The Sustainability of Life Cycle Costs in a Systems

Engineering Process of a 21st Century Reliability

Engineering Environment

By:

Reboneng Mothupi Maoto N-Dip: Eng. (Mech), B-Tech: Eng. (Mech), B-Tech: Business Admin and GCC-Factories Eng. (Mech)

A Dissertation Submitted in Partial Fulfilment of the

Requirements for the Degree of Magister Philosophiae

in

Engineering Management

at the

Faculty of Engineering and the Built Environment

of the

University of Johannesburg

Supervisors: Prof. JHC Pretorius (UJ) and Mr. Arie Wessels (UJ)

November 2012

1

Dedication

The work done in this research is dedicated to the field of engineering as it has brought

joy, purpose and meaning to my life.

2

Acknowledgements

This dissertation would not have been possible without the interventions and helping

hand from the following:

To God be the glory for providing the courage, strength and knowledge to carry out the

research.

Prof. JHC Pretorius (UJ) and Mr. A Wessels (UJ) for reading and evaluating this document

and for providing guidance along the way.

Friends and family for the encouragement and providing support in the course of this

journey.

Mr. Siegfried Schubert (mentor and business partner) for constantly challenging my

views on the topic and for providing guidance.

3

Abstract

With the current global political and economic environments, there is a lot of economic

fluctuation and uncertainty in the world markets. This results in the instability of prices

for goods and other products. And since we operate in a globalised era, this has a direct

impact on the life cycle costs of many systems and products.

Experience has indicated that a large portion of the total cost of many systems is as a

direct result of activities associated with the operation and support of these systems and

products, while the commitment of these costs is based on decisions made in the early

stages of the system life cycle (Blanchard, 1990:505 & Blanchard, 2004:24-26).

Further, the various costs associated with the different phases of the life cycle of a

system or a piece of equipment are interrelated. Thus, in addressing the economic

aspects of a system, one must look at the total cost in the context of the overall life

cycle, particularly during the early stages of conceptual design and advanced system

planning. Life cycle cost, when included as a parameter in the systems engineering

process, provides the opportunity to design for economic feasibility. To address these

aspects the following questions are answered through the research:

What are life cycle costs and what are the benefits of costing them?

When and where are costs incurred in a systems life cycle?

What are the key variables in establishing life cycle costs?

How can these variables be better defined to ensure that the life cycle costs are

sustained through the entire life of a system?

Can the engineering inflation be defined and be used instead of the general inflation

rate?

Now the challenge is that with the fluctuating economic conditions mentioned earlier,

one cannot predict the life cycle costs of a system as closely accurate as is required. The

proposed research focused on identifying sustainable measures to ensure that life cycle

costs remain relevant through the lifespan of a system or equipment.

4

In establishing LCC (Life Cycle Costs), it was found that there are various interpretations

with the detail of the definitions differing from case to case. But ultimately all definitions

of LCC make considerations of all relevant costs associated with the acquiring and

ownership of an asset. The costs are established through an iterative costing process of

estimating, planning, monitoring and reviewing of costs throughout an asset's life. This

process is used in decision making by evaluating alternative options and performing

trade-off studies. The costing process also known as LCCA (Life Cycle Cost Analysis) is

critical in early project stages for evaluating possible solutions, but it is also applicable to

all stages of the a systems life cycle.

The LCC were found to be incurred throughout the entire life cycle of a system but at

different amounts depending on the phase of the life cycle. During LCCA all costs are

classified and categorised using a CBS (Cost Breakdown Structure). The levels to which

costs in the CBS are broken down depend on the objective and scope of LCCA, and the

resource availability to conduct the work. Ultimately, the CBS must provide management

with a sufficient data to identify high-cost areas.

There are variables which required understanding to be able to successfully establish

LCC. These variables include baseline costs, economic factors and technical performance.

From a cost point of view, the 3 main methods used to estimate and generate the

appropriate cost data are namely engineering costing, analogue costing and parametric

costing. The economic factors established included time value of money, discounting,

inflation, interest rates and valuation methods. On the other hand the technical

performance is made up of figures of merit associated with RAM (Reliability, Availability

and Maintainability).

With the value of money eroding of time, inflation has been found to have an impact on

the acquisition and maintaining systems during operation. There are cost increases due

to wear and tear, increased labour skills, material demand, changes in logistics support

capabilities, energy/electricity consumption and initial estimate inaccuracies. So when

preparing cash flows for LCC purposes over a life of a system, the discounting interest

rate used must cover these costs.

The management measures identified conclude on the frequency of cost reviewing, the

correctness of key variables data and reliability management being the crux to the

sustainability of life cycle costs.

5

Contents

Dedication ............................................................................................... 1

Acknowledgements ................................................................................. 2

Abstract .................................................................................................. 3

Contents ................................................................................................. 5

Terms and Definitions ............................................................................. 8

Abbreviations .......................................................................................... 9

List of Figures ....................................................................................... 10

List of Tables ......................................................................................... 10

Chapter 1. Introduction ........................................................................ 11

1.1 Problem Statement ........................................................................................... 11

1.2 Purpose ........................................................................................................... 12

1.3 Questions to be addressed ................................................................................. 12

1.4 Background ...................................................................................................... 12

1.5 Scope and Objective .......................................................................................... 16

1.6 Research Methodology ....................................................................................... 16

1.7 Structure of the Dissertation ............................................................................... 17

1.8 Conclusion ....................................................................................................... 18

Chapter 2. Life Cycle Cost (Background) ............................................... 19

2.1 Introduction ..................................................................................................... 19

