32

Long Range Planning,

Vol. 14, No. 6, pp. 32 to 43, 1981
Printed in Great Britain

0024-6301/81/060032-12$02.00/O
Pergamon
Press Ltd.

The Use of Life Cycle Costing

Acquiring Physical Assets
W. B. Taylor,

Treasurer,

Kent Ccyzty

Introduction
There
is considerable
evidence
of an increasing
interest
in asset management
not
only
in this
country
but also throughout
the world.
This may
be partly due to the worldwide
economic
recession
which
forces
companies
and
governments
to
examine
carefully
their use of resources
but it may
also be partly due to the rapid advances
being made
in technology
which underlines
the importance
of
the correct
choice of capital
asset acquisition
and
operation.
Out of this growing
interest
has come a recognition
of the significance
of considering
the total cost
picture
related
to the acquisition,
operation
and
disposal of capital assets and also a realization
that in
the past there has been a failure to assess adequately
the costs arising from the use of a capital asset over
the length
of its life. In short there has been undue
emphasis
on the initial costs of acquisition
without
due consideration
of subsequent
costs.
This view
of the management
of capital
assets
comes
under
the
esoteric
subject
heading
of
which
has been
defined
as a
terotechnology
combination
of management,
financial,
engineering and other practices,
applied to physical
assets in
pursuit
of economic
life cycle costs.
W. B. Taylor is Treasurer
Maidstone M El 4 1 XE.

of Kent

County

Council,

County

Hall,

in

Council

Terotechnology
is a concept
of asset management
in which all the disciplines
in any way involved
in
the specification,
design,
installation,
operation,
maintenance
or disposal
of an asset are given
the
opportunity
to consider
the cost consequences
of
their decisions
at various
points
in its life and to
bring their professional
expertise
to bear in seeking
economic
cost solutions.
Above all terotechnology
is an attitude
of mind which seeks to ensure the best
use of physical
assets at the lowest total costs to the
organization.
It is inlmediately
apparent
that the
life cycle cost concept
is fundamental
to this view of
asset management.
It is the vehicle by which costs
arising at each stage of the life of an asset are taken
into account.
Figure
1 demonstrates
the life cycle
costs concept for a building
with a 60 year estimated
life.
The value of life cycle costing as a management
tool
is in my opinion
incontrovertible
because it places a
premium
on the best use of resources-financial,
technical
and manpower
to the benefit
of the
organization.
It is an essential ingredient
in medium
and long-term
planning
because
it aims to ensure
the optimum
value from the use of capital assets.
When
one considers
that the estimated
value of
total national
assets in 1979 at 1975 replacement
values is A530,OOOm
so that maintenance
costs at
say 3 per cent of capital value are of the order of
Al6,000m,
it
is possible
to
appreciate
the
significance
of this
subject.
PA
Management
Consultants
in a study
of maintenance
costs in
industry
for the Department
of Trade and Industry
in 1969 concluded
that it would be possible
to save
A5OOm per year on maintenance
in industry
in this
country
if greater
care was taken in the design and
specification
of capital assets. At present day values
that figure would
be A2000m.
This paper considers
the application
of life cycle
costing
as a decision
making
tool in the acquisition
of capital
assets and deals with
the issues and
techniques
involved.
It also outlines
a methodology

The Use of Life Cycle

Costing

in Acquiring

Physical

Assets

33

Start

MAINTENANCE

CONSTRUCTION

(Labour)

(Energy)

Year 2-60

Figure

1. Life cycle costs for a building

for the introduction

of the technique
case study in the Appendix.

with a 60 year estimated

and includes a

What is Life Cycle Costing?

Life cycle costing may be described as a forecasting
tool used to compare
or evaluate
alternative
planned
capital expenditures
with the aim of
ensuring the optimum
value from capital assets.
The technique involves the expression of all future
costs and benefits in present day values.
The technique
draws attention
to the cost of
physical assets during their whole life from initial
specification
to ultimate disposal and is the means
by which the cost of asset ownership
may be
optimized.
This approach
recognizes
the cost
implications
of decisions made at every stage of an
assets life-span and will reflect on future decisions
and costs in the ownership
of physical assets.

life

There is an assumption
that life cycle costing is a
technique of accountants only-this
is not so, it is a
concept
which
brings
together
a number
of
techniques-engineering,
accounting,
mathematical and statistical-so
that all significant expenditures and incomes arising during the ownership of
an asset can be identified.
It becomes apparent that when an attempt has been
made to evaluate all significant costs arising during
the life ofa physical asset and these costs (cash flows)
are expressed in present day values, managers have
the means to quantify
options and to select the
optimum
asset configuration.
The
technique
to consider
the trade-offs
enables
managers
between cost elements during the asset life phases,
e.g. an increased initial cost ofequipment
to secure a
future reduction in maintenance
costs, and to select
the optimum
solution. This aspect of trade-off is
fundamental
to the concept of life cycle costs.

