Measures of project worth: Economic methods that combine project benefits (savings) and costs in
various ways to evaluate the economic value of a project. Examples are life-cycle costs, net benefits
or net savings, benefit-to-cost ratio or savings-to-investment ratio, and adjusted internal rate of
return.
Net savings: The difference between savings and costs, where both are discounted to present or annual
values. The net savings method is used to measure project worth.
Present value: The time-equivalent value at a specified base time (the present) of past, present, and
future cash flows.
Risk exposure: The probability that a project’s economic outcome is different from what is desired (the
target) or what is acceptable.
Sensitivity analysis: A technique for measuring the impact on project outcomes of changing one or
more key input values about which there is uncertainty.
Spider diagram: A graph that compares the potential impact, taking one input at a time, of several
uncertain input variables on project outcomes.
Study period: The length of time over which an investment is evaluated.
References
ASTM. Standard guide for selecting techniques for treating uncertainty and risk in the economic evaluation of buildings and building systems. E1369-93. ASTM Standards on Buildings Economics, 3rd ed.,
American Society for Testing and Materials, Philadelphia, 1994.
Hillier, F. The derivation of probabilistic information for the evaluation of risky investments, Manage.
Sci., p. 444, April 1963.
Office of Management and Budget. 1963 Guidelines and Discount Rates for Benefit-Cost Analysis of Federal
Programs, p. 12–13, Circular A-94, October 29, Washington, DC, 1992.
Further Information
Marshall, H. E. Techniques for Treating Uncertainty and Risk in the Economic Evaluation of Building
Investments, Special Publication 757, National Institute of Standards and Technology, Gaithersburg,
MD, 1988.
Ruegg, R. T. and Marshall, H. E. Building Economics: Theory and Practice, Chapman and Hall, New York,
1990.
Uncertainty and Risk, part II in a series on least-cost energy decisions for buildings, National Institute of
Standards and Technology, 1992. VHS tape and companion workbook are available from Video
Transfer, Inc., 5709-B Arundel Avenue, Rockville, MD 20852. Phone: (301)881-0270.
8.13
Life-Cycle Costing5
Wolter J. Fabrycky and Benjamin S. Blanchard
A major portion of the projected life-cycle cost (LLC) for a given product, system, or structure is traceable
to decisions made during conceptual and preliminary design. These decisions pertain to operational
requirements, performance and effectiveness factors, the design configuration, the maintenance concept,
production quantity, utilization factors, logistic support, and disposal. Such decisions guide subsequent
design and production activities, product distribution functions, and aspects of sustaining system support. Accordingly, if the final LCC is to be minimized, it is essential that a high degree of cost emphasis
be applied during the early stages of system design and development.
5Material presented in this section adapted from chapter 6 in W. J. Fabrycky and B. S. Blanchard, Life-Cycle Cost
and Economic Analysis, Prentice Hall, 1991.
© 2000 by CRC Press LLC
The Life-Cycle Costing Situation
The combination of rising inflation, cost growth, reduction in purchasing power, budget limitations,
increased competition, and so on has created an awareness and interest in the total cost of products,
systems, and structures. Not only are the acquisition costs associated with new systems rising, but the
costs of operating and maintaining systems already in use are also increasing rapidly. This is due primarily
to a combination of inflation and cost growth factors traceable to the following:
1.
2.
3.
4.
5.
6.
7.
Poor quality of products, systems, and structures in use
Engineering changes during design and development
Changing suppliers in the procurement of system components
System production and/or construction changes
Changes in logistic support capability
Estimating and forecasting inaccuracies
Unforeseen events and problems
Experience indicates that cost growth due to various causes has ranged from five to ten times the rate
of inflation over the past several decades. At the same time, budget allocations for many programs are
decreasing from year to year. The result is that fewer resources are available for acquiring and operating
new systems or products and for maintaining and supporting existing systems. Available funds for
projects, when inflation and cost growth are considered, are decreasing rapidly.
The current situation is further complicated by some additional problems related to the actual determination of system and/or product cost.
1. Total system cost is often not visible, particularly those costs associated with system operation and
support. The cost visibility problem is due to an “iceberg” effect, as is illustrated in Fig. 8.6.
2. Individual cost factors are often improperly applied. Costs are identified and often included in
the wrong category; variable costs are treated as fixed (and vice versa); indirect costs are treated
as direct costs; and so on.
FIGURE 8.6 The problem of total cost visibility.
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3. Existing accounting procedures do not always permit a realistic and timely assessment of total
cost. In addition, it is often difficult (if not impossible) to determine costs on a functional basis.
4. Budgeting practices are often inflexible regarding the shift in funds from one category to another,
or from year to year, to facilitate cost improvements in system acquisition and utilization.