2.2 Defining the Concept (What are Life Cycle Costs?) ................................................. 20

2.3 What is the value of Life Cycle Costing? ............................................................... 21

2.4 Cost Emphasis in the System Life Cycle ................................................................ 22 2.4.1 Define the Need/Problem ............................................................................................ 22 2.4.2 Conceptual Design ..................................................................................................... 23 2.4.3 Preliminary Design ..................................................................................................... 24 2.4.4 Detail Design and Development.................................................................................... 25 2.4.5 Production and Construction ........................................................................................ 25 2.4.6 Utilization and Support ............................................................................................... 25 2.4.7 System Retirement and Phase-out ................................................................................ 25

2.5 Summary ........................................................................................................ 26

6

Chapter 3. Life Cycle Costing Economics ............................................... 27

3.1 Introduction ..................................................................................................... 27

3.2 Time Value of Money ......................................................................................... 28

3.3 Economic Principles ........................................................................................... 28 3.3.1 Simple Interest .......................................................................................................... 28 3.3.2 Compound Interest .................................................................................................... 28 3.3.3 Equal-Payment Series (Annuities) ................................................................................. 29 3.3.4 Inflation ................................................................................................................... 30

3.4 Investment Decision Evaluation Methods .............................................................. 31 3.4.1 Payback Method ......................................................................................................... 31 3.4.2 Net Present Value Method ........................................................................................... 32 3.4.3 IRR (Internal Rate of Return) Method ............................................................................ 32 3.4.4 Profitability Index Method ............................................................................................ 32

3.5 Summary ........................................................................................................ 33

Chapter 4. Life Cycle Cost Analysis........................................................ 34

4.1 Introduction ..................................................................................................... 34

4.2 Life Cycle Cost Analysis ..................................................................................... 35 4.2.1 Define the need for analysis ........................................................................................ 37 4.2.2 Development of CBS (Cost Breakdown Structure) ........................................................... 37 4.2.3 Selecting the LCC Models ............................................................................................ 37 4.2.4 Cost Model Selection .................................................................................................. 40 4.2.5 Cost Estimation and Data Generation ............................................................................ 40

4.3 Summary ........................................................................................................ 41

Chapter 5. LCC vs. Technical Performance ............................................ 42

5.1 Introduction ..................................................................................................... 42

5.2 Technical Performance ....................................................................................... 43 5.2.1 Reliability .................................................................................................................. 43 5.2.2 Availability ................................................................................................................ 44 5.2.3 Maintainability ........................................................................................................... 45

5.3 Summary ........................................................................................................ 47

Chapter 6. Case Studies ........................................................................ 48

6.1 Introduction ..................................................................................................... 48

6.2 Case Study 1 – Sheet Metal Print Modernization Project .......................................... 49 6.2.1 Background ............................................................................................................... 49 6.2.2 Problem Statement .................................................................................................... 49 6.2.3 Proposed Solution ...................................................................................................... 50 6.2.4 System Description .................................................................................................... 51 6.2.5 Life Cycle Costing ....................................................................................................... 53 6.2.6 Conclusion ................................................................................................................ 55

6.3 Case Study 2 – High Pressure Compressor Replacement ......................................... 56 6.3.1 Background ............................................................................................................... 56 6.3.2 Problem Statement .................................................................................................... 56 6.3.3 Proposed Solution ...................................................................................................... 57 6.3.4 System Description .................................................................................................... 58 6.3.5 Life Cycle Costing ....................................................................................................... 59 6.3.6 Conclusion ................................................................................................................ 60

7

Chapter 7. Research Findings ................................................................ 61

7.1 Introduction ..................................................................................................... 61

7.2 What are life cycle costs and what are the benefits of costing them? ........................ 62

7.3 When and where are costs incurred in a systems life cycle? .................................... 63

7.4 What are the key variables in establishing life cycle costs? ...................................... 64

7.5 How can these variables be better defined to ensure that the life cycle costs are

sustained through the entire life of a system? ............................................................. 65

7.6 Can the engineering inflation be defined and be used instead of the general inflation

rate? .................................................................................................................... 69

Chapter 8. Conclusions & Recommendations ........................................ 70

8.1 Introduction ..................................................................................................... 70

8.2 Management of Life Cycle Costing ....................................................................... 71 8.2.1 Objectives ................................................................................................................. 71 8.2.2 Planning ................................................................................................................... 71 8.2.3 Organisation ............................................................................................................. 71 8.2.4 Calculation of Life Cycle Costs ...................................................................................... 72 8.2.5 Monitoring ................................................................................................................ 73 8.2.6 Controlling ................................................................................................................ 74

8.3 Conclusion ....................................................................................................... 76

Bibliography .......................................................................................... 77

8

Terms and Definitions

Availability – is the probability that a system will be available when required and will

achieve its overall mission satisfactorily. (Blanchard, 2004:72)

Cash Flow – stream of costs and savings resulting from a project investment. (Fuller &

Petersen, 1996:GL-1)

Compound Interest – this is the interest that is earned on a given deposit and has

become part of a principal amount at the end of a specific period. (Gitman, 2009:166)

Discount Rate – rate of interest reflecting an investor’s time value of money that is

used in discount formula’s to convert cash flow to a common time. (Fuller et al.,

1996:GL-2)

Inflation – a loss in purchasing power of money over time. (Park, 2009:145)

Interest Rate – a percentage periodically applied to a sum of money to determine the

amount of interest to be added to that sum. (Park, 2009:90)

Maintainability – is defined, as the ease, accuracy, safety and economy in the

performance of maintenance actions. (Blanchard, 2004:34)

Payback Period – the amount of time required for a firm to recover its initial

investment of a project. (Gitman, 2009:425)

Present Value – the current value of future cash flows discounted at the appropriate

rate. (Firer, Ross, Westerfield & Jordan, 2004:127)

Reliability – is the probability that a system or product will perform in a satisfactory

manner for a given period of time when used under specified operating conditions.

