment of Britain (Clift and Bourke, 1998) have identified a significant lack ofLCCA adoption and have listed several possible reasons for this (discussed in the LCCA

section below). Importantly, the lack of a universal framework of methods and standard

formats for calculating Life Cycle costs was identified as a major issue.

This report sets out to address this problem of LCCA adoption by drawing from different

examples of LCCA use from different public and private sector members. The aim is toprovide a concise, uniform model framework for addressing whole of life cost

implications, not only in the traditional applications of new product development andcapital acquisition, but also in the continued operational phase off the asset. It is in thisarea that the real benefits of LCCA as an asset management and budgeting tool are still

largely unexplored. It is also the area where substantial benefit can be gained in terms of

effective and efficient management of assets and the scarce resources they consume.

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Life Cycle Cost Analysis

Life Cycle Cost Analysis (LCCA) can be summarised as:

the structured analysis of the entire set of costs which are associated with a

project or asset, in order to evaluate the total cost of ownership of the asset.

The set of costs involved in the analysis occur throughout the entire useful life of theasset, or at the very least, the period in which the asset is owned by the entity performing

the analysis. The life cycle for an arbitrary asset is made up of many different phases but

can, at a basic level, be separated into the following sections:Acquisition, Operation and

maintenance,Renewal (if applicable), andDisposal.

LCCA involves the structuring and analysis of the sum of all costs attributed to an asset

during its life cycle. These costs, referred to as Life Cycle Costs, occur at different timesduring the above life cycle stages, and arise due to all expenses related to various

activities that are performed. These may include, but are not restricted to:

- Initial capital costs, such as those associated with project planning, acquisition andpreparation of asset, cost of raising funds and feasibility studies etc.

- Operating costs, for such elements as operations personal, materials, fuel, energyconsumption etc.

- Maintenance costs- Risk exposure costs- Renewal costs- Disposal costsWhile these costs occur throughout the life cycle, it has been noted (Kawauchi et al,1999) that often, the majority of costs will stem from the actual ownership activities; in

some cases as much as 80% of the costs will occur during the operational life of the asset.

It is this fact that makes LCCA a powerful management tool in applications such aschoosing between competing projects or assets. That is because the decision processes

will incorporate qualitative and quantitative information relating to the entire life cycle

costs of the project, rather than the small subset of initial costs.

The International Infrastructure Management Manual (2006) and the Australian/New

Zealand standards guide on LCCA (AS/NZS 4536:1999) provide a comprehensive list ofapplications in which LCCA is most commonly utilized. These include:

1. The evaluation options for the procurement of new assets, such as design trade-offs,source selection and affordability studies.

2. The on-going support of management decision making throughout the life of anasset.

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3. The identification of asset attributes which significantly influence the LCC, allowingtheir proper management. These are often referred to as `Cost Drivers.

4. The benchmarking of assets actual cost performance.5. The review of the procurement process for future design/acquisition decisions.Depending on the particular application in question, the method by which the life cycle isdefined may change. That is, it may incorporate different cost elements, group theseelements in different ways, or even leave out certain cost elements that are deemed

unnecessary for the particular analysis and problem being examined. The analysis may

also be applied at any stage during the Life Cycle, however as noted in the Defence

Policy on Life Cycle Cost Analysis (DI(G) LOG 4-5-004), the popular application ofLCCA is during the initial stages of an assets life cycle. The most common justification

of this analysis timing is that it is during the design and early life of the where

management has the greatest control in guiding the project towards the lowest LCC.

In most sectors, both public and private, LCCA has without a doubt been applied most

often in the economic evaluation of alternative projects related to asset creation oracquisition. The common LCCA methodology which is applied can be summarised by

the following steps. This accepted framework can be adapted to the particular purpose of

the analysis, such as to assist in planning, budgeting, contracting etc. While each purpose

may include different factors in the actual life cycle cost aggregation itself, the basicmethodology in most cases remains the same, and as such can be taken as best practice of

the basic structuring of an LCC application.

1. Plan LCC analysis

The initial planning phase allows the specific objectives of the LCCA to be defined and

specified, along with any assumptions that must be made regarding the assets and theirassociated costs. Typically, the objectives of the analysis are specified in terms of the

outputs which are required by management for decision making, a process that relates

back to the above notion of shaping the analysis for the particular application in question.

