Week 1:
A Total Cost Approach
Key Points
Total Cost Approach
Terminology
First Generation
Technique
Second Generation
Technique
Third Generation
Technique
Life-Cost Studies
Total Cost Approach
Commonly the measurement of costs is
undertaken on a capital cost basis
The total cost approach takes into account both
capital and operating costs so that more effective
decisions can be made
Concern that evaluation based on capital costs
alone may lead to society paying more for its
buildings than the theoretical optimum
Still not widespread use in many countries
Terminology
Life-cost (preferred)
Life cycle cost (most common UK and US)
Costs-in-use (original term)
Operational cost, running cost, total cost analysis
Occupancy cost, functional-use cost
Ultimate cost
Terotechnology , whole-of-life cost
Recurrent cost
First Generation Technique
Although the idea of discounted cash flow
analysis has been around for over a century, the
total cost approach for buildings was first
seriously proposed in 1960 (Stone)
The reason for its interest was that in the UK there
was concern at this time over the maintenance
burden of the country’s aging stock of buildings
Maintenance was therefore behind the first
generation use of the technique
Second Generation Technique
The technique was often discussed and
advocated but never became common practice
It took the world oil crisis of the 1970s to
revitalise interest in the technique, particularly
as there was great concern that the enormous
increases in fuel prices could not be afforded in
the future
Energy conservation was therefore behind the
second generation use of the technique
Third Generation Technique
While the technique became popular in the US,
mainly due to legislation, most other countries
lost interest again as world oil prices stabilised
In the late 1980s the need to use non-renewable
resources in a sustainable manner renewed
interest in the technique as a means of
measuring building performance
Environmental protection is driving the third
(current) generation use of the technique
Life-Cost Studies
Total asset management must be seen as the
ultimate bounds of the life-cost technique
This involves project initiation processes,
investment analysis, project management and
facility management
Life-cost studies are vital to total asset
management and will become common practice
as governments become more concerned over
resource usage and sustainability
Sustainable Development
Background
Economic Interaction
Intergenerational
Equity
Resource Usage
Building Projects
Evaluation
Requirements
Background
Over the last decade there has been worldwide
consensus on the need for ecologically
sustainable development (ESD)
Alarming realisations about the rate of depletion
of the natural environment in terms of resource
extraction and waste disposal have caused a
groundswell of public and political interest
Attitudes are changing, but this change needs to
occur at a faster rate
Economic Interaction
Development implies change, and should by
definition lead to an improvement in the quality of
life of individuals
Development encompasses not only growth but
improvements in utility and well-being and the
transformation of natural resources into
productive output
Therefore the environment and the economy
necessarily interact
Intergenerational Equity
Sustainable development is the balance between
economic progress and environmental
protection
The notion of sustainable development places
clear emphasis on intergenerational equity
In other words, future generations should not be
worse off than present generations and any
development should be consistent with such
long-term objectives
Resource Usage
Sustainable development implies using
renewable natural resources in a way which does
not eliminate or degrade them or otherwise
decrease their usefulness to future generations
It also implies using non-renewable natural
resources at a rate slow enough as to ensure a
high probability of an orderly societal transition
to new alternatives
An increased value for the environment is needed
Building Projects
Development is undeniably associated with
construction and the built environment
Natural resources are consumed by modification
of the land, manufacture of materials and
systems, the construction process, energy
requirements and waste products of operation
Building projects are a major contributor to both
economic growth and environmental protection
and hence are concerned with sustainable goals
Evaluation Requirements
When evaluating buildings due consideration
should be given to all the costs and benefits that
flow from the decision over its life
Past analyses have concentrated on capital costs
The effects of subsequent operating costs are
often completely ignored
Yet there is evidence to suggest that operating
costs far outweigh capital costs over a building’s
economic life
Life-Costs
Definition
Purpose
Relative Importance
Past Reasons for
Ignoring
Other Disadvantages
New Imperatives
Characteristics of
Life-Costs
Definition
Life-cost is the total cost of creating and
maintaining an asset over a specified time
horizon
Life-cost includes expenditure related to capital,
operating and finance that may occur during the
period of financial interest of the owner
It is applied to buildings and building
components, but the technique is equally
applicable to any asset
Purpose
Life-costs identify the total cost commitment for
the acquisition of any asset
They facilitate an effective choice between
alternative methods of achieving a stated
objective
A life-cost approach is a management or planning
tool that details current operating commitments
It identifies areas in which operating costs may
be reduced, either by usage or system design
Relative Importance
Initial costs are clear and visible at an early
stage, whereas life-costs are not
Longer term costs can far outweigh initial costs
and should have a much stronger influence on
decisions than is currently the case
It is increasingly important for QSs to offer total
cost advice and become proficient in life-cost
methods upon which such advice is based
Capital costs are often just the “tip of the iceberg”
Past Reasons for Ignoring
Uninformed client
Changes in the relative importance of energy and
labour costs over the past few decades
Separation of capital and operating budgets
Lack of historical data and standards
Time constraints during project documentation
Complex nature of buildings and service systems
Concentration by consultants on services in
demand rather than new markets
Other Disadvantages
The diverse nature of the industry’s clients and
their motivations
The complex and theoretical relationship
between money now and money in the future
Frequently changing economic conditions
Long time lag between design and performance
feedback
Reservations about long-term predictions
Taxation changes and implications
New Imperatives
There is no longer any doubt that the construction
industry must take account of the long-term
implications of current design decisions
The relative balance between fixed (initial
capital) costs and variable (operating and
finance) costs has changed
Labour and energy costs will continue to rise
(limited natural resources ensures this)
Need to get involved in the early stages of design
Characteristics of Life-Costs
The major technical characteristics of the
analytical tools on which comparative life-cost
studies are based has long been recognised
Life-costing represents a particular application
of a classic financial technique called
discounted cash flow analysis
This technique enables the time-phased costs
and benefits of a project over a specified period
to be evaluated on an equivalent basis
Practice Issues
Implementation
Strategy
Procedural Steps
Discounting
Philosophy
Risk Analysis
Education and
Marketing
Implementation Procedure
Identify the overall time period (life) for the study,
given that different components may have
different lives
Consider all costs by time period (ie. initial
investment, running costs and replacement)
Adjust for the effects of time on the value of
money received or spent
Undertake risk analysis to manage the
uncertainty of future events
Procedural Steps
Establish the objective
Determine the choice of alternatives
Formulate assumptions
Identify the time horizon for the study
Estimate all the costs over the life
Compare costs and rank the alternatives
Undertake risk analysis
Investigate capital cost constraints
Discounting Philosophy
Discounting is a means by which an equivalent
(abstract) value is determined
Costs and benefits which arise in different time
periods must be brought to a common base so
that a proper comparison can be made
Discounting is merely a technique invented to
help make judgements between investments that
have different timings of costs and benefits
Discounting used for comparative purposes only
Risk Analysis
Forecasting possible events is normally an
integral part of the decision-making process
It is also the subject of considerable uncertainty
and exposure to risk
Discounting and life-cost studies are clearly
reliant on appropriate forecasts of future events
The only way to overcome the difficulties
associated with forecasting the future is to
manage the risk through a risk analysis process
Education and Marketing
Techniques need to be better communicated to
the industry as part of continuing professional
development
Clients need to be made aware of the advantages
that life-cost studies can provide
Government authorities need to take a leading
role in development of guidelines and standards
Research is necessary to objectively identify the
financial benefits