(Blanchard, 1994:347)

Simple Interest – interest earned only on the original principal amount of an

investment. (Firer et al., 2004:119)

9

Abbreviations

Aa – Achieved Availability

Ai – Inherent Availability

Ao – Operational Availability

CBS – Cost Breakdown Structure

Cfm – cubic feet per minute

CPI – Consumer Price Index

et al. – And Others

f – General Inflation

F – Future Value

FMECA – Failure Mode, Effects and Criticality Analysis

FMCG – Fast Moving Consumer Goods

FOM – Figure of Merit

FRACAS – Failure Reporting, Analysis and Corrective Action System

i – Annual Interest Rate

IS – Simple Interest

IRR – Internal Rate of Return

kWh – Kilo Watt Hour

LCC – Life Cycle Cost/s

LCCA – Life Cycle Cost Analysis

M – Mean active maintenance time

MARR – Minimum Attractive rate of Return

Mct – Mean corrective Maintenance Time

MDT – Mean Maintenance Downtime

Mpt – Mean Preventative Maintenance Time

MTBM – Mean Time between Maintenance

MTBF – Mean Time between Failures

MTTR – Mean Time to Repair

N – Number of years

n.d. – No date

NPV – Net Present Value

P – Principal sum of the original amount borrowed or invested

PI – Profitability Index

PV – Present Value

PPI – Producer Price Index

R – Republic of South Africa Rand (Also ZAR)

RAM – Reliability Availability Maintainability

RBI – Risk Based Inspections

RCM – Reliability Centred Maintenance

R(t) – Reliability Function

SARB – South African Reserve Bank

SARS – South African Revenue Service

STATSSA – Statistics South Africa

US$ – United States of America Dollar

VAT – Value Added Tax

λ – Failure Rate

10

List of Figures

Figure 1: History of South African Inflation Rate...................................................... 13

Figure 2: Brent Crude Oil Price (2000 to 2010) ....................................................... 13

Figure 3: 36 year gold price history in US Dollars/ounce .......................................... 14

Figure 4: Currency Exchange Rate of US Dollars vs. South African Rand .................... 14

Figure 5: Eskom’s average tariff adjustment for the last 15 years ............................. 15

Figure 6: System Requirement Definition Process .................................................... 23

Figure 7: System Development Process ................................................................. 24

Figure 8: % of LCC Committed During the Systems Life ........................................... 26

Figure 9: An Investment Cash Flows Example ......................................................... 31

Figure 10: Top Level of LCC Tree .......................................................................... 35

Figure 11: Acquisition Cost Tree ............................................................................ 36

Figure 12: Sustaining Cost Tree ............................................................................ 36

Figure 13: Relationship between Reliability and Total Cost ........................................ 47

Figure 14: Cost Phasing in System Life Cycle .......................................................... 63

Figure 15: Bath Tub Curve ................................................................................... 67

Figure 16: Double Loop Reliability Management Process ........................................... 75

List of Tables

Table 1: Sheet Metal Printing Old Technology vs. New Technology ............................ 50

Table 2: LCC for Case Study 1 .............................................................................. 54

Table 3: LCC Key Variables ................................................................................... 64

11

Chapter 1. Introduction

1.1 Problem Statement

Living costs and those of running businesses are constantly increasing resulting in the

inevitable need for smarter and rigorous ways of managing costs. This has had a direct

impact on engineering systems (Blanchard, 2004:24-26) as they become less and less

cost-effective over time. The sustainability of systems and equipment life cycle costs in

the 21st century will require different thinking and approach to ensure a reliable

engineering environment.

This research will look at the theory of life cycle costing; variable aspects of life cycle

costs; and the relationship between costs and asset performance. The research areas

are demarcated into a set of questions indicated in section 1.3.

12

1.2 Purpose

When a system or product is selected for use, the decision is based on the information at

hand at that particular point in time. Over time the same input information which was

used to evaluate alternatives and make the decision will change. As a result, the present

circumstance will see costing being different and could end up with increased financial

risk to the organisation.

The purpose of this dissertation is to identify the short comings of life cycle cost

allocation and to develop a management process/tool that will assist in achieving more

control of life cycle costs for systems and products during their operational period into

the future.

1.3 Questions to be addressed

The specific research questions which will be answered are as follows:

What are life cycle costs and what are the benefits of costing them?

When and where are costs incurred in a systems life cycle?

What are the key variables in establishing life cycle costs?

How can these variables be better defined to ensure that the life cycle costs are

sustained through the entire life of a system?

Can the engineering inflation be defined and be used instead of the general inflation

rate?

1.4 Background

The value of money depreciates over time as indicated by the 5 graphs of economic and

financial indicators below. This depreciation and erosion occurs at an inconsistent rate

making it difficult to accurately predict future costs of goods and services. This notion of

inconsistently fluctuating costs has raised the question; is there still effective

management of industrial assets (focusing on both operational and capital costs)?

13

Figure 1: History of South African Inflation Rate (Source: http://www.tradingeconomics.com/south-africa/inflation-cpi Accessed: 16 August 2012))

Figure 2: Brent Crude Oil Price (2000 to 2010) (Source: http://www.shell.com/home/content/bitumen/risk_marketing/ Accessed: 16 August 2012)

These economic indicators show that even though physics taught us that everything that

goes up must come down, it doesn’t necessarily apply to economics. This is due to the

political interferences as shown above which result in a nonlinear reacting market.

(Bienen & Gersovitz, 39(4):729-754 &

http://www.resbank.co.za/Financial%20Stability/Pages/FinancialStability-Home.aspx)

In

flati

on

Rate

(%

)

14

Figure 3: 36 year gold price history in US Dollars/ounce (Source: http://goldprice.org/gold-price-history.html#10_year_gold_price Accessed: 15 August 2012)

Figure 4: Currency Exchange Rate of US Dollars vs. South African Rand (Source: http://www.tradingeconomics.com/south-africa/currency Accessed: 15 August 2012)

US

Do

llar

15

The wider economic impact of electricity tariff hikes cannot be ignored (HSRC, 2008).