The planning phase is also used to identify any limitations, assumptions or constraints

which may affect the set of options which are involved in the decision problem. As the

analysis proceeds, changes in these constraints may in turn increase or decrease thenumber of possible project alternatives.

2. Select/Develop LCCA Model

Once the objectives have been determined, the particular life cycle model can be selected.This step is where differences between LCC applications usually become evident, as

different applications call for different analysis frameworks to be employed. Specifically

the life cycle is broken down based on a Cost Breakdown Structure (CBS) that sets outthe particular life cycle phases and the relevant cost categories. The life cycle can be

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The LCC results can be used in a variety of analyses in accordance with the objectivesdefined in the analysis plan, thus ensuring that all goals have been fulfilled and that

sufficient information has been provided to support the required decision. The objectives

are of course dependent on the application in question, and while some industries mayfind that a similar LCCA can be used in multiple settings, in general the objectives of the

analysis will vary on a case by case basis.

4.Document and review LCCA results

In general, the LCCA process is heavily documented to allow all users (both current and

future) to understand the outcomes and their implications, along with any limitations

which have been placed on the results. The reporting process is important and while itcan take many different forms, several key components are usually incorporated.

Specifically, the reporting documentation must clearly set out the intentions of the

analysis and what it is trying to achieve. Secondly, it should include discussion of allrelevant assumptions made in the analysis, along with the actual model applied. Finally, it

should include conclusions related to the objectives of the analysis, along with anyrecommendations related to further work or revision of the analysis. In the case of LCCA

applied to decision making between competing alternative assets, these recommendations

may also extend to adjustments or revisions of the alternatives; for example, in the designof specific components, or the inclusion of external factors relating to user demands on

the assets.

5. Prepare on-going life cycle costing methodology

The above steps describe the common application of LCCA; that is, applying the analysisto help decide between competing alternative acquisitions. While the results of the study

are often not further addressed once the decision has been made, there is often value in

maintaining the LCCA model that has been developed for aiding operational decisionmaking processes. As stated in the Life Cycle Costing Guidelines released by NSW

treasury (TAM04-10), LCCA is primarily a tool for both acquisition and ongoing

decision making, and therefore it is possible to apply this tool to areas other than theinitial decision making process; namely, in the management of the ongoing costs of the

asset. The model may remain roughly the same throughout the assets life, however

variations can appear in such quantities as the type of discount rate used (real ornominal), the specific costs that are incorporated into the model and the quality of cost

data that is input. As time progresses, more and more real data becomes available which

can be used to replace estimates. The user may even find that this real data changes theresults of the initial LCC analysis entirely; however, a good initial model minimizes the

chances of such an occurrence.

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6. Implement and monitor on-going life cycle costing

This step involves the application of the LCCA model throughout the assets operationallife. As mentioned in the previous step, the principal use of LCCA throughout an assetslife is to continuously monitor the performance of the asset, in order to identify potential

cost savings and aid in the assets general management and the planning of any future

changes. These processes can be critical in determining the optimal time for interventionby way of possible replacement or enhancement of the asset to minimise costs and ensure

ongoing service delivery meets desired levels.

DiscussionA survey of both domestic and international literature indicates that most

implementations of LCCA follow the same methodology in terms of their design,

definition of cost elements and calculations. However it is clear that significant variationexists in a number of key areas, and while some can be related simply to sector

differences in which the analyses are applied, other differences may indicate a more

fundamental set of issues. The few items below are the areas where LCCA applicationswere found to vary.

Structural differences

The first, and perhaps most obvious variation that has been observed between analysisapplications, is the way in which the life cycle of particular assets are broken down. The

purpose of the breakdowns is to organise the set of associated costs in some sort of time

frame, which helps planners and decision makers understand where and when costs willbe incurred. The specific time period in which the cost is incurred (usually denoted by the

year in which the cost occurs) is also important when evaluating the present value of the

costs. In this way, the LCC breakdown is an accounting structure, specifying all costsassociated with an asset out over a time horizon (which, in nearly all cases is finite).

