AAMCoG ‐ Life Cycle Cost Analysis (LCC Report)   

Life Cycle Cost Analysis

(LCCA)

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The Australian Asst Management Collaborative Group (AAMCoG)

The Australian Asset Management Collaborative Group (AAMCoG) was formed in August 2006
by the CRC for Integrated Engineering Asset Management (CIEAM). AAMCoG is a
collaboration of several of Australia’s peak bodies interested in work programmes in asset
management. AAMCoG’s mission - “Facilitate collaboration between interested organisations to
promote and enhance asset management for Australia”.

Members of AAMCoG aim to:-

ƒ Collaborate nationally on asset management strategies between all asset management
groups
ƒ Coordinate transfer of technology and knowledge sharing of asset management R&D
ƒ Promote skills development in asset management
ƒ Host the annual National Forum for Asset Management
ƒ Act as a communication channel between member bodies
ƒ Inform asset owners/custodians of the critical aspects of whole of life asset management

For further details, please refer to the AAMCoG Website www.aamcog.com

Acknowledgments
The CRC for Integrated Engineering Asset Management (CIEAM) would like to acknowledge the
financial support from the Commonwealth Government’s Cooperative Research Centres
Programme and the contributions from our industry, government and university participants.
CIEAM would also like to acknowledge the following contributions to this report;
Dr Lyle Turner – Research Fellow QUT
Mr Peter Way - Chair - IPWEA-NAMS.AU
Dr Nick Hastings – CIEAM Training Facilitator

This project was undertaken under the guidance of Professor Joseph Mathew chair of AAMCoG
and Professor Kerry Brown, Executive Officer, AAMCoG.

Confidentiality
In accordance with Australian freedom of information legislation, all information collected as
part of this study will be retained for seven years in a safe and secure environment. Paper-based
data will be stored in a locked filing cabinet, and electronic data will be encrypted and stored at
CIEAM Head Office, Brisbane.

Disclaimer
AAMCoG members make use of this report or any information provided by CIEAM at its own
risk. CIEAM will not be responsible for the results of any actions taken by members or third
parties on the basis of the information in this report, or other information provided, nor for any
errors or omissions that may be contained in this report. CIEAM expressly disclaims any liability
or responsibility to any person in respect of anything done or omitted to be done by any person in
reliance on this report or any information provided.Enquiries

Communication Officer/ Jane Davis Phone: +617 3138 1471

CRC for Integrated Engineering Asset Fax: +617 3138 4459
Management Email: jane.davis@cieam.com
Level 7, O Block, QUT Gardens Point campus
GPO Box 2434
BRISBANE QLD 4001

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CONTENTS

The Australian Asst Management Collaborative Group (AAMCoG) ........... 2 

Acknowledgments ...................................................................................... 2 

Confidentiality ............................................................................................ 2 

Disclaimer ................................................................................................... 2 

Enquiries ..................................................................................................... 2 

Introduction ................................................................................................... 4 

Life Cycle Cost Analysis .................................................................................. 5 

Discussion ...................................................................................................... 9 

Recommendations ....................................................................................... 14 

Appendix ...................................................................................................... 18 

Engineering cost method .......................................................................... 18 

Analogous cost method ............................................................................ 18 

Parametric cost method ........................................................................... 18 

Probabilistic estimation method .............................................................. 18 

References: .................................................................................................. 19 

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Towards a Unified LCC Framework

Introduction 

Life Cycle Cost Analysis (LCCA) is a method applied by a business or government entity
in the management of its asset base. As a tool, it is used to aid in a variety of situations
where a decision must be made, such as in the acquisition of one of a number of assets, or
in the continued upkeep of a portfolio of existing assets. LCCA is primarily concerned
with the cost of ownership over the life of an asset, and as such, provides a valuable
framework for the analysis and allocation of all related expenses that will be incurred.

Given the ability of LCCA to be used to capture important information related to the
management of an entity’s assets, and the improvements in decision making capability
which it provides, it may be somewhat surprising that in general these benefits are not
reflected in the real world where there is a distinct lack of attention paid to LCCA.
Indeed, recent studies such as those commissioned by the Building Research
Establishment of Britain (Clift and Bourke, 1998) have identified a significant lack of
LCCA adoption and have listed several possible reasons for this (discussed in the LCCA
section below). Importantly, the lack of a universal framework of methods and standard
formats for calculating Life Cycle costs was identified as a major issue.

This report sets out to address this problem of LCCA adoption by drawing from different
examples of LCCA use from different public and private sector members. The aim is to
provide a concise, uniform model framework for addressing whole of life cost
implications, not only in the traditional applications of new product development and
capital acquisition, but also in the continued operational phase off the asset. It is in this
area that the real benefits of LCCA as an asset management and budgeting tool are still
largely unexplored. It is also the area where substantial benefit can be gained in terms of
effective and efficient management of assets and the scarce resources they consume.

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Life Cycle Cost Analysis 

Life Cycle Cost Analysis (LCCA) can be summarised as:

“…the structured analysis of the entire set of costs which are associated with a
project or asset, in order to evaluate the total cost of ownership of the asset.”

