Life Cycle Costing In Construction: Introduction to Core Concepts

What is Life Cycle Costing?

Life cycle costing, often abbreviated as LCC, represents a systematic approach to comprehensively assess the total cost of a construction project over its entire lifespan. While the term may sound complex, its core principle is something we all engage with in our daily lives, whether consciously or unconsciously.

Consider the example of purchasing a car. It’s not just about the initial price tag; a wise buyer would also contemplate the ongoing expenses, such as fuel consumption, maintenance costs, parts replacements, and even the vehicle’s expected residual value upon eventual disposal. In essence, buyers assess the total cost of ownership and weigh it against various options.

In the context of construction, LCC serves as a powerful tool for evaluating the cost performance of a project. Its primary goal is to facilitate informed decision-making, especially when faced with alternative means of achieving a client’s objectives. These alternatives may vary not only in their initial construction costs but also in their subsequent operational expenses. LCC levels the playing field by allowing these alternatives to be compared on the same basis.

What is the difference between Life Cycle Costing  and Whole Life Costing?

While we primarily focus on life cycle costing in this article, it’s essential to note that some publications use the term “whole life costing” (WLC) synonymously. However, WLC can also encompass a broader scope, including both costs and incomes related to construction works.

Why is Life Cycle Costing Important?

At its core, LCC seeks answers to essential questions:

1. What needs to be done?
2. When should it be done?
3. How much will it cost?

LCC proves invaluable for budgeting and option appraisal. For instance:

1. Opting for higher expenditure on building fabric or insulation may result in lower energy expenses.
2. Choosing a lighter but more expensive cladding system could lead to savings in frame and foundation costs, though it might entail higher costs upon renewal.
3. Selecting a cheaper component might seem cost-effective initially but could result in more frequent replacements or maintenance, impacting long-term costs.

Crucially, LCC accounts for all relevant costs over a defined period of time, known as the period of analysis.

Benefits of Life Cycle Costing

When it comes to construction projects, clients stand to gain numerous advantages by embracing life cycle costing (LCC) as a fundamental practice. Let’s explore the key benefits that LCC offers:

1. Strategic Analysis of Business Needs

LCC encourages clients to embark on a strategic journey by analysing their business needs comprehensively. This process involves assessing not only the immediate project requirements but also long-term objectives. By clearly communicating these needs to the project team, clients ensure that construction efforts align with their overarching goals.

2. Evaluation of Total Ownership Costs

One of the central tenets of LCC is the evaluation of the total ownership costs of alternative options over their entire lifecycle. This means clients gain a holistic view of the financial implications of their choices, not just at the outset but throughout the project’s existence.

3. Optimisation of Total Cost of Ownership/Occupation

LCC empowers clients to strike a delicate balance between initial capital costs and ongoing operational expenses. This optimisation ensures that they make informed decisions that lead to the most cost-effective and sustainable outcomes.

4. Risk Analysis and Mitigation

With LCC, clients benefit from a thorough examination of potential risks and the costs associated with the loss of functional performance due to failure or maintenance issues. This proactive approach allows for risk mitigation strategies to be implemented, reducing the likelihood of costly setbacks.

5. Realistic Budgeting

Clients can bid farewell to budgeting guesswork as LCC promotes the creation of realistic budgets that encompass operation, maintenance, and repair expenses. This foresight ensures that clients are well-prepared to manage the financial aspects of their construction projects throughout their lifecycle.

6. Durability Considerations from the Outset

LCC encourages clients and project teams to engage in discussions and decisions about the durability of materials and components right from the project’s inception. This early focus on durability can lead to the selection of materials and methods that enhance longevity and reduce the need for frequent replacements or repairs.

7. Adoption of Best Value for Money Solutions

By taking a holistic view of costs and performance, LCC increases the likelihood that clients will adopt solutions that offer the best value for their money. This means clients not only save on immediate costs but also reap long-term benefits from their investments.

8. Data-Driven Decision-Making and Benchmarking:

LCC provides clients with valuable data on the actual performance and operation of their projects compared to initial predictions. This data can be used for future predictions, benchmarking against industry standards, and continually improving decision-making processes.

In summary, life cycle costing (LCC) isn’t just a financial tool; it’s a strategic approach that empowers clients to make informed choices, optimise costs, mitigate risks, and achieve lasting value in their construction projects. It ensures that the journey from project inception to its full lifecycle is marked by efficiency, sustainability, and fiscal prudence.

Types of Costs in Life Cycle Costing (LCC)

A fundamental aspect of Life Cycle Costing (LCC) lies in its structured approach to considering various cost components over the entire lifespan of a construction project. This approach not only ensures transparency but also facilitates comparisons and benchmarking across similar projects. Let’s delve into the different types of costs that fall within the purview of LCC, as outlined in the standardised presentation understood by both clients and professionals:

Construction Costs

Construction costs, often equivalent to total development costs, encompass a range of expenses, including:

• Site costs or opportunity costs related to the site already in ownership (e.g., legal fees, stamp duty).
• Finance charges.
• Professional fees (e.g., architect, quantity surveyor, engineer).
• Costs associated with the actual construction and infrastructure.
• Tax allowances (such as capital equipment allowance, capital gains, and corporation tax).
• Statutory charges.
• Development grants.
• Planning gain.
• Third-party costs, which can include rights of light, oversailing charges, wayleaves, and easements.