Depending on the sector and industry in question, an assets life cycle and associated cost

elements can vary in definition from rather crude breakdowns to quite intricate listings.The level of granularity to which the breakdown is extended depends on the practitioner,

who in many cases will try to find a balance between accuracy, and the level of resourcesallocated to the analysis. The methods through which these breakdowns are created are

varied, however they generally consist of a top down approach, starting from the main

components of the life cycle and then breaking these up into smaller and smaller parts.

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In particular, there are two common techniques used in creating the breakdown of costelements. The first, as described in the LCCA Better Practice Guide released by the

Australian Audit Office (2001), is to organise the costs via general cost categories, such

as labour, materials or operations costs. This method is popular when applying LCC toinfrastructure based asset classes, and aids in making sure all relevant costs have been

included. The second method, described in a number of sources including the LCCAprimer released by the US department of Transportation (FHWA IF-02-047), is toidentify the major activities which occur over the assets life cycle, and to then assign all

relevant costs to their respective activity. This technique has the advantage of linking

costs to real, physical activities that are linked to the asset, rather than generic costcategories that may be difficult to relate back to the assets operation. The level of activity

analysis recommended by LCCA standards, in particular the Australian/New Zealand

standards guide on LCCA (AS/NZS 4536:1999) could be considered the minimumrequired for any particular cost breakdown, as will be discussed in the related section

below (See `The Australian/New Zealand Standards Guide to LCCA).

It is also apparent from industry sources that the final set of cost elements which areincluded in the model depend greatly on the purpose of the analysis. For example,

depending on the asset being considered, disposal costs are sometimes replaced with asalvage value. Further still, costs which are common across several different assets may

be left out completely if the LCC models are simply for comparative use between

different asset alternatives. Usually however, these assumptions are made in adeterministic world, and this should be remembered when deciding on which costs are

left in or excluded from the analysis.

Discount Rate and LCC formula variations

To obtain appropriate life cycle costs and further LCC measures, it was described abovehow the present value formula is used to discount all costs back to present day values, so

that they can be combined using a particular measure. The PVformula requires, as part of

its definition, an appropriate discount rate to be chosen which is relevant to the particularindustry sector in question. As noted by Barringer (1996), generally the most difficult

question in any LCCA application is which discount rate to apply.

It is important to note that the discount rate used in an LCCA application can have quite a

large impact on the analysis and the eventual conclusions that it reaches. In fact, as the

LCCA primer released by the US department of Transportation (FHWA IF-02-047)indicates, the LCCA relationship between different alternatives can change completely

between different discount rates. For example, if the discount rate for a particular

alternative is set too low, a valid project option may be incorrectly rejected, and vice

versa. It is therefore important to apply the correct discount rate for each particular

decision problem; however, the question ofwhich discount rate to actually use in a given

situation does not have a simple answer.

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A number of issues regarding discount rates where noted from the literature. Firstly,while some sources simply stated that a discount rate was used, there were variations in

which particular form the rate was interpreted. Specifically, the application in question

seemed to dictate whether nominal or real costs were used, and consequently whether therate was set inclusive of inflation. A justification for using either real or nominal rates

(given in the LCCA primer (FHWA IF-02-047)) was that for public assets, benefitsshould depend only on real gains such as expansion of output or cost savings. It wasnoted however that the price change effects from nominal cost values and rates can be

factored out, or nominal values can themselves be used in the analysis, so long as

consistency is maintained throughout. However, a common trend in the literatureappeared to be to base LCC calculations on the constant real values and real discount

rate.

The more important issue when setting the models discount rate is that an accurate value

is selected to begin with. The appropriate rate is not a fixed value; it depends on both the

entity in question, the point in time at which the cost is being incurred and of course the

nature of the asset being examined. Leaving aside the problem of non-constant discountrates, selecting a value which accurately discounts future costs back to present day will

be based on a number of different factors. As stated in both the LCCA Better PracticeGuide released by the Australian Audit Office (2001) and the Australian/New Zealand

standards guide, a rate is selected which reflects the risk-adjusted rate of return on the

asset which justifies the long-term retention of the asset by the entity. It is sensible thatthe rate be linked to the cost of borrowing for that particular company, and the required

returns of its shareholders. In fact, it is often the case that the required rate of return for

the investment is computed, and this value set as the discount rate.