The set of costs involved in the analysis occur throughout the entire useful life of the
asset, or at the very least, the period in which the asset is owned by the entity performing
the analysis. The life cycle for an arbitrary asset is made up of many different phases but
can, at a basic level, be separated into the following sections: Acquisition, Operation and
maintenance, Renewal (if applicable), and Disposal.

LCCA involves the structuring and analysis of the sum of all costs attributed to an asset
during its life cycle. These costs, referred to as Life Cycle Costs, occur at different times
during the above life cycle stages, and arise due to all expenses related to various
activities that are performed. These may include, but are not restricted to:

- Initial capital costs, such as those associated with project planning, acquisition and
preparation of asset, cost of raising funds and feasibility studies etc.
- Operating costs, for such elements as operations personal, materials, fuel, energy
consumption etc.
- Maintenance costs
- Risk exposure costs
- Renewal costs
- Disposal costs

While these costs occur throughout the life cycle, it has been noted (Kawauchi et al,
1999) that often, the majority of costs will stem from the actual ownership activities; in
some cases as much as 80% of the costs will occur during the operational life of the asset.
It is this fact that makes LCCA a powerful management tool in applications such as
choosing between competing projects or assets. That is because the decision processes
will incorporate qualitative and quantitative information relating to the entire life cycle
costs of the project, rather than the small subset of initial costs.

The International Infrastructure Management Manual (2006) and the Australian/New

Zealand standards guide on LCCA (AS/NZS 4536:1999) provide a comprehensive list of
applications in which LCCA is most commonly utilized. These include:

1. The evaluation options for the procurement of new assets, such as design trade-offs,
source selection and affordability studies.
2. The on-going support of management decision making throughout the life of an
asset.

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3. The identification of asset attributes which significantly influence the LCC, allowing
their proper management. These are often referred to as `Cost Drivers’.
4. The benchmarking of assets actual cost performance.
5. The review of the procurement process for future design/acquisition decisions.

Depending on the particular application in question, the method by which the life cycle is
defined may change. That is, it may incorporate different cost elements, group these
elements in different ways, or even leave out certain cost elements that are deemed
unnecessary for the particular analysis and problem being examined. The analysis may
also be applied at any stage during the Life Cycle, however as noted in the Defence
Policy on Life Cycle Cost Analysis (DI(G) LOG 4-5-004), the popular application of
LCCA is during the initial stages of an assets life cycle. The most common justification
of this analysis timing is that it is during the design and early life of the where
management has the greatest control in guiding the project towards the lowest LCC.

In most sectors, both public and private, LCCA has without a doubt been applied most
often in the economic evaluation of alternative projects related to asset creation or
acquisition. The common LCCA methodology which is applied can be summarised by
the following steps. This accepted framework can be adapted to the particular purpose of
the analysis, such as to assist in planning, budgeting, contracting etc. While each purpose
may include different factors in the actual life cycle cost aggregation itself, the basic
methodology in most cases remains the same, and as such can be taken as best practice of
the basic structuring of an LCC application.

1. Plan LCC analysis

The initial planning phase allows the specific objectives of the LCCA to be defined and
specified, along with any assumptions that must be made regarding the assets and their
associated costs. Typically, the objectives of the analysis are specified in terms of the
outputs which are required by management for decision making, a process that relates
back to the above notion of shaping the analysis for the particular application in question.

The planning phase is also used to identify any limitations, assumptions or constraints
which may affect the set of options which are involved in the decision problem. As the
analysis proceeds, changes in these constraints may in turn increase or decrease the
number of possible project alternatives.

2. Select/Develop LCCA Model

Once the objectives have been determined, the particular life cycle model can be selected.
This step is where differences between LCC applications usually become evident, as
different applications call for different analysis frameworks to be employed. Specifically
the life cycle is broken down based on a Cost Breakdown Structure (CBS) that sets out
the particular life cycle phases and the relevant cost categories. The life cycle can be

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broken down into a structure as simple as the four stages of acquisition, operation,
renewal and disposal, or a more complex breakdown can be applied. Each section then
has an associated set of cost elements, which are generally identified by breaking down
the cost categories into smaller and smaller groupings. It is generally accepted throughout
industry that given a particular application, cost elements that do not vary between
alternatives may be excluded from the LCC calculations. However, some sources also
make a further assumption in that cost elements are omitted from the analyses if they are
deemed to have a minimal impact on the calculations.

Once all cost elements have been identified, a method for estimating each associated cost
must be agreed upon. The methods of cost estimation are varied, with the main types
listed in Appendix 1. They range from comparative methods which take cost data from
other assets which have analogous size, characteristics or usage patterns, to parametric
methods which models mathematically historical cost data to find the best estimate for
the cost element in question. An alternative method of estimating costs is by statistical
means, an approach which stems from the fact that often, quantitative inputs to the LCC
process exhibit a certain amount of uncertainty.

