The Sustainability of Life Cycle Costs in a Systems
Engineering Process of a 21st Century Reliability
Engineering Environment
By:
Reboneng Mothupi Maoto N-Dip: Eng. (Mech), B-Tech: Eng. (Mech), B-Tech: Business Admin and GCC-Factories Eng. (Mech)
A Dissertation Submitted in Partial Fulfilment of the
Requirements for the Degree of Magister Philosophiae
in
Engineering Management
at the
Faculty of Engineering and the Built Environment
of the
University of Johannesburg
Supervisors: Prof. JHC Pretorius (UJ) and Mr. Arie Wessels (UJ)
November 2012
1
Dedication
The work done in this research is dedicated to the field of engineering as it has brought
joy, purpose and meaning to my life.
2
Acknowledgements
This dissertation would not have been possible without the interventions and helping
hand from the following:
To God be the glory for providing the courage, strength and knowledge to carry out the
research.
Prof. JHC Pretorius (UJ) and Mr. A Wessels (UJ) for reading and evaluating this document
and for providing guidance along the way.
Friends and family for the encouragement and providing support in the course of this
journey.
Mr. Siegfried Schubert (mentor and business partner) for constantly challenging my
views on the topic and for providing guidance.
3
Abstract
With the current global political and economic environments, there is a lot of economic
fluctuation and uncertainty in the world markets. This results in the instability of prices
for goods and other products. And since we operate in a globalised era, this has a direct
impact on the life cycle costs of many systems and products.
Experience has indicated that a large portion of the total cost of many systems is as a
direct result of activities associated with the operation and support of these systems and
products, while the commitment of these costs is based on decisions made in the early
stages of the system life cycle (Blanchard, 1990:505 & Blanchard, 2004:24-26).
Further, the various costs associated with the different phases of the life cycle of a
system or a piece of equipment are interrelated. Thus, in addressing the economic
aspects of a system, one must look at the total cost in the context of the overall life
cycle, particularly during the early stages of conceptual design and advanced system
planning. Life cycle cost, when included as a parameter in the systems engineering
process, provides the opportunity to design for economic feasibility. To address these
aspects the following questions are answered through the research:
What are life cycle costs and what are the benefits of costing them?
When and where are costs incurred in a systems life cycle?
What are the key variables in establishing life cycle costs?
How can these variables be better defined to ensure that the life cycle costs are
sustained through the entire life of a system?
Can the engineering inflation be defined and be used instead of the general inflation
rate?
Now the challenge is that with the fluctuating economic conditions mentioned earlier,
one cannot predict the life cycle costs of a system as closely accurate as is required. The
proposed research focused on identifying sustainable measures to ensure that life cycle
costs remain relevant through the lifespan of a system or equipment.
4
In establishing LCC (Life Cycle Costs), it was found that there are various interpretations
with the detail of the definitions differing from case to case. But ultimately all definitions
of LCC make considerations of all relevant costs associated with the acquiring and
ownership of an asset. The costs are established through an iterative costing process of
estimating, planning, monitoring and reviewing of costs throughout an asset's life. This
process is used in decision making by evaluating alternative options and performing
trade-off studies. The costing process also known as LCCA (Life Cycle Cost Analysis) is
critical in early project stages for evaluating possible solutions, but it is also applicable to
all stages of the a systems life cycle.
The LCC were found to be incurred throughout the entire life cycle of a system but at
different amounts depending on the phase of the life cycle. During LCCA all costs are
classified and categorised using a CBS (Cost Breakdown Structure). The levels to which
costs in the CBS are broken down depend on the objective and scope of LCCA, and the
resource availability to conduct the work. Ultimately, the CBS must provide management
with a sufficient data to identify high-cost areas.
There are variables which required understanding to be able to successfully establish
LCC. These variables include baseline costs, economic factors and technical performance.
From a cost point of view, the 3 main methods used to estimate and generate the
appropriate cost data are namely engineering costing, analogue costing and parametric
costing. The economic factors established included time value of money, discounting,
inflation, interest rates and valuation methods. On the other hand the technical
performance is made up of figures of merit associated with RAM (Reliability, Availability
and Maintainability).
With the value of money eroding of time, inflation has been found to have an impact on
the acquisition and maintaining systems during operation. There are cost increases due
to wear and tear, increased labour skills, material demand, changes in logistics support
capabilities, energy/electricity consumption and initial estimate inaccuracies. So when
preparing cash flows for LCC purposes over a life of a system, the discounting interest
rate used must cover these costs.
The management measures identified conclude on the frequency of cost reviewing, the
correctness of key variables data and reliability management being the crux to the
sustainability of life cycle costs.
5
Contents
Dedication ............................................................................................... 1
Acknowledgements ................................................................................. 2
Abstract .................................................................................................. 3
Contents ................................................................................................. 5
Terms and Definitions ............................................................................. 8
Abbreviations .......................................................................................... 9
List of Figures ....................................................................................... 10
List of Tables ......................................................................................... 10
Chapter 1. Introduction ........................................................................ 11
1.1 Problem Statement ........................................................................................... 11
1.2 Purpose ........................................................................................................... 12
1.3 Questions to be addressed ................................................................................. 12
1.4 Background ...................................................................................................... 12
1.5 Scope and Objective .......................................................................................... 16
1.6 Research Methodology ....................................................................................... 16
1.7 Structure of the Dissertation ............................................................................... 17
1.8 Conclusion ....................................................................................................... 18
Chapter 2. Life Cycle Cost (Background) ............................................... 19
2.1 Introduction ..................................................................................................... 19
2.2 Defining the Concept (What are Life Cycle Costs?) ................................................. 20
2.3 What is the value of Life Cycle Costing? ............................................................... 21
2.4 Cost Emphasis in the System Life Cycle ................................................................ 22 2.4.1 Define the Need/Problem ............................................................................................ 22 2.4.2 Conceptual Design ..................................................................................................... 23 2.4.3 Preliminary Design ..................................................................................................... 24 2.4.4 Detail Design and Development.................................................................................... 25 2.4.5 Production and Construction ........................................................................................ 25 2.4.6 Utilization and Support ............................................................................................... 25 2.4.7 System Retirement and Phase-out ................................................................................ 25
2.5 Summary ........................................................................................................ 26
6
Chapter 3. Life Cycle Costing Economics ............................................... 27
3.1 Introduction ..................................................................................................... 27
3.2 Time Value of Money ......................................................................................... 28
3.3 Economic Principles ........................................................................................... 28 3.3.1 Simple Interest .......................................................................................................... 28 3.3.2 Compound Interest .................................................................................................... 28 3.3.3 Equal-Payment Series (Annuities) ................................................................................. 29 3.3.4 Inflation ................................................................................................................... 30
3.4 Investment Decision Evaluation Methods .............................................................. 31 3.4.1 Payback Method ......................................................................................................... 31 3.4.2 Net Present Value Method ........................................................................................... 32 3.4.3 IRR (Internal Rate of Return) Method ............................................................................ 32 3.4.4 Profitability Index Method ............................................................................................ 32
3.5 Summary ........................................................................................................ 33
Chapter 4. Life Cycle Cost Analysis........................................................ 34
4.1 Introduction ..................................................................................................... 34
4.2 Life Cycle Cost Analysis ..................................................................................... 35 4.2.1 Define the need for analysis ........................................................................................ 37 4.2.2 Development of CBS (Cost Breakdown Structure) ........................................................... 37 4.2.3 Selecting the LCC Models ............................................................................................ 37 4.2.4 Cost Model Selection .................................................................................................. 40 4.2.5 Cost Estimation and Data Generation ............................................................................ 40
4.3 Summary ........................................................................................................ 41
Chapter 5. LCC vs. Technical Performance ............................................ 42
5.1 Introduction ..................................................................................................... 42
5.2 Technical Performance ....................................................................................... 43 5.2.1 Reliability .................................................................................................................. 43 5.2.2 Availability ................................................................................................................ 44 5.2.3 Maintainability ........................................................................................................... 45
5.3 Summary ........................................................................................................ 47
Chapter 6. Case Studies ........................................................................ 48
6.1 Introduction ..................................................................................................... 48
6.2 Case Study 1 – Sheet Metal Print Modernization Project .......................................... 49 6.2.1 Background ............................................................................................................... 49 6.2.2 Problem Statement .................................................................................................... 49 6.2.3 Proposed Solution ...................................................................................................... 50 6.2.4 System Description .................................................................................................... 51 6.2.5 Life Cycle Costing ....................................................................................................... 53 6.2.6 Conclusion ................................................................................................................ 55
6.3 Case Study 2 – High Pressure Compressor Replacement ......................................... 56 6.3.1 Background ............................................................................................................... 56 6.3.2 Problem Statement .................................................................................................... 56 6.3.3 Proposed Solution ...................................................................................................... 57 6.3.4 System Description .................................................................................................... 58 6.3.5 Life Cycle Costing ....................................................................................................... 59 6.3.6 Conclusion ................................................................................................................ 60
7
Chapter 7. Research Findings ................................................................ 61
7.1 Introduction ..................................................................................................... 61
7.2 What are life cycle costs and what are the benefits of costing them? ........................ 62
7.3 When and where are costs incurred in a systems life cycle? .................................... 63
7.4 What are the key variables in establishing life cycle costs? ...................................... 64
7.5 How can these variables be better defined to ensure that the life cycle costs are
sustained through the entire life of a system? ............................................................. 65
7.6 Can the engineering inflation be defined and be used instead of the general inflation
rate? .................................................................................................................... 69
Chapter 8. Conclusions & Recommendations ........................................ 70
8.1 Introduction ..................................................................................................... 70
8.2 Management of Life Cycle Costing ....................................................................... 71 8.2.1 Objectives ................................................................................................................. 71 8.2.2 Planning ................................................................................................................... 71 8.2.3 Organisation ............................................................................................................. 71 8.2.4 Calculation of Life Cycle Costs ...................................................................................... 72 8.2.5 Monitoring ................................................................................................................ 73 8.2.6 Controlling ................................................................................................................ 74
8.3 Conclusion ....................................................................................................... 76
Bibliography .......................................................................................... 77
8
Terms and Definitions
Availability – is the probability that a system will be available when required and will
achieve its overall mission satisfactorily. (Blanchard, 2004:72)
Cash Flow – stream of costs and savings resulting from a project investment. (Fuller &
Petersen, 1996:GL-1)
Compound Interest – this is the interest that is earned on a given deposit and has
become part of a principal amount at the end of a specific period. (Gitman, 2009:166)
Discount Rate – rate of interest reflecting an investor’s time value of money that is
used in discount formula’s to convert cash flow to a common time. (Fuller et al.,
1996:GL-2)
Inflation – a loss in purchasing power of money over time. (Park, 2009:145)
Interest Rate – a percentage periodically applied to a sum of money to determine the
amount of interest to be added to that sum. (Park, 2009:90)
Maintainability – is defined, as the ease, accuracy, safety and economy in the
performance of maintenance actions. (Blanchard, 2004:34)
Payback Period – the amount of time required for a firm to recover its initial
investment of a project. (Gitman, 2009:425)
Present Value – the current value of future cash flows discounted at the appropriate
rate. (Firer, Ross, Westerfield & Jordan, 2004:127)
Reliability – is the probability that a system or product will perform in a satisfactory
manner for a given period of time when used under specified operating conditions.
