Wednesday, July 30, 2008

Energy Solutions: "First Costs are Not Last Costs"

I had a great conversation this week with a colleague. She made one of those profound statements that instantly and thoroughly resonated with me, as I think it will for you:

“First costs are not last costs.”

As anyone who promotes industrial energy efficiency knows, facility managers operate with tight budgets. First costs—meaning the initial cost of buying an asset—are the sole focus of a hard-nosed procurement director. The procurement director's neck is on the line for minimizing costs today. He couldn’t care less if the lowest-cost assets actually lead to excessive energy or maintenance expenses for years to come. Those costs simply become another manager's problem. Unfortunately, the opportunities for bad procurement choices are many. The typical industrial facility will consume a significant volume of hardware, lubricants, tools, filters, and other consumables that are integral to the facility’s daily functioning. The procurement director will secure products from the lowest bidders—supposedly ensuring the company’s out-of-pocket expenditure is minimized. Unfortunately, the “cheapest” selection is not always the most durable, especially when it comes to valves, steam traps, couplings, and similar hardware. That which wears out faster is replaced more frequently. Similarly, capital investments in energy system maintenance and upgrades may be scaled back to satisfy this year’s spending limits—a great idea until the sacrifice of proper instrumentation, insulation, condensate return, and commissioning results in excessive energy loss that stripped-down assets will endure—often for years or decades to come. So who’s to blame? The procurement director makes his bonus today by keeping first costs to a minimum. Other department managers will bear the costs of energy and labor that compensate for these bad choices. Facility-wide financial performance suffers as a result.

The alternative to this dilemma is to use life-cycle cost criteria. In other words, asset selection is predicated on the total cost of ownership, which includes the first (initial investment) cost as well as energy, maintenance, and financial carrying cost over the asset’s useful life. To make this happen, top management must ensure that procurement managers have the incentive to use life-cycle criteria.



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