An important factor in developing the LCC model is the collection of the appropriate
data. Identifying the required data and the sources of this data can often take up a large
proportion of the development process, and as will be discussed below, this can
sometimes be a deterrence in the application of LCCA.

3. Apply LCCA model

At this point, with the model, cost estimation methods and required data sources selected,
the process turns to the actual analysis of the life cycle costs. Once the model has been
developed, and estimates made for every cost element, an aggregated LCC value can be
evaluated. This is almost universally computed by firstly discounting all cost elements
back to their present day value, using the standard discounting equation

FV
PV = ,
(1 + r ) n

where PV is the discounted value of the future cost FV, r is the discount rate and n is the
number of years until the cost will be incurred. This formula is the accepted discount
method throughout all areas; although some private sector applications will take the
computation further by evaluating relevant measures such as the net present value,
benefit cost ratio and the internal rate of return of each project. There is, also, variation
amongst users of LCCA in the appropriate value of the discount rate r that is applied, and
this is discussed below (See Discussion). Given the set of discounted costs, the life cycle
cost results can be determined for each relevant combination of operating and support
scenarios defined in the analysis plan.

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The LCC results can be used in a variety of analyses in accordance with the objectives
defined in the analysis plan, thus ensuring that all goals have been fulfilled and that
sufficient information has been provided to support the required decision. The objectives
are of course dependent on the application in question, and while some industries may
find that a similar LCCA can be used in multiple settings, in general the objectives of the
analysis will vary on a case by case basis.

4. Document and review LCCA results

In general, the LCCA process is heavily documented to allow all users (both current and
future) to understand the outcomes and their implications, along with any limitations
which have been placed on the results. The reporting process is important and while it
can take many different forms, several key components are usually incorporated.

Specifically, the reporting documentation must clearly set out the intentions of the
analysis and what it is trying to achieve. Secondly, it should include discussion of all
relevant assumptions made in the analysis, along with the actual model applied. Finally, it
should include conclusions related to the objectives of the analysis, along with any
recommendations related to further work or revision of the analysis. In the case of LCCA
applied to decision making between competing alternative assets, these recommendations
may also extend to adjustments or revisions of the alternatives; for example, in the design
of specific components, or the inclusion of external factors relating to user demands on
the assets.

5. Prepare on-going life cycle costing methodology

The above steps describe the common application of LCCA; that is, applying the analysis
to help decide between competing alternative acquisitions. While the results of the study
are often not further addressed once the decision has been made, there is often value in
maintaining the LCCA model that has been developed for aiding operational decision
making processes. As stated in the Life Cycle Costing Guidelines released by NSW
treasury (TAM04-10), LCCA is primarily a tool for both acquisition and ongoing
decision making, and therefore it is possible to apply this tool to areas other than the
initial decision making process; namely, in the management of the ongoing costs of the
asset. The model may remain roughly the same throughout the asset’s life, however
variations can appear in such quantities as the type of discount rate used (real or
nominal), the specific costs that are incorporated into the model and the quality of cost
data that is input. As time progresses, more and more real data becomes available which
can be used to replace estimates. The user may even find that this real data changes the
results of the initial LCC analysis entirely; however, a good initial model minimizes the
chances of such an occurrence.

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6. Implement and monitor on-going life cycle costing

This step involves the application of the LCCA model throughout the assets operational
life. As mentioned in the previous step, the principal use of LCCA throughout an assets
life is to continuously monitor the performance of the asset, in order to identify potential
cost savings and aid in the assets general management and the planning of any future
changes. These processes can be critical in determining the optimal time for intervention
by way of possible replacement or enhancement of the asset to minimise costs and ensure
ongoing service delivery meets desired levels.

Discussion 

A survey of both domestic and international literature indicates that most

implementations of LCCA follow the same methodology in terms of their design,
definition of cost elements and calculations. However it is clear that significant variation
exists in a number of key areas, and while some can be related simply to sector
differences in which the analyses are applied, other differences may indicate a more
fundamental set of issues. The few items below are the areas where LCCA applications
were found to vary.

Structural differences

The first, and perhaps most obvious variation that has been observed between analysis
applications, is the way in which the life cycle of particular assets are broken down. The
purpose of the breakdowns is to organise the set of associated costs in some sort of time
frame, which helps planners and decision makers understand where and when costs will
be incurred. The specific time period in which the cost is incurred (usually denoted by the
year in which the cost occurs) is also important when evaluating the present value of the
costs. In this way, the LCC breakdown is an accounting structure, specifying all costs
associated with an asset out over a time horizon (which, in nearly all cases is finite).

Depending on the sector and industry in question, an assets life cycle and associated cost
elements can vary in definition from rather crude breakdowns to quite intricate listings.
The level of granularity to which the breakdown is extended depends on the practitioner,
who in many cases will try to find a balance between accuracy, and the level of resources
allocated to the analysis. The methods through which these breakdowns are created are
varied, however they generally consist of a top down approach, starting from the main
components of the life cycle and then breaking these up into smaller and smaller parts.