(Blanchard, 1994:347)
Simple Interest – interest earned only on the original principal amount of an
investment. (Firer et al., 2004:119)
9
Abbreviations
Aa – Achieved Availability
Ai – Inherent Availability
Ao – Operational Availability
CBS – Cost Breakdown Structure
Cfm – cubic feet per minute
CPI – Consumer Price Index
et al. – And Others
f – General Inflation
F – Future Value
FMECA – Failure Mode, Effects and Criticality Analysis
FMCG – Fast Moving Consumer Goods
FOM – Figure of Merit
FRACAS – Failure Reporting, Analysis and Corrective Action System
i – Annual Interest Rate
IS – Simple Interest
IRR – Internal Rate of Return
kWh – Kilo Watt Hour
LCC – Life Cycle Cost/s
LCCA – Life Cycle Cost Analysis
M – Mean active maintenance time
MARR – Minimum Attractive rate of Return
Mct – Mean corrective Maintenance Time
MDT – Mean Maintenance Downtime
Mpt – Mean Preventative Maintenance Time
MTBM – Mean Time between Maintenance
MTBF – Mean Time between Failures
MTTR – Mean Time to Repair
N – Number of years
n.d. – No date
NPV – Net Present Value
P – Principal sum of the original amount borrowed or invested
PI – Profitability Index
PV – Present Value
PPI – Producer Price Index
R – Republic of South Africa Rand (Also ZAR)
RAM – Reliability Availability Maintainability
RBI – Risk Based Inspections
RCM – Reliability Centred Maintenance
R(t) – Reliability Function
SARB – South African Reserve Bank
SARS – South African Revenue Service
STATSSA – Statistics South Africa
US$ – United States of America Dollar
VAT – Value Added Tax
λ – Failure Rate
10
List of Figures
Figure 1: History of South African Inflation Rate...................................................... 13
Figure 2: Brent Crude Oil Price (2000 to 2010) ....................................................... 13
Figure 3: 36 year gold price history in US Dollars/ounce .......................................... 14
Figure 4: Currency Exchange Rate of US Dollars vs. South African Rand .................... 14
Figure 5: Eskom’s average tariff adjustment for the last 15 years ............................. 15
Figure 6: System Requirement Definition Process .................................................... 23
Figure 7: System Development Process ................................................................. 24
Figure 8: % of LCC Committed During the Systems Life ........................................... 26
Figure 9: An Investment Cash Flows Example ......................................................... 31
Figure 10: Top Level of LCC Tree .......................................................................... 35
Figure 11: Acquisition Cost Tree ............................................................................ 36
Figure 12: Sustaining Cost Tree ............................................................................ 36
Figure 13: Relationship between Reliability and Total Cost ........................................ 47
Figure 14: Cost Phasing in System Life Cycle .......................................................... 63
Figure 15: Bath Tub Curve ................................................................................... 67
Figure 16: Double Loop Reliability Management Process ........................................... 75
List of Tables
Table 1: Sheet Metal Printing Old Technology vs. New Technology ............................ 50
Table 2: LCC for Case Study 1 .............................................................................. 54
Table 3: LCC Key Variables ................................................................................... 64
11
Chapter 1. Introduction
1.1 Problem Statement
Living costs and those of running businesses are constantly increasing resulting in the
inevitable need for smarter and rigorous ways of managing costs. This has had a direct
impact on engineering systems (Blanchard, 2004:24-26) as they become less and less
cost-effective over time. The sustainability of systems and equipment life cycle costs in
the 21st century will require different thinking and approach to ensure a reliable
engineering environment.
This research will look at the theory of life cycle costing; variable aspects of life cycle
costs; and the relationship between costs and asset performance. The research areas
are demarcated into a set of questions indicated in section 1.3.
12
1.2 Purpose
When a system or product is selected for use, the decision is based on the information at
hand at that particular point in time. Over time the same input information which was
used to evaluate alternatives and make the decision will change. As a result, the present
circumstance will see costing being different and could end up with increased financial
risk to the organisation.
The purpose of this dissertation is to identify the short comings of life cycle cost
allocation and to develop a management process/tool that will assist in achieving more
control of life cycle costs for systems and products during their operational period into
the future.
1.3 Questions to be addressed
The specific research questions which will be answered are as follows:
What are life cycle costs and what are the benefits of costing them?
When and where are costs incurred in a systems life cycle?
What are the key variables in establishing life cycle costs?
How can these variables be better defined to ensure that the life cycle costs are
sustained through the entire life of a system?
Can the engineering inflation be defined and be used instead of the general inflation
rate?
1.4 Background
The value of money depreciates over time as indicated by the 5 graphs of economic and
financial indicators below. This depreciation and erosion occurs at an inconsistent rate
making it difficult to accurately predict future costs of goods and services. This notion of
inconsistently fluctuating costs has raised the question; is there still effective
management of industrial assets (focusing on both operational and capital costs)?
13
Figure 1: History of South African Inflation Rate (Source: http://www.tradingeconomics.com/south-africa/inflation-cpi Accessed: 16 August 2012))
Figure 2: Brent Crude Oil Price (2000 to 2010) (Source: http://www.shell.com/home/content/bitumen/risk_marketing/ Accessed: 16 August 2012)
These economic indicators show that even though physics taught us that everything that
goes up must come down, it doesn’t necessarily apply to economics. This is due to the
political interferences as shown above which result in a nonlinear reacting market.
(Bienen & Gersovitz, 39(4):729-754 &
http://www.resbank.co.za/Financial%20Stability/Pages/FinancialStability-Home.aspx)
In
flati
on
Rate
(%
)
14
Figure 3: 36 year gold price history in US Dollars/ounce (Source: http://goldprice.org/gold-price-history.html#10_year_gold_price Accessed: 15 August 2012)
Figure 4: Currency Exchange Rate of US Dollars vs. South African Rand (Source: http://www.tradingeconomics.com/south-africa/currency Accessed: 15 August 2012)
US
Do
llar
15
The wider economic impact of electricity tariff hikes cannot be ignored (HSRC, 2008).
This impact is seen in the capacity, supply and reserve margin problems experienced
currently in South Africa. Due to these problems, a need for infrastructure investment
has been identified. And this has resulted in high electricity tariff increases (HSRC, 2008)
impacting directly on the life cycle costs of systems and equipment. Below is a historic
view of the year-on-year price increases in electricity tariffs compared to the inflation
rate.
Figure 5: Eskom’s average tariff adjustment for the last 15 years (Source: http://www.eskom.co.za/c/article/143/average-price-increases/ Accessed: 15 October 2012)
0
5
10
15
20
25
30
35
40
45
50
55
60
65
0%
2%
4%
6%
8%
10%
12%
14%
16%
18%
20%
22%
24%
26%
28%
30%
32%
34%
c/kW
h
CPI (%) Average Electricity Price Adjustment (%) Avarage Electricity Cost (c/kWh)
16
1.5 Scope and Objective
The scope of this research will cover the following main sections:
The research begins with a literature review to provide a holistic understanding of
life cycle costing. This will include an overview of life cycle costing, the economics
of life cycle costing, the analytical process and the technical performance impact
on life cycle costs.
The literature review is followed by case studies of real life situation to
substantiate the need for this research.
After the case studies, the research questions will be answered to conclude on the
finding of the research.
This will lead to the author establishing a systematic method of ensuring that life
cycle costs are effectively monitored and managed.
1.6 Research Methodology
The research methods employed to get to the solution involved a literature review and
field research. The literature review was conducted with library books and internet
articles by abstracting and referencing to the contents of published data. While the field
research involved analysis of case studies and observations of life cycle cost
management processes of various projects in a similar industrial sector.
This is an applied type of research as it aims at uncovering a solution to an immediate
problem facing organisations. All in all a qualitative approach was followed to execute
this research (Kothari, 1985 & Kumar, 2005). This was to ensure that the underlying
reasons for the erosion in life cycle costs is identified and a practical approach
formulated to minimise the economic impact.
17
1.7 Structure of the Dissertation
To put forth the argument a structure that is proposed will include the following
contents:
Title page
Table of contents
Chapter 1 - Introduction
o Chapter 2
Life Cycle Cost (Background)
o Chapter 3
Life Cycle Costing Economics
Literature Review
o Chapter 4
Life Cycle Cost Analysis
o Chapter 5
LCC vs. Technical Performance
Chapter 6
o Case Studies
Chapter 7
o Research Findings
Chapter 8
o Conclusion and Recommendations
Bibliography
18
1.8 Conclusion
The purpose of this chapter is to provide an overview of the dissertation and an
introduction to get a feel of the approach to the research. In the next chapter life cycle
costing is introduced and its significance in the systems engineering is highlighted.
Ethical considerations made during the research included referencing references used in
the literature survey. The references included books, standards, articles, internet based
information, and listing them in the bibliography section of the research document. All
human participants who provided input in the research are named only after their
consent. And the industry examples provided in the case studies are anonymous to avoid
distribution of confidential information.
19
Chapter 2. Life Cycle Cost (Background)
2.1 Introduction
In this chapter, LCC (Life Cycle Cost) is defined and a better understanding of its
purpose is established. A cost emphasis on the life cycle of a system is also made,
focusing more on the design phase of the systems engineering process. The design
process is based on many current system engineering models and is constructed to
convert a need into a practical solution. Throughout this process other elements of
reliability engineering such as engineering economics, logistics engineering, asset
management and financial management are considered.
20
2.2 Defining the Concept (What are Life Cycle Costs?)
Many authors define life cycle costs in various ways. Below are a few of the published
definitions:
LCC is the sum of all recurring and one-time (non-recurring) costs over the full
life span or a specified period of a good, service, structure, or system. It includes
the purchase price, installation cost, operating costs, maintenance
and upgrade costs, and remaining (residual or salvage) value at the end
of ownership or its useful life. (www.businessdictionary.com/definition/life-cycle-
cost.html#ixzz1tu4oKYs8 Accessed: 12 October 2012)
LCC is the total cost of the entire user system over its full life in its intended
environment. (RSA-MIL-PRAC-175, 1993:16)
LCC is the sum of all costs incurred during the life span of an item or system.
(Dhillon, 2010:2)
LCC is the total cost throughout its life including planning, design, acquisition and
support costs and any other costs directly attributable to owning or using the
asset.
(http://www.treasury.nsw.gov.au/__data/assets/pdf_file/0005/5099/life_cycle_c
ostings.pdf, 2004:1)
Life cycle cost is the total cost of ownership of machinery and equipment,
including its cost of acquisition, operation, maintenance, conversion, and/or
decommission (Barringer, 2003:2).