The current trends of inflation and cost growth, combined with these additional problems, have led
to inefficiencies in the utilization of valuable resources. Systems and products have been developed that
are not cost-effective. It is anticipated that these conditions will become worse unless an increased degree
of cost consciousness is assumed by engineers. Economic feasibility studies must address all aspects of
life LCC, not just portion thereof.
LCC is determined by identifying the applicable functions in each phase of the life cycle, costing these
functions, applying the appropriate costs by function on a year-to-year basis, and then accumulating the
costs over the entire span of the life cycle. LCC must include all producer and consumer costs to be
complete.
Cost Generated over the Life Cycle
LCC includes all costs associated with the product, system, or structure as applied over the defined life
cycle. The life cycle and the major functions associated with each phase are illustrated in Fig. 8.7. LCC
is employed in the evaluation of alternative system design configurations, alternative production schemes,
alternative logistic support policies, alternative disposal concepts and so on. The life cycle, tailored to the
specific system being addressed, forms the basis for LCC.
There are many technical and nontechnical decisions and actions required throughout the product or
system life cycle. Most actions, particularly those in the earlier phases, have life-cycle implications and
greatly affect life LCC. The analysis constitutes a step-by-step approach employing LCC figures of merit
as criteria at a cost-effective solution. This analysis process is iterative in nature and can be applied to
any phase of the life cycle of the product, system, or structure. Cost emphasis throughout the system/product life cycle is summarized in the following sections.
Conceptual System Design
In the early stages of system planning and conceptual design, when requirements are being defined,
quantitative cost figures of merit should be established to which the system or product is to be designed,
tested, produced (or constructed), and supported. A design-to-cost (DTC) goal may be adopted to
establish cost as a system or product design constraint, along with performance, effectiveness, capacity,
accuracy, size, weight, reliability, maintainability, supportability, and so on. Cost must be an active rather
than a resultant factor throughout the system design process.
FIGURE 8.7 Product, process, and support life cycles.
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Preliminary System Design
With quantitative cost requirements established, the next step includes an iterative process of synthesis,
trade-off and optimization, and system/product definition. The criteria defined in the conceptual system
design are initially allocated, or apportioned, to various segments of the system to establish guidelines
for the design and/or the procurement of needed element(s). Allocation is accomplished from the system
level down to the level necessary to provide an input to design and also to ensure adequate control. The
factors projected reflect the target cost per individual unit (i.e., a single equipment unit or product in a
deployed population) and are based on system operational requirements, the system maintenance concept, and the disposal concept.
As system development evolves, various approaches are considered that may lead to a preferred
configuration, Life-cycle cost analyses (LCCAs) are accomplished in (1) evaluating each possible candidate, with the objective of ensuring that the candidate selected is compatible with the established cost
targets, and (2) determining which of the various candidates being considered is preferred from an overall
cost-effectiveness standpoint. Numerous trade-off studies are accomplished, using LCCA as an evaluation
tool, until a preferred design configuration is chosen. Areas of compliance are justified, and noncompliant
approaches are discarded. This is an iterative process with an active-feedback and corrective-action loop.
Detail Design and Development
As the system or product design is further refined and design data become available, the LCCA process
involves the evaluation of specific design characteristics (as reflected by design documentation and
engineering or prototype models), the prediction of cost-generating sources, the estimation of costs, and
the projection of LCC as a life-cycle cost profile (LCCP). The results are compared with the initial
requirement, and corrective action is taken as necessary. Again, this is an iterative process, but at a lower
level than what is accomplished during preliminary system design.
Production, Utilization, and Support
Cost concerns in the production, utilization, support, and disposal stages of the system or product life
cycle are addressed through data collection, analysis, and an assessment function. High-cost contributors
are identified, cause-and-effect relationships are defined, and valuable information is gained and utilized
for the purposes of product improvement through redesign or reengineering.
The Cost Breakdown Structure
In general, costs over the life cycle fall into categories based on organizational activity needed to bring
a system into being. These categories and their constituent elements constitute a cost breakdown structure (CBS), as illustrated in Fig. 8.8. The main CBS categories are as follows:
1. Research and development cost. Initial planning, market analysis, feasibility studies, product
research, requirements analysis, engineering design, design data and documentation, software, test
and evaluation of engineering models, and associated management functions.
2. Production and construction cost. Industrial engineering and operations analysis, manufacturing
(fabrication, assembly, and test), facility construction, process development, production operations, quality control, and initial logistic support requirements (e.g., initial consumer support, the
manufacture of spare parts, the production of test and support equipment, etc.).
3. Operation and support cost. Consumer or user operations of the system or product in the field,
product distribution (marketing and sales, transportation, and traffic management), and sustaining maintenance and logistic support throughout the system or product life cycle (e.g., customer
service, maintenance activities, supply support, test and support equipment, transportation and
handling, technical data, facilities, system modifications, etc.).