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In particular, there are two common techniques used in creating the breakdown of cost
elements. The first, as described in the LCCA Better Practice Guide released by the
Australian Audit Office (2001), is to organise the costs via general cost categories, such
as labour, materials or operations costs. This method is popular when applying LCC to
infrastructure based asset classes, and aids in making sure all relevant costs have been
included. The second method, described in a number of sources including the LCCA
primer released by the US department of Transportation (FHWA IF-02-047), is to
identify the major activities which occur over the asset’s life cycle, and to then assign all
relevant costs to their respective activity. This technique has the advantage of linking
costs to real, physical activities that are linked to the asset, rather than generic cost
categories that may be difficult to relate back to the assets operation. The level of activity
analysis recommended by LCCA standards, in particular the Australian/New Zealand
standards guide on LCCA (AS/NZS 4536:1999) could be considered the minimum
required for any particular cost breakdown, as will be discussed in the related section
below (See `The Australian/New Zealand Standards Guide to LCCA’).

It is also apparent from industry sources that the final set of cost elements which are
included in the model depend greatly on the purpose of the analysis. For example,
depending on the asset being considered, disposal costs are sometimes replaced with a
salvage value. Further still, costs which are common across several different assets may
be left out completely if the LCC models are simply for comparative use between
different asset alternatives. Usually however, these assumptions are made in a
deterministic world, and this should be remembered when deciding on which costs are
left in or excluded from the analysis.

Discount Rate and LCC formula variations

To obtain appropriate life cycle costs and further LCC measures, it was described above
how the present value formula is used to discount all costs back to present day values, so
that they can be combined using a particular measure. The PV formula requires, as part of
its definition, an appropriate discount rate to be chosen which is relevant to the particular
industry sector in question. As noted by Barringer (1996), generally the most difficult
question in any LCCA application is which discount rate to apply.

It is important to note that the discount rate used in an LCCA application can have quite a
large impact on the analysis and the eventual conclusions that it reaches. In fact, as the
LCCA primer released by the US department of Transportation (FHWA IF-02-047)
indicates, the LCCA relationship between different alternatives can change completely
between different discount rates. For example, if the discount rate for a particular
alternative is set too low, a valid project option may be incorrectly rejected, and vice
versa. It is therefore important to apply the correct discount rate for each particular
decision problem; however, the question of which discount rate to actually use in a given
situation does not have a simple answer.

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A number of issues regarding discount rates where noted from the literature. Firstly,
while some sources simply stated that a ‘discount’ rate was used, there were variations in
which particular form the rate was interpreted. Specifically, the application in question
seemed to dictate whether nominal or real costs were used, and consequently whether the
rate was set inclusive of inflation. A justification for using either real or nominal rates
(given in the LCCA primer (FHWA IF-02-047)) was that for public assets, benefits
should depend only on real gains such as expansion of output or cost savings. It was
noted however that the price change effects from nominal cost values and rates can be
factored out, or nominal values can themselves be used in the analysis, so long as
consistency is maintained throughout. However, a common trend in the literature
appeared to be to base LCC calculations on the constant real values and real discount
rate.

The more important issue when setting the model’s discount rate is that an accurate value
is selected to begin with. The appropriate rate is not a fixed value; it depends on both the
entity in question, the point in time at which the cost is being incurred and of course the
nature of the asset being examined. Leaving aside the problem of non-constant discount
rates, selecting a value which accurately discounts future costs back to present day will
be based on a number of different factors. As stated in both the LCCA Better Practice
Guide released by the Australian Audit Office (2001) and the Australian/New Zealand
standards guide, a rate is selected which reflects the risk-adjusted rate of return on the
asset which justifies the long-term retention of the asset by the entity. It is sensible that
the rate be linked to the cost of borrowing for that particular company, and the required
returns of its shareholders. In fact, it is often the case that the required rate of return for
the investment is computed, and this value set as the discount rate.

In general, a number of different factors, both internal and external to the entity, affect
the choice of discount rate. The rate can be based on such variables as the standard low
risk interest rate or the returns on standard government issued notes; for example, the
Guidance on Life-Cycle Cost Analysis released by the Federal Energy Management
Program (2003) suggest a rate based on the 12 month average of the composite yields of
all outstanding US treasury bonds. Another method is to consider the value of any of
these rates, additionally subject to an extra premium to compensate for the extra risk of
the asset or project. Depending on the entity in question, a premium may of course be
added if the company’s asset is expected to generate high returns.

Given the many factors that can affect the discount rate, an appropriate level of guidance
or framework for the actual value selection was a notable absence from the literature
studied. As stated below, the failure of the current literature to define a standard method
for selecting the discount rate is an area of LCCA which at present requires some
additional work.