21
2.3 What is the value of Life Cycle Costing?
The main idea is to be able to compare alternatives in order to ensure that the final
decision is financially beneficial to the organisation. Life cycle costing consolidates all the
various costs (acquisition, maintenance, refurbishment or disposal) of different solutions
to a problem or a need. This is done for the full life cycle of the system or product to
allow the evaluation and selection processes to be consistent.
LCC helps change perspectives on economic issues. Consider the following conflicts in
most companies as expressed by Barringer (2003:3):
Accountings main concern is maximising project NPV (Net Present Value)
Project Engineering is concerned mainly with minimising capital costs
Maintenance Engineering is only concerned with minimising repair hours
Production is mainly concerned with maximising up time hours and production output
Reliability Engineering wants to avoid failures
Shareholders want increased dividend and share value
So with these conflicting scenarios, a scientifically derived tool needs to be used to assist
management to get to a point that they can make well informed decisions. As the
saying goes, it is important for engineers to think like MBA’s but still act like engineers
(Barringer, 2003:3). Beside the need to align objectives as a result of these conflicts, life
cycle costing has several benefits (Dhillon, 2010:34):
Reduced cost ownership
Alignment of engineering decisions with corporate and business objectives
Development of common objectives (between suppliers and operations)
Reduction of the risk of operating cost surprises
Identification of business performance improvements
Maximising the value of current operating experience
Providing a framework within which to compare options at all stages of development
Providing a mechanism for identifying and reducing major cost drivers
Use the power of collective experience
22
2.4 Cost Emphasis in the System Life Cycle
To be able to improve benefits of LCC there is a necessity to understand the impact of
decisions made during the systems engineering phase. The majority of the projected life
cycle costs for a given system or product are as a direct result of decisions made during
the design and development phase of the systems engineering process (Blanchard,
1990:505 & Blanchard, 2004:24-26). These decisions deal with system configuration,
operational requirements, performance and effectiveness factors, system utilization
factors, quality of items to be produced, the maintenance concept, logistic support
polices, system retirement (material recycling) and system upgrades (Blanchard,
1990:505).
Resources are getting more limited resulting in a higher need for different approaches
toward systems life cycle costing. So if we want optimized life-cycle costs to be an end
result in the process of designing for economic feasibility, it is important that there is a
strong focus on cost emphasis in the early stages of system development. The emphases
will provide a much highly needed level of detailed cost allocation. And with this detail
then there is a much better chance of controlling the life cycle costs. (Blanchard,
1990:508).
2.4.1 Define the Need/Problem
The systems engineering process commences with the definition of a need or a problem.
This is done by means of making a statement of the problem which provides a
qualitative and a quantitative baseline to be able to continue with the process. This part
of the process must make the following outputs very clear:
Capability required by the customer
An estimation of resources required to acquire the system
Time when the system needs to be in place
23
2.4.2 Conceptual Design
Conceptual design is the initial phase of the design process and it is intended to respond
to the need which has been identified. This should take an idea and convert it into
something with shape and is capable of performing a set function repeatedly. To
establish LCC of this new solution, the cost estimation methods in Chapter 3 may be
adopted to establish system design parameters. These estimation methods will along
with the functional details and design requirements be used as active factors throughout
the design process (Blanchard, 2004:257).
To effectively carry out a conceptual design, Blanchard (1990:34) explains that the
following steps need to be executed (process flow show below):
Conduct a needs analysis
Conduct feasibility studies
Define systems operational requirements
Define system maintenance concept
Identify systems’ technical performance measures
Figure 6: System Requirement Definition Process (Source: Blanchard, 1990:35)
System Specification
Conceptual Design
Review
Definition of Need
Advance System
Planning
Feasibility Studies System Operational
Requirements
Preliminary system
Analysis
System Maintenance
Concept
Technology
Development and
Application
24
2.4.3 Preliminary Design
With the functional or technical baseline determined during conceptual design, the
preliminary design will take the process further by establishing detailed qualitative and
quantitative design requirements (Blanchard, 1990:55).
From a cost point of view, the cost is allocated to each item in the system to establish a
guideline and alternatives evaluated to get the best “cost” solution. At the end of it all,
the preliminary design phase will ensure that items selected are comparable to the
targeted costs, and that they are the most cost effective solution (Blanchard, 1990:508).
So an iterative process is followed to get results and this is done by using LCCA as a tool
for evaluating alternatives and making trade-off’s.
Figure 7: System Development Process (Source: Blanchard, 1990:56)
Disapproval
Approval
System Requirements
Definition
System Functional
Analysis
Preliminary Synthesis and
Allocation of Requirements
Trade-off and optimisation
Synthesis and Definition
System Design Review
Is Design
Approach
Acceptable
Yes
No
25
2.4.4 Detail Design and Development
As system design is further refined and design data becomes available, the LCCA (Life
Cycle Cost Analysis) effort involves the evaluation of specific design characteristics, the
prediction of cost-generating variables, the estimation of costs, and the projection of life-
cycle cost as a profile. The results are compared with the initial requirements and
corrective action is taken as necessary. Again, this is an iterative process, but at a lower
level than what is accomplished during the preliminary system design.
2.4.5 Production and Construction
Cost concerns in these latter stages of the system or product life cycle involve data
collection, analysis, and assessment function. Hopefully, valuable information is gained
and utilized for the purposes of product improvement and for the development of good
historical data for future applications.
2.4.6 Utilization and Support
For the purpose of this study, the last 2 stages of the system engineering process which
include utilisation, support and system phase-out are looked at as part of the case
studies and the solution thereof. This is as a result of these parts of the process leaning
more towards the operational environment and not a more controlled systematic design
environment.
2.4.7 System Retirement and Phase-out
Similar to the Utilisation and Support phase, the above statement will apply.
26
2.5 Summary
Life cycle costing is applicable in all phases of system design and development,
production, construction, operational use and logistic support. Cost emphasis is created
early in the life cycle by establishing quantitative cost factors as requirements.
As the life cycle progresses, the cost is employed as a major parameter 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 which are
shown below in figure 8.
These projections in turn are compared with the initial requirements to determine the
degree of compliance and the ultimate necessity for corrective action. In essence life
cycle costing evolves from a series of rough estimates to a relatively refined
methodology, and is employed as a management tool for decision-making purposes.
Figure 8: % of LCC Committed During the Systems Life (Source: Blanchard, 2004:87)
Preliminary
system design
System planning
function and
conceptual design
Detail design
and
development
Production,
construction
and evaluation
System use
and logistic
support
25
50
75
100
% o
f Lif
e C
ycle
Cost
Co
mm
itte
d
Market analysis, feasibility
study, operational
requirements, maintenance
concept, etc.
System analysis, evaluation
of alternatives, system
definition, etc.
Detail design and development
27
Chapter 3. Life Cycle Costing Economics
3.1 Introduction
Money as a resource is scarce in any business, government or major corporation. This
leaves the businessman no choice but to select his/her investment options carefully. The
same applies to engineers when making engineering investment decisions. To assist in
making these decisions, economic principles are utilised and applied to cash flows for
systems and equipment. This chapter highlights key elements in economics which affects
the value of money.
28
3.2 Time Value of Money
One of the important financial concepts is the time value of money. This concept refers
to a rand on hand today having a higher value than a rand promised in the future (Firer
et al., 2004:118). Since money has the purchasing power and earning power, it is
important that its value be understood to be able to make good engineering investment
decisions.
3.3 Economic Principles
When making an investment in an engineering asset, it is a similar ideology to
investment made by financial institutions when lending money out. The similarity is that
there is an expectation that a return on the investment will be realised sometime in the
future (Park, 2009:180). To work out the life cycle costs of an engineering investment,
one needs to understand a number of economic principles as costs are experienced
throughout the life of a system or an equipment. Below are a few key principles to allow
for a better understanding of engineering economics which involves the compounding
and discounting of cash flows (Park, 2009:20-36).
3.3.1 Simple Interest
Simple interest refers to the simplest form of interest. When an investment is made, the
interest is charged or earned only on the original principal amount invested. This
method does not include an interest charged on the accrued interest. The simple
interest is calculated as per the following formula:
NiPsI (3-1)
Therefore the total amount of money to be received in the future for this investment can
be calculated as follows:
)NiP(1NiPPsIPF (3-2)
3.3.2 Compound Interest
The word compounding in economics refers to the process of earning interest from an
investment over a period of time and accumulating even more interest. The interest
earned monthly or yearly gets to be added to the original principal amount and the sum
total earns interest. This can be obtained using the following calculation:
Ni)P(1F (3-3)
29
The formula can also be used to work out the present value of a future amount by
making P (Present Value) the subject of the formula. This is also referred to as the
discounting of cash flows. The question that this formula is concerned with answering is
that, to receive a desired lump sum after a number of periods at a specified interest
what is the investment that needs to be made today?
Ni)(1
FP
(3-4)
3.3.3 Equal-Payment Series (Annuities)
This method is also called or known as annuities. It is applied to a series or stream of
equal payments over a specified period. This method is used for 4 different purposes and
they are all expressed below.
a. Compounding-Amount Method
To find out the future value of equal payments made over a period of time the following
formula is used:
i
1i)(1AF
N
(3-5)
b. Sinking-Fund Method
The following formula is obtained by rearranging the compounding method to calculate
the annuity of a future amount.
1i)(1
iFA
N
(3-6)
c. Present-Worth Method
This method deals with working out the present value of an amount of money to be paid
at the end of each given period and is computed as follows:
i
i)(11AP
N
(3-7)
d. Capital Recovery Method
The formula for this method is obtained by rearranging the present-worth formula
above:
Ni)(11
iPA
(3-8)
30
3.3.4 Inflation
Up to this point, the entire focus has been on discount rates. The other critical economic
concept is inflation as history has shown (refer to Figure 1, 2, 3, 4 and 5 in Chapter 1)
that prices of goods and services are consistently on the rise. This loss of purchasing
power of money over time is called inflation. The treatment given to inflation can
dramatically affect the outcome of LCCA and make the process inconclusive and
insignificant.
Making projections of inflation can be complex and possibly misleading considering the
number of factors that affect it. Typically, there are 2 main approaches of dealing with it
and are mentioned below.
a. General Inflation
General inflation is the average inflation rate based on the CPI (Consumer Price Index).
The measure is produced by the STASSA (Statistics South Africa) by taking into account
the change of prices in goods and services over time. These goods and services are
grouped into a number of classifications such as housing, entertainment, food, personal
care, beverages, transportation, medical care and apparel. The CPI compares the cost of
a sample market basket of these goods and services taken over a specific period. This
measure is calculated as follows:
1N
1NN
CPI
CPICPIf
(3-9)
b. Specific Inflation
The logic here is that the general inflation affects both the cost and benefits of a project
over time. However, specific items may not follow the general pattern. As an example,
Eskom hiked electricity prices to over a 100% in the last 4 years while the general
inflation rate was extremely lower than that.
So, to get to an inflation rate which is relevant to engineering investment analysis the
appropriate price index needs to be established (Park, 2009:147). This can also be
looked at as what is known as the PPI (Producer Price Index). This specific inflation rate
is represented by fj (Park, 2009:151).