4. Retirement and disposal cost. Disposal of nonrepairable items throughout the life cycle, system/product retirement, material recycling, and applicable logistic support requirements.
© 2000 by CRC Press LLC
FIGURE 8.8 A general cost breakdown structure.
The CBS links objectives and activities with organizational resource requirements. It constitutes a
logical subdivision of cost by functional activity area, major system elements, and/or one or more discrete
classes of common or like items. The CBS provides a means for initial resource allocation, cost monitoring,
and cost control.
Life-Cycle Cost Analysis
The application of LCC methods during product and system design and development is realized through
the accomplishment of LCCA. LCCA may be defined as a systematic analytical process of evaluating
various designs or alternative courses of action with the objective of choosing the best way to employ
scarce resources.
Where feasible alternative solutions exist for a specific problem and a decision is required for the
selection of a preferred approach, there is a formal analysis process that should be followed. Specifically,
the analyst should define the need for analysis, establish the analysis approach, select a model to facilitate
the evaluation process, generate the appropriate information for each alternative being considered,
evaluate each alternative, and recommend a proposed solution that is responsive to the problem.
Cost Analysis Goals
There are many questions that the decision maker might wish to address. There may be a single overall
analysis goal (e.g., design to minimum LCC) and any number of subgoals. The primary question should
be as follows: What is the purpose of the analysis, and what is to be learned through the analysis effort?
In many cases the nature of the problem appears to be obvious, but its precise definition may be
the most difficult part of the entire process. The design problem must be defined clearly and precisely
and presented in such a manner as to be easily understood by all concerned. Otherwise, it is doubtful
whether an analysis or any type will be meaningful. The analyst must be careful to ensure that realistic
goals are established at the start of the analysis process and that these goals remain in sight as the
process unfolds.
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Analysis Guidelines and Constraints
Subsequent to definition of the problem and the goals, the cost analyst must define the guidelines and
constraints (or bounds) within which the analysis is to be accomplished. Guidelines are composed of
information concerning such factors as the resources available for conducting the analysis (e.g., necessary
labor skills, availability of appropriate software, etc.), the time schedule allowed for completion of the
analysis, and/or related management policy or direction that may affect the analysis.
In some instances a decision maker or manager may not completely understand the problem or the
analysis process and may direct that certain tasks be accomplished in a prescribed manner or time frame
that may not be compatible with the analysis objectives. On other occasions a manager may have a preconceived idea as to a given decision outcome and direct that the analysis support the decision. Also, there
could be external inhibiting factors that may affect the validity of the analysis effort. In such cases the cost
analyst should make every effort to alleviate the problem by educating the manager. Should any unresolved
problems exist, the cot analyst should document them and relate their efforts to the analysis results.
Relative to the technical characteristics of a system or product, the analysis output may be constrained
by bounds (or limits) that are established through the definition of system performance factors, operational requirements, the maintenance concept, and/or through advanced program planning. For example,
there may be a maximum weight requirement for a given product, a minimum reliability requirement,
a maximum allowable first cost per unit, a minimum rated capacity, and so on. These various bounds,
or constraints, should provide for trade-offs in the evaluation of alternatives. Candidates that fall outside
these bounds are not allowable.
Identification of Alternatives
Within the established bounds and constraints, there may be any number of approaches leading to a
possible solution. All possible alternatives should be considered, with the most likely candidates selected
for further evaluation. Alternatives are frequently proposed for analysis even though there seems to be
little likelihood that they will prove feasible. This is done with the thought that it is better to consider
many alternatives than to overlook one that may be very good. Alternatives not considered cannot be
adopted, no matter how desirable they may actually prove to be.
Applying the Cost Breakdown Structure
Applying the CBS is one of the most significant steps in LCC. The CBS constitutes the framework for
defining LCC categories and provides the communications link for cost reporting, analysis, and ultimate
cost control.
In developing the CBS one needs to proceed to the depth required to provide the necessary information
for a true and valid assessment of the system or product LCC, identify high-cost contributors and enable
determination of the cause-and-effect relationships, and illustrate the various cost parameters and their
application in the analysis. Traceability is required from the system-level LCC figure of merit to the
specific input factor.
Cost Treatment over the Life Cycle
With the system/product CBS defined and cost-estimating approaches established, it is appropriate to
apply the resultant data to the system life cycle. To accomplish this, the cost analyst needs to understand
the steps required in developing cost profiles that include aspects of inflation, the effects of learning
curves, the time value of money, and so on.
In developing a cost profile, there are different procedures that may be used. The following steps are
suggested:
1. Identify all activities throughout the life cycle that will generate costs of one type or another. This
includes functions associated with planning, research and development, test and evaluation. production/construction, product distribution, system/product operational use, maintenance and
logistic support, and so on.
