Lifecycle Selling: Is There a SHORTER Payback?

Nov. 1, 2010
Buyers' choices in HVACR equipment, and their reluctance to upgrade aging and costly systems, frequently puzzles policy makers and energy efficiency advocates. After all, reduced energy consumption and operating costs are good for owners, good for society and the planet. Why would anyone choose otherwise? Answer: incremental first cost.

Buyers' choices in HVACR equipment, and their reluctance to upgrade aging and costly systems, frequently puzzles policy makers and energy efficiency advocates. After all, reduced energy consumption and operating costs are good for owners, good for society and the planet. Why would anyone choose otherwise? Answer: incremental first cost.

The concept of lifecycle selling and payback analysis is not new. Many of us were first exposed to the concept in our engineering economics course. Also known as Life Cycle Costing (LCC) or Life Cycle Cost Analysis (LCCA), it's an economic method of evaluation in which all costs associated with the purchasing, installation, owning, operating, maintaining, and disposition of a project or system over its useful life are considered in the procurement decision.

LCCA is not only a smart way to evaluate design alternatives; it's sometimes mandated in the public sector. Federal energy and water conservation, and renewable energy projects require LCCA evaluation by statute (as codified in 10 CFR 436A) and by the U.S. government’s Executive Order’s 13123, 13423 and 13514. Executive Order 13514 even requires the analysis to "take into consideration environmental measures as well as economic and social benefits and costs in evaluating projects and activities…"

Many state and local jurisdictions have similar requirements. Policy makers have championed this approach to tip the economic analysis in favor of broad national energy independence and sustainability goals. For the private sector, it's all about return on investment (ROI) based on tangible, hard costs, and benefits.

Under the current economic conditions, the private sector's tolerance for long-term paybacks is thin. Consequently, the projects that the private sector is willing to approve are limited in scope, require minimal investment, but have a very high ROI. Larger projects that would produce significant operational savings are hitting the cutting room floor due to higher first cost, long-payback and low ROI. Contractors and owners alike must be wary of an analysis that promises unrealistic returns. As with almost anything; if it seems too good to be true, it usually is.

Challenges of Alternative Designs
The most challenging task of an LCCA is to determine the economic effects of alternative design options and to quantify these effects in terms of total cost of ownership. System-related costs fall into the following categories:

  • initial costs (purchase, acquisition, construction/implementation, commissioning costs);
  • utility and fuel costs;
  • operation, maintenance and repair costs;
  • replacement costs;
  • residual values (resale or salvage values or disposal costs);
  • finance charges or internal cost of capital;
  • non-monetary benefits or costs.

Initial costs are typically the easiest to estimate. Detailed estimates of equipment and construction costs are not necessary for preliminary economic analyses of alternative building designs or systems. Initially, equipment and construction costs can be determined by referencing historical data from similar facilities or from government and private-sector cost-estimating guides and databases.

Non-fuel operating, maintenance and repair costs are typically more difficult to estimate. Operating schedules, standards of maintenance, facility type and age all come into play. It is therefore, especially important to use engineering and business judgment when calculating these costs. Supplier quotes and published estimating guides can provide information on maintenance and repair costs. Some data estimation guides derive cost data from statistical relationships of historical data — such as Means, or data from the Building Owners and Managers Assoc. (BOMA) —and report on average owning and operating costs per sq.ft., building age, geographic location, number of stories, and square footage.1

The number and timing of capital improvements depend on the estimated life of the system and the length of the study period.

Energy costs are often the largest life-cycle cost element and the most difficult to predict. The operational expenses for energy, water and other utilities are based on consumption, current rates and future price projections. Assumptions must be made about use profiles, occupancy rates, and schedules, all of which impact energy consumption. Estimates of energy consumption can come from engineering analysis or from computer programs such as Energy-10 or eQuest, and energy price projections can be obtained either from the supplier or from energy price escalation rates published annually by the US DOE.2

Non-monetary benefits or costs are project-related effects for which there's no objective way of assigning a dollar value. Examples of non-monetary effects may be the benefit derived from a particularly quiet HVAC system, or from an expected, but hard-to-quantify productivity gain from improved lighting. By their nature, these effects are external to the LCCA, but if they're significant to the bottom line they should be considered in the final investment decision and included in the project documentation.

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Solutions & Alternatives
Using LCCA as a comparative analysis of design alternatives, instead of a predictor of absolute future performance, dilutes some of the uncertainty in cost and price projects. However, significant differences in predicted and actual costs can result in a reversal of the LCCA recommended lowest cost alternative.

A design-build-maintain contracting approach with imbedded LCCA and rigorous energy modeling can provide more certainty to project implementation cost estimates and long-term operating costs. Using DOE-2.1E or BLAST, along with proprietary programs such as TRACE (Trane), ESPRE (EPRI), and HAP (Carrier) to assist in mechanical equipment selection and sizing, will result in more certain energy performance predictions (see Turn-key pricing eliminates the construction cost risk inherent in the typical design-bid-build-change order-litigate-occupy process and rewards on-time schedule performance.

A sensitivity analysis should be conducted around the most significant cost elements, particularly future energy costs, to ensure the recommended option is acceptable under changing future conditions.

Even after all that, the analysis can be rendered moot by unforeseen circumstances. Consider:

  • GHG legislation imposes a carbon tax that doubles the cost of energy;
  • Your local utility rolls out a significant rebate program;
  • Geopolitical strife results in supply disruptions of oil, gas or coal;
  • A break-through technology significantly alters the economic analysis;
  • A 'value engineering' review slashes first cost but significantly increases operating costs;
  • The cost of capital significantly increases or decreases.

Expect the Unexpected
The purpose of an LCCA is to estimate the overall costs of system alternatives and to select the design that ensures the facility will provide the lowest overall cost of ownership consistent with its mission. The LCCA should be performed early in the design process while there's still time to refine and adjust the design to ensure a reduction in life-cycle costs. Even after careful consideration future events can swamp the best alternative. Control the elements that you can and plan for variations in those that you cannot. A robust analysis will help guide design decisions and lead to a more profitable outcome.

General Dwight David Eisenhower once said, "In preparing for battle, I have always found that plans are useless, but planning is indispensable." Consider LCCA battle planning.

While LCCA is a time-tested proven analytical method, the current economy is introducing new reservations. An uncertain business outlook causes many to take a short-term view, requiring increased ROI's before investing in any new projects. A slow economy puts downward pressure on energy prices, but for how long? Washington's foray into climate change, carbon "cap & trade," new taxes on fossil fuels, a national Renewable Electricity Standard (RES), and EPA GHG regulations will certainly increase the cost of energy, but how much and when?

Consider your options carefully, perform a robust sensitivity analysis, and always consider the cumulative opportunity cost of doing nothing.

1. The National Institute of Building Sciences’ Whole Building Design Guide lists sources of non-fuel operating costs, and maintenance and repair (OM&R) costs.

2. The National Institute of Standards and Technology (NIST), Energy Price Indices and Discount Factors for Life-Cycle Cost Analysis 2010, Annual Supplement to Handbook 135.

Paul Wenner, P.E., is in charge of business development, energy solutions for Southland Industries, Las Vegas, NV. He has dedicated his career to advancing the valve proposition of going green.

Southland Industries recently received a Contracting 2010 Design/Build Award. To read about Southland’s winning project, read "Design/Build Deals a Winning Hand"