An additional shortcoming which affects not just the discount rate but also the above
LCC calculations, is the application of deterministic methods and assumptions of
homogeneity of model values. Rarely were issues such as risk, uncertainty and associated

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realistic assumptions acknowledged other than by passing comment. Even the

Australian/New Zealand standard failed to adequately deal with the notion of including
risk and uncertainty in LCC calculations, a fact which is surprising given the, at times
high level of subjectivity of certain values and assumptions made regarding the model
and its application. The extent to which the standard addresses uncertainty is to suggest
sensitivity analyses be conducted, a measure which falls far short of current accepted
modeling methods such as Monte Carlo simulation, time series modeling and general
probabilistic and statistical analysis methods. These types of approaches however, do
depend on adequate and sufficient data to be collected, a problem that will be discussed
in the recommendations.

Ongoing management of assets

As opposed to the above application of comparing future projects for acquisition decision
making, the use of LCCA throughout the life cycle of an asset or assets appears quite
restricted and undeveloped. The applications examined indicated that while most
proponents of LCCA acknowledge it’s inclusion in the basic methodology, little attention
was given as to its application. The general strategy seems to be to apply LCCA during
the initial stages of asset development, and to then discard the results. Using LCCA as a
through life management tool in some cases even has a negative view; as Barringer
(1996) points out, an often held view is that LCCA results are not good budgeting tools.
This view is based on the subjectivity that is found in most LCC applications, and the
inaccuracy that this commonly leads to by the time operational budgeting concerns are
raised.

The view that LCCA is useful only as an initial method of deciding between competing
alternatives is unfortunately a widely held notion, however there is a case to be made for
its wider use throughout the operational life of the asset as well. The sources examined
make note of several different applications of such in-service analysis. For example, an
application noted by Boussabaine and Kirkham (2004) is to use a continued LCCA as a
form of economic benchmarking of the asset. By comparing updated LCC estimates with
the original, the owner can see how the asset is performing economically in comparison
with the original forecasts. Depending on the quality of initial cost estimates used these
numbers could change substantially as operational cost data becomes available and
replaces the forecast values.

The key issue of through life LCCA adoption tends to be based around maintaining
certain performance and/or service standards. Fane et al (2004) notes that the question
most commonly asked in the management of an asset is, “What are we trying to achieve
by managing these assets?” Depending on the type of asset, there may be several
different answers:

1. Service to customers or community

2. Minimize LCC for asset/s
3. Optimize maintenance and downtime

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4. Increase the capability or efficiency of asset/s

5. Ensure ongoing financial sustainability to continue operating the asset

Points 2 and 3 relate to getting the most ‘bang for buck’ from a given amount of money
spread over a given set of assets, however this consideration is commonly taken in
relation to the fulfilment of point 1. For example, the South Australian government’s
2001 report into asset management within local Councils (Burns et al, 2001) identifies
that, given the restricted budget available for renewal and replacement of assets, there is a
need for much greater scrutiny of existing assets in relation to community worth. LCCA
can be applied in this decision making process to judge, given the value of an asset to the
community, if renewal or replacement is appropriate and when is the optimal time for
such an event.

Aside from the above issues, another important use of LCC is in the continued
management of financial risk associated with an asset or project. Boussabaine and
Kirkham (2004) note this in the context of PFI or PPP contracts, which are generally long
term pairings of the public and private sectors. An important factor in these types of
projects is not only that they are cost effective (value for money from the public’s point
of view), but also that there is an appropriate level of risk transfer to the private sector.
This balance between adequate risk transfer and ensuring that there is an acceptable level
of quality service delivery throughout the contracted operational life of the asset can be
provided by using LCC techniques in an iterative approach. By continually updating the
LCC model and using associated real data and improved estimates of unknown values,
management can examine the economic performance of the asset in association with the
expected life cycle costs that will be incurred under any changes to the asset or its
operation. This allows decisions to be based on real time analysis of the relationships
between the various cost elements of the asset, and the risks associated with each of these
elements.

The Australian/New Zealand standards guide on LCCA

The above framework for LCCA is in part drawn from the Australian and New Zealand
standards guide on LCCA, which is the primary source for the application of LCCA
within Australia, across all sectors and industries. The guide is generally clear and
concise in its description of the various stages of the application of LCCA (though it can
be unclear in some sections; for example, the discussion of the differences between real
and nominal costs and rates), and provides a treatment which is general enough to be
applied across many types of decision problems, from infrastructure to unit assets.

There are however, several notable areas within the standard which are lacking in both
their coverage and general guidance. The first of these relates to the above discussion of
the application of LCCA during the operational phase of an asset. The document contains
a brief reference to the application of LCCA during ‘any life cycle phase’, and also
denotes that LCCA can be used in the `efficient allocation of resources’. However it then
proceeds to concentrate on the normal case of using LCCA for initial decision making.

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The justification, once again, is based on the fact that it is the initial period at which most
associated costs are yet to be locked in, and can so be changed. While the LCCA models
used during operation may be applied in much the same method as the common case, it
would be worthwhile to include an additional example application where LCCA is
applied in a more general asset management framework. Currently, the four examples
included cover much the same ground, and could be viewed as redundant.