This impact is seen in the capacity, supply and reserve margin problems experienced

currently in South Africa. Due to these problems, a need for infrastructure investment

has been identified. And this has resulted in high electricity tariff increases (HSRC, 2008)

impacting directly on the life cycle costs of systems and equipment. Below is a historic

view of the year-on-year price increases in electricity tariffs compared to the inflation

rate.

Figure 5: Eskom’s average tariff adjustment for the last 15 years (Source: http://www.eskom.co.za/c/article/143/average-price-increases/ Accessed: 15 October 2012)

0

5

10

15

20

25

30

35

40

45

50

55

60

65

0%

2%

4%

6%

8%

10%

12%

14%

16%

18%

20%

22%

24%

26%

28%

30%

32%

34%

c/kW

h

CPI (%) Average Electricity Price Adjustment (%) Avarage Electricity Cost (c/kWh)

16

1.5 Scope and Objective

The scope of this research will cover the following main sections:

The research begins with a literature review to provide a holistic understanding of

life cycle costing. This will include an overview of life cycle costing, the economics

of life cycle costing, the analytical process and the technical performance impact

on life cycle costs.

The literature review is followed by case studies of real life situation to

substantiate the need for this research.

After the case studies, the research questions will be answered to conclude on the

finding of the research.

This will lead to the author establishing a systematic method of ensuring that life

cycle costs are effectively monitored and managed.

1.6 Research Methodology

The research methods employed to get to the solution involved a literature review and

field research. The literature review was conducted with library books and internet

articles by abstracting and referencing to the contents of published data. While the field

research involved analysis of case studies and observations of life cycle cost

management processes of various projects in a similar industrial sector.

This is an applied type of research as it aims at uncovering a solution to an immediate

problem facing organisations. All in all a qualitative approach was followed to execute

this research (Kothari, 1985 & Kumar, 2005). This was to ensure that the underlying

reasons for the erosion in life cycle costs is identified and a practical approach

formulated to minimise the economic impact.

17

1.7 Structure of the Dissertation

To put forth the argument a structure that is proposed will include the following

contents:

Title page

Table of contents

Chapter 1 - Introduction

o Chapter 2

Life Cycle Cost (Background)

o Chapter 3

Life Cycle Costing Economics

Literature Review

o Chapter 4

Life Cycle Cost Analysis

o Chapter 5

LCC vs. Technical Performance

Chapter 6

o Case Studies

Chapter 7

o Research Findings

Chapter 8

o Conclusion and Recommendations

Bibliography

18

1.8 Conclusion

The purpose of this chapter is to provide an overview of the dissertation and an

introduction to get a feel of the approach to the research. In the next chapter life cycle

costing is introduced and its significance in the systems engineering is highlighted.

Ethical considerations made during the research included referencing references used in

the literature survey. The references included books, standards, articles, internet based

information, and listing them in the bibliography section of the research document. All

human participants who provided input in the research are named only after their

consent. And the industry examples provided in the case studies are anonymous to avoid

distribution of confidential information.

19

Chapter 2. Life Cycle Cost (Background)

2.1 Introduction

In this chapter, LCC (Life Cycle Cost) is defined and a better understanding of its

purpose is established. A cost emphasis on the life cycle of a system is also made,

focusing more on the design phase of the systems engineering process. The design

process is based on many current system engineering models and is constructed to

convert a need into a practical solution. Throughout this process other elements of

reliability engineering such as engineering economics, logistics engineering, asset

management and financial management are considered.

20

2.2 Defining the Concept (What are Life Cycle Costs?)

Many authors define life cycle costs in various ways. Below are a few of the published

definitions:

LCC is the sum of all recurring and one-time (non-recurring) costs over the full

life span or a specified period of a good, service, structure, or system. It includes

the purchase price, installation cost, operating costs, maintenance

and upgrade costs, and remaining (residual or salvage) value at the end

of ownership or its useful life. (www.businessdictionary.com/definition/life-cycle-

cost.html#ixzz1tu4oKYs8 Accessed: 12 October 2012)

LCC is the total cost of the entire user system over its full life in its intended

environment. (RSA-MIL-PRAC-175, 1993:16)

LCC is the sum of all costs incurred during the life span of an item or system.

(Dhillon, 2010:2)

LCC is the total cost throughout its life including planning, design, acquisition and

support costs and any other costs directly attributable to owning or using the

asset.

(http://www.treasury.nsw.gov.au/__data/assets/pdf_file/0005/5099/life_cycle_c

ostings.pdf, 2004:1)

Life cycle cost is the total cost of ownership of machinery and equipment,

including its cost of acquisition, operation, maintenance, conversion, and/or

decommission (Barringer, 2003:2).

21

2.3 What is the value of Life Cycle Costing?

The main idea is to be able to compare alternatives in order to ensure that the final

decision is financially beneficial to the organisation. Life cycle costing consolidates all the

various costs (acquisition, maintenance, refurbishment or disposal) of different solutions

to a problem or a need. This is done for the full life cycle of the system or product to

allow the evaluation and selection processes to be consistent.