31
3.4 Investment Decision Evaluation Methods
Now that the basic economic principles have been laid down and clarified, it’s time to
look at the methods which uses these principles for investment evaluations.
3.4.1 Payback Method
The first method that is looked at is the payback method. This method determines the
time it takes to recover an investment. This is done by adding the cash inflows and
outflows together until a point where the result is zero. At this point the period noted is
considered the payback period. This payback period identified is compared to a
predetermined number which will establish whether or not the investment is acceptable.
Figure 8 below displays an example of cash flows for an investment. The investment will
have a payback of 2 years as the net cash flows will be zero at that point.
Figure 9: An Investment Cash Flows Example (Firer, et al., 2004:253)
When using this method the time value of money can be included or ignored. When
included the calculation is termed the discounted-payback method and when it is ignored
it’s known as the conventional–payback method. This method is preferred for use on
projects with small investments and has a short period of paying back the initial
investment. This is done to avoid the time and resources consumed by other more
complex methods. The downside of this method is that it assumes that there are no
profits made by the project (Park, 2009:184) and that it doesn’t look at activities of any
future cash flows beyond the breakeven point.
Year
R50 000
3 2 1
0
4
R30 000 R20 000 R10 000 R50 000
Breakeven Point
32
3.4.2 Net Present Value Method
The second method that can be used is the NPV analysis. With this method the idea is to
determine whether an investment is acceptable based on the difference between the
present value of all the net cash flows and the initial cost of the investment. When using
this method, an investment decision should be rejected if the NPV is negative and
acceptable if the NPV is positive.
Since the concept of cash flow discounting is used, an interest rate acceptable to the
organisation should be selected for determining the present value. This interest is
termed either the required rate of return or MARR (Minimum Rate of Return). The NPV
analysis is the preferred method in selecting investment as it has no major flaws.
3.4.3 IRR (Internal Rate of Return) Method
The IRR is the second most popular method closest to the NPV (Firer et al., 2004:261).
This method identifies the rate of return of an investment and compares it to the
required rate of return/MARR set by an organisation. This identified value must be
greater than the pre-identified rate of return for an investment to be acceptable.
3.4.4 Profitability Index Method
The PI (Profitability Index) method looks at the ratio of the benefit and the cost. The
benefit in this case is the present value of all future net cash flows while the cost is the
initial investment (Firer et al., 2004, Pg:273). This method provides an acceptable
investment when the ratio it is greater than 1. It is one of the easier to understand and
has similarities with the NPV analysis method.
33
3.5 Summary
Since costs for differing engineering investment options and systems occur at different
times throughout their life cycle, they can only be compared by reducing them to costs
at a common base date. This is achieved through the process of discounting. This
reflects the real value of an investment in the present day’s context based on these
variables:
The interest earned on an invested instead of asset procurement,
The interest rate available for long term investment in banks,
The interest rate that business would expect as a return, and
The inflation rate that would affect the purchasing power of money.
34
Chapter 4. Life Cycle Cost Analysis
4.1 Introduction
To be able to quantify a systems’ LCC, the economic principles learnt in the previous
chapter needs to be applied to establish the real overall present day investment value.
This value is then taken used in the LCCA process. This analysis process is quite useful
for comparing alternative solutions as these solutions will have varying initial,
maintenance and operating costs.
35
4.2 Life Cycle Cost Analysis
Throughout the systems life cycle there are many decisions that need to be taken. Most
of these decisions (both technical and non-technical) will have significant impact LCC.
Since each problem will have several alternative solutions, a uniform analysis process
should be followed to make the best possible decision. This analysis process has the
following steps:
Define the need for analysis
Develop a cost breakdown structure
Establish the analysis approach
Select a model to facilitate the evaluation process
Identify feasible alternatives
Generate the appropriate data for each alternative being considered
Evaluate the alternatives
Recommend a proposed solution in response to the problem at hand
The LCC tree is shown in the figures below. The acquisition and sustaining costs are in
most cases not mutually exclusive. When a piece of equipment is procured, it must be
maintained in its original working order and that requires funding. These costs are
established by gathering cost data, evaluating the LCC and conducting sensitivity
analysis to identify cost drivers. Both acquisition costs and sustaining costs have
branches which are case dependent (Barringer, 2003:5).
Figure 10: Top Level of LCC Tree
Life Cycle Cost Tree
Acquisition Costs Sustaining Costs
36
Figure 11: Acquisition Cost Tree
Figure 12: Sustaining Cost Tree
Acquisition Costs
Research &
Development Costs
Engineering Data
R&D
Program Management
Engineering Design
Equipment
Development & Test
Non-recurring
Investment Costs
Spare Parts & Logistics
Manufacturing and Operations & Maintenance
Facilities & Construction
Initial Training
Technical Data
Recurring
Investment Costs
Upgrade Parts
Support Equipment Upgrades
System Intergration of Improvements
Utility Improvement
Costs
Green & Clean Costs
Sustaining Costs
Scheduled & Unsched.
Maintenance Costs
Labor, Materials
& Overhead
Replacement &
Renewal Costs
Replacement/Renewal
Transportation Costs
System/Equipment
Modification Costs
Engineering
Documentation Costs
Facility Usage Costs
Energy Costs &
Facility Usage Costs
Support & Supply
Maintenance Costs
Operations Costs
Ongoing Training For
Maint. & Operations
Technical Data
Management Costs
Disposal Costs
Permits & Legal Costs
Allowing Disposition
Wrecking/Disposal
Costs
Remediation Costs
Write-off/Asset
Recovery Costs
Green & Clean Costs
37
4.2.1 Define the need for analysis
Similar to when defining the need in the systems engineering design process, the
operational requirements, technical performance and maintenance concept needs to be
outlined for LCCA.
4.2.2 Development of CBS (Cost Breakdown Structure)
A CBS is a mechanism for initial cost allocation, cost categorisation, and cost monitoring
and control. It is the basis for life cycle cost assessment of all possible alternatives. It
links the objectives and activities with resources, and creates a subdivision of cost by
functional activity area, major system elements, and discrete classes of common items.
Establishing the cost breakdown structure is one of the most significant steps in life cycle
costing. The CBS constitutes the framework for defining life cycle costs.
4.2.3 Selecting the LCC Models
After the CBS is established a costing model needs to be developed to facilitate the life
cycle cost evaluation process. Life cycle costing in itself includes a compilation of a
variety of cost factors, reflecting the many different types of activities indicated by the
CBS. The objective in using a model is to evaluate a system in terms of total life cycle
cost, as well as the various individual segments of cost. Total system life cycle cost is
compiled through the use of economic principles learnt in Chapter 3.
Life cycle cost models are not standard for every application. They are selected based on
the information available and the need for effective evaluations of costs (Dhillon,
2010:43). Some of the useful general life cycle cost models are presented below in no
particular scientific order.
a. Life Cycle Cost Model I - Recurring and Nonrecurring Costs (Dhillon, 2010:44)
This model simply breaks down the LCC into two branches of recurring and nonrecurring
cost. The relationship is defined by:
NRCRCLCC (4-1) Where: RC is recurring costs
NRC is nonrecurring costs
38
The nonrecurring cost includes:
Training
Support
Transportation
Acquisition
Test equipment
Installation
Research and Development
LCC management
Reliability and maintainability improvement
The recurring cost includes:
Inventory
Labour
Maintenance
Operating
Support
b. Life Cycle Cost Model II (Dhillon, 2010:45)
In this model the life cycle cost is divided into 3.
321 CCCLCC
(4-2)
Where:
C1 acquisition costs
C2 initial logistics costs (training, technical data, support equipment modification)
C3 recurring costs (Operating, management and maintenance costs)
c. Life Cycle Cost Model III (LCC Phase Cost – Including CBS) (Dhillon, 2010:46)
This model was developed by the US Navy with the purpose of quantifying LCC of major
weapon systems. Lt is made up of five major cost components and it is expressed as
follows:
LCC = C1 + C2 + C3 + C4 + C5 (4-3)
Where: C1 research and development costs
C2 cost of associated systems
C3 investment cost
C4 termination cost
C5 operation and support cost
39
d. Life Cycle Cost Model IV (LCC Phase Cost – Including CBS) (Dhillon, 2010:47)
This model also is made up of four major cost components and it is expressed as follows:
LCC = Ccp + Cdp + Cap + Cop (4-4)
Where: Ccp denotes costs of the conceptual phase
Cdp denotes costs of the definition phase
Cap denotes costs of the acquisition phase
Cop denotes costs of the operational phase
The definition phase and conceptual phase costs are relatively small as compared with
the acquisition and operational phase’s costs. The definition phase and conceptual phase
costs are essentially labour effort costs related to the design and development of a
system. Acquisition and operational costs represent a major portion of the equipment
LCC. Both Cap and Cop may be subdivided as follows:
Cap includes the cost of program management, cost of personnel acquisition, support
equipment, transportation, testing, production, facilities, documentation, installation,
design and development, initial spares and repair component costs.
Cop includes the cost of maintenance, functional operating expense and operational
administrative expense. The following costs are part of the maintenance cost:
Equipment downtime costs
Cost of personnel replacement
Cost of maintenance manning
Cost of maintenance consumables
Cost of maintenance facilities
Cost of repairs and spare parts
e. Life Cycle Cost Model V (LCC phase cost – Excluding CBS) (Dhillon, 2010:47)
This model is made up of four main cost components is shown below.
rtospcrd CCCCLCC
(4-5)
Where: Crd represent the research and development cost
Cpc represents the production and construction cost
Cos represents the operation and support cost
Crt represents the retirement and disposal cost
40
4.2.4 Cost Model Selection
Selecting the right model to use is in key life cycle costing. The challenge when
selecting a model is the variety of cost data available. So at this point the analysis
should be done using a simple model with a few input requirements. The selected
analytical model should include the following:
It should be comprehensive.
The model design should be straight forward.
It should highlight important factors.
The model should be able to accommodate system characteristic changes.
Any item in the model should be easily evaluated on its own.
The model should be flexible to allow for it to be expanded or modified.
4.2.5 Cost Estimation and Data Generation
With the development of a CBS and a selection of a cost model, data needs to be
generated for the analysis. The requirements of this data may vary based on the depth
of the analysis, the extent at which the system was initially defined and the systems
design phase. During the planning and conceptual stages data is limited. When the
system design progresses and more information becomes available, system
characteristics can be compared with similar existing systems where cost data has been
recorded. There are few ways that one can estimate costs and they are as follows:
1. Expert Opinion Method - When there is no cost data available or there is low
confidence in the data available this method is used. The method uses the
opinions of experts. This expects are people who have years of cost data
experience on the system for which the information is required.
2. Catalogue Prices per Unit Method - With this method a catalogue price is
used. The catalogue is obtained working out the average of historical cost data.
3. Cost Estimation with Specific Analogy - This method draws an analogy of
equipment under study to some earlier similar type of product. It uses the
operating, design, and performance characteristics for predicting costs.