Maintenance Costs

Maintenance costs, often referred to as hard facilities management costs, encompass all expenditures aimed at ensuring the continued specified functional performance of the asset. Maintenance costs are often further divided into Renewal costs and Maintain costs. This category includes:

1. Maintain Costs

• Redecoration.
• Periodic inspection activities.
• Periodic maintenance.
• Unscheduled corrective and responsive maintenance and repair.
• Planned and preventative maintenance.

2.Replacement Costs

• Periodic asset replacement activities.
• Unscheduled asset replacements.
• Planned and preventative asset replacements.

Operation Costs

Operation costs, often termed soft facilities management costs, encompass expenses related to running and managing the facility, including:

• General support services, letting fees, facilities management fees, caretaker, and janitorial services.
• Service transport (e.g., internal deliveries).
• IT services.
• Laundry and linen services.
• Catering.
• Cleaning.
• Waste management.
• Rent.
• Rates and other local taxes and charges.
• Insurances.
• Energy costs, specifically heating, lighting, air conditioning, lifts, etc.

Occupancy Costs

Occupancy costs go beyond general support services and encompass additional services to support the occupier’s explicit operation. These costs can include:

• Staffing expenses related to building operation (e.g., security, mailroom staff, ICT support staff).
• Outsourcing contracts for services like security.

End of Life Costs

End of life costs focus on the later stages of the asset’s existence and may include:

• Residual values, which assign a monetary value to an asset at the end of the LCC analysis period.
• Terminal values, representing the scrap value of a component or asset at the point of its replacement.
• Other end of life costs, not directly associated with the building itself.

In conclusion, the comprehensive structure of Life Cycle Costing (LCC) provides clients and professionals with a clear framework for evaluating the multitude of costs associated with construction projects. Precise determination of which costs should or should not be included is essential and should be discussed with the client to ensure an accurate assessment. By considering these diverse cost components, LCC empowers clients to make informed decisions that optimise the financial performance of their construction projects.

Next, we will explore the intricate world of time value of money and its role in LCC calculations.

The Time Value of Money (TVM) in Life Cycle Costing (LCC) Calculations

The concept of the time value of money (TVM) is a fundamental principle that underpins the calculations of Life Cycle Costing (LCC). Understanding TVM is crucial for anyone seeking to make informed decisions regarding the financial aspects of construction projects. Let’s delve into what TVM is and why it plays a central role in LCC calculations.

What is the Time Value of Money (TVM)?

At its core, TVM recognises that the value of money changes over time. In the context of LCC, it means that a pound received or spent today is not equivalent in value to the same pound received or spent in the future. Simply put, a pound today is worth more than a pound tomorrow.

The Role of TVM in LCC Calculations

LCC is not merely about summing up costs and benefits; it’s about making these costs and benefits comparable across different time periods. TVM serves as the tool to achieve this comparability. Here’s how TVM factors into LCC calculations:

Discounting Future Cash Flows

In LCC, future costs and benefits are typically discounted to their present value. This means that every future cash flow is adjusted to reflect its current worth. Why is this necessary? Because the further into the future a cost or benefit occurs, the less valuable it is in today’s terms due to factors like inflation, risk, and the opportunity cost of money.

The Role of the Discount Rate

The discount rate is a pivotal parameter in LCC calculations. It represents the rate at which future cash flows are discounted. The choice of the discount rate is not arbitrary; it depends on various factors, including the project’s risk profile and the prevailing economic conditions. A higher discount rate places more emphasis on immediate costs and benefits, while a lower rate gives more weight to long-term costs and benefits.

Net Present Value (NPV) and Net Present Cost (NPC)

Discounting future cash flows results in what is known as the Net Present Value (NPV) or Net Present Cost (NPC).  An NPV represents the current worth of all costs and benefits over the project’s lifecycle whilst an NPC only represents the current worth of all costs. These terms are sometimes used interchangeably so it is important to understand the scope of the cost analysis that you are undertaking.

Decision-Making Based on NPV or NPC

NPV calculations enable objective decision making to be made across different scenarios and options that the client may wish to study. A project with a positive NPV is typically deemed financially viable, as it is expected to generate a return that exceeds the initial investment. A project with the lowest comparative NPC may be deemed the lowest cost solution in the long-term.

Sensitivity Analysis

Given that discount rates can vary, LCC calculations often involve sensitivity analysis. This entails examining how changes in the discount rate can impact the project’s NPV or NPC. By assessing the sensitivity of the analysis to different discount rates, stakeholders can make more robust financial decisions.

In conclusion, the time value of money (TVM) is a cornerstone of Life Cycle Costing (LCC). It helps bring costs and benefits from various time periods into a common framework, allowing for informed comparisons and assessments. By discounting future cash flows, understanding the role of the discount rate, and utilising metrics like Net Present Value (NPV) and Net Present Cost (NPC), LCC practitioners can make financially sound decisions that optimise the value of construction projects.