In general, a number of different factors, both internal and external to the entity, affect

the choice of discount rate. The rate can be based on such variables as the standard low

risk interest rate or the returns on standard government issued notes; for example, the

Guidance on Life-Cycle Cost Analysis released by the Federal Energy Management

Program (2003) suggest a rate based on the 12 month average of the composite yields of

all outstanding US treasury bonds. Another method is to consider the value of any ofthese rates, additionally subject to an extra premium to compensate for the extra risk of

the asset or project. Depending on the entity in question, a premium may of course be

added if the companys asset is expected to generate high returns.

Given the many factors that can affect the discount rate, an appropriate level of guidance

or framework for the actual value selection was a notable absence from the literaturestudied. As stated below, the failure of the current literature to define a standard method

for selecting the discount rate is an area of LCCA which at present requires some

additional work.

An additional shortcoming which affects not just the discount rate but also the aboveLCC calculations, is the application of deterministic methods and assumptions of

homogeneity of model values. Rarely were issues such as risk, uncertainty and associated

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realistic assumptions acknowledged other than by passing comment. Even theAustralian/New Zealand standard failed to adequately deal with the notion of including

risk and uncertainty in LCC calculations, a fact which is surprising given the, at times

high level of subjectivity of certain values and assumptions made regarding the modeland its application. The extent to which the standard addresses uncertainty is to suggest

sensitivity analyses be conducted, a measure which falls far short of current acceptedmodeling methods such as Monte Carlo simulation, time series modeling and generalprobabilistic and statistical analysis methods. These types of approaches however, do

depend on adequate and sufficient data to be collected, a problem that will be discussed

in the recommendations.

Ongoing management of assets

As opposed to the above application of comparing future projects for acquisition decision

making, the use of LCCA throughout the life cycle of an asset or assets appears quite

restricted and undeveloped. The applications examined indicated that while mostproponents of LCCA acknowledge its inclusion in the basic methodology, little attention

was given as to its application. The general strategy seems to be to apply LCCA duringthe initial stages of asset development, and to then discard the results. Using LCCA as a

through life management tool in some cases even has a negative view; as Barringer

(1996) points out, an often held view is that LCCA results are not good budgeting tools.This view is based on the subjectivity that is found in most LCC applications, and the

inaccuracy that this commonly leads to by the time operational budgeting concerns are

raised.

The view that LCCA is useful only as an initial method of deciding between competing

alternatives is unfortunately a widely held notion, however there is a case to be made for

its wider use throughout the operational life of the asset as well. The sources examinedmake note of several different applications of such in-service analysis. For example, an

application noted by Boussabaine and Kirkham (2004) is to use a continued LCCA as a

form of economic benchmarking of the asset. By comparing updated LCC estimates withthe original, the owner can see how the asset is performing economically in comparison

with the original forecasts. Depending on the quality of initial cost estimates used these

numbers could change substantially as operational cost data becomes available andreplaces the forecast values.

The key issue of through life LCCA adoption tends to be based around maintainingcertain performance and/or service standards. Fane et al (2004) notes that the question

most commonly asked in the management of an asset is, What are we trying to achieve

by managing these assets? Depending on the type of asset, there may be severaldifferent answers:

1. Service to customers or community2. Minimize LCC for asset/s3. Optimize maintenance and downtime

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4. Increase the capability or efficiency of asset/s5. Ensure ongoing financial sustainability to continue operating the asset

Points 2 and 3 relate to getting the most bang for buck from a given amount of moneyspread over a given set of assets, however this consideration is commonly taken in

relation to the fulfilment of point 1. For example, the South Australian governments2001 report into asset management within local Councils (Burns et al, 2001) identifiesthat, given the restricted budget available for renewal and replacement of assets, there is a

need for much greater scrutiny of existing assets in relation to community worth. LCCA

can be applied in this decision making process to judge, given the value of an asset to thecommunity, if renewal or replacement is appropriate and when is the optimal time for

such an event.