Long Range

34

Planning

Vol. 14

December

Life cycle costing includes a number of well known

techniques
already
used in capital
investment
appraisal including
cost benefit analysis, preparation of cash flows, discounting,
sensitivity analysis
and probability
theory. This is not a new concept, it
merely
brings together
in a coherent
manner
techniques which permit managers to consider the
costs of asset management
over the life of the asset
so that the value of the asset may be optimized.

The Aims
Having
look a
costing
already
optimize
physical

of Life Cycle

1981

will need to be prepared. It is also possible of course

that a detailed
consideration
of the need may
indicate certain key factors affecting the use of the
proposed asset or even in extreme cases indicate that
it may not be necessary, e.g. the provision to build a
community
centre by a Local Authority
when there
is available a primary school shortly to be closed.
The second step is the selection of physical assets
which match the needs at the lowest costs over the
life of the asset. In order to do this it is necessary:
(a) to predict physical
cost levels;

Costing

(b) quantify
options;

stated the general proposition

let us now
little more deeply at the way life cycle
works by considering
its aims. I have
explained that the fundamental
aim is to
the life cycle costs of owning and using
assets. These include costs of:

(c) determine

It seems too simple a proposition

to state but when
considering the provision of a physical asset the first
step must be to consider
the environment
and
objectives of the enterprise over a period of time so
that the need for the asset is established at the outset.
This is an essential discipline because it is at this
means of achieving
the
stage that alternative
objectives of the enterprise may be identified which
will figure in the options for which life cycle costs

the life cycle costs of alternative

2. The life cycle costing

This diagram demonstrates

the aspects of planning
and monitoring
in the life cycle management
of the
asset. Planning involves the forecasting
of all costs
and an understanding
of the inter-relationships
between the costs at every phase of the asset life
cycle. Actual costs and events are monitored and fed
back to assess the degree
to which aims are
achieved, to enhance future designs and to improve
subsequent
life cycle
costing
exercises.
The
monitoring
of actual life cycle costs against the
experience
of other users of identical or similar
assets and against the claims of improved
designs,
may provide an early warning of opportunities
for
optimizing
asset life cycle costs.

Feedback

system

asset

the best alternative.

Cost Inter-relationshios

Figure

and their

Once the best option has been determined

the aim
of life cycle costing will shift to monitoring
actual
costs against the predicted
life cycle costs. This
continuous
and self motivating
system of planning
and monitoring
to achieve improvements
is an
essential feature of life cycle costing.
Figure 2
illustrates this aspect of a life cycle costing system.

specification,
design,
acquisition/manufacture/build,
installation,
commissioning,
operating,
maintenance,
disposal.

Monitoring

asset requirements

The Use of Life Cycle

The Costs of Physical Asset

0 wnership

Costing

in Acquiring

Physical

Assets

for example in an organization

which designs and
constructs
physical assets for its own use or for
resale would be:

In any discussion
on life cycle costing and the
concept
of trade-offs
between
initial and subsequent costs, a point which is frequently
made is
that it is all very well in theory but in practice there
is a major distinction
between initial capital costs
which are capitalized and the subsequent running
costs which
are revenue.
It is claimed
that
companies
and public bodies faced with limited
capital budgets or costs limits do not have the
facility to increase initial capital costs on the chance
that there will be future revenue economies. There
may be some substance in this point but it does not
detract from the benefits which can arise from
trade-offs.
The distinction
between
capital and
revenue expenditure
is an accounting
one which
does not affect the life cycle cost concept based on
cash flows throughout
the life of the asset.
Let us look in some detail at the costs of owning
physical assets set out in Figure 3. It will be seen that
these fall into three groups, first the initial capital
costs, secondly the revenue costs of operating and
maintaining
the asset during its operational life and
thirdly the cost of asset disposal which may be
revenue or capital if it is substantial. The initial costs

research and development,

design and specification,
manufacturing,
quality control and testing,
monitoring
performance.
It is likely that most of these costs will be capitalized
in the accounts and generally are readily available
from the accounting
records.
The second group of costs are incurred during the
operational
life of the asset and this would include
the costs of:
operating the assets,
including labour,
materials,
tools,
fixtures and overheads,
maintenance
including

spares and labour.