The second critique involves the attention given to factors involving uncertainty in the
LCCA results. Values for cost estimates are found from a variety of sources: historical
data, ‘objective’ estimates given by relevant experts and other basic forecasting methods.
All of these sources are susceptible to different levels of uncertainty, due to either errors
made in the experts estimates, or general variability in the cost values estimated from
historical data. Given that all real world instances display some level of randomness,
taking this variability into consideration when evaluating LCCA results is both a valuable
and important exercise. While modelling for uncertainty has been a part of the LCCA
literature for several decades now, the standard fails to make no mention of the methods,
let alone the fact that such uncertainty exists. It must be stated that this is an issue within
the wider LCCA literature, with many practitioners still failing to adjust their modelling
practices (even though technological advances have made such calculations almost
routine. It would be appropriate for the Standard, as the central LCCA resource within
Australia, to detail this body of statistical techniques, which for minimal effort can
provide not only an understanding of the life cycle costs, but also the inherent financial
risk associated with an asset or decision.

Finally, as stated above the selection of an appropriate discount rate can require many
different factors to be taken into account. To do this in a systematic manner requires
some formal standard or framework in which the factors can be incorporated. The
literature surveyed however did not provide such a framework, in particular the standard.
Given that this is supposed to be the definitive guide to LCCA, it is of concern that such
an important factor of the modelling process is given minimal treatment.

Recommendations 

The purpose of this short study has been to review a cross section of the available
literature regarding current LCCA practice and application. This review aimed to capture
any general LCCA methods that were applied, with the intent of forming a general model
that can be applied across all sectors and industries. This review concluded that, a
framework for the application of an LCC model exists which is applied in most
situations. The general method set out above is of course adjusted depending on the
application in question, whether it be deciding on certain building methods for a new
university facility, or planning future maintenance costs for a new naval platform.
However, the main steps of the framework remain the same.

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There were several other items which came up during the review that warrant final
comment here, of both a technical and general nature.

1. Discount rates

While it is noted that there are general guidelines in the selection of an appropriate
discount rate, there needs to be a more uniform and universal approach to selecting the
discount rate used in the analysis. As suggested in a report by the Bureau of Transport
Economics (1999), most LCC models usually rely on precedent values for discount rates
and other inputs, rather than solid justification. It is noted that the rate changes depending
on the industry, sector and size of the entity, and it is suggested that a rating system be
established which gives guidance to rates depending on such factors. This would provide
a uniform, definitive source to which all organisations could refer to when selecting a
discount rate (to the author’s knowledge no such system exists). As stated below, a
standard framework would be expected to be included within the Australian / New
Zealand standard.

Another point that has been made by such authors as Howard (2001) is that for very long-
lived assets (such as large public works infrastructure), the discounting method often fails
to properly gauge the impact of costs which are incurred towards the end of the life cycle.
Depending on the particular application this may be of significance when applying
LCCA, and it is suggested that this point is taken into consideration in future guidelines
and standards (such as the Aus / NZ standard).

2. Uncertainty in data and LCC calculations

In the author’s opinion, the most important paradigm shift required in LCCA is the
acknowledgement by practitioners of the variability in nearly all model inputs. Given the
advances in computing power and analysis technologies, the application of statistical
methods to LCCA is no more difficult than deterministic modelling methods. To obtain
distributional estimates of all cost values is in fact a more accurate representation of the
real situation than current point estimate methods, and also has the added advantage of
automatically incorporating the notion of risk into the analysis. The extra information
provided by a statistical analysis of the life cycle cost would also be of particular benefit
during the operational stages of the asset, when benchmarking or risk analysis are
combined with wider customer or shareholder value. There are many techniques, several
of which were listed above, which could easily be applied in most situations for minimal
extra effort.

The notion of uncertainty also, in the author’s opinion, casts doubt on several
assumptions made in most LCC applications. For example, the exclusion of costs on the
basis of contribution to the final result could, in some situations, be made in error if the
particular cost process is highly variable. Without an understanding of the behaviour of

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such inputs, negligible costs could very well turn into contributing factors later on in the
assets life cycle.

3. Ongoing application of LCC throughout the Life Cycle – Data collection can affect
confidence in results

As stated above, one of the major areas where LCC is currently underutilised is during
the operational life of the asset. While it is true that opportunities for the results of an
LCC study to promote savings and influence decisions are reduced as the life cycle
progresses, the analysis can still be applied in maintaining levels of quality, value, risk
and a general understanding of management issues related to the entities assets. As stated
in the Defence Policy on Life Cycle Costing Analysis (DI(G) LOG 4-5-004) states,
LCCA can be used in the development of budgets for the ongoing through life support of
assets, a use of LCCA which has received little attention in most applications.