4. Cost-to-Cost Estimation Method - Cost-to-cost estimation looks at a as
percentage of specific product cost and important equipment cost.
5. Non-Cost-to-Cost Estimation Method - With this method the product costs are
estimated as a function of one or more of product parameters such as
performance size, weight or operating characteristics.
(http://www.treasury.nsw.gov.au/__data/assets/pdf_file/0005/5099/life_cycle_costings.
pdf Accessed: 11 July 2012), 2004:5 & Fuller et al., 1996:Chp. 4)
41
4.3 Summary
With the system CBS defined and cost estimating approaches established, it is
appropriate to apply the results data to the life cycle cost analysis. In accomplishing
this, one needs to understand the steps required in developing cost profiles, aspects of
inflation, interest rates, the effects of learning curves, sensitivity analysis and the time
value of money.
42
Chapter 5. LCC vs. Technical Performance
5.1 Introduction
Technical performance measures refer to the quantitatively design and operational
related factors that can be applied in the evaluation of a system. With an objective to
develop a system that will perform its intended function in a cost-effective manner, one
needs to recognise that there are many considerations that need to be made by both
engineering and management alike. Although there are many different levels of trade-
offs performed, the ultimate criterion is cost-effectiveness leading to reduced life cycle
costs.
43
5.2 Technical Performance
Every system is designed and developed to perform a specific function. It must perform
this function as intended in its design and do it economically and effectively throughout
its life cycle (Blanchard, 1990:346). To do so, a set of quantitative measure needs to be
defined while designing the system to ensure operational excellence. The key measures
of a systems performance are reliability, availability and maintainability (Blanchard,
2004:46).
In the mists of it all it mainly comes down to availability from the user’s point of view.
The systems availability (as we will discover through the definition later on) reflects the
extent to which the needs of the user were met, while the reliability and maintainability
are the design engineers key inputs in the selection of equipment, materials and design
architecture to meet the predicted performance during the design phase.
5.2.1 Reliability
Reliability is all about the probability of a system to achieving specified requirements.
This makes it an inherent part of the design process as it was elaborated in Chapter 1
that a system is developed to satisfy a specific need. The definition of reliability stresses
that a system needs to operate under specified conditions, for a given time, and
satisfactorily meet a performance criteria. One can therefore safely say that a system's
reliability consists of 4 main elements namely; probability, time, performance and
operating conditions. (Blanchard, 1990:359-365)
To be able to ensure that these elements are satisfied in operation a few factors needs to
be considered.
a. Design Factors
System operating environment
Equipment rated capacity
Maintenance while in operation
Spares required
Redundant equipment
Simplicity of design
44
b. Maintenance Factors
Preventive maintenance based data analysis
Condition monitoring of equipment to anticipate maintenance needs
Quality of the maintenance task
Skills requirement
c. Operations Factors
Equipment utilisation compared to its rated capacity
Spares stock keeping
Procedures for starting up and shutting down the system
Raw materials selected
All of these reliability factors and elements are measured using this formula:
MTBF
1λwhere
λteR(t)
(5-1)
5.2.2 Availability
Blanchard (2004:46) explains that availability is the key measure of systems'
performance of which it is a function of both reliability and maintainability. Reliability and
maintainability are a function of the inherent design characteristics availability is a
function of what actually occurs in operating the system. This measure has 4 common
FOM’s (Figures of Merit) and they are presented on the next page.
a. Inherent Availability (Ai)
Inherent availability excludes preventive or scheduled maintenance actions, logistics
delay time, and administrative delay time.
ctMMTBF
MTBFiA
(5-2)
b. Achieved Availability (Aa)
Achieved availability excludes logistics delay time, and administrative delay time.
MMTBM
MTBMaA
(5-3)
45
c. Operational Availability (Ao)
Operational availability is defined as the probability of a system to operate satisfactorily
when called upon when used under stated conditions in an actual operational
environment. This is identified using the following formula.
MDTMTBM
MTBMoA
(5-4)
d. Throughput Availability
Throughput availability is the measure of availability that deals directly with production
volume or throughput.
ProductionLost tThroughtpu
ThroughputA p
(5-5)
5.2.3 Maintainability
Maintainability like reliability is an inherent design characteristic of a system and it refers
to the ease, accuracy, safety, and economy in the performance of maintenance actions.
System engineers are concerned with the design and development of a system that can
be maintained in the least amount of time, at the lowest possible cost and resource
requirements without affecting the intended performance of the system. As expressed
by Blanchard (1990:403-410) maintainability has a number of factors which helps design
it into a system.
a. Maintenance Factors
Maintenance philosophy
Cost
Quality of maintenance procedures
Availability of resources to perform a maintenance tasks
Training
Management, supervision, and organizational effectiveness
Availability of maintenance facilities
Effectiveness of test and support equipment
Transport time between maintenance facility and site
46
b. Design Factors
Accessibility
Ease of maintenance
Operating environment
Cost
c. Operations Factors
Troubleshooting process effectiveness
Availability of equipment for maintenance
These factors may be presented as different FOM’s such as:
Figure of Merit Description
M Mean active maintenance time
Mct Mean corrective maintenance time
MDT Maintenance down time
Mpt Mean preventative maintenance time
MTBM Mean time between maintenance
MTBR Mean time between replacements
MTTR Mean time to repair
MTBF Mean time before failure
TAT Turnaround time
LDT Logistics delay time
ADT Administrative delay time
(Source: Blanchard 2004:33-73)
47
5.3 Summary
The approach that the systems engineering process follow is one that ensures that the
final product is operationally fit. This process applies science and engineering in order to
achieve its quantitative objectives. As seen in this chapter, these objectives are
reliability, availability and maintainability.
This chapter has shown that there is a traceable relationship between LCC and technical
performance. The relationship is through the system engineering design process where
costs and performance have trade-offs to find a cost effective solution to meet the
identified need. The figure below explains this point illustrating that as the reliability
increases, the procurement cost increases accordingly. However, the increase in the
reliability decreases the ownership cost.
Figure 13: Relationship between Reliability and Total Cost (Source: Reliability HotWire, 2002:¶7)
Total cost
Ownership cost
Reliability
Procurement cost
Lif
e C
ycle
Co
st
Optimum Reliability
48
Chapter 6. Case Studies
6.1 Introduction
Two case studies were considered for this research. The 2 projects are all from a similar
industry as they involve equipment and systems utilised in the manufacturing of
packaging for FMCG related goods. The purpose of the case studies it to provide practical
circumstance’s where life cycle costs were established and to understand how best
where they managed thorough the life of a system or equipment.
49
6.2 Case Study 1 – Sheet Metal Print Modernization Project
6.2.1 Background
A flat sheet printing facility for aerosol cans established in 1952 had its printing line
installed in 1956. With time and increased demand 4 more machines were installed with
manufacture dates ranging from 1958 to 1972.
In the 1980’s the company decided not to invest in flat sheet printing as it was felt that
it was a trade that was fading. The reality at the time this project was identified was that
despite a global recession the demand for printed flat sheet is on the increase.
Manufacturers of printing equipment have invested heavily with the focus on quick
change high speed technology which meets the requirements of short lead times and
high repeatable quality at the lowest cost. The current volume of printed aerosols is
approximately 40 million units at a value R300 per 1000 cans.
6.2.2 Problem Statement
The printed sheets manufacturer had continued to come under pressure from customers
with regards to lead time reduction, print quality and cost of the print. The major cause
for these customer frustrations is the inability of the manufacturer to meet these
demands. Some multinational customers moved away from printed cans toward sleeves.
They believed this will relieve them of the inflexibility and long lead times from the
manufacturer. Some of the customers left also indicated that they are exploring this
move to sleeves, while the paint customers have moved to plastic containers for the
similar reasons.
With the printing technology changing since the 1950’s to the 1970’s when the machines
were purchased, the following drawbacks were realised by the manufacturer:
Old Technology
New Multi-Colour
Printing Technology Benefits with new technology
Manual Sheet size set. Automated Sheet size
set.
Reduced change time with
accurate setting.
Manual Ink colour
setting.
Computerised Ink
colour setting.
Reduced change time and with
quality consistent, order to order.
Manual machine plate
fitting.
Automated machine
plate fitting.
Reduced change time and damage
to image area.
Manual wash up. Automated wash up. Reduced change time with no
manual adjustment to wash setting
50
Old Technology
New Multi-Colour
Printing Technology Benefits with new technology
Manual registration and
design fitment setting.
Computerised
registration and
design fitment setting.
Reduced change time and set up
waste.
Colour variation grip to
tail.
Colour consistency
grip to tail.
Colour consistency resulting in
higher quality, less can print
variation
Low crank speed. High crank speed. Increased sheets per hour with
accurate registration. Increased
capacity.
Manual water/ink
control.
Automated water/ink
control.
Reduced waste. Improved quality.
High dependency on
printer skill.
Low dependency on
printer skill.
Ability to operate with lower skill
and still ensure quality and speed.
Old technology. Latest Technology. Ability to offer Photographic print.
Table 1: Sheet Metal Printing Old Technology vs. New Technology
6.2.3 Proposed Solution
Doing nothing was an option but not a viable option as it will mean further loss in
printing business. The number of sheet passes in the operation has decreased from 54
million in 2006 to 36 million in the 2009/2010 financial year due to unreliable plant
equipment. And commitments were made to one of the big customers and the
manufacturer stood to lose the printing contribution of about 40 million Aerosol cans if
the commitment is not honoured. This potential loss could mean R6m loss in profits.
The second option was to look at what developments are available in the market. New
technologies were investigated and various suppliers and factories in Europe were visited
to explore the options available. The following Suppliers were visited:
KBA (Germany)
FUJI ex Japan (Wales)
Crabtree (Belgium and UK)
And the following factories where new technology has been implemented:
Print Services in Coburg, Germany (KBA is running for 6 years)
Crown Cork in Antwerp, Belgium (Crabtree installed February 2010)
The conclusion of the various European visits narrowed down the options to two
alternatives namely a second hand KBA (6 colour) or a new 5 colour Crabtree machine.
51
6.2.4 System Description
Second Hand KBA (6 colour) at Print Services (Germany)
The KBA machine has a single grip system with a quite complicated printing
cylinder/printing deck configuration. Once a tinplate sheet enters the machine via its
stream feed table, it travels through a series of cylinders and emerges only at the back
of the Lacquering tower (after deck 6). Only two decks can be changed at a time
(increased change over time), but the colour matching and the fit is very simple. The
KBA machine was developed from a paper press and its ideal for long-running printing
jobs.
Because of the complexity of the KBA, Print Services decided to use KBA as the supplier
to service their machine three times a year. The machine is stopped for a week each
time to allow KBA technicians to service the machine.
New Crabtree (5 colour)
52
The Crabtree Fastready Generation 3 is a high speed metal decorating press and as the
name suggests is a fast change machine. Crabtree has many years of experience in
metal deck printing equipment. The machine is not as complex as the KBA. The sheet
feed and transfer is on a flat tin line.