Aside from the above issues, another important use of LCC is in the continued

management of financial risk associated with an asset or project. Boussabaine and

Kirkham (2004) note this in the context of PFI or PPP contracts, which are generally long

term pairings of the public and private sectors. An important factor in these types ofprojects is not only that they are cost effective (value for money from the publics point

of view), but also that there is an appropriate level of risk transfer to the private sector.This balance between adequate risk transfer and ensuring that there is an acceptable level

of quality service delivery throughout the contracted operational life of the asset can be

provided by using LCC techniques in an iterative approach. By continually updating theLCC model and using associated real data and improved estimates of unknown values,

management can examine the economic performance of the asset in association with the

expected life cycle costs that will be incurred under any changes to the asset or itsoperation. This allows decisions to be based on real time analysis of the relationshipsbetween the various cost elements of the asset, and the risks associated with each of these

elements.

The Australian/New Zealand standards guide on LCCA

The above framework for LCCA is in part drawn from the Australian and New Zealand

standards guide on LCCA, which is the primary source for the application of LCCA

within Australia, across all sectors and industries. The guide is generally clear andconcise in its description of the various stages of the application of LCCA (though it can

be unclear in some sections; for example, the discussion of the differences between real

and nominal costs and rates), and provides a treatment which is general enough to beapplied across many types of decision problems, from infrastructure to unit assets.

There are however, several notable areas within the standard which are lacking in boththeir coverage and general guidance. The first of these relates to the above discussion of

the application of LCCA during the operational phase of an asset. The document contains

a brief reference to the application of LCCA during any life cycle phase, and alsodenotes that LCCA can be used in the `efficient allocation of resources. However it then

proceeds to concentrate on the normal case of using LCCA for initial decision making.

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The justification, once again, is based on the fact that it is the initial period at which mostassociated costs are yet to be locked in, and can so be changed. While the LCCA models

used during operation may be applied in much the same method as the common case, it

would be worthwhile to include an additional example application where LCCA isapplied in a more general asset management framework. Currently, the four examples

included cover much the same ground, and could be viewed as redundant.

The second critique involves the attention given to factors involving uncertainty in the

LCCA results. Values for cost estimates are found from a variety of sources: historical

data, objective estimates given by relevant experts and other basic forecasting methods.All of these sources are susceptible to different levels of uncertainty, due to either errors

made in the experts estimates, or general variability in the cost values estimated from

historical data. Given that all real world instances display some level of randomness,taking this variability into consideration when evaluating LCCA results is both a valuable

and important exercise. While modelling for uncertainty has been a part of the LCCA

literature for several decades now, the standard fails to make no mention of the methods,

let alone the fact that such uncertainty exists. It must be stated that this is an issue withinthe wider LCCA literature, with many practitioners still failing to adjust their modelling

practices (even though technological advances have made such calculations almostroutine. It would be appropriate for the Standard, as the central LCCA resource within

Australia, to detail this body of statistical techniques, which for minimal effort can

provide not only an understanding of the life cycle costs, but also the inherent financialrisk associated with an asset or decision.

Finally, as stated above the selection of an appropriate discount rate can require manydifferent factors to be taken into account. To do this in a systematic manner requiressome formal standard or framework in which the factors can be incorporated. The

literature surveyed however did not provide such a framework, in particular the standard.

Given that this is supposed to be the definitive guide to LCCA, it is of concern that suchan important factor of the modelling process is given minimal treatment.

Recommendations

The purpose of this short study has been to review a cross section of the availableliterature regarding current LCCA practice and application. This review aimed to capture

any general LCCA methods that were applied, with the intent of forming a general model

that can be applied across all sectors and industries. This review concluded that, aframework for the application of an LCC model exists which is applied in most

situations. The general method set out above is of course adjusted depending on the

application in question, whether it be deciding on certain building methods for a newuniversity facility, or planning future maintenance costs for a new naval platform.

However, the main steps of the framework remain the same.

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There were several other items which came up during the review that warrant finalcomment here, of both a technical and general nature.

1. Discount ratesWhile it is noted that there are general guidelines in the selection of an appropriatediscount rate, there needs to be a more uniform and universal approach to selecting the

discount rate used in the analysis. As suggested in a report by the Bureau of Transport

Economics (1999), most LCC models usually rely on precedent values for discount ratesand other inputs, rather than solid justification. It is noted that the rate changes depending

on the industry, sector and size of the entity, and it is suggested that a rating system be

established which gives guidance to rates depending on such factors. This would providea uniform, definitive source to which all organisations could refer to when selecting a

discount rate (to the authors knowledge no such system exists). As stated below, a

standard framework would be expected to be included within the Australian / New

Zealand standard.

