8 Steps To the Life Cycle Costing Process

Until recently, life cycle costing was a term used by large developers, real estate investors, and a handful of top commercial service sales people. Now, it's used by most real estate management firms. Simply stated, it's a method to identify a building's true costs of ownership. It's also the best (perhaps only) means of justifying the price of a commercial service agreement.

Invariably, when building owner/managers are asked about annual costs for HVAC, they talk about what they pay for service. In reality, many other costs enter the equation. A professional service salesperson should help prospects identify every cost that affects short- and long-term budgets.

To do this, I begin with the largest part of the pie — the annualized replacement cost of the entire system. This requires some investigation during the front end of the selling cycle.

In Step 1, I ask if the prospect knows the original investment cost. They seldom know this, but if they do, that's the number you should use (after factoring in inflationary costs). If they don't, I use cost per ton as a basis. In today's market that number is between $1,700 and $2,000 per ton, depending on the sophistication of the system and associated controls. For example, let's say the system uses a total tonnage of 100 X $1,700 or a total replacement cost at today’s prices of $170,000. The next step is establishing the age of the equipment. For our example, let's assume five years.

Then, by using ASHRAE's 15-year life cycle figure for unitary equipment, we can show the prospect that they have a mean life left of 10 years. Divide the $170,000 by the remaining life (10 years), to derive an annual replacement budget of $17,000. Then I explain that my comprehensive maintenance program will add significant years of useful life. Let's use 10 years of life extension. This changes the denominator from 10 to 20 and the total cost of annualized replacement of $8,500 or an annualized cost avoidance of $8,500. This is a current cost that disappears with a maintenance program.

Step 2 helps the prospect discover their annual energy waste. Early in the selling cycle, I ask for at least one year of the customer's energy bills. Then, by using figures from the U.S. Department of Energy (DOE) and some third-party sources, I show them an energy savings from 10% to 30%. Assuming an annual cost of $80,000 — half of that figure for HVAC — that would be an annualized cost avoidance of $4,000 at a 10% reduction.

Step 3 is in major component replacement. Whenever possible, I get this from customer records. The prospect should supply you with old service reports or numbers from the previous year's budget. If they're averaging $3,000 per year, that number will go away under a full coverage agreement. If you're offering a PM agreement, list a reduction of 50%, explaining that a program will catch smaller costs such as contactors, before they cause a larger cost of a compressor. Assuming this is a PM agreement the cost avoidance would be another $1,500.

Step 4: determine the prospect's cost for consumables such as belts, filters, refrigerants, etc. If we're including these in our program, we'll also move that cost to our side of the ledger. Let's use $2,000 per year for that cost avoidance.

Step 5 is the cost associated with any outside contract. Usually, this number is much smaller than what's required for comprehensive preventive maintenance. For this illustration, we'll use $2,400.

Step 6 is tenant loss. Losing a tenant due to poor comfort conditions is a significant cost. BOMA states that the number one cause of tenant loss is due to HVAC problems. If you get a number, simply divide it by the present life of the system, to arrive at an annualized cost avoidance. If not, mark the column N/A.

Step 7 is lost productivity. Once again, they may not have a number available, but occasionally this cost can be huge, especially in large IT operations or manufacturing facilities.

Step 8 administrative cost. This is the owner/manager's time, clerical time for processing P.O.s and all other associated admin costs that they would not experience with my program.

My final page of the presentation looks something like this:

Replacement Cost Avoidance $ 8,500
Energy Waste Reduction $ 4,000
Component Replacement Reduction $ 1,500
Consumables $ 2,000
Contracted Services $2,400
Tenant Loss N/A
Productivity Loss N/A
Earl's PM Price $ 9,400

This should become part of every selling cycle. If this exercise is omitted, the only numbers the prospect will compare is the $2,400 that he/she is spending (for their present contract) and my sell price of $9,400.

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