Tuesday, September 02, 2008

Industrial Energy and Life-Cycle Cost Analysis

Life-cycle cost analysis is a straight-forward approach to measuring the total cost of owning a particular product or asset. This concept is particularly useful when acquiring an asset that has ongoing costs of operation, such as fuel, power, maintenance, insurance, interest (holding) costs, and other expenses above and beyond the initial investment. The life-cycle cost concept is championed especially by the energy-efficiency community, which offers a wide array of products that sometimes cost more to buy, but cost less to operate, therefore resulting in a lower total cost of ownership when compared to “standard” equipment options.

Another way to put it is this: you can buy the cheapest possible choice, which may impose greater costs of operation, or invest carefully up-front to secure an option with lower operating costs—resulting in less overall out-of pocket costs.

I realize that most people understand the life-cycle cost concept. Still, not every organization uses it. In other words, many facilities insist on making lowest-cost acquisitions, even when these choices lead to higher overall costs of ownership.

Why? I’ll offer a sampling of reasons:

  1. The procurement director may be responsible for holding costs to a minimum for the current accounting period. The operating costs accrue to another department—so the operating costs are someone else’s problem.

  2. Facilities may enter into a service relationship with a vendor that limits the available hardware choices to those that suit the vendors’ needs more so than the clients.’

  3. Businesses, or perhaps their key leaders, have a time horizon for meeting certain performance goals. Sub-optimal investment choices are sometimes attractive because underinvestment will artificially boost earnings in the short run. Managers can hit their short-term targets and run—the problems associated with long-term operating costs will accrue to later, to the next manager.

Life-cycle costing makes sense for the entire organization’s bottom line. In practice, however, few people work for the “entire” organization. Rather, they manage local (departmental) budgets and focus on short-term goals.

What’s the premium paid by an organization that fails to embrace life-cycle cost principles? Calculate the gap between current vs. optimal energy cost performance, and you’ll get some idea….


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