Another point that has been made by such authors as Howard (2001) is that for very long-lived assets (such as large public works infrastructure), the discounting method often fails

to properly gauge the impact of costs which are incurred towards the end of the life cycle.

Depending on the particular application this may be of significance when applyingLCCA, and it is suggested that this point is taken into consideration in future guidelines

and standards (such as the Aus / NZ standard).

2. Uncertainty in data and LCC calculationsIn the authors opinion, the most important paradigm shift required in LCCA is theacknowledgement by practitioners of the variability in nearly all model inputs. Given the

advances in computing power and analysis technologies, the application of statistical

methods to LCCA is no more difficult than deterministic modelling methods. To obtaindistributional estimates of all cost values is in fact a more accurate representation of the

real situation than current point estimate methods, and also has the added advantage of

automatically incorporating the notion of risk into the analysis. The extra informationprovided by a statistical analysis of the life cycle cost would also be of particular benefit

during the operational stages of the asset, when benchmarking or risk analysis are

combined with wider customer or shareholder value. There are many techniques, severalof which were listed above, which could easily be applied in most situations for minimal

extra effort.

The notion of uncertainty also, in the authors opinion, casts doubt on several

assumptions made in most LCC applications. For example, the exclusion of costs on the

basis of contribution to the final result could, in some situations, be made in error if theparticular cost process is highly variable. Without an understanding of the behaviour of

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such inputs, negligible costs could very well turn into contributing factors later on in theassets life cycle.

3. Ongoing application of LCC throughout the Life Cycle Data collection can affectconfidence in results

As stated above, one of the major areas where LCC is currently underutilised is during

the operational life of the asset. While it is true that opportunities for the results of an

LCC study to promote savings and influence decisions are reduced as the life cycleprogresses, the analysis can still be applied in maintaining levels of quality, value, risk

and a general understanding of management issues related to the entities assets. As stated

in the Defence Policy on Life Cycle Costing Analysis (DI(G) LOG 4-5-004) states,LCCA can be used in the development of budgets for the ongoing through life support of

assets, a use of LCCA which has received little attention in most applications.

One of the main reasons behind this slow uptake of in-service LCCA is that of dataintegrity. It has been cited in such sources as Boussabaine and Kirkham (2004) that one

of the reasons for a lack of LCCA application in general, let alone during the operationalphase, has been the general lack of confidence in LCCA results. As Barringer (1996)

points out, commonly held views amongst practitioners are that LCCA is that the results

obtained from an analysis are only as accurate as the data that are input into the model,that there are no right or wrong LCCA results, only reasonable or unreasonable and that

because of this assumed subjectivity, LCCA is not a good tool for budgeting. While

current data collection and usage methods may be questionable in some instances, theauthor feels that LCCA is unnecessarily excluded from such applications. Techniques

such as those found in Statistical Activity Cost Theory or SACT (see Turner (2006))demonstrate practical approaches to such issues of data integrity and methods through

which data can be collected. These approaches allow the statistical analysis of such

measures as life cycle cost, amongst others, and are by no means impractical toimplement. It is the authors opinion that firm recommendations related to the collection

and quality of data would be valuable in strengthening the confidence of practitioners in

the use of LCCA in budgeting roles, and therefore in the increase of this particularapplication.

4. Revision of the Australian / New Zealand LCCA StandardGiven the concerns raised about the current version of the standard, there appears to be astrong case for its revision, in order to update and expand certain sections of the analysis

guidelines. In particular, the above areas of critique warrant attention first. These are:

1. A set of firm guidelines for choosing the discount rate,2. Examples on applying LCCA throughout the entire operating life of the asset, and3. Recommendations for the application of statistical methods which capture the

uncertainty associated with a life cycle cost result.

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At present, both the Life Cycle Costing Guide released by the Australian National Audit

Office, and the Cost benefit Analysis Handbook released by the Department of Finance,

give an improved overview of choosing the rate, and in general could be used as aninterim source until the standard is updated. A consequence of this final point may also

be the additional recommendation of specific data requirements and associated collectingregimes.