For the remainder of this article we will adopt the phase Net Present Value (NPV) to mean either type of calculation. Now that we’ve demystified the concept of TVM, let’s explore how to apply the discount rate effectively in LCC calculations.

Undertaking Life Cycle Cost Calculations

A LCC calculation will list all the types of cost included in the analysis across a cashflow profile. This cashflow profile will then be discounted and the summation is the Net Present Value.

The equation used to convert future values into a present value is as follows,

• PV = FV / (1 + r) ^ n

or

• Present Value = Future Value / (1 + Discount Rate) ^ Number of Time Periods.

For example in the following 10 year cashflow a 3.5% Discount Rate has been used to list the Future Values against the Present Values using the above equation.

In the above example the Net Present Cost would be £551.55, being the sum of each years Present Value.

How to Calculate Residual Values

Calculating residual values may require some additional explanation. Consider a scenario where a 40-year time horizon is used, and two different options involve identical construction costs. However, one scenario includes an asset with a lifespan of 60 years, while the other features an asset lasting only 40 years. Clearly, the scenario with the asset lasting 60 years is more preferable. In the realm of Life Cycle Costing (LCC), this preference is represented by assigning a “Residual Value” to the 60-year asset at the end of the 40-year time horizon.

To break it down further, the 60-year asset is deemed to have 20/60ths of its total asset life remaining at the conclusion of the 40-year life cycle costing model. This remaining value is then adjusted by the discount factor for year 40. For instance, if we consider a £30,000 asset, it would have £10,000 of Future Value remaining at year 40. When this £10,000 is multiplied by the discount factor (3.5%) for year 40, which is 0.2526, it equates to £2,526 of Present Value that remains. This amount is subtracted from the Net Present Value (NPV). This calculation method effectively models options with longer remaining asset lives as offering better value within the NPV analysis.

This approach ensures that the extended lifespan of an asset is accurately reflected in the financial evaluation, helping stakeholders make more informed decisions.

Applying Life Cycle Costing Calculations

Life Cycle Costing (LCC) analysis offers a versatile framework that can be applied at various levels of detail, depending on the specific needs and stage of a construction project. Understanding the different levels of LCC analysis is crucial for tailoring your cost evaluation to the project’s complexity and chronology. Let’s explore the levels at which LCC estimates can take place:

1. Component Level

At the most granular level, LCC analysis can focus on individual components or manufactured products within a construction project. For instance, you might assess the cost implications of selecting a particular central heating thermostat. This level of analysis allows for detailed cost evaluation of specific elements.

2. System Level

Moving up the hierarchy, the system level entails considering a collection of discrete components that function together as a system. An example would be evaluating the LCC of an entire central heating system, which includes components like a gas boiler, pump, thermostat, pipes, and radiators. System-level analysis provides a broader view of cost implications within a subsystem.

3. Element Level

LCC analysis at the element level focuses on parts of construction that serve the same function, regardless of the specific components used. For instance, you might assess the LCC of external walls, irrespective of the materials or components used to construct them. This level allows for a more generalised evaluation of cost considerations for specific construction elements.

4. Cluster Level

Cluster-level analysis combines elements, often on the basis of a work package for contracting purposes. For example, you could evaluate the LCC of the entire building envelope, encompassing various elements such as walls, roofs, and windows. This level provides a more comprehensive view of cost implications for specific building components and their interactions.

5. Single Asset or Whole Building Level

This level of analysis typically considers different options for a single building or asset. For instance, you might compare the LCC of constructing a new building against the LCC of refurbishing an existing one. This level often involves the assessment of multiple options for a single site and helps in determining the most cost-effective approach for a specific building.

6. Multiple Assets or Portfolio/Estate Level

At the highest level, LCC analysis can encompass a portfolio of properties or assets. This is common when considering options for the development or management of multiple properties, such as consolidating staff into fewer locations. The “do nothing” option, maintaining the current status, is usually included as a baseline, although it rarely comes without costs.

The choice of the level at which to undertake LCC analysis depends on various factors, including project complexity and timing. Typically, higher-level analyses are considered in earlier project stages, while component-level options are evaluated later in the design and development process.

Guiding Construction with LCC Wisdom

In the intricate world of construction and asset management, the beacon of Life Cycle Costing (LCC) illuminates the path to informed decisions and optimised financial performance. As we wrap up this exploration of LCC’s fundamental concepts, it’s clear that this approach empowers clients and professionals alike to navigate the complexities of construction projects with precision and foresight.

LCC is not merely a financial tool; it’s a strategic approach. It encourages clients to analyse their business needs comprehensively, evaluate total ownership costs, and optimise the balance between initial capital and ongoing operational expenses. Moreover, it equips stakeholders to tackle risks proactively, embrace realistic budgeting, and make data-driven decisions.

About CappKind

CappKind specialises in undertaking life cycle costing and other quantity surveying services in both building and infrastructure sectors. Contact us for further information or support.