LCC helps change perspectives on economic issues. Consider the following conflicts in

most companies as expressed by Barringer (2003:3):

Accountings main concern is maximising project NPV (Net Present Value)

Project Engineering is concerned mainly with minimising capital costs

Maintenance Engineering is only concerned with minimising repair hours

Production is mainly concerned with maximising up time hours and production output

Reliability Engineering wants to avoid failures

Shareholders want increased dividend and share value

So with these conflicting scenarios, a scientifically derived tool needs to be used to assist

management to get to a point that they can make well informed decisions. As the

saying goes, it is important for engineers to think like MBA’s but still act like engineers

(Barringer, 2003:3). Beside the need to align objectives as a result of these conflicts, life

cycle costing has several benefits (Dhillon, 2010:34):

Reduced cost ownership

Alignment of engineering decisions with corporate and business objectives

Development of common objectives (between suppliers and operations)

Reduction of the risk of operating cost surprises

Identification of business performance improvements

Maximising the value of current operating experience

Providing a framework within which to compare options at all stages of development

Providing a mechanism for identifying and reducing major cost drivers

Use the power of collective experience

22

2.4 Cost Emphasis in the System Life Cycle

To be able to improve benefits of LCC there is a necessity to understand the impact of

decisions made during the systems engineering phase. The majority of the projected life

cycle costs for a given system or product are as a direct result of decisions made during

the design and development phase of the systems engineering process (Blanchard,

1990:505 & Blanchard, 2004:24-26). These decisions deal with system configuration,

operational requirements, performance and effectiveness factors, system utilization

factors, quality of items to be produced, the maintenance concept, logistic support

polices, system retirement (material recycling) and system upgrades (Blanchard,

1990:505).

Resources are getting more limited resulting in a higher need for different approaches

toward systems life cycle costing. So if we want optimized life-cycle costs to be an end

result in the process of designing for economic feasibility, it is important that there is a

strong focus on cost emphasis in the early stages of system development. The emphases

will provide a much highly needed level of detailed cost allocation. And with this detail

then there is a much better chance of controlling the life cycle costs. (Blanchard,

1990:508).

2.4.1 Define the Need/Problem

The systems engineering process commences with the definition of a need or a problem.

This is done by means of making a statement of the problem which provides a

qualitative and a quantitative baseline to be able to continue with the process. This part

of the process must make the following outputs very clear:

Capability required by the customer

An estimation of resources required to acquire the system

Time when the system needs to be in place

23

2.4.2 Conceptual Design

Conceptual design is the initial phase of the design process and it is intended to respond

to the need which has been identified. This should take an idea and convert it into

something with shape and is capable of performing a set function repeatedly. To

establish LCC of this new solution, the cost estimation methods in Chapter 3 may be

adopted to establish system design parameters. These estimation methods will along

with the functional details and design requirements be used as active factors throughout

the design process (Blanchard, 2004:257).

To effectively carry out a conceptual design, Blanchard (1990:34) explains that the

following steps need to be executed (process flow show below):

Conduct a needs analysis

Conduct feasibility studies

Define systems operational requirements

Define system maintenance concept

Identify systems’ technical performance measures

Figure 6: System Requirement Definition Process (Source: Blanchard, 1990:35)

System Specification

Conceptual Design

Review

Definition of Need

Advance System

Planning

Feasibility Studies System Operational

Requirements

Preliminary system

Analysis

System Maintenance

Concept

Technology

Development and

Application

24

2.4.3 Preliminary Design

With the functional or technical baseline determined during conceptual design, the

preliminary design will take the process further by establishing detailed qualitative and

quantitative design requirements (Blanchard, 1990:55).

From a cost point of view, the cost is allocated to each item in the system to establish a

guideline and alternatives evaluated to get the best “cost” solution. At the end of it all,

the preliminary design phase will ensure that items selected are comparable to the

targeted costs, and that they are the most cost effective solution (Blanchard, 1990:508).

So an iterative process is followed to get results and this is done by using LCCA as a tool

for evaluating alternatives and making trade-off’s.

Figure 7: System Development Process (Source: Blanchard, 1990:56)

Disapproval

Approval

System Requirements

Definition

System Functional

Analysis

Preliminary Synthesis and

Allocation of Requirements

Trade-off and optimisation

Synthesis and Definition

System Design Review

Is Design

Approach

Acceptable

Yes

No

25

2.4.4 Detail Design and Development

As system design is further refined and design data becomes available, the LCCA (Life

Cycle Cost Analysis) effort involves the evaluation of specific design characteristics, the

prediction of cost-generating variables, the estimation of costs, and the projection of life-

cycle cost as a profile. The results are compared with the initial requirements and

corrective action is taken as necessary. Again, this is an iterative process, but at a lower

level than what is accomplished during the preliminary system design.

2.4.5 Production and Construction

Cost concerns in these latter stages of the system or product life cycle involve data

collection, analysis, and assessment function. Hopefully, valuable information is gained

and utilized for the purposes of product improvement and for the development of good

historical data for future applications.

2.4.6 Utilization and Support

For the purpose of this study, the last 2 stages of the system engineering process which

include utilisation, support and system phase-out are looked at as part of the case

studies and the solution thereof. This is as a result of these parts of the process leaning

more towards the operational environment and not a more controlled systematic design

environment.

2.4.7 System Retirement and Phase-out

Similar to the Utilisation and Support phase, the above statement will apply.

26

2.5 Summary

Life cycle costing is applicable in all phases of system design and development,

production, construction, operational use and logistic support. Cost emphasis is created

early in the life cycle by establishing quantitative cost factors as requirements.

As the life cycle progresses, the cost is employed as a major parameter in the evaluation

of alternative design configurations and in the selection of a preferred approach.

Subsequently, cost data are generated based on established design and production

characteristics and used in the development of life cycle cost projections which are

shown below in figure 8.

These projections in turn are compared with the initial requirements to determine the

degree of compliance and the ultimate necessity for corrective action. In essence life

cycle costing evolves from a series of rough estimates to a relatively refined

methodology, and is employed as a management tool for decision-making purposes.

