Wednesday, March 04, 2009

Life-Cycle Cost: The Challenge for Industrial Energy Managers

This post describes the life-cycle cost concept and its application to energy management.

“Life-cycle cost” describes the total cost of ownership for any asset placed in service by a business organization. This is more than just the “catalogue” or acquisition price. There are costs incurred for research prior to purchase, the cost of the asset itself, financing and installation fees, insurance, then the costs of maintenance, operating inputs (especially energy), and the asset’s eventual disposal. Energy-saving industrial hardware is usually described in terms of the life-cycle cost benefits that they provide. These benefits are relevant to an organization that seeks to minimize its operating costs over time.

Here’s the problem: organizations are made up of individuals with different responsibilities and therefore very different time horizons. There’s usually no one person who is responsible for maximizing value at all stages of an asset’s utilization.

First costs—meaning the initial cost of buying an asset—are the sole focus of most procurement directors. The procurement director's neck is on the line for minimizing costs today. In most cases, 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 an operating manager's problem. The procurement director makes his bonus today by keeping first costs to a minimum.

Similar constraints impact finance directors. Corporations usually impose annual or even quarterly earnings targets on production facilities. At the same time, production depends on assets that slowly wear out over time or are made obsolete by the advent of newer, more efficient alternatives. Finance directors are always tempted to coax more life out of old equipment rather than investing in upgrades. This approach will artificially boost this quarter’s earnings. Finance directors can hit their short-term targets and run, while the problems associated with eventual asset failure and escalating operating costs will hopefully accrue later, to the next manager.

Most major assets have significant ancillary needs such as lubricants, tools, filters, and other consumables. These items are also subject to procurement from the lowest bidders—supposedly ensuring that the company’s out-of-pocket expenditure is minimized. Unfortunately, the “cheapest” selection is not always the most durable. That which wears out faster is replaced more frequently. Another complication may be the structure of vendor relationships, which blend service with the supply of components dictated by the vendor.

Operations staff present a different perspective. These people are focused on production schedules. Time is a valuable commodity in operations, to the point where other factors, including energy, may be readily sacrificed in order to save time. For operations staff, job risk is related to production goals, not energy waste. Allowing machines to run without work in progress is of no consequence to machine operators neither see nor pay the utility bill.

Organizations pay a premium—in the form of energy purchased and wasted—for failing to minimize life cycle costs. This premium is value waiting to be captured. The advocate for this is an energy manager. In practice, the energy manager seeks a balance among financial, technical, and operational criteria. It should be clear now that energy cost control is as much people-oriented as it is technical. Communication and persuasion are crucial to the task. Execution of this agenda becomes more urgent as the price of energy rises.



At 6:50 AM, Anonymous Anonymous said...


Your updates are always very informative.

Keep the good work.

Kelly Paffel
Technical Manager
Swagelok Energy


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