On visits to evaluate the KBA and the Fastready Crabtree, it became clear that although
there is a place for the KBA machine in metal printing assuming high quality tinplate and
long run orders, this machine would not be recommended for the manufacturer. Tinplate
was sent from South Africa to Germany to trial and this trial failed due to the quality of
available material.
As a result of the above, it was recommended to pursue the New 5 colour Crabtree
(Fastready) option for the following reasons:
The change of a successful project implementation was far greater with the
Crabtree Fastready as the KBA is a far more complex machine.
The KBA is a more expensive option, especially if more production lines are
required in the future.
The Crabtree Fastready was a more familiar technology and it was believed that
operators will make an easy transition to the new technology.
The Crabtree Fastready is more forgiving towards tin-plate quality.
The product change over time for the Fastready was 45 minutes compared to 70
minutes on the KBA.
53
6.2.5 Life Cycle Costing
Summary of project costs (R’000)
1. Crabtree Fastready with 5 Printing decks and FOV R26 277
Freight Cost (Fastready) R1 200
Installation cost (Fastready) R1 000
Removal of old production lines R2 100
Computer to Plate Technology costs R3 693
Civil work for the rest of the assembly R600
Civil work for new Fastready/Air-conditioning R2 500
Buy-off Cost R698
Sub Total R38 068
Contingency @ 7.5% R2 855
Grand Total R40 923
Projects Savings per Annum (R’000)
2. Printing Labour R1 797
Coating Labour R1 402
Installation cost (Fastready) R882
Maintenance Labour R150
Rebuilds R6 000
Electricity R167
Gas R4 542
Spoilage -R107
Consumables R2 607
Sorting R0
Packing R0
Total R17 441
The below table illustrates the maintenance spend per production line. The average
maintenance spend of the last three years (last column) was used in the savings
calculation. Lines highlighted in lightest grey shades represent phase 1, while lines
highlighted in green phase 2.
Printer Modernization (5 Colour Machine) R ‘000.00
Tax Allowance
Year: 1 2 3 4 5 6 7 8 9 10
Plant and Machinery:
a. New Plant 40,923
b. Balance at Beginning of Year 40,923 40,923 24,554 16,368 8,184 - - - - - -
c. Wear and Tear allowance 16,369 8,185 8,185 8,184 - - - - - -
d. Scrapping Allowance - - - - - - - - - -
Total Tax Allowance 16,369 8,185 8,185 8,184 - - - - - -
Written down tax value 40,923 24,554 16,368 8,184 - - - - - - -
Discounted Cash Flow
Year: 1 2 3 4 5 6 7 8 9 10
Net Profit 4,363 14,729 13,604 15,804 15,804 15,804 15,804 15,804 15,804 15,804 Depreciation 1,637 1,637 1,637 1,637 1,637 1,637 1,637 1,637 1,637 1,637 Gross Cash Inflow 6,000 16,366 15,241 17,411 17,411 17,411 17,411 17,411 17,411 17,411 Tax Allowance 16,369 8,185 8,185 8,184 - - - - - -
Taxable Income (10,396) 11,894 11,894 11,895 12,037 12,037 12,037 12,037 12,037 12,037
Tax (3,538) 4,058 4,059 4,059 4,107 4,107 4,107 4,107 4,107 4,107
Capital 40,923
Net Cash Flow (40,923) 8,028 7,979 7,979 7,979 7,930 7,930 7,930 7,930 7,930 7,930
Cumulative Cash flow (40,923) 2,291 2,407 3,158 9,951 9,951 9,951 9,951 9,951 9,951 9,951
Internal Rate of Return 26.35 %
Simple Rate of Return 35.02 %
Payback Period 3.3 Years
Source: Technical Appraisal Document: Anonymous. (Due to confidentiality of the information)
Table 2: LCC for Case Study 1
6.2.6 Conclusion
a. Economic considerations (Interest and inflation)
The achieved payback period in this case study is 3.3 years which is less that the
internally set target of 5 years. And the simple rate of return being 26.35%, this was a
value adding project. This project provided way above inflation results and as such made
a good engineering investment.
b. Costing and analysis
The total manning of the printing department including both direct and indirect
operations employees’ totals 129. With the installation of the 5 Colour Crabtree
Fastready machine the total reduction of heads is 20. The maintenance labour
complement was 23 people and with the implementation of the new printing machinery
only 14 people are needed. In total a 19% reduction in labour costs will be realized.
The data analysed from this case study indicated that since the commissioning of the
new printing system, actual maintenance spent on the new printing machine has been R
57, 345.00 (from February 2012 to September 2012). This compared to the
maintenance costs of the old printing process shown on page 53 is a much lower cost.
Therefore, the costs predicted where close to accurate as the maintenance savings have
been realised. But since the plant is fairly new the accuracy of the costs will be of
interest as the system ages.
c. Technical performance
Complete change over time: 55 minutes from product to product.
22.5 operating Hours per day.
Three shift system.
Days per year: 215. Derived from = 260 - 12 Proofing days – 14 Public Holiday
days – 14 Planned Maintenance days – 5 Annual shut down days.
Resulting productive capacity: 5, 1 million sheets per annum.
Running efficiency: 80%.
Average running speed: 4700 sheets per hour.
56
6.3 Case Study 2 – High Pressure Compressor Replacement
6.3.1 Background
A manufacturing facility produces 130 million Aerosol cans in its diversified factory
ranging in diameter sizes from 52mm to 65mm. Part of the quality offer to customers, is
a promise that every can will be 100% pressure tested. For this, the manufacturer
employs Wilco testers which test each can at a pressure of 10 Bar.
In this manufacturing facility 3 testers are installed. Feeding the three Wilco testers with
compressed air is two Ingersoll Rand compressors, an MU55 and an MU90. The MU55
was bought in 1999/2000 when a 36 head Wilco tester was installed. In 2004 two more
testers where installed and it was at that point the bigger Ingersoll Rand MU90 was
bought to supply the demand for the three Testers.
6.3.2 Problem Statement
In 2004 when the MU90 was new it was able to supply the demand of the three testers,
with the MU55 as standby. It was only on the odd occasion in summer when the
temperature rose above 30 degrees Celsius or when the humidity was above 60%, when
the MU55 was started. The following problems were experienced with the installation:
Both compressors have run up a significant number of hours; the MU55: 59,617
hours and the MU90: 49,349 hours.
Both have undergone two air end overhauls which have reduced their capacity to
only 72% of a new compressor – 15% loss per overhaul. This implies that both
compressors currently run all the time (all year round) with supply problems
during hot summer days - exactly during the aerosol production peak season. A
failure/stoppage of any one of the compressors reduces the supply to the air
testers significantly and results in only one of the three Aerosol assembly lines
being able to run.
Both the MU55 and MU90 is part of the maintenance contract and all services to the
compressors are part of the contract. But additional maintenance necessary to repair
these two compressors has cost additional amounts below since 2007:
Ingersoll Rand MU55: R 87, 000.00
Ingersoll Rand MU90: R 162, 500.00
57
With the main cause of failure identified as being the repair or replacement of the oil
cooler system. It was envisaged that the trend of maintenance cost will continue and
escalate further. Every breakdown interrupted production for as long as 2 days at a
time, as the agents do not hold stock of major spares like coolers. Thus repairs have to
be done instead of replacements. Delivery of coolers is usually 6 to 10 weeks from the
manufacturer.
With both compressors running, spare capacity exits, especially during cooler dry days.
This means that each one is loaded only about 50% of the time. The following illustrates
the loading per compressor as on the 9th of November 2011:
Ingersoll Rand MU55
Total hours: 59,617 hours
On load hours: 25,080 hours
% Loaded: 42%
Ingersoll Rand MU90
Total hours: 49,349 hours
On load hours: 26,218 hours
% Loaded: 53%
Because the manufacturer cannot run one compressor at a time, it means with both
running 50% of the time the compressors are in idling/off-load condition, resulting in
20% energy wastage (conservatively speaking).
6.3.3 Proposed Solution
It was proposed to replace the existing two High Pressure compressors with one new
Variable speed drive compressor. In choosing the correct compressor for the application,
various experts were consulted and the following well known research has been used to
decide on the correct compressor:
Typical Life Cycle Cost of a Compressed Air System
Energy Costs (75%)
Maintenance Costs (10%)
Equipment Acquisition
Costs (15%)
58
6.3.4 System Description
From the above pie-chart one can see that energy cost plays a significant role in the
service life of a compressor. The following comparison was made between three well
know compressor manufacturers, Ingersoll Rand, Atlas Copco and Kaeser compressors:
Manufacturer Compressor
Model
Air delivery
cubic feet per
minute (cfm)
Cost per m3
@ R0.6/kWh
Current Installation MU55 & MU90 433 cfm R0.0884
Ingersoll Rand SSR M110 475 cfm R0.0870
Atlas Copco GA110VCS 535 cfm R0.0787
Kaerser DSD202 SFC 528 cfm R0.0752
One can see that the Kaeser is much more energy efficient and the user will save 1.3
cents/m3. It is estimated that the user consumes 5.76 million m3 per annum. This will
realise a saving of R74 880 per year.
Other considerations in choosing the Kaeser compressor above the Ingersoll Rand/Atlas
Copco compressors are:
A specific drive power can be used to turn a smaller airend at higher speed or a
larger airend at lower speed. Larger, low speed airends are more efficient,
delivering more compressed air for the same drive power. The slightly higher
investment cost of the larger airend is quickly recovered by the energy saved
during operation. Ingersoll Rand and Atlas Copco uses lighter, high speed
airends.
Standard electrical motors are used in Kaeser compressors, which mean it is easy
and quicker to replace because they are available off the shelf. These motors are
also guaranteed for 5 years, while both Ingersoll Rand and Atlas Copco can only
guarantee their specialized motors (unique to them) for 1 year with a lead time of
8 to 16 weeks.
Air delivery from a Kaeser compressor can be matched to actual air demand,
according to required system pressure, by continuously adjusting drive motor
speed (and therefore the airend) with its specific control range. Depending on
the buffer capacity of the downstream air network, the working pressure can be
precisely maintained to +/- 0.1bar. This means the system maximum pressure
can be reduced, which leads to significant savings, as each 1 bar reduction
amounts to 7% reduction in energy cost.
59
6.3.5 Life Cycle Costing
Summary of project costs
1 x Kaeser DSD 202 oil injected rotary screw compressor. R 648 000
1 x Kaeser DC133E heatless adsorption dryer R 305 000
Installation and pipe work Included
5 year guarantee Included
Total R 953 000
Unforeseen Costs 2% R 19 000
Grand Total R 972 000
Project Savings Per Annum
Projected energy savings R 76 500
Maintenance cost maintaining two old compressors R 62 000
Once off cost to overhaul air-end on the MU90 R 90 000
Difference in the maintenance contracts. R 50 000
Total Project Savings Per Annum R 278 500
Project Returns
Equipment Cost R 972 000
Payback Period 3.5 Years
6.3.6 Conclusion
a. Economic considerations (Interest and Inflation)
The achieved payback period in this case study is 3.5 years which is less that the
internally set target of 5 years. With this criterion the project makes financial sense and
is a good investment.
b. Costing and analysis
The costing model for the project took into account the costs from design into operation.