Figure 8: % of LCC Committed During the Systems Life (Source: Blanchard, 2004:87)

Preliminary

system design

System planning

function and

conceptual design

Detail design

and

development

Production,

construction

and evaluation

System use

and logistic

support

25

50

75

100

% o

f Lif

e C

ycle

Cost

Co

mm

itte

d

Market analysis, feasibility

study, operational

requirements, maintenance

concept, etc.

System analysis, evaluation

of alternatives, system

definition, etc.

Detail design and development

27

Chapter 3. Life Cycle Costing Economics

3.1 Introduction

Money as a resource is scarce in any business, government or major corporation. This

leaves the businessman no choice but to select his/her investment options carefully. The

same applies to engineers when making engineering investment decisions. To assist in

making these decisions, economic principles are utilised and applied to cash flows for

systems and equipment. This chapter highlights key elements in economics which affects

the value of money.

28

3.2 Time Value of Money

One of the important financial concepts is the time value of money. This concept refers

to a rand on hand today having a higher value than a rand promised in the future (Firer

et al., 2004:118). Since money has the purchasing power and earning power, it is

important that its value be understood to be able to make good engineering investment

decisions.

3.3 Economic Principles

When making an investment in an engineering asset, it is a similar ideology to

investment made by financial institutions when lending money out. The similarity is that

there is an expectation that a return on the investment will be realised sometime in the

future (Park, 2009:180). To work out the life cycle costs of an engineering investment,

one needs to understand a number of economic principles as costs are experienced

throughout the life of a system or an equipment. Below are a few key principles to allow

for a better understanding of engineering economics which involves the compounding

and discounting of cash flows (Park, 2009:20-36).

3.3.1 Simple Interest

Simple interest refers to the simplest form of interest. When an investment is made, the

interest is charged or earned only on the original principal amount invested. This

method does not include an interest charged on the accrued interest. The simple

interest is calculated as per the following formula:

NiPsI (3-1)

Therefore the total amount of money to be received in the future for this investment can

be calculated as follows:

)NiP(1NiPPsIPF (3-2)

3.3.2 Compound Interest

The word compounding in economics refers to the process of earning interest from an

investment over a period of time and accumulating even more interest. The interest

earned monthly or yearly gets to be added to the original principal amount and the sum

total earns interest. This can be obtained using the following calculation:

Ni)P(1F (3-3)

29

The formula can also be used to work out the present value of a future amount by

making P (Present Value) the subject of the formula. This is also referred to as the

discounting of cash flows. The question that this formula is concerned with answering is

that, to receive a desired lump sum after a number of periods at a specified interest

what is the investment that needs to be made today?

Ni)(1

FP

(3-4)

3.3.3 Equal-Payment Series (Annuities)

This method is also called or known as annuities. It is applied to a series or stream of

equal payments over a specified period. This method is used for 4 different purposes and

they are all expressed below.

a. Compounding-Amount Method

To find out the future value of equal payments made over a period of time the following

formula is used:

i

1i)(1AF

N

(3-5)

b. Sinking-Fund Method

The following formula is obtained by rearranging the compounding method to calculate

the annuity of a future amount.

1i)(1

iFA

N

(3-6)

c. Present-Worth Method

This method deals with working out the present value of an amount of money to be paid

at the end of each given period and is computed as follows:

i

i)(11AP

N

(3-7)

d. Capital Recovery Method

The formula for this method is obtained by rearranging the present-worth formula

above:

Ni)(11

iPA

(3-8)

30

3.3.4 Inflation

Up to this point, the entire focus has been on discount rates. The other critical economic

concept is inflation as history has shown (refer to Figure 1, 2, 3, 4 and 5 in Chapter 1)

that prices of goods and services are consistently on the rise. This loss of purchasing

power of money over time is called inflation. The treatment given to inflation can

dramatically affect the outcome of LCCA and make the process inconclusive and

insignificant.

Making projections of inflation can be complex and possibly misleading considering the

number of factors that affect it. Typically, there are 2 main approaches of dealing with it

and are mentioned below.

a. General Inflation

General inflation is the average inflation rate based on the CPI (Consumer Price Index).

The measure is produced by the STASSA (Statistics South Africa) by taking into account

the change of prices in goods and services over time. These goods and services are

grouped into a number of classifications such as housing, entertainment, food, personal

care, beverages, transportation, medical care and apparel. The CPI compares the cost of

a sample market basket of these goods and services taken over a specific period. This

measure is calculated as follows:

1N

1NN

CPI

CPICPIf

(3-9)

b. Specific Inflation

The logic here is that the general inflation affects both the cost and benefits of a project

over time. However, specific items may not follow the general pattern. As an example,

Eskom hiked electricity prices to over a 100% in the last 4 years while the general

inflation rate was extremely lower than that.

So, to get to an inflation rate which is relevant to engineering investment analysis the

appropriate price index needs to be established (Park, 2009:147). This can also be

looked at as what is known as the PPI (Producer Price Index). This specific inflation rate

is represented by fj (Park, 2009:151).

31

3.4 Investment Decision Evaluation Methods

Now that the basic economic principles have been laid down and clarified, it’s time to

look at the methods which uses these principles for investment evaluations.

3.4.1 Payback Method

The first method that is looked at is the payback method. This method determines the

time it takes to recover an investment. This is done by adding the cash inflows and

outflows together until a point where the result is zero. At this point the period noted is

considered the payback period. This payback period identified is compared to a

predetermined number which will establish whether or not the investment is acceptable.

Figure 8 below displays an example of cash flows for an investment. The investment will

have a payback of 2 years as the net cash flows will be zero at that point.