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2. Relate each activity identified in step 1 to a specific cost category in the CBS. All program activities
should all into one or more of the CBS categories.
3. Establish the appropriate cost factors in constant dollars for each activity in the CBS, where
constant dollars reflect the general purchasing power of the dollar at the time of decision (i.e.,
today). Relating costs in terms of constant dollars will allow for a direct comparison of activity
levels from year to year prior to the introduction of inflationary cost factors, changes in price
levels, economic affects of contractual agreements with suppliers, and so on, which can often cause
some confusion in the evaluation of alternatives.
4. Within each cost category in the CBS, the individual cost elements are projected into the future
on a year-to-year basis over the life cycle as applicable. The result should be a cost stream in
constant dollars for the activities that are included.
5. For each cost category in the CBS and for each applicable year in the life cycle, introduce the
appropriate inflationary factors, economic effects of learning curves, changes in price levels, and
so on. The modified values constitute a new cost stream and reflect realistic costs as they are
anticipated for each year of the life-cycle (i.e., expected 1996 costs in 1996, 1997 costs in 1997,
etc.). These costs may be used directly in the preparation of future budget requests, since they
reflect the actual dollar needs anticipated for each year in the life cycle.
6. Summarize the individual cost streams by major categories in the CBS and develop a top-level
cost profile.
Results from the foregoing sequence of steps are presented in Fig. 8.9. First, it is possible and often
beneficial to evaluate the cost stream for individual activities of the life cycle such as research and
development, production, operation and support, and so on. Second, these individual cost streams may
be shown in the context of the total cost spectrum. Finally, the total cost profile may be viewed from the
standpoint of the logical flow of activities and the proper level and timely expenditure of dollars. The
profile in Fig. 8.9 represents a budgetary estimate of future resource needs.
When dealing with two or more alternative system configurations, each will include different levels of
activity, different design approaches, different logistic support requirements, and so on. No two systems
alternatives will be identical. Thus, individual profiles will be developed for each alternative and ultimately
compared on an equivalent basis utilizing the economic analysis techniques found in earlier sections.
Figure 8.10 illustrates LCCPs for several alternatives.
Summary
LCC is applicable in all phases of system design, development, production, construction, operational use,
and logistic support. Cost emphasis is created early in the life cycle by establishing quantitative cost
factors as “design to” requirements. As the life cycle progresses, cost is employed as a major parameter
FIGURE 8.9 Development of LCCPs.
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FIGURE 8.10 LCCPs of alternatives.
in the evaluation of alternative design configurations and in the selection of a preferred approach.
Subsequently, cost data are generated based on established design and production characteristics and
used in the development of life-cycle cost projections. These projections, in turn, are compared with the
initial requirements to determine the degree of compliance and the necessity for corrective action. In
essence, LCC evolves from a series of rough estimates to a relatively refined methodology and is employed
as a management tool for decision-making purposes.
Defining Terms
Cost breakdown structure (CBS): A framework for defining life-cycle costs; it provides the communications link for cost reporting, analysis, and ultimate cost control.
Design-to-cost (DTC): A concept that may be adopted to establish cost as a system or product design
constraint, along with performance, effectiveness, capacity, accuracy, size, weight, reliability, maintainability, supportability, and others.
Life-cycle cost (LCC): All costs associated with the product or system as anticipated over the defined
life cycle.
Life-cycle cost analysis (LCCA): A systematic analytical process for evaluating various alternative
courses of action with the objective of choosing the best way to employ scarce resources.
Life-cycle cost profile (LCCP): A budgetary estimate of future resource needs over the life cycle.
References
Fabrycky, W. J. and Blanchard, B. S. Life-Cycle Cost and Economic Analysis, Prentice Hall, Englewood
Cliffs, NJ, 1991.
Further Information
The reference above should be studied by readers who want a complete view of life-cycle cost and
economic analysis. Further information may be obtained from the following:
Blanchard, B. S. and Fabrycky, W. J. Systems Engineering and Analysis, 3rd ed., Prentice Hall, Upper Saddle
River, NJ, 1990.
Canada, J. R. and Sullivan, W. G. Economic and Multiattribute Evaluation of Advanced Manufacturing
Systems, Prentice Hall, Upper Saddle River, NJ, 1989.
Fabrycky, W. J., Thuesen, G. J., and Verma, D., Economic Decision Analysis, 3rd ed., Prentice Hall, Upper
Saddle River, NJ, 1998.
Ostwald, P. F. Engineering Cost Estimating, 3rd ed., Prentice Hall, Upper Saddle River, NJ, 1992.
Thuesen, G. J. and Fabrycky, W. J. Engineering Economy, 8th ed., Prentice Hall, Upper Saddle River, NJ, 1993.
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