These costs are invariably

treated
as revenue
expenditure
and here there is often difficulty
in
establishing
the true costs of operation
and
maintenance.

Specification
Design
Development

ITIc

Operating

Costs -

Revenue
costs

Maintenance

3. Physical

asset cost elements

Direct Materials
Direct Labour
Direct Expenses and
Overheads
Indirect Materials
Indirect Labour
Establishment Overheads

Costs -

Disposal Value
Disposal Costs -

Figure

Asset Reliability
Asset Maintainability
Asset Availability

Manufacture/Build
Installation/Commissioning
Manuals and Training - Operations
Manuals and Training - Maintenance
A provision of Spares, Inventory,
Space, Tools, etc.

Capital
costs

35

Spares
Labour
Facilities and Equipment
Establishment Overheads
Down-time

Output Quantity
Output Quality
Material Utilisation
Labour Utilisation
Asset Utilisation

Preventive
Repair
1

I
Demolition
Dislocation
Disposal

and interactions

Residual Costs

Long Range

36

For example,
downtime
breakdown,

Planning

in operational

Vol. 14

December

costs of equipment:

during maintenance
or following
i.e. the cost of lost production;

(1) The
a

low utilization
because the equipment
is not
suited to needs or because product or service is
not required;
poor performance,
because the equipment
does
not produce the quality of output required;
poor

reliability

because

of design

Finally there are disposal costs which may include

costs of demolition
and removal,
dislocation
of
existing production
capacity and making good a
site. Against these may be set any disposal value of
the physical asset.
Like initial costs, disposal costs are likely to be
readily available
but I suspect they are rarely
considered in convential investment
appraisal. Yet
the cost of disposal can be costly in social and
environmental
terms, e.g. the disposal of a coal
mine or the problem of storing radio active waste.
It is in the interaction
of these three groups; initial
expenditure,
operation
and maintenance
and
disposal that trade-offs (the substitution
of one cost
element
for another)
become
significant.
For
example, a higher degree of insulation provided in a
building
will increase the initial costs but will
reduce future running costs. It is this interactive
nature of the cost elements which points the way to
a total assessment of life cycle costs, so that the
impact of one cost element upon another can be
weighed.
Figure 4 illustrates the relationship
between
the
three groupings
of costs elements and the way in
which they can be varied to achieve optimum
life
cycle costs.
The optimization
of life cycle costs by substituting
one cost element for another can be demonstrated
graphically
as in Figure 5 in relation
to the
acquisition
of an item of equipment.
As the acquisition
costs
of the equipment
represented
by curve A increase the operating cost
including
cost of downtime
and maintenance,
represented
by curve B decreases, curve C is the
total cost of acquisition
and operating.
The
optimum
life cycle cost is the bottom of curve C.
of points

emerge

from

lowest capital cost falls short of the lowest

life cycle cost.

(2) Additional

capital expenditure
to points
results in lowest life cycle costs.

X-Y

(3) The area to aim at X-Y is that area where total

life cycle costs are lowest though it is significant
that a choice of capital and maintenance
costs
between X and Y will not affect significantly
the total life cycle costs.

failures.

This illustrates another feature of life cycle costing

and that is the need for adequate costing data to
enable monitoring
of each stage of the life of the
asset. Without
this information,
the exercise is
sterile because cost assumptions
cannot be verified
throughout
the life of the asset.

A number

1981

Figure

5:

How to go about Introducing

Cycle Costs

Life

By now the reader, given sufficient stamina, will be

getting some idea of the theory of life cycle costing
and hopefully will have recognized
the good sense
of a technique which aims to spotlight the costs of a
physical asset over its life so that the life cycle costs
can be optimized.
Perhaps the perceptive
reader
may even have grasped the wider implications
of
the technique
in that it not only points up the
financial
implications
of the management
of
physical
assets but also makes
a significant
contribution
to the engineering,
manpower
and
management
aspects.