The costs of unanticipated failures and of disposal were not included as they were not
concrete at the point of design and making the investment decision. Saving from the old
system to the newly installed one are very evident proving that the investment decision
was sound. Now with the new system having been installed recently, there are not
sufficient ownership costs to analyse to see if the LCC in the justification of the project
are being met.
c. Technical performance
Improving the efficiency of the production equipment required supplying better quality
air, without rust particles and moisture from compressed air. This means fewer
breakdowns and fewer interruptions to production. The new system does not have leaks
and because of the standard sizes used, the flow of compressed air is better. This means
that fewer compressors will run, saving money on electricity and maintenance costs.
The compressors will also run more efficiently reducing maintenance and increasing their
life span.
61
Chapter 7. Research Findings
7.1 Introduction
At the beginning of this research the following questions were mentioned as being the
fundamental purpose of the literature review and field research:
What are life cycle costs and what are the benefits of costing them?
When and where are costs incurred in a systems life cycle?
What are the key variables in establishing life cycle costs?
How can these variables be better defined to ensure that the life cycle costs are
sustained through the entire life of a system?
Can the engineering inflation be defined and be used instead of the general
inflation rate?
Chapter 7 is a consolidation of the findings for these questions.
62
7.2 What are life cycle costs and what are the benefits of costing them?
LCC's have various interpretations and the details of what they involve differ from case
to case. Ultimately they systematically make a consideration of all relevant costs
associated with the acquiring and ownership of an asset. The costs are established
through an iterative costing process of estimating, planning and monitoring costs and
revenues throughout an asset's life. This process is used in decision making by
evaluating alternative options and performing trade-off studies. The costing process also
known as LCCA is critical in early project stages for evaluating possible solutions, but it
is also applicable to all stages of the a systems life cycle.
The main benefits of life cycle costing as expressed and uncovered in Chapter 1 are
expected to be:
Reduced Ownership Costs – With considerations of operating costs made before
making procurement decisions, the supply industry has taken different approaches to
quality and service. This has benefited the customer/user as now they can realise the
maximum benefits of a selected solution.
The alignment of engineering decisions with business objectives – Engineering
decisions need to be aligned with what the business is aiming to achieve. This will make
sure that the decisions will have fewer consequences on operating costs and revenue.
Reduced risk of operating cost surprises – When new assets are being considered
and there is little information on operating costs, it is important to apply LCC
methodologies which enable high operating cost elements to be identified at an early
stage. The applied LCC methodology will systematically quantify all costs to reduce the
risk of cost underestimation.
The identification of cost reduction opportunities – When compiling a technical
solution for a problem, one looks at the costs as well as the technologies available. With
life cycle costing there needs to be involvements at the point of use with operators to
have first-hand understand to assist in making the correct decisions.
Providing a framework within which to compare options – LCC defines planning
needs and resource requirements to ensure studies are carried out at the right time, to
the right depth and within planned resource budgets and targets.
Providing a mechanism by which major cost drivers can be identified, targeted
and reduced – Having identified the cost drivers of a system, a sensitivity analysis can
be carried out to establish critical areas where improvement will lead to increased cost
effectiveness.
63
Collective Experience – By utilising the collective experience of technical team
members, the best suited option can be selected. This will also allow for valuable
knowledge transfer amongst employees.
7.3 When and where are costs incurred in a systems life cycle?
Life cycle costs are incurred throughout the life of a system. The phases where costs are
experienced are as follows:
Conceptual design phase
Preliminary design phase
Detailed design and development phase
Production and construction phase
Utilization and support phase
Phase out and disposal phase
This cradle to the crave process initially involves systems design costs. These are the
costs which shape the finished products and they enable an opportunity for the overall
cost effectiveness of the system. As shown in the figure below, these costs are
experienced before the actual use of the system and can help determine the optimum
and cost effective solution.
Figure 14: Cost Phasing in System Life Cycle (Figure 2.2 Blanchard, 1990:18 combined with Figure 3.1 Blanchard 2004:82)
The production and construction costs are the beginning of the major part of the LCC
expenditure. These costs are for the procurement and installation of the newly acquired
system. The rest of the costs are for running and maintaining the operation till its use is
terminated.
Conceptual – Preliminary
Design
Detail Design and
Development
Production and/or
Construction
Product use, Phase out, and Disposal
Acquisition Phase Utilisation Phase
Acquisition Costs
Sustaining Costs
Research and development Costs
Production and/or
Construction Costs
Retirement and Disposal Costs
Operation and Support Costs
64
7.4 What are the key variables in establishing life cycle costs?
To be able to achieve this optimum or cost effective solution which was elaborated on in
the previous question, LCCA is conducted. The analysis involves the assessment and
comparison of possible alternative solutions. The process utilised economic principles to
discount future forecasted cash flow to a present value. Then these discounted amounts
are computed in a suitable and predetermined LCC model to summate a comparative
value of applicable alternatives. These involve the costs as broken down in the cost tree
on pages 35 and 36.
Therefore, the key variables involved in life cycle costing will include and involve
elements which will have an impact on the cost tree. These are listed as follows:
Costs (Chapter 4)
Acquisition
Training
Transportation
Test equipment
Installation
Research and Development
LCC management
Support
Labour
Maintenance
Operating
Inventory (Repairs and spare
parts)
Reliability, and maintainability
improvement
Disposal
Economics (Chapter 1 and 3) Technical Performance
(Chapter 5)
Inflation
Interest Rate
Exchange rates
Taxes
Reliability
Availability
Maintainability
Machine Operating Efficiency
Table 3: LCC Key Variables
One of the other key variables is the time period. All of the above measures of merit are
based on a relative time period, therefore making time the key to any life cycle costing
process. Therefore in summary, the key variables can be grouped into 4; namely cost,
economics, technical performance and time period.
65
7.5 How can these variables be better defined to ensure that the life
cycle costs are sustained through the entire life of a system?
a. Costs
To start off, all costs need to be classified and categorised throughout the life cycle
phases using a CBS. The level to which costs in the CBS are broken down will depend on
the objective and scope of LCCA, and the resource availability to conduct the work. In
most cases the CBS will drill down costs to significant levels of activity or with the major
item of material. But ultimately, the CBS must provide management with a sufficient
amount of data to identify high-cost areas.
There are a few methods which can be used to generate the appropriate cost data for
each alternative being considered in LCCA.
Engineering costing – With engineering costing experts opinions are used, and/or a
catalogue price is used and historic capital and operational cost of the system under
assessment.
Analogue Costing This method draws an analogy of equipment under study to some
earlier similar type of product. It uses the operating, design, and performance
characteristics for predicting costs.
Parametric Costing - With this method the product costs are estimated as a function of
one or more of product parameters such as performance size, weight or operating
characteristics. Or a percentage of specific product cost and important equipment cost
are used.
The main purpose of identifying the costs as stipulated above is to make comparisons
amongst alternative solutions to a problem. This is done by selecting a model suitable for
the cost data available. The analysis should be done using a simple yet comprehensive
model with fewer input requirements. The selected model should highlight important
factors and be flexible and be able to accommodate changes in the systems
characteristics.
66
b. Economics
The 4 key economic variables are inflation, interest rates, exchange rates and taxes as
highlighted earlier on. These economic variables are lagging indicators as they cannot be
accurately predicted. They need to be understood in order to make a sound financial
evaluation of the benefits of correct LCC.
The first variable is inflation. This deals with the increase in prices of goods and services.
The inflation rate has not been stable as shown on Figure 1 and Figure 4 in chapter 1.
The graph indicates the volatility of this measure as it is targeted for a figure between
3% and 6%. It has bounced from 5.8% in 2003; to 1.4% in 2004; to 3.4 % in 2005, to
4.6% in 2006, to 5.2% in 2007, to 10.3% in 2008, to 6.16% in 2009, to 5.4% in 2010
and 4.5% to in 2011. Therefore this has had a direct impact on the LCC for many
systems (http://www.eskom.co.za/c/article/143/average-price-increases/ Accessed: 15
October 2012).
Interest rates are a percentage at which lenders borrow money. This figure is internally
decided by the SARB (South African Reserve Bank) periodically based on economic and
financial statistics. These rates affect LCC as money borrowed from financial institutions
is based the interest rate at that point in time of the borrowing. This changes with time
and can be tricky to predict. The best way to manage this uncertainty is for an
organisation to have a higher expected rate of return (known as the IRR) when deciding
on projects to embark on.
As shown in Figure 4, South African currency rises and falls all the time versus the US
dollar which is used as a comparative currency globally. In the global range, South
African currency has been one of the most unstable of the world’s major currencies. This
poses a threat to organisations exporting products that receive payments in dollars or
euros, but pay their employees and suppliers in ZAR. But also for organisations that
import supplies and machinery as the rise in interest rates will force rise in selling prices
i.e. Brand Crude Oil - see Figure 2. Therefore, LCC will be affected by exchange rates as
many of the recurring costs in the cost tree are based on this factor.
With regards to the South African taxes, it is the responsibility of the National Treasury
to advise the Minister of Finance on the tax-policy. Then the Treasury and SARS (South
African Revenue Service) co-operate in compiling the tax policies for the upcoming year.
The taxes that directly affect LCC of a system include income tax, secondary companies’
tax, VAT (Value Added Tax) and capital gains tax. These have an effect on the recurring
costs of LCC due to the uncertainty of the changes of taxes each year.
67
c. Technical Performance
Technical performance is an assessment and monitoring of a system or equipment to see
what is achieved versus the intended design. The measures used are an input to the
design process and they are integrated into the LCC as they not only help meet the
customer’s initial need, but shape the utilization and disposal phases of the systems life
cycle.
To get a firm grasp of the technical performance parameters, the system and equipment
reliability patterns need to be assessed. These patterns are also referred to as Bath tub
curves and an illustration of a typical curve is shown below (Blanchard, 2004:53).
Figure 15: Bath Tub Curve
With the fundamental laws of physics one can safely assume that random events do not
exist. This means that random and unexpected occurrences shouldn’t exist in mechanical
and electronic systems. If and when they do, they appear as failures. Failures in these
systems are not spontaneous but are preceded by some form of a sequence of events.
And events can be predicted by defining and using appropriate measures and models.
To manage the impact of low technical performance, potential system failures are
analysed to understand the causes and the consequences of the failure. Based on the
profiles of the failures, maintenance strategies are put in place. The strategies include
planned maintenance; Condition Monitoring (Predictive maintenance); corrective
maintenance; breakdown maintenance; RBI (Risk Based Inspections) and run to failure.