Figure 9: An Investment Cash Flows Example (Firer, et al., 2004:253)

When using this method the time value of money can be included or ignored. When

included the calculation is termed the discounted-payback method and when it is ignored

it’s known as the conventional–payback method. This method is preferred for use on

projects with small investments and has a short period of paying back the initial

investment. This is done to avoid the time and resources consumed by other more

complex methods. The downside of this method is that it assumes that there are no

profits made by the project (Park, 2009:184) and that it doesn’t look at activities of any

future cash flows beyond the breakeven point.

Year

R50 000

3 2 1

0

4

R30 000 R20 000 R10 000 R50 000

Breakeven Point

32

3.4.2 Net Present Value Method

The second method that can be used is the NPV analysis. With this method the idea is to

determine whether an investment is acceptable based on the difference between the

present value of all the net cash flows and the initial cost of the investment. When using

this method, an investment decision should be rejected if the NPV is negative and

acceptable if the NPV is positive.

Since the concept of cash flow discounting is used, an interest rate acceptable to the

organisation should be selected for determining the present value. This interest is

termed either the required rate of return or MARR (Minimum Rate of Return). The NPV

analysis is the preferred method in selecting investment as it has no major flaws.

3.4.3 IRR (Internal Rate of Return) Method

The IRR is the second most popular method closest to the NPV (Firer et al., 2004:261).

This method identifies the rate of return of an investment and compares it to the

required rate of return/MARR set by an organisation. This identified value must be

greater than the pre-identified rate of return for an investment to be acceptable.

3.4.4 Profitability Index Method

The PI (Profitability Index) method looks at the ratio of the benefit and the cost. The

benefit in this case is the present value of all future net cash flows while the cost is the

initial investment (Firer et al., 2004, Pg:273). This method provides an acceptable

investment when the ratio it is greater than 1. It is one of the easier to understand and

has similarities with the NPV analysis method.

33

3.5 Summary

Since costs for differing engineering investment options and systems occur at different

times throughout their life cycle, they can only be compared by reducing them to costs

at a common base date. This is achieved through the process of discounting. This

reflects the real value of an investment in the present day’s context based on these

variables:

The interest earned on an invested instead of asset procurement,

The interest rate available for long term investment in banks,

The interest rate that business would expect as a return, and

The inflation rate that would affect the purchasing power of money.

34

Chapter 4. Life Cycle Cost Analysis

4.1 Introduction

To be able to quantify a systems’ LCC, the economic principles learnt in the previous

chapter needs to be applied to establish the real overall present day investment value.

This value is then taken used in the LCCA process. This analysis process is quite useful

for comparing alternative solutions as these solutions will have varying initial,

maintenance and operating costs.

35

4.2 Life Cycle Cost Analysis

Throughout the systems life cycle there are many decisions that need to be taken. Most

of these decisions (both technical and non-technical) will have significant impact LCC.

Since each problem will have several alternative solutions, a uniform analysis process

should be followed to make the best possible decision. This analysis process has the

following steps:

Define the need for analysis

Develop a cost breakdown structure

Establish the analysis approach

Select a model to facilitate the evaluation process

Identify feasible alternatives

Generate the appropriate data for each alternative being considered

Evaluate the alternatives

Recommend a proposed solution in response to the problem at hand

The LCC tree is shown in the figures below. The acquisition and sustaining costs are in

most cases not mutually exclusive. When a piece of equipment is procured, it must be

maintained in its original working order and that requires funding. These costs are

established by gathering cost data, evaluating the LCC and conducting sensitivity

analysis to identify cost drivers. Both acquisition costs and sustaining costs have

branches which are case dependent (Barringer, 2003:5).

Figure 10: Top Level of LCC Tree

Life Cycle Cost Tree

Acquisition Costs Sustaining Costs

36

Figure 11: Acquisition Cost Tree

Figure 12: Sustaining Cost Tree

Acquisition Costs

Research &

Development Costs

Engineering Data

R&D

Program Management

Engineering Design

Equipment

Development & Test

Non-recurring

Investment Costs

Spare Parts & Logistics

Manufacturing and Operations & Maintenance

Facilities & Construction

Initial Training

Technical Data

Recurring

Investment Costs

Upgrade Parts

Support Equipment Upgrades

System Intergration of Improvements

Utility Improvement

Costs

Green & Clean Costs

Sustaining Costs

Scheduled & Unsched.

Maintenance Costs

Labor, Materials

& Overhead

Replacement &

Renewal Costs

Replacement/Renewal

Transportation Costs

System/Equipment

Modification Costs

Engineering

Documentation Costs

Facility Usage Costs

Energy Costs &

Facility Usage Costs

Support & Supply

Maintenance Costs

Operations Costs

Ongoing Training For

Maint. & Operations

Technical Data

Management Costs

Disposal Costs

Permits & Legal Costs

Allowing Disposition

Wrecking/Disposal

Costs

Remediation Costs

Write-off/Asset

Recovery Costs

Green & Clean Costs

37

4.2.1 Define the need for analysis

Similar to when defining the need in the systems engineering design process, the

operational requirements, technical performance and maintenance concept needs to be

outlined for LCCA.

4.2.2 Development of CBS (Cost Breakdown Structure)

A CBS is a mechanism for initial cost allocation, cost categorisation, and cost monitoring

and control. It is the basis for life cycle cost assessment of all possible alternatives. It

links the objectives and activities with resources, and creates a subdivision of cost by

functional activity area, major system elements, and discrete classes of common items.

Establishing the cost breakdown structure is one of the most significant steps in life cycle

costing. The CBS constitutes the framework for defining life cycle costs.

4.2.3 Selecting the LCC Models

After the CBS is established a costing model needs to be developed to facilitate the life

cycle cost evaluation process. Life cycle costing in itself includes a compilation of a

variety of cost factors, reflecting the many different types of activities indicated by the

CBS. The objective in using a model is to evaluate a system in terms of total life cycle

cost, as well as the various individual segments of cost. Total system life cycle cost is

compiled through the use of economic principles learnt in Chapter 3.