5. LCCA is part of the wider area of asset management techniquesFinally, it should be remembered always that LCCA is simply one tool in a much larger

portfolio of asset management techniques, and therefore should be one input among

many others in a larger evaluation or management process. Techniques such as Benefit-Cost Analysis, SACT and areas such as Real Options theory, can all aid by incorporating

different factors into the overall management framework of the asset. LCCA is of most

benefit when interpreted within this larger framework, and it is in the authors opinionthat this fact is commonly understated when demonstrating the advantages of LCCA.

Thanks:

The author would like to thank Peter Way, Kerry Brown and Nick Hastings for their

input into the drafting of this report, and also to CIEAM for their monetary support.

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AppendixThe set of cost elements in any LCC analysis are assigned numerical cost values, and

these can be determined via a number of methods. The Australian/New Zealand standardsguide on LCCA (AS/NZS 4536:1999) lists the three main methods that are used to

estimate the cost element values: the Engineering cost method, the Analogous cost

method and the Parametric cost method. Each estimates the value of the cost elementdifferently; however all are deterministic in nature, which restricts management to simple

sensitivity analysis later once the LCC model has been completed and evaluated.

Engineering cost method

The Engineering Cost Method is used where there is detailed and accurate capital and

operational cost data for the asset under study. It involves the direct estimation of aparticular cost element by examining the asset component-by-component. It uses

standard established cost factors (e.g. Firm engineering and/or manufacturing estimates)

to develop the cost of each element and its relationship to other elements (known as Costelement Relationships - CER).

Analogous cost method

This method provides the same level of detail as the Engineering Cost Method but draws

on historical data from components of other assets having analogous size, technology, use

patterns and operational characteristics.

Parametric cost method

The Parametric Cost Method is employed where actual or historical detailed assetcomponent data is limited to known parameters. This available data from existing cost

analyses is used to develop a mathematical regression or progression formula that can be

solved for the cost estimate required.

Probabilistic estimation method

The Life Cycle Cost Analysis Primer released by the US Department of Transportation(FHWA IF-02-047) extends these methods to include computational evaluation of the

cost elements, allowing statistical distributions to be used for each cost elements value

instead of a single point estimate. Probabilistic LCCA methods such as the one proposedby Salem et al (2003), provide a much more realistic model for the LCC, as they

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incorporate the inherent variability which exists in all cost estimates directly into themodel, providing a final distribution for the LCC value. Once again however, the uptake

of the deterministic and statistical methods of LCC calculation is not comparable, with

some studies such as that by Zayed (2002) finding mixed results using both methods.

References:- Association of Local Government Engineering New Zealand, 2006,International

Infrastructure Management Manual, (Version 3.0), Thames, New Zealand.

- Australian National Audit Office, 2001,Life Cycle Costing: Better PracticeGuide, Australian Government, Canberra.

- Barringer, P., 1998,Life Cycle Costs and good practices, NPRA maintenanceConference, San Antonio, Texas.

-- Barringer, P. and Weber, D., 1996,Life Cycle Cost Tutorial, Fifth International

Conference on Process Plant Reliability, Houston, Texas.

- Boussabaine, A. and Kirkman, R., 2004, Whole Life Cycle Costing: Risk andResponses, Blackwell Publishing, UK.

- Burns, P. and Roorda, J. and Hope, D., 2001,A Wealth of Opportunities: A Reporton the Potential from Infrastructure Asset Management in South Australian LocalGovernment, Local Government Infrastructure Management Group, South

Australia.

- Clift, M. and Bourke, K., 1998, Study on Whole Life Cycle Costing for theDepartment of the Environment, Transport and the Regions (DETR), (CR

336/98), Building Research Establishment, Watford.

- Commander Joint Logistics, 2004,Defence Policy on Life Cycle Cost Analysis,(DI(G) LOG 4-5-004), Australian Defence Force, Canberra.

-

Committee OB/11, Life Cycle Costing, 1999,Life Cycle Costing An ApplicationGuide, (AS/NZS 4536:1999), Standards Australia/Standards New Zealand.

- Bureau of Transport Economics , 1999, Facts and Furphies in Benefit-CostAnalysis: Transport, Report 100, Commonwealth of Australia.