Constant failure
probability Region
Infant
Mortality
Period
Time
Wear out
Period
Reli
ab
ilit
y
68
Based on these strategies, certain tasks are performed by operational staff, maintenance
staff and external service technicians. The tasks include the following:
Lubrication
Cleaning
Servicing
Inspections
Testing
Condition Monitoring
Restorations or overhauling
Discarding
Design modification
In support of the execution of these tasks, all the logistics needs to be in place. They
includes trained and skilled personnel, spares inventory, facilities to execute repairs and
maintenance, communication and Information systems, reliable transportation, handling
equipment, test and support equipment, technical data and maintenance plans.
Some of the known measures and indicators which can be used for performance
measurement include the following:
Aa – Achieved Availability
Ai – Inherent Availability
Ao – Operational Availability
ADT – Administrative delay time
LDT – Logistics delay time
M – Mean active maintenance time
Mct – Mean corrective maintenance time
MDT – Maintenance down time
Mpt – Mean preventative maintenance time
MTBM – Mean time between maintenance
MTBR – Mean time between replacements
MTTR – Mean time to repair
MTBF – Mean time before failure
TAT – Turnaround time
λ – Failure Rate
69
7.6 Can the engineering inflation be defined and be used instead of the
general inflation rate?
The value of money erodes over time as a result of increases in the prices of various
goods and services. This erosion has been coined as inflation. This phenomenon also has
an effect on engineering systems as they have a cost element for acquiring and keeping
them operational. The difference between the change in the prices of engineering good
and general goods is the rate of inflation applicable. For general good one needs to
understand the CPI, while with engineering goods also need to take a closer look needs
to be taken towards the PPI.
It is important to note that not all cash flow increases for engineering systems and
equipment are as a result of general inflation. There are cost increases due to wear and
tear, increased labour skills, material demand, changes in logistics support capabilities,
energy/electricity consumption and initial estimate inaccuracies. So when preparing cash
flows for LCC purposes over a life of a system, the interest used must cover these costs.
This is done by evaluating the general inflation rate represented by
1N
1NN
CPICPICPIf
,
and the market interest rate represented by '' iffii to get to a specific inflation
which will look at the changes in prices of an engineering item.
70
Chapter 8. Conclusions & Recommendations
8.1 Introduction
From the literature review and the two case studies in this research, it was clear that the
life cycle costing processes associated with the systems engineering phases (Conceptual
design, preliminary design, detailed design and development, production and
construction, operation and disposal) are well defined and understood. There was a lack
of supporting evidence to show that when a system is in use (utilization phase), there is
still emphasis on maintaining the predefined LCC. And having established that most of
the systems’ LCC will be experienced during operation phase, it is imperative to be able
to sustain and manage them.
To attempt to keep the notion of having value in establishing life cycle costs of a system
(Chapter 2 sections 2.2 and 2.3) before making decisions on which alternative to select,
a management system is developed to ensure continuity of managed LCC post the
acquisition and project implementation phase. This is a necessity on the basis that the
economic environment constantly changes and it has a direct impact on operating costs
of many systems.
71
8.2 Management of Life Cycle Costing
8.2.1 Objectives
The purpose of putting together a LCC management programme is to maintain and
potentially exceed the cost effectiveness of an investment decision made on a system or
equipment. It forms part and parcel of the business environment requirement of
continuously eradicates financial risks. For such a programme to have meaning and for it
to succeed, senior management of an organisation will need to endorse it. This will help
in clarifying the role of LCC management as part of the organisations goals and
objectives, and the importance thereof will need to be communicated throughout the
organisation.
8.2.2 Planning
A LCC management plan needs to be in place for organisations with significant asset
investments in order to ensure that the above objective is achieved. The plan should
outline all life cycle cost management activities and milestones anticipated to be
necessary throughout an assets' (system or equipment) life. The plan should cover the
following:
Resources required
Training needs for the organisational resources
Data collection activities
Specific requirements for tools to be used
Technical performance management processes and activities
Requirements for monitoring and audits
8.2.3 Organisation
After LCC are made a priority by adopting them as part of the organisations objectives,
the need for clarifying roles and responsibilities arises. Those that have a part to play in
managing LCC must be identified and informed of the responsibilities assigned to them.
There also needs to be either a team or individual who shall be assigned the role of co-
ordinating LCC for the organisation. Policies and Procedures for LCC will also need to be
established to govern the entire programme and to provide a means to evaluate if the
objectives of LCC management are being met. The actual LCC management
organisational structure will differ from organisation to organisation based on resources
available and benefit to be gained.
72
8.2.4 Calculation of Life Cycle Costs
During the selection of alternatives in the systems engineering process LCCA is followed
as a method to objectively make a technically and economically informed decision. Once
the initial calculations have been carried out as part of the LCCA during the project
implementation, there will be a need to assess the actual LCC result after each period.
So during actual operation the LCCA needs to be followed through by continuously
assessing and managing the costs as they form part of the original of the investment
decision.
To do the follow on analysis, the future values of all the recurring and nonrecurring costs
will need to be established based on current costs and the anticipated inflation and
interest rates. Where the analysis shows that a single cost element dominates the
calculation it may be necessary to break this down into sub-elements. The idea with the
calculation is to establish a LCC to use as a means of budgeting for a system. This will
form the basis for the yearly cost control. Inputs required into the calculation are listed
below.
The operating period and profile
The utilisation factors
All the cost elements
The critical parameters that affect the equipment’s life cycle costs
Costs at current prices
Inflation and interest rate
With this information, all costs will then be discounted and the discounted costs summed
up. The discounting process will take all relevant current costs and provide a future cost
which will be influenced by potential economic fluctuations which have been accounted
for. This LCC calculation for reviewing and realigning yearly budgeting can be viewed as
follows:
)]i (C)i (Ci))(1CCC(C[LCC jLjE LE
N
PMOCFactorn Utilizatio (8-1)
Where;
LCC = Life Cycle Cost for one cost cycle (Year)
N = 1 Year
CC = Annual Capital expenditure (Systems upgrades and modifications)
CO = Operation expenditure (fixed value or variable)
CM = Maintenance and repair costs
CP = Lost production costs (Downtime, quality defects and idle time)
73
CE = Energy costs (Gas, diesel, petrol, coal and electricity)
CL = Logistic Support costs
i = annual market discount rate
jEi = specific discounting rate for energy
jLi = specific discounting rate based on PPI
8.2.5 Monitoring
In order to ensure that the management system is effective, an annual assessment will
need to be carried out. The purpose of the assessment is to ensure that planned LCC are
maintained and control measures are adequate. This assessment should be in a form of
an audit which is appropriate for the corrective actions required to meet LCC targets. As
to when, how and who conducts the audit it will be at the discretion of management
based on available resources.
a. Audit Scope
The audit needs to be executed in 2 distinct sections namely financial and utilisation
review aspects. The financial aspect needs to focus on the actual cash flows and item
costs associated with a system or equipment while the utilisation aspect will look at the
operating and maintenance practices. The 2 aspects of the audit are detailed as follows.
1. Finance
Summary of the LCC
Fluctuation in inflation and interest rates
Actual costs vs. Forecasted Costs
Validity and of the interest calculations
Spares stock volumes
Spares costs
2. Utilisation
Equipment Efficiency (Availability)
Maintenance effectiveness
Spares utilisation
Operating and maintenance personnel skills levels and training requirements
Quality of inputs (Electricity, water, chemicals, raw materials, etc.)
Availability and quality of maintenance facilities
Effectiveness of test and support equipment
Transport time between maintenance facility and site
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b. Deliverables of the Audit
The outcomes of the Auditing process should include the following:
An assessment report that identifies specific gaps between the current LCC
program and best practices
Analysis of the relevance and effectiveness of LCC models used
Asset Reliability Management gaps
Summary of recommendations
Prioritized action plan
8.2.6 Controlling
As systems and equipment ages, their reliability reduces and to improve it or maintain it
more costs will be incurred. This makes the reliability management curtail in ensuring
that the LCC are maintained as per the forecast done using the LCC calculations/models.
To bring more control from a reliability point of view, reliability engineering principle and
practices will need to be introduced.
a. RCM (Reliability Centred Maintenance)
In order to have a systematic and logical way of controlling the reliability of a system,
the very well-known theory of RCM needs to be employed. With the application of RCM,
the failures which could potentially result in higher LCC will be managed by together a
set of system and equipment maintenance strategies. The strategies must be honoured
by continuously monitoring execution and reviewing their effectiveness.
b. FMECA (Failure Mode, Effects and Criticality Analysis)
To decide on which maintenance strategy is best suited for the each type of failure
FMECA need to be carried out. The FMECA will assist to identify the root cause of a
failure for every maintenance significant item by analysing the failure cause and effect.
Based on the criticality and frequency of failures, the analysis will lead to a selection of
tasks or activities to prevent the failure form occurring, and subsequently eliminate
unplanned, high maintenance costs.
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c. Continuous Improvement Process
To support the effectiveness of the FMECA and to ensure that there is continuous system
improvement, a failure reporting and corrective action system needs to be in place.
FRACAS (Failure reporting, analysis and corrective action system) is a platform for the
collection of data, record and to analyse system failures. This is done in a close loop
process as displayed below, to ensure failures do not recur and that there is continued
improvement.
d. Training and Succession Planning
To be able to execute the reliability and improvement plans above a skills labour force is
a necessity. All identified labour resources need to be competent to execute their job
requirements. This will require a comprehensive training programme to ensure that
critical activities are executed effectively.
To ensure continuity and to sustain corporate memory, there needs to be sharing of
learning’s. To gain value from this, there needs to be people being trained in the
requirements and competencies of all identified critical jobs. This will ensure that there
will not be interruptions in the delivery of a reliable system environment even if the
appointed person is no longer in their job.
Process Analysis
Process Control
Performance Improvement
Figure 16: Double Loop Reliability Management Process
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e. Performance Management
In order to align the organisations goals and priorities with the resources available, a
performance management structure needs to be in place. This will help in ensuring that
individuals and groups within the organisation know what is expected of them and to
ensure that they take responsibility to ensure that costs are met and that systems
operate at their optimum.
f. Process Capability Studies
In industrial engineering, processes are monitored by use of an approach called
statistical quality control. This allows identification of areas of waste and put together
plans for improvement. This will be of value to engineering systems as if done regularly
the need for engineering improvements will be identified before costs of running
escalates.
8.3 Conclusion
LCC has been established to be a never ending journey. Therefore management
processes which provide the necessary tools to engineer in order to manage costs of
ownership and decision making is crucial.
In conclusion, the following key outcomes of the study are noted:
Each system or equipment needs to be treated as being unique to eliminate
assumptions towards life cycle costing.
The systems engineering phase is the most critical as this is where life cycle costs
are established.
The LCC models selected during LCCA needs to be appropriate.
LCC needs to be continually managed and maintained.
Competency is important in establishing LCC and maintaining it. Therefore,
personnel appropriately skilled for the task are critical to the success of this
process.
Management processes need to be implemented to ensure that the LCC are
adequately controlled throughout the systems life cycle.
Life cycle costing encourages the consideration of alternative reliability
management strategies by evaluating their impact on the systems LCC.
Inflation plays a real and significant role in LCC and cannot be ignored when
discounting cash flows.
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