Personally I have never experienced

any difficulty
in persuading
people that life cycle costing
is
essential
to proper
asset
management.
The
difficulty arises when enthusiastic converts want to
see examples of the technique because I have found
them to be thin on the ground in this country. One
of the difficulties is that the concept is large and all
embracing-it
concerns every stage of an assets life
from blue print to extinction
and demands,
if
developed fully, a great deal of expert staff time and
perhaps even more significantly
an extensive data
processing
capability
rarely
found
in British
industry or public service.
The answer is simple. It is that life cycle costing
should be adapted to meet perceived needs of the
organization
in the light of its available resources. It
is a start ifan organization
recognizes the validity of
the technique
for at the very least it will then
introduce
it into its procedure
for appraising and
selecting investment
options. It may be that it will
be introduced
in order to review maintenance
costs
or as part of a plan to maximize the utilization
of
physical assets. In each of these cases the technique
of life cycle costing is essential.
Although
I recognize that few organizations
will
aspire to a full life cycle costing system, in the
remainder
of this paper
I will
set out
a
methodology,
highlighting
what I regard as the
essential features which will, if required, permit a
piecemeal implementation.

The Use of Life Cycle

Option

Discounted

Costing

in Acquiring

Physical

37

Assets

Cost

Operating and
Maintenance Cost
Capital
cost

Time

Disposal Cost

Option 2

Trade-off

Discounted

cost
,--__

Capital

cost
Operating and
Maintenance Cost

Disposal

cost

I
I

Time

Figure

4. Relationship

between

grouping

of cost elements

The Start
It may seem trite but the first step must be to
appreciate the objectives of asset management
and
to relate them to the overall objectives
of the
organization.
Fortunately
it is not difficult usually
to do this, e.g. the care and management
of aircraft
can easily be related to the objectives
of British
Airways but there is a danger in environmental
changes affecting the management
of assets, e.g. the
provision
of steel production
plants at a time of
decreasing
demand.
It is important
that the
environment
in which
the concept
is to be
introduced
is fully appreciated.
Secondly there will be a need for management
specify the criteria against which alternatives

to
in

over the life span of physical

assets

asset selection and use are to be assessed. These

criteria may include engineering,
personnel
and
financial considerations.
These criteria will form
the parameters
for the evaluation
process. For
example,
the engineering
criteria in connection
with
equipment
may
include
safety
aspects,
minimum
production
capacity
and maximum
tolerance for down time while financial criteria will
include an assessment of the earning capacity of the
equipment
expressed perhaps as a return on capital
employed
in the business
or public
service
provided.
Similarly
marketing
and personnel
criteria will need to be taken into account.
Then there will be the need to identify the group
which will prepare the life cycle costing report.
Because of the implications
for the different parts of

38

Long Range

Planning

Vol. 14

December

1981
C
Total
cost

Operating

Cost Inclusive

of Maintenance

Lowest
Capital
cost

Lowest
Life Cycle Cost

ASSET

Figure

MAINTAINABILITY

5. The cost of asset ownership

the organization,
the team
disciplinary
and its functions
following :

should be multiwould include the

To formulate
the criteria for the project.
To determine
the factors
to be taken into
account.
To determine
the data needs, sources
and
validity, interpreting
the data and preparation
of
cost figures, preparation
of reports.
To devising form and content of progress reports,
setting up monitoring
system.

Preparing

the Project

Now
that
the team
has been
set up, the
environment
of the organization
understood
and
the criteria for the exercise specified, the next step is
to prepare the asset specification
in outline. This
will involve
considering
options
in design or
purchase of the physical asset in the light of the

criteria already established

and other significant
criteria, such as, in the case of a manufacturing
firm,
purchasing new plant or equipment:
(i) the product

demand;

(ii) the finance

available

(iii) the manpower

(iv) the limits
(v) the location

and cost of finance;

availability,

its skill and cost;

of technology;
of the plant or equipment;

(vi) any social or ecological

factors.

When the user of the plant or equipment

is also its
designer the team will need to produce a detailed
specification,
otherwise it will need to select from
among competing
manufactured
assets, choosing
the product which gives the most favourable
life
cycle costs compatible
with the criteria, objectives
and environmental
circumstances
specified. This is
an extremely important
stage too often done badly