One of the main reasons behind this slow uptake of in-service LCCA is that of data
integrity. It has been cited in such sources as Boussabaine and Kirkham (2004) that one
of the reasons for a lack of LCCA application in general, let alone during the operational
phase, has been the general lack of confidence in LCCA results. As Barringer (1996)
points out, commonly held views amongst practitioners are that LCCA is that the results
obtained from an analysis are only as accurate as the data that are input into the model,
that there are no right or wrong LCCA results, only reasonable or unreasonable and that
because of this assumed subjectivity, LCCA is not a good tool for budgeting. While
current data collection and usage methods may be questionable in some instances, the
author feels that LCCA is unnecessarily excluded from such applications. Techniques
such as those found in Statistical Activity Cost Theory or SACT (see Turner (2006))
demonstrate practical approaches to such issues of data integrity and methods through
which data can be collected. These approaches allow the statistical analysis of such
measures as life cycle cost, amongst others, and are by no means impractical to
implement. It is the author’s opinion that firm recommendations related to the collection
and quality of data would be valuable in strengthening the confidence of practitioner’s in
the use of LCCA in budgeting roles, and therefore in the increase of this particular
application.

4. Revision of the Australian / New Zealand LCCA Standard

Given the concerns raised about the current version of the standard, there appears to be a
strong case for its revision, in order to update and expand certain sections of the analysis
guidelines. In particular, the above areas of critique warrant attention first. These are:

1. A set of firm guidelines for choosing the discount rate,

2. Examples on applying LCCA throughout the entire operating life of the asset, and
3. Recommendations for the application of statistical methods which capture the
uncertainty associated with a life cycle cost result.

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At present, both the Life Cycle Costing Guide released by the Australian National Audit
Office, and the Cost benefit Analysis Handbook released by the Department of Finance,
give an improved overview of choosing the rate, and in general could be used as an
interim source until the standard is updated. A consequence of this final point may also
be the additional recommendation of specific data requirements and associated collecting
regimes.

5. LCCA is part of the wider area of asset management techniques

Finally, it should be remembered always that LCCA is simply one tool in a much larger
portfolio of asset management techniques, and therefore should be one input among
many others in a larger evaluation or management process. Techniques such as Benefit-
Cost Analysis, SACT and areas such as Real Options theory, can all aid by incorporating
different factors into the overall management framework of the asset. LCCA is of most
benefit when interpreted within this larger framework, and it is in the author’s opinion
that this fact is commonly understated when demonstrating the advantages of LCCA.

Thanks:

The author would like to thank Peter Way, Kerry Brown and Nick Hastings for their
input into the drafting of this report, and also to CIEAM for their monetary support.

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Appendix 

The set of cost elements in any LCC analysis are assigned numerical cost values, and
these can be determined via a number of methods. The Australian/New Zealand standards
guide on LCCA (AS/NZS 4536:1999) lists the three main methods that are used to
estimate the cost element values: the Engineering cost method, the Analogous cost
method and the Parametric cost method. Each estimates the value of the cost element
differently; however all are deterministic in nature, which restricts management to simple
sensitivity analysis later once the LCC model has been completed and evaluated.

Engineering cost method 

The Engineering Cost Method is used where there is detailed and accurate capital and
operational cost data for the asset under study. It involves the direct estimation of a
particular cost element by examining the asset component-by-component. It uses
standard established cost factors (e.g. Firm engineering and/or manufacturing estimates)
to develop the cost of each element and its relationship to other elements (known as Cost
element Relationships - CER).

Analogous cost method 

This method provides the same level of detail as the Engineering Cost Method but draws
on historical data from components of other assets having analogous size, technology, use
patterns and operational characteristics.

Parametric cost method 

The Parametric Cost Method is employed where actual or historical detailed asset
component data is limited to known parameters. This available data from existing cost
analyses is used to develop a mathematical regression or progression formula that can be
solved for the cost estimate required.

Probabilistic estimation method 

The Life Cycle Cost Analysis Primer released by the US Department of Transportation
(FHWA IF-02-047) extends these methods to include computational evaluation of the
cost elements, allowing statistical distributions to be used for each cost elements value
instead of a single point estimate. Probabilistic LCCA methods such as the one proposed
by Salem et al (2003), provide a much more realistic model for the LCC, as they

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incorporate the inherent variability which exists in all cost estimates directly into the
model, providing a final distribution for the LCC value. Once again however, the uptake
of the deterministic and statistical methods of LCC calculation is not comparable, with
some studies such as that by Zayed (2002) finding mixed results using both methods.

References: 

- Association of Local Government Engineering New Zealand, 2006, International

Infrastructure Management Manual, (Version 3.0), Thames, New Zealand.

- Australian National Audit Office, 2001, Life Cycle Costing: Better Practice
Guide, Australian Government, Canberra.

- Barringer, P., 1998, Life Cycle Costs and good practices, NPRA maintenance
Conference, San Antonio, Texas.
-
- Barringer, P. and Weber, D., 1996, Life Cycle Cost Tutorial, Fifth International
Conference on Process Plant Reliability, Houston, Texas.

- Boussabaine, A. and Kirkman, R., 2004, Whole Life Cycle Costing: Risk and
Responses, Blackwell Publishing, UK.

- Burns, P. and Roorda, J. and Hope, D., 2001, A Wealth of Opportunities: A Report
on the Potential from Infrastructure Asset Management in South Australian Local
Government, Local Government Infrastructure Management Group, South
Australia.

