13rd May 2017
This article was originally published in the LinkedIn. Read the full version here.
Infrastructure projects are the catalyst that drives economic growth. Physical infrastructure such as roads, ports, rail, highways, airports, power and water supply are needed for the transportation of goods, people mobility, ensuring the production of manufacturers and so many other daily activities.
Infrastructure, just like other types of capital expenditure, will become obsolete after years of continuous usage and exposure to various usage and environmental factors. In order to continue the operations, these ageing infrastructure will require periodic maintenance, modernization and replacement in whole or parts. On average, the annual expenditure on maintenance and modernization would typically ranging from 2% to 20% or more depending on various factors not just by the size, nature, capacity but also including their for purpose, design, materials, quality of construction and most importantly, the way it operates and maintains. These OPEX items are expenditures over a period of 20 to 30 years or more ! It is highly possible that the capital spending on an infrastructure throughout its life-cycle to be a lot more than the initial capital expenditure to build it. And we do not see enough of this analysis being done when we are building our asset, city or mega project.
There is a critical need to look into this and optimize the expenditure to be spent on the infrastructure throughout its life-cycle. Life-Cycle Cost Analysis (LCCA) is particularly helpful in this situation to ensure the cost-effectiveness of an infrastructure project. LCCA is a tool to determine the most cost-effective option among different competing alternatives to purchase, own, operate, maintain and, finally, dispose of an object or process, when each is equally appropriate to be implemented on technical grounds. The LCCA takes into consideration all the costs incurred in the life-cycle of the infrastructure, this refers to the most cost-effective option to build, operate, maintain and decommission the infrastructure.
To provide more clarity, for a highway pavement, in addition to the initial construction cost, LCCA takes into account all the user costs, (e.g., reduced capacity at work zones), and agency costs related to future activities, including future periodic maintenance and rehabilitation. All the costs are usually discounted and total to a present-day value known as net present value (NPV). A lifecycle model is usually incorporated with the total cost of ownership to provide a more complete and comprehensive costing model to the developer or more precisely the owner of the infrastructure asset.
In order to provide certainty in Asset Performance, it’s important to replace the assets at the right time in line with good practice, organization policy and manufacturer’s recommendations. Therefore, an effective capital planning prior to the actual cost incurred can improve the efficiency in the usage of time and resources. Cost savings can also be due to the standardizing of approach to purchasing, smoothening out of costs, obsolescence through procurement of assets through supply chain partners. The aim is also to improve stakeholder’s confidence as reduced uncertainty in cost planning can lead to better asset performance and decrease the disruption and risks to the business.
In short, the objective of the Life Cycle Management exercise comprises of the following targets:
- Minimise the total Life Cycle Cost of a facility or asset, including design, build, operate and decommissioning costs
- Optimise the balance between CAPEX & OPEX based upon factual data rather than subjectivity
- Maximise the performance of the facility and minimise risk of failure through ensuring that the design incorporates optimal operability, reliability and maintainability characteristics
- Minimise time-to-first-production through effective commissioning approaches
- Ensure energy efficient or ‘green’ building at optimal Life Cycle Cost with no safety or production related compromises
- Ensure sustainability of facilities through appropriate design processes
Life cycle is not to be confused with life span of a built asset. Life cycle is the asset’s estimated life before the next replacement happen whereas the life span might consist of more than one life cycle. It is also known as the assessment period which is determined by the owner. A typical life cycle costing exercise includes capital expenditure (CAPEX), operations expenditure (OPEX), replacement expenditure and cost of disposal.
CAPEX is defined as the initial cost to purchase or construct or deliver the infrastructure asset, which is normally the construction cost of the asset for infrastructure project. Moreover, the OPEX of the asset consists of several type of cost components including, manpower, utility, equipment, insurance, health & safety, spares, planned and routine repairs. Replacement cost is incurred in every periodic of years according to the replacement age of different type of assets with advice from the manufacturer’s recommendation. Another crucial element in the LCCA is the cost of disposal, by incorporating the cost to remove or terminate the asset from the system, which is also known as salvage value can help to offset the cost incurred in the particular year.
In summary, there are critical processes that must be completed in order to fully understand and derive the benefits of an LCC model:
- Development of Base Model to determine model structure and data requirements
- Generation of LCC Analysis on the core components: Capital Expenditure, Operations and Maintenance Cost, Lifecycle Replacement Cost
- Challenge and gap analysis of LCC model for all relevant stakeholders
- Assessment and optimization of lifecycle cost
Rigorous LCC modelling enables the design to be value engineered so that the cost profile of an infrastructure can effectively reduce the expenditure throughout the life cycle by a significant amount. These value engineering exercises are done by conducting a series of sensitivity tests on the cost components. LCC modelling must also have the flexibility to adjust the type or cost for assets and materials used for an infrastructure project and simulate the total spending over the Life Span. This exercise allows the developer or promoter to be more informed on the financial impact of selecting a particular combination of development options and enabling an effective capital budgeting.
The value engineer process could help the developer or concessionaire to decide the type of assets and materials to be used. As each assets or materials might have different specifications in terms of the acquisition cost and maintenance characteristics. For example, a more expensive asset might have better quality and performance, but it might also carry higher amount of maintenance costs. However, a cheaper asset might need more frequent maintenance, but the overall spending could be lower. Further simulation can also be done to determine the timing of the financial obligation at different phases of the asset life cycle. A proper use of LCC could help the user to identify the development combination that will result in a favorable timing for financial exposure to the developer.
By utilizing the LCC to conduct extensive testing, comparison and analysis, the user could determine the optimized development combination for the infrastructure project that is likely to have the most preferred cost profile and financial exposure to the developer from all aspects. Hence, the business risk, financial risk and disruption to operations for the infrastructures or any other type of mega development can be significantly reduced.
In conclusion, life cycle analysis provides an overall framework for considering total incremental costs over the life span of the product which can assist to manage the cash cycles of the organization by projecting the cash requirements accurately. A comprehensive LCCA can provide ‘win-win’ strategies in terms of identifying appropriate technologies, products and services that are environmentally, economically and socially sustainable. Finally, consideration of life-cycle costs is essential to evaluate the infrastructure construction, regeneration and rehabilitation alternatives as it ensures better decision from a more accurate and realistic assessment of revenues and costs.