The

Use of Life Cycle

both in the private and public sector. Insufficient

attention to this aspect of asset management
results
in high life cycle costs, e.g. schools with flat roofs
and too much glazing giving low initial costs and
high maintenance
costs, or equipment
which does
not match the requirements
of the user.
The life cycle costing study will only be as reliable
as the information
supplied. This is a vital part of
the study and will entail production
of data from
many sources including
financial costing records;
maintenance,
utility
asset
of
asset
records
production
control, of down time; and asset design
specification.
These records also certainly will not
be in the form required so that there is likely to be a
need for setting up new information
systems. Again
this is an area in which industry,
commerce
and
public bodies are weak. It is not that records do not
exist but they are rarely brought
together
in the
coherent
form required
by a study of life cycle
costing
of physical
assets. It is important
too
because of the need for subsequent
monitoring
of
Fortunately
data processing
asset performance.
today has reached the stage at which much of this
data can be produced from ad hoc systems on micro
or mini computers
without a great deal of trouble
or expense.
Clearly the exercise will entail forecasts of future
costs and benefits and to a large extent these will be
based on past experience
and expectation
of
performance
of the physical asset, e.g. the cost of
the incidence
of breakdown,
the
maintenance,
duration of down time of an item of equipment.
All
these will be influenced
by the history of use of
maintenance
of similar equipment.
is to
identify
the
key
The
crucial
factor
assumptions,
i.e. those which have material impact
in the life cycle costing exercise and to test the
sensitivity
of changing
these. Whatever
mathematical techniques are used in predicting future costs
and benefits and however accurate these predictions
are, the study will still remained
a projection-a
projection
which will need refining as actual costs
and benefits become known.
It is possible to introduce
an elementary
level of
sensitivity
analysis by preparing
the forecast for
three
possible
outcomes-the
most
likely,
an
optimistic
assumption
and a pessimistic
view.

Costing

the Options

The next stage is the consideration

of options, in
design or in the purchase of available equipment.
By this stage the members of the team will have a
good
idea of the objectives
to be met,
the
organizational
environment,
managements
intentions and the future costs and values of the proposed
physical asset. Now is the time to consider whether
there are better options available to the organiz-

Physical

Assets

39

ation. Ideally a short list of the most favourable

options should be identified
for appraisal.

The Appraisal
The costing of the most favourable
alternatives
is
best conducted
by preparing cash flow projections
of expenditure
and income. A cash flow statement
will show the timing of expenditure
and income
analysed over the life span of the physical asset. In
order to compare the alternative
cost expenditure
and income patterns of the options considered,
it
will be necessary
to express them in a common
form-the
common form used in life cycle costing
is the present day value, based on the concept of the
time value of money.
This concept stated simply is that a Al investment
today is worth more than a Al invested in 1 years
time. There are two obvious reasons for this-the
first is that interest can be earned by the Al invested
today so that in 1 years time it is worth more than a
Al (this is referred
to as the Time Theory
of
Money) and secondly the effect of inflation is that
the Ll in 1 years time will buy less goods than a Ll
spent today.
Taking the interest aspect first-because
the cash
flows over the life of the asset represent expenditure
and income arising in each year, they will need to be
discounted
back to Year 1 to reflect the time
preference of money. This is achieved by using the
following
formula :
Let P = Principle
i = Interest
n = Number

of years

A = Accumulated
Now

at the beginning

amount
of the first year

A=P
At the end of the first year

A=P+Pi
=P(l

+i)

At the end of the second

year

A=P(l+i)+P(l+i)i
(P+Pi)

=(l+i)
=P(l

Considering

in Acquiring

+i)2

At the end of the nth year

A=P(l

+Qn.

(1)

This formula may be inverted to give the principal

which if invested for y1years would accumulate to A
pounds at i per cent interest so that

P=-.

A
(1 + i) n

(2)

40

Long Range

Where
p=_

A = Al,

Planning

the formula

Vol. 14

December

1981
(1-t i) = (1 +x)

may be stated

(1 + i)

1
or

(1 +i)
This formula may
day value of a kl
each year of the
account the time

now be used to define the present

expenditure
or income arising in
cash flow statement
taking into
theory of money.

(1 + y)

(1 +Y) = (1+x)

(l+i)
___y = (1 +X)

i.e.

It can be seen from this formula

than i, then

Of course it is immediately
apparent that the choice
of discount or interest on money is a crucial factor
in the calculation.
There
are any number
of
possibilities but perhaps the best course is to use the
rate of interest charged on borrowed
money. The
example shown as Figure 6 includes a typical cash
flow
statement
with
its present
value
day
calculation.

that if x is greater

(1 + i)

(1+ x)
is less than 1, and hence y will be negative, i.e. if the
inflation rate is greater than the interest rate, then
the real rate of return on the investment
is negative.
Example

The reflection of the effect of inflation is altogether

a more complex
issue mainly because it is so
difficult to assess future rates of inflation.
One
simple way of reflecting inflation is to assume that
the interaction
of interest rate and inflation will
result in a low real interest rate of say 1 or 2 per cent
and to use this as the discount
factor in the
determination
of the present
value by using
formula (3) with i being 1 or 2 per cent.