- Clift, M. and Bourke, K., 1998, Study on Whole Life Cycle Costing for the
Department of the Environment, Transport and the Regions (DETR), (CR
336/98), Building Research Establishment, Watford.

- Commander Joint Logistics, 2004, Defence Policy on Life Cycle Cost Analysis,
(DI(G) LOG 4-5-004), Australian Defence Force, Canberra.

- Committee OB/11, Life Cycle Costing, 1999, Life Cycle Costing – An Application
Guide, (AS/NZS 4536:1999), Standards Australia/Standards New Zealand.

- Bureau of Transport Economics , 1999, Facts and Furphies in Benefit-Cost

Analysis: Transport, Report 100, Commonwealth of Australia.

- Department of Finance, 1991, Handbook of Cost Benefit Analysis,

Commonwealth of Finance.

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- Department of Victorian Communities, 2006, Local Government Asset Investment

Guidelines, Local Government Victoria, Australia.

- Defence Material Organisation, 2005, Defence Cost and Schedule Estimation

Methodology Handbook, Version 1.1, Department of Defence, Canberra.

- Education Support Services, 1999, Life Cycle Cost Analysis Handbook, Alaska
Department of Education and early Development, State of Alaska.

- Fane, S. et al, 2004, Evaluating Reliability and Life-Cycle Cost for Decentralized
Wastewater within the Context of Asset Management, 1st International
Conference on Onsite Wastewater Treatment and Recycling, Fremantle,
Australia.

- Fuller, S., 2007, Life Cycle Cost Analysis, National Institute of Standards and
Technology, http://www.wbdg.org/resources/lcca.php.

- Federal Energy Management Program, Guidance on Life-Cycle Cost Analysis,

Required by Executive Order 13123, 2003.

- Holden, G., 2003, Life Cycle Cost Issues in Rolling Stock Asset Management,
Llyods List DCN Rail Maintenance and Asset Management Conference, Sydney.

- Howard, 2001, Annual Service Cost for Capital Works Proposals, 2001 Perth
International Public Works Conference, Australia.

- Kawauchi, Y. and Rausand, M., 1999, Life Cycle Cost (LCC) Analysis in Oil and
Chemical Process Industries, RAMS Group, NTNU, Norway.

- Life Cycle Cost Analysis Team, 2005, Guidelines for Life Cycle Cost Analysis,
Stanford University.

- Lambrineas, P., March 2007, Logistical Cost of Ownership Research, Sydney.

- National Institute of Building Sciences, 2007, Whole Building Design Guide,

viewed 25th January 2008, http://www.wbdg.org/.

- New South Wales Treasury, 2004, Total Asset Management: Life Cycle costing
Guidelines, (TAM04-10).

- Office of Asset Management, 2002, Life Cycle Cost Analysis Primer, (FHWA IF-
02-047), US Department of Transportation, Federal Highway Administration,
Washington D.C.

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- Office of Engineering, 1998, Life Cycle Cost Analysis in Pavement Design –

Interim Technical Bulletin, (FHWA-SA-98-079), US Department of
Transportation, Federal Highway Administration, Washington D.C.

- Office of Management and Budget, 1992, Guidelines and Discount rates for
Benefit-Cost Analysis for Federal Programs, Circular No. A-94, Transmittal No.
64.

- Prabhu, A. and Edgerton, D., 2007, Prabhu-Edgerton Asset Management

Consumption Model: Incorporating Advanced SLAM, ACEAM/APV.

- The Federal Facilities Council Acquisition Task Group. 2001. Sustainable

Federal Facilities – A Guide to Integrating Value Engineering, Life Cycle Costing
and Sustainable Development, (Report No. 142), The Federal Facilities Council,
Washington D.C.

- The New Zealand national Asset Management Steering Group (NAMS), 2004,
Optimised Decision Making Guidelines: A sustainable approach to managing
Infrastructure, NAMS, Thames, New Zealand.

- Turner, L.R, 2006, Production Structure Models and Applications within a

Statistical Activity Cost theory (SACT) Framework, PhD Thesis, QUT,
Queensland.

- Salem, O. et al, 2003, Risk-based Life-cycle Costing of Infrastructure:

Rehabilitation and Construction Alternatives, Journal of Infrastructure Systems,
Volume 9, pp 6 – 15.

- US Department of Commerce/National Institute of Standards and Technology,

2004, Energy Price Indices and Discount Factors for Life-Cycle Cost Analysis,
(NISTIR 85-3273-19), US Department of Energy, Federal Energy Management
Program, Washington D.C.

- Wilson, A., 2002, Asset Maintenance Management: A Guide to Developing

Strategy and Improving Performance, Industrial Press Inc., New York.

- Woodward, D.G., 1997, Life Cycle Costing – Theory, Information Acquisition and
Application, International Journal of Project Management, Volume 15, No. 6, pp
335 – 344.

- Various Industry and Association websites.

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