Capital vs Full Life Cycle Costing

Posted: November 15, 2017
Tagged As: Asset Management, Public Procurement, Training

What are Capital Costs?

Capital costs are “fixed, one-time expenses incurred on the purchase of land, buildings, construction, and equipment used in the production of goods or in the rendering of services.” (Source: Wikipedia)  These usually only include the product’s purchase price and any installation costs associated with making it fully functional.  It is relatively simple to compare the capital options associated with a given project, assuming the bid documents are sound.

Public Sector organizations have a duty to spend the public purse wisely.  With that comes a responsibility to properly procure and evaluate all goods and services purchased.  However, solicited quotations and proposals do not always take into account the costs associated with a product after its initial purchase price. A simple capital cost price evaluation cannot provide the proper measurement for variations in the performance potential of a product or service that a life cycle cost analysis can.

What is a Life Cycle Cost Analysis?

Unlike in the case of capital costs that just look at the initial cost outlay for a product, life cycle costs more accurately reflect the “true cost of ownership” over the complete lifespan of the product.  A Life Cycle Cost Analysis (LCCA) can determine the most cost-effective product to select given the costs to purchase, own, operate, maintain, and dispose of each option available, assuming that they all meet the same technical requirements.    

Consider an Example

Your municipality is upgrading a pump in its water system and have asked you investigate the options.  Using the capital cost approach, one would do a simple price comparison of all available options:
  1. Do nothing.  Simply doing nothing, (zero capital cost outlay) is a valid approach and can be a conscious choice.
  2. Repair the existing pump.  The evaluation can incorporate this consideration into the evaluation too.  These first two approaches are usually the most appealing low-capital cost options when using this method.
  3. Purchase a new inefficient pump.  Reviews based on purchase price alone can incorrectly make this appear to be the most cost-effective option to implement.
  4. Purchase a more efficient pump.  This pump contains additional value-add components such as a high efficiency motor, better impellers, etc., but with a cost premium. A capital cost review can skew the simple comparison between different pumps, as not all pumps will have the same features.
  5. Purchase of the most efficient pump.  This is best pump available on the market, featuring the highest level of quality available, and most technologically advanced options. This may initially appear as the most expensive option and may be considered “off the table” without a practical and legitimate reason.
Decisions based solely on the initial outlay of capital dollars (price) are only appropriate when all of the requirements of the product are equal across the board.  In cases where these requirements can vary from one product to another, life cycle costing is more appropriate.  Some examples of such variations are:
  • Additional product options and components
  • Reputable quality, use of materials and length of warranties
  • Delivery timing
  • Design, installation and commissioning
  • Length of useful life

In Today’s World, “Simple” May be a Thing of the Past

Purchasing any item(s) in our current high-tech marketplace that do not have additional technological options or components seems highly unlikely and that factor alone makes the ability to do a simple “apples-to-apples” price comparison nearly impossible.

Gone are the days of inquiring with knowledgeable sales staff about the different options and technologies available to assist in purchasing decisions.  Left in its place is the ability for buyers to go online and freely access a treasure trove of product information and specifications at the touch of a finger.  While this may aid in the decision-making process of finding the “best” product, it may come with the need for a thorough read-through of a large manual accompanying the product before being able to perform what should be the simplest of tasks.

In addition, product information and specifications may not account for the continual purchases required to keep that product operational.  Almost everything purchased today will have continual purchasing requirements or ongoing “consumables”, be it energy, materials, human resources or external amounts for operations, repairs and/or maintenance.  These are all separate cost components included in the “total cost of ownership.”  Here are some of the costs to consider in a life cycle costing scenario:
  • Capital costs including the initial product purchase, and any design or commissioning required for the installation.
  • Energy Use including power and consumption.
  • Materials consumed during the operation of the product, as well as any disposables required during operation, such as filters.
  • Operations expenses can include training costs to orient staff with a new product, as well as any downtime resulting in lost use.
  • Maintenance can include both preventative maintenance such as regular cleaning or lubrication, as well as corrective maintenance, such as repairs to broken components.
  • End of Useful Life
After collecting, compiling and comparing the total cost of ownership amounts, an entirely different picture emerges from the original capital cost comparison. The key items under review may not necessarily be in the initial outlay costs, but rather factors affecting the operational costs, such as energy efficiency or environmental impact, that determine the best purchase decision. Evaluating all costs over the product life expectancy, in addition to the initial amounts, can even put the aspects of inaction or low capital cost repairs into a proper perspective.  In this case, what were initially thought to be the least expensive purchase options (Options 1 & 2) actually turned out to have the highest total cost of ownership.  And conversely, what was initially regarded as the most expensive purchase option (Option 5) ended up having the lowest total cost of ownership.

Life Cycle Costing Chart comparing Alternatives

It is only logical then that “the big picture” of capital purchasing will require the inclusion of all-ongoing budgetary costing amounts for a complete “cradle to grave” timeline. Therefore, the best practice for comparison purposes is a “Full Life Cycle Cost Analysis,” which makes for the best-informed decisions on all today’s major purchases.

LAS offers a convenient, online Procuring for Energy Efficiency course that can provide essential life cycle costing tools for all staff that have to deal with purchasing in the public eye. Implementing a life cycle approach to tender evaluations is a credible and transparent process that validates long-term sustainability choices and performance based measurements to benefit any organization.

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