If the present rate of borrowing

is 13 per cent and
the average rate of inflation over the appropriate
period has been estimated at 11 per cent, what is the
effective rate of borrowing
money?
Using formula (4), where i = 13% (i.e. 0.13) and
x = llo/;, (i.e. 0.11) then the effective rate,
(l+i)

The mathematical
expression
of this interaction
between interest rates and inflation may be derived
by considering the above interest rate i (termed the
money interest rate) as being the compound
effect
of two separate interest rates, x and y, where x is
equal to (and thus compensates the investor for) the
rate of inflation, and y is the effective or real rate of
interest on the investment
(which may be negative:
see below). The annual interest factor (1-t i), which
is applied
to the principal
P to produce
the
accumulated
amount A = P( 1 + i), is thus formed of
two subfactors
multiplied
together
to allow for
their compound effect: i.e. the annual interest factor

Start
Year

Purchase/
Disposal
of Asset

100,000

Operating
costs

1.13
1.11

= 0.018, i.e. 1.8%.

Whatever method is used it is important
to bear in
mind that the rate of interest and rate of inflation are
interdependent.
The cost of borrowing
reflects a
projected rate of inflation. It would be inconsistent
to discount an asset life cycle cost cash flow without
first adjusting the figures in the cash flow statement
for inflation.

Income
Generated

Net
Annual
cost

Discount
Factor
(13% p.a.)

Net
Present
Value

100,000

1 .oooo

100,000

0.8850

f
5000

5000

-10,000

5000

-15,000

-10,000

0.7831

5000

-15,000

-10,000

0.693

4400

7800

6900
8000

7000

-20,000

-13,000

0.6133

7000

-20,000

-13,000

0.5428

7100

7000

-25,000

-18,000

0.4803

8600

10,000

-25,000

-15,000

0.4251

6400

10,000

-30,000

-20,000

0.3762

7500

10

12,000

-20,000

0.3329

2700

7000

--10,000

-13,000

0.2946

3800

11
Total

Figure

of

y = (1 +x)

6. Example

-10,000
90,000

of discounted

75,000

-190,000

cash flow calculation

8000

-25,000

for hypothetical

36,800

asset with

10 year life

The Use of Life Cycle

Outcome

of the Appraisal

The appraisal will show which of the options will

provide the lowest life cycle costs consistent with
the parameters
which have been laid down. It is
important
to bear in mind that the choice of option
following
the appraisal
is not just a financial
decision.
It should be made after a comparison
between many variables viewed from the different
points
of view
of the
functional
interests
represented
on the team. Take for example in the
choice of equipment
there might be:
Financial-initial
and financing
quences, effect

costs and borrowing

facilities
costs, future
revenue
conseof taxation.

Engineering-maintainability,
operating
and
performance
characteristics,
diagnostic
and
repair equipment
and availability
of spares.
Marketing-production
capacity-flexibility
of
the equipment
to meet changing demand for end
product or service, labour considerations.
It may be possible to introduce trade-offs between
these considerations,
e.g. more expenditure
on
design to save future operating
or maintenance
costs, to affect the preferred option. In this respect it
is important
to realize that this is the critical time in
the determination
of life cycle costs because of the
extensive opportunities
which may be available for
design modiftcations
leading to future reductions in
cost or improvements
in productive
capacity or
better reliability standards. Because of the nature of
life cycle costing it will always be possible to
introduce
modifications
at any stage of the assets
life to optimize
its value, e.g. modifications,
refurbishing,
provision
of additional
facilities
which will enhance production,
reduce maintenance, or improve quality but the most critical time is
at design stage.
Another important consideration
at this stage when
the appraisal has been produced, perhaps modified
and a view has to be taken of the best buy, is to test
the costing reflected in the appraisal. At best the
forecasts of demand and costs of operating
and
maintaining
can only be a guide and should not be
given the same validit
as initial costs of design and
manufacture
or pure Kase which are likely to be
altogether
more accurate.
It is recommended
that a procedure
is adopted
which will isolate the critical factors and assess
changes
in these factors
on the costing.
For
example, in considering
the purchase of two pieces
of capital equipment,
type A may have a higher rate
of return than type B, but type B shows a pay back
period of 3 years compared to As 5 years. In a risk
situation given a small difference in the overall rate
of return, B might be the preferred option. Utility
theory,
a technique
for assessing
managerial
perception
of risk to reward preferences can help to

Costing

in Acquiring

Physical

Assets

41

place the choice facing management

into a simple
framework
of risk to reward values.

