Today’s construction companies do more than just build things; they can be information providers. A prime example of this is a contractor’s role in a process called life-cycle costing (LCC). Read on and consider whether your business might want to add LCC analysis to its portfolio of services.
Originally developed by the U.S. Department of Defense, LCC is a risk-evaluation method that identifies, qualifies and analyzes all costs associated with the construction and operation of a building over its expected life. These can include, but aren’t limited to:
- Initial capital outlay,
- Maintenance and operating expenses,
- Financing costs, and
- Expected useful life of equipment.
LCC analysis primarily involves owners, engineers and other project planners. However, expertise in the areas of timing of work zones, materials costs and labor costs may be required.
The objective of LCC is to improve decision-making, elevate design quality and lower costs. Yet the lowest life-cycle cost may not be the best solution when political and environmental concerns are factored in. So, while LCC analysis typically yields critical information, other influencing factors also should be considered.
Generally, an LCC analysis evaluates three variables: 1) cost of ownership, 2) duration over which costs will be incurred, and 3) the discount rate applied to future costs to equate them with present-day costs.
To generate the evaluation, LCC first calculates initial and future expenses. Initial expenses are incurred before people move into a building, while future expenses are incurred after move-in. Future expenses, such as those for repair or replacement of roofs and HVAC systems along with ongoing maintenance, can be difficult to predict months or years before they’re incurred. Still, considering all available information and making reasonable assumptions can lead to a credible analysis.
Next, LCC determines when costs will be incurred. The analysis is designed to examine future economic consequences of present-day decisions. In doing that, an LCC analysis looks at two time periods:
- Planning and construction, which ends when the building is operational, and
- The service period, which begins when the building becomes operational.
A typical 20- or 30-year LCC analysis considers the expected life of major building components and systems, recognizing that individual user preferences and habits can add or subtract longevity.
As mentioned, the last step in the process is discounting. This is a method of including the time value of an investment or determining an interest rate that would make an investor indifferent to whether he or she was paid now or received a greater payment sometime in the future.
If an LCC analysis uses a real discount rate, which excludes the rate of inflation, it must use constant dollars that also don’t consider inflation. If the analysis accounts for inflation, it’s based on current dollars and a nominal discount rate. In either case, the end goal of any LCC analysis is the same: to improve decision-making at every step and establish the true cost of owning and occupying a building.
Challenges and risks
Collecting LCC data can be time-consuming and labor-intensive. Every team member involved must have adequate experience and expertise, along with the ability to document how assumptions are made and modify documentation when appropriate. The analysis will be error-ridden if assumptions about inflation rates, building or equipment life, or repair and replacement costs are incorrect.
There’s also the unpredictable. For instance, natural disasters may shrink supplies and elevate prices. Or a technological breakthrough may outmode certain equipment overnight. Reliably predicting inflation or interest rates over 30 or 40 years, or accurately determining how long building fittings and fixtures will last, may prove difficult as well.
Is your construction business looking for a competitive edge? If so, explore the possibility of becoming a participant in an LCC analysis in your local market. Although doing so will require a commitment of time and resources, you may find it a good way to differentiate yourself from the competition. If you have questions, we have answers. Give us a call today.