- Department of Finance, 1991,Handbook of Cost Benefit Analysis,Commonwealth of Finance.

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- Department of Victorian Communities, 2006,Local Government Asset InvestmentGuidelines, Local Government Victoria, Australia.

- Defence Material Organisation, 2005,Defence Cost and Schedule EstimationMethodology Handbook, Version 1.1, Department of Defence, Canberra.

- Education Support Services, 1999,Life Cycle Cost Analysis Handbook, AlaskaDepartment of Education and early Development, State of Alaska.

- Fane, S. et al, 2004,Evaluating Reliability and Life-Cycle Cost for DecentralizedWastewater within the Context of Asset Management, 1st International

Conference on Onsite Wastewater Treatment and Recycling, Fremantle,

Australia.

- Fuller, S., 2007,Life Cycle Cost Analysis, National Institute of Standards andTechnology, http://www.wbdg.org/resources/lcca.php .

- Federal Energy Management Program, Guidance on Life-Cycle Cost Analysis,Required by Executive Order 13123, 2003.

- Holden, G., 2003,Life Cycle Cost Issues in Rolling Stock Asset Management,Llyods List DCN Rail Maintenance and Asset Management Conference, Sydney.

- Howard, 2001,Annual Service Cost for Capital Works Proposals, 2001 PerthInternational Public Works Conference, Australia.

- Kawauchi, Y. and Rausand, M., 1999,Life Cycle Cost (LCC) Analysis in Oil andChemical Process Industries, RAMS Group, NTNU, Norway.

- Life Cycle Cost Analysis Team, 2005, Guidelines for Life Cycle Cost Analysis,Stanford University.

- Lambrineas, P., March 2007,Logistical Cost of Ownership Research, Sydney.- National Institute of Building Sciences, 2007, Whole Building Design Guide,

viewed 25th January 2008, http://www.wbdg.org/.

- New South Wales Treasury, 2004, Total Asset Management: Life Cycle costingGuidelines, (TAM04-10).

- Office of Asset Management, 2002,Life Cycle Cost Analysis Primer, (FHWA IF-02-047), US Department of Transportation, Federal Highway Administration,

Washington D.C.

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- Office of Engineering, 1998,Life Cycle Cost Analysis in Pavement Design Interim Technical Bulletin, (FHWA-SA-98-079), US Department of

Transportation, Federal Highway Administration, Washington D.C.

- Office of Management and Budget, 1992, Guidelines and Discount rates forBenefit-Cost Analysis for Federal Programs, Circular No. A-94, Transmittal No.64.

- Prabhu, A. and Edgerton, D., 2007, Prabhu-Edgerton Asset ManagementConsumption Model: Incorporating Advanced SLAM, ACEAM/APV.

- The Federal Facilities Council Acquisition Task Group. 2001. SustainableFederal Facilities A Guide to Integrating Value Engineering, Life Cycle Costing

and Sustainable Development, (Report No. 142), The Federal Facilities Council,Washington D.C.

-

The New Zealand national Asset Management Steering Group (NAMS), 2004,Optimised Decision Making Guidelines: A sustainable approach to managingInfrastructure, NAMS, Thames, New Zealand.

- Turner, L.R, 2006, Production Structure Models and Applications within aStatistical Activity Cost theory (SACT) Framework, PhD Thesis, QUT,

Queensland.

- Salem, O. et al, 2003,Risk-based Life-cycle Costing of Infrastructure:Rehabilitation and Construction Alternatives, Journal of Infrastructure Systems,Volume 9, pp 6 15.

- US Department of Commerce/National Institute of Standards and Technology,2004,Energy Price Indices and Discount Factors for Life-Cycle Cost Analysis,

(NISTIR 85-3273-19), US Department of Energy, Federal Energy Management

Program, Washington D.C.

- Wilson, A., 2002,Asset Maintenance Management: A Guide to DevelopingStrategy and Improving Performance, Industrial Press Inc., New York.

- Woodward, D.G., 1997,Life Cycle Costing Theory, Information Acquisition andApplication, International Journal of Project Management, Volume 15, No. 6, pp

335 344.

- Various Industry and Association websites.

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LifeCycle Costing Project Report April 2008 (2)

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