Monitoring

and Feedback

I now

come to the final stage in the proposed

methodology
but it is certainly
not the least
important of the stages. By its very nature life cycle
costing does not end with the implementation
of a
decision affecting the acquisition of a physical asset.
I am almost tempted to say it really begins there
because then the collection
of actual cost data
becomes possible and this is at the very heart of life
cycle costing.
Actual
costs and experience
of
handling the physical asset must be fed back and
compared with the cost assumptions reflected in the
appraisal. Deviations
from the forecasts must be
analysed and where necessary corrected to achieve
planned objectives. From this process it is possible
to accumulate
better
information
about
asset
management
which will feed into the next project
and aid design, operating and maintenance
policies.
There will inevitably
be advances in technology
which will affect the management
of existing assets
and policies for future asset acquisition.
These too
will have to be fed back to the life cycle costing
team.
The major problem
in this field is data capture
which I have already referred to. My own view is
that the cost of setting up a sound existing system
which will provide the details needed to monitor
the use of physical
assets properly
will yield
immense benefits if used in conjunction
with life
cycle costing. It will also provide
the means by
which post life cycle costing exercises may be
audited.
Monitoring
asset life cycle costs goes far beyond
verifying
achievement
against
expectation.
It
permits the organization
to keep abreast of new
opportunities
for optimizing
the return on physical
assets. To this end advanced technology,
projected
changes in demand for the end product or service,
and changes in cost patterns
will need to be
monitored
and their impact measured in terms of
the management
of existing assets and the design
and acquisition
of future
assets. The multidisciplinary team will have a major role to play as a
forum
for design and maintenance,
operating,
marketing,
finance and personnel staff, to suggest
and assess proposals for grasping new opportunities
and optimizing
the cost of asset ownership.

Conclusion
I have attempted

in this paper to argue the case for

life cycle costing in the management
of physical
assets and suggested a possible methodology
for the
introduction
of the technique of life cycle costing. I
believe that the technique has immense possibilities
which by and large have been ignored by industry

42

Long Range

Planning

Vol. 14

December

and the public authorities

in this country. I think
the reason for this is that firms and organizations
have been reluctant to devote resources of expert
manpower
to the technique
but, even more
significantly,
have not had the costing systems to
provide the data necessary to the successful use of
the technique.
My hope is that the rapidly increasing computer
technology
will remove the latter difficulty and a
realization
of the significance
of the technique,
perhaps as a result of reading
the article, will
encourage managers to pursue the ideas outlined in
this paper to the benefit of asset management
in
industry and the public sector.
The technique is in its infancy. There is a need for
experimentation
and the publication
of further
studies to increase the body of knowledge
on the
subject. I have little doubt that its potential in asset
management
it has an
is immense
because
immediate
impact
on all disciplines
in any
organization
that owns or uses physical assets. To
the private sector where profits are the principal
goal the objective ofoptimizing
life cycle costs over
the life of a physical asset would seem to be at the
very core of profit maximization.
For the public
sector, seeking to meet an almost inexhaustible
demand for services with limited resources, any
practice that can point the way to achieving more
with less, has to receive serious consideration.

References
R. J.

Kaufman, Life cycle costing-a

equipment
acquisition,
Cost
March/April
(1970).

decision-making
and
Management

The following booklets were published by HMSO on behalf

Department
of Industrys Committee for Terotechnology:
of Terotechnology-life

Cycle Costing

(1975).

Appendix
Example

of L(fe

project chosen was the Ashford Godinton

County
Primary
School-a
staged development
serving a new
and expanding housing estate, and eventually to consist of
nursery unit, infants and junior schools. The first phase
was planned to be the major part of the junior school, i.e.
the communal
and service areas plus 50 per cent of the
teaching
area with a completion
date in 1978. The
remaining
teaching area was to be added later as pupil
numbers increased.

(3) The terms of reference for the project limited it to single

storey solutions with the objectives
of (a) incorporating
recent developments
in educational
planning philosophy;
(b) obtaining improved
etivironmental
conditions
with a
low energy cost; and (c) developing
an alternative
to the
use of steel as the principal structural material.
proposals were put forward for each of
(4) Many alternative
the elements ofthe construction,
and these were discussed,
compared
and analysed in relation to existing traditional
school buildings.
These investigations
indicated
that
significant
energy savings and increased user satisfaction
could be achieved by a co-operative
teamwork
approach,
examining
each aspect as an inter-dependent
part of the
whole solution.
(5) The finally approved scheme was put out to competitive
tender and awarded to a local building contractor
in the
sum of ~225,000 approximately,
a figure more than 10
per cent over the IIES permitted
maximum
for this size
and type of school. Once-off
approval was given by the
DES on the grounds that this was an experimental
project,
with a forecast reduction
of some 15 per cent in running
costs, but no further approvals would be allowed until the
monitored
results
had
been
analyscd.
A detailed
breakdown
of costs compared with those of an equivalent
traditional design is given in the Annex to this Appendix.
like 20 new
(6) Something
concepts were incorporated
the following:

