How whole life cost helps Procurement decision-making
Whole life costing can help you to factor ongoing operating costs when making capital investment procurement decisions.
Whole life costing provides many benefits, including:
- Encourages the analysis and questioning of business requirements – helping to optimize decision-making and avoid costly specification mistakes:
- Optimizes the total cost of ownership by balancing the initial capital outlay with the ongoing running costs – leading to better value-based decisions
- Ensures future maintenance requirements are understood and factored into the upfront decision-making – for example, specialist services or skills
- An understanding of the key drivers behind the whole life cost can help to unlock opportunities for innovation
However, it can be difficult to achieve these benefits in practice due to three factors:
- The perceived additional complexity of modeling future costs
- Reliance on non-contractually-binding supplier performance data covering future reliability and consumption ratios
- A lack of consistent and comprehensive historical operational cost data
Yet these obstacles can be overcome. A whole life cost model does not have to be exhaustive to be effective. Keeping it simple is better than not doing it at all.
First, identify the key cost elements of the purchase:
- Capital costs
- Operational costs (for example, labour, consumables, power) and incomes (for example, rents)
- Repair and renewal assumptions
- Maintenance cycles
- Frequency and volume of use
- Disposal value/cost
Second, use ‘discounted cash flow’ analysis to bring the costs back to a common basis.
You then need to know how to model, for which we’ll recommend the following steps:
- Identify the key maintenance and repair interventions, their frequency and their associated costs. This can be a direct estimate from known costs and components or relevant historical data
- Identify the relevant discount and inflation factors – if the discount factor is set too high it will make future costs appear insignificant
- Choose the appropriate time period and assess all options over the same period to get an ‘apples-for-apples’ comparison
- Ensure your model can enable sensitivity analysis of the key variables, such as the discount rate, time period, predicted design lives of components and assumptions about key running costs
Build your whole life cost variables into your bid costing model, and require all bidders to provide key data (such as power consumption, maintenance intervals, labour requirements) in the correct format as part of their tenders. This will enable you to build a whole life cost of the various solutions.