Conducting Lifecycle Cost in Order to Make Better Decisions

Published on Monday, 17 November 2014 20:05:02    Written by Marc
By definition, the lifecycle cost is the total cost of an equipment over its useful life. For example, if we purchase a new rooftop unit for a commercial building, the lifecycle cost will include the cost of purchasing the unit, the cost of installation, and the cost of all its maintenance and energy used during its lifespan. If we take the long definition, it also normally includes any upgrade costs as well as residual value.

In real life, upgrade costs are rarely considered since no one really knows what upgrade they would do to the equipment when they purchase it. In addition, as for the salvage cost, we all know that most equipment, or at least HVAC building equipment, have little or no salvage cost. In the vast majority of the time, we actually have to pay someone to remove it and we are lucky when we can find a scrapper that will accept to remove it free.

When faced with the obligation to replace an HVAC equipment for a building, the obvious way to compare different equipment would be to look at the lifecycle cost and determine which one we should buy. Normally logic would dictate that the equipment with the lowest lifecycle cost wins. However, it is not that simple.

We took time a few months ago to survey a number of companies and ask them what they did when the time came to replace a piece of equipment. We were actually surprised not only by how few companies actually take the time to evaluate proposals based on the lifecycle cost of the equipment, but also by the reasons why they did not do proper evaluations.

Reasons included:

  1. Do not have time. In many cases, if the equipment is vital to the operations of the company, the cost of the equipment itself is minimal compared to the loss of production that is taking place because of the broken equipment. Therefore, lifecycle cost is not something they have time to do.
  2. Ask for a few bids and select the lowest one. This seemed to be a popular answer but when we dig a little deeper, we understand that the companies do know that they might not be making a sound decision. In many cases, people are simply following the company’s guideline of seeking three bids for an equipment replacement, but not taking the time to compare in detail the specs, performance and ongoing costs of the proposals. In many cases, they know that they might not be taking the best decision for the long run, but they follow policies. While that might help the employees stay out of trouble, it does not help the company’s bottom line.
  3. Do not have much budget, always take the cheapest solution. Although we know this is not the best way to go, we were not surprised by this one. At times where many companies struggle simply to stay afloat, it is hard to point fingers at a company trying to reduce their expenses every way they can. The downside is that is selecting the cheapest purchase, they might actually end up paying much more in the end.
  4. We purchase the minimum because we do not keep the buildings long enough. There are times when going for the cheapest solution might make sense. Few companies would really spend to replace an equipment with the most expensive option if they were getting ready to sell the building. In this case, even if the cheapest equipment used twice the energy consumption that another equipment that would be priced a little higher, the company would probably not have the time to recuperate the extra cost, so going with the lowest cost can make sense.
  5. We do some analysis when we have time, but not always and even with the equipment specs in hand, for most equipment replacement, it requires lots of engineering calculation to come up with valid numbers and we would need to pay a consultant for this service, so all savings would probably go to the consultant. This one did came as a surprise to us and actually took us some time to understand it well, but from a building owner or manager’s point of view it does make sense. If doing a lifecycle cost analysis of a number of equipment like chillers and boilers requires significant engineering load calculations and if the company does not have the internal resources to do these calculations, then it must outsource it to a consultant and the argument is that the cost of the consultant will probably be equal to the savings he might find in recommending the best equipment to purchase. In the end, there is no net gain for the building owner, so there is no reason to do a lifecycle cost analysis.

If we recap the most common answers, we can see that for the most part, for different and often valid reasons, companies do either very little or no lifecycle costing. As outlined, in the rare cases where the building owner or user is on the verge of disposing of the building (selling it or having a short term lease) it does make sense to focus on the cost of acquisition and installation, but what if you are keeping the building or you have a long term lease for a site? In that case, taking the time (when possible) to do a detailed lifecycle cost might provide interesting savings in the long term.

For example, let us take three cooling units that are proposed by three different suppliers to replace our existing (and aging) cooling unit in our building. Here we have three different purchase and installation cost:

  1. Unit no.2-N: Purchase price: $90,000. Installation: $70,000 for a total of $160,000
  2. Unit no. 2-N-2: Purchase price: $50,000. Installation: $30,000 for a total of $80,000
  3. Unit no. 8-N-2: Purchase price: $180,000. Installation: $140,000 for a total of $320,000

A quick analysis could conclude that unit number 2-N-2 is much cheaper than the other two proposals, so it should be the one to purchase.

However, when we add in the annual cost of repairs and maintenance:

  1. Unit no 2-N: Maintenance cost of $28,000
  2. Unit no 2-N-2: Maintenance cost of $45,000
  3. Unit 8-N-2: Maintenance cost of $15,000

Now things start to get a little more complicated. If the user is only going to keep the building for a short period, then the first conclusion of selecting the cheapest unit might still make sense. However, if the owner is planning to keep the building for say five years, then we calculate the total cost of purchase and maintenance as:

  1. Unit 2-N: Purchase $160,000 + 5 years of maintenance (5X28,000) = $300,000
  2. Unit 2-N-2: Purchase $80,000 + 5 years of maintenance (5X45,000) = $ 305,000
  3. Unit 8-N-2: Purchase $320,000 + 5 years of maintenance (5X15,000) = $395,000

Now we can see that Unit 2-N with a cost of purchase and maintenance is cheaper over a period of five years than then two comparing units.

This however this scenario does not yet into consideration the performance of the units. Since these cooling units use electricity in our case, we need to compare the energy efficiency of each unit:

  1. Unit 2-N uses 1.0 Kw/Ton
  2. Unit 2-N-2 uses 1.2 Kw/Ton
  3. Unit 8-N uses 0.6 Kw/Ton

When we run the load calculations of total energy use for the three equipment over a period of five years, we find the total cost of Purchase (with installation) plus maintenance and energy costs to be:

  1. Unit 2-N: $1,338,845
  2. Unit 2-N-2: $1,608,870
  3. Unit 8-N: $1,212,990

We see that Unit 8-N is now the least expensive equipment over the period of five years. In this case, we did not consider the cost of money, so financing cost of the equipment has not been taking into consideration here. In real life, we would considerer the cost of financing the equipment. But we can see in a simple example that depending on what we consider, either purchase cost only, or purchase and maintenance or purchase, maintenance and energy cost, the decision to go with one or another equipment might change completely. This is where doing a sound lifecycle cost comes in.

In our case, we decided to create a lifecycle cost to our EnExPlan software. Because we use it to compare one or many new pieces of equipment with existing equipment (equipment already installed in a building), we decided to call our feature “Lifecycle Savings.” It allows a user to very rapidly enter the specification of proposed equipment and compare the savings over any period of time that the user decides. In our example above, we compared three different cooling units versus an existing unit that had a performance of 1.3 Kw/Ton. Here is the result as produced by the Lifecycle savings function:

As we can see, Unit 8-N starts lower than the other two equipment on the chart (the number is negative in year one because of the cost of the equipment) because it is more expensive. However, because of its higher performance, the unit rapidly generates savings and after five years, it comes out as the clear winner in generating savings versus the two other equipment. Although we do not include the cost of money over time in the chart above, EnExPlan does consider this and user simply needs to add the discount rate to be used.

Lifecycle cost (or savings) is a practical and neutral way to evaluate which equipment to purchase, based on a given timeframe. Without taking the time to evaluate this, most companies risk-leaving money on the table.