(ii)

(iii)

(iv)

(v)
Cycle

Costinq

(1) In the Autumn

of 1974 Kent County Council, concerned
by the rapid escalation of energy costs, set up a research
group to review building techniques
with a view to the

or newly
modified
design
in the project. These included

(4 A high standard of well-distributed

of the

Life Cycle Costing in the Management

of Assets-A
Practical Guide,
April (1977).
There are also various publications on Terotechnology
and Life Cycle
Costs obtainablefrom the Asset Management
Group, British Institute
of Management.

An

(2) The

Management

W. B. Taylor, The management of assets: terotechnology

in the pursuit
of economic life cycle costs, KMA
Occasional
Paper, February
(1980).

ManagementAspects

conservation
ofenergy.
Because education establishments
are the major part of the Authoritys
capital programme,
a
school was selected as a pilot project to put some of the
theory into practice.

tool for capital

Accountant,

R. P. Reynolds,
Helping the engineer to get the best value from
maintenance
expenditure,
Management
Accounting,
December
(1974).
G. Harvey, Lifecyclecosting-a
review of thetechnique,
Accounting,
October (1976).

1981

(vi)

daylighting
was
achieved with a substantially
reduced total glazing
area, by using double glazed, north-facing
rooflights, angled to keep out direct sunlight even at
summer solstice.
The orientation
of the building, at 10 west of north,
was selected to reduce solar heat again through the
rooflights.
The primary artificial lighting system was installed
with over-riding
photo-sensitive
controls to prevent use other than when inadequate natural light was
available.
The mechanical ventilation/heating
system employs
exposed,
ceiling level ductwork
to circulate
air
throughout
the building.
The air is withdrawn
through
a series of extract ducts and in winter a
tneasure of fresh air is added before the warm air is
recirculated.
The mechanical ventilation/heating
system operates
in a sealed environment
with no openable windows
and each main entrance is designed in a lobby style to
provide
an outer thermal
zone with background
heating only.
High mass construction
tnaterials were chosen for

The Use of Life Cycle

the building to afford a high level of heat retention
in winter and a slow rate of solar gain in summer.
(The selected option was for a traditional cavity wall
construction
comprising
an external skin of facing
brickwork
and an internal
skin of lightweight
aggregate,
insulating,
concrete
blockwork
with
polystyrene
insulatilig built into, but not bridging,
the cavity of the wall.)
(vii)

A new range of modular

component,
integrated
furniture
was designed, balancing users needs and
aesthetic considerations
against cost.

(7) Detailed
monitoring
procedures
have been established,
principally
in the three fields of (a) environmental
performance;
(b) acoustic performance;
and (c) cost-in-

Costing

in Acquiring

Physical

Assets

use. For the first the school is to be used as a test bed for
studies oflighting
utilization,
air leakage, air change rates,
environmental
conditions
and thermal performance
ofthc
selected
structural
materials.
For the latter, detailed
records are to be kept of all the elements of running costs
for matching
with
similar
records
for comparable,
traditionally
constructed
schools. The school was first
occupied in September
1978 so that 2 full academic years
history is now available, although this will be atypical due
to the low first year and second years intake.
(8) The conclusions
drawn from this intensive performance
monitoring
will assist in identifying
proposals
for
inclusion in future school designs and may assist in the
identification
of cost effective modifkations
to existing
schools.

Annex to Appendix
L+ Cycle Costing and Traditionally Designed Buildings
A Comparism Based on the A.&ford Codinton Project
LCC designed
building
&No
Capital costs
Design and specification
costs
Construction
costs (including
installation)

Traditional
building
~000

41
277

36
246

318

282

246
87
13

307
120
15

346

442

172
73

198
84

245

2x2

591

724

15

15

Total costs

924

1021

Present value (discounted)

626

65X

Running costs-for
Operating
costs
-1abour
-energy
-materials

Maintenance
-1abour
-materials

h0 year period

costs

Total running costs

Disposal costs

43

Note
All prices are in real terms, i.e. after accounting
for inflation. A time preference
per cent per annum has been applied to the costs to produce present values.

discount

rate of24