Life cycle cost models are not standard for every application. They are selected based on

the information available and the need for effective evaluations of costs (Dhillon,

2010:43). Some of the useful general life cycle cost models are presented below in no

particular scientific order.

a. Life Cycle Cost Model I - Recurring and Nonrecurring Costs (Dhillon, 2010:44)

This model simply breaks down the LCC into two branches of recurring and nonrecurring

cost. The relationship is defined by:

NRCRCLCC (4-1) Where: RC is recurring costs

NRC is nonrecurring costs

38

The nonrecurring cost includes:

Training

Support

Transportation

Acquisition

Test equipment

Installation

Research and Development

LCC management

Reliability and maintainability improvement

The recurring cost includes:

Inventory

Labour

Maintenance

Operating

Support

b. Life Cycle Cost Model II (Dhillon, 2010:45)

In this model the life cycle cost is divided into 3.

321 CCCLCC

(4-2)

Where:

C1 acquisition costs

C2 initial logistics costs (training, technical data, support equipment modification)

C3 recurring costs (Operating, management and maintenance costs)

c. Life Cycle Cost Model III (LCC Phase Cost – Including CBS) (Dhillon, 2010:46)

This model was developed by the US Navy with the purpose of quantifying LCC of major

weapon systems. Lt is made up of five major cost components and it is expressed as

follows:

LCC = C1 + C2 + C3 + C4 + C5 (4-3)

Where: C1 research and development costs

C2 cost of associated systems

C3 investment cost

C4 termination cost

C5 operation and support cost

39

d. Life Cycle Cost Model IV (LCC Phase Cost – Including CBS) (Dhillon, 2010:47)

This model also is made up of four major cost components and it is expressed as follows:

LCC = Ccp + Cdp + Cap + Cop (4-4)

Where: Ccp denotes costs of the conceptual phase

Cdp denotes costs of the definition phase

Cap denotes costs of the acquisition phase

Cop denotes costs of the operational phase

The definition phase and conceptual phase costs are relatively small as compared with

the acquisition and operational phase’s costs. The definition phase and conceptual phase

costs are essentially labour effort costs related to the design and development of a

system. Acquisition and operational costs represent a major portion of the equipment

LCC. Both Cap and Cop may be subdivided as follows:

Cap includes the cost of program management, cost of personnel acquisition, support

equipment, transportation, testing, production, facilities, documentation, installation,

design and development, initial spares and repair component costs.

Cop includes the cost of maintenance, functional operating expense and operational

administrative expense. The following costs are part of the maintenance cost:

Equipment downtime costs

Cost of personnel replacement

Cost of maintenance manning

Cost of maintenance consumables

Cost of maintenance facilities

Cost of repairs and spare parts

e. Life Cycle Cost Model V (LCC phase cost – Excluding CBS) (Dhillon, 2010:47)

This model is made up of four main cost components is shown below.

rtospcrd CCCCLCC

(4-5)

Where: Crd represent the research and development cost

Cpc represents the production and construction cost

Cos represents the operation and support cost

Crt represents the retirement and disposal cost

40

4.2.4 Cost Model Selection

Selecting the right model to use is in key life cycle costing. The challenge when

selecting a model is the variety of cost data available. So at this point the analysis

should be done using a simple model with a few input requirements. The selected

analytical model should include the following:

It should be comprehensive.

The model design should be straight forward.

It should highlight important factors.

The model should be able to accommodate system characteristic changes.

Any item in the model should be easily evaluated on its own.

The model should be flexible to allow for it to be expanded or modified.

4.2.5 Cost Estimation and Data Generation

With the development of a CBS and a selection of a cost model, data needs to be

generated for the analysis. The requirements of this data may vary based on the depth

of the analysis, the extent at which the system was initially defined and the systems

design phase. During the planning and conceptual stages data is limited. When the

system design progresses and more information becomes available, system

characteristics can be compared with similar existing systems where cost data has been

recorded. There are few ways that one can estimate costs and they are as follows:

1. Expert Opinion Method - When there is no cost data available or there is low

confidence in the data available this method is used. The method uses the

opinions of experts. This expects are people who have years of cost data

experience on the system for which the information is required.

2. Catalogue Prices per Unit Method - With this method a catalogue price is

used. The catalogue is obtained working out the average of historical cost data.

3. Cost Estimation with Specific Analogy - This method draws an analogy of

equipment under study to some earlier similar type of product. It uses the

operating, design, and performance characteristics for predicting costs.

4. Cost-to-Cost Estimation Method - Cost-to-cost estimation looks at a as

percentage of specific product cost and important equipment cost.

5. Non-Cost-to-Cost Estimation Method - With this method the product costs are

estimated as a function of one or more of product parameters such as

performance size, weight or operating characteristics.

(http://www.treasury.nsw.gov.au/__data/assets/pdf_file/0005/5099/life_cycle_costings.

pdf Accessed: 11 July 2012), 2004:5 & Fuller et al., 1996:Chp. 4)

41

4.3 Summary

With the system CBS defined and cost estimating approaches established, it is

appropriate to apply the results data to the life cycle cost analysis. In accomplishing

this, one needs to understand the steps required in developing cost profiles, aspects of

inflation, interest rates, the effects of learning curves, sensitivity analysis and the time

value of money.

42

Chapter 5. LCC vs. Technical Performance

5.1 Introduction

Technical performance measures refer to the quantitatively design and operational

related factors that can be applied in the evaluation of a system. With an objective to

develop a system that will perform its intended function in a cost-effective manner, one

needs to recognise that there are many considerations that need to be made by both

engineering and management alike. Although there are many different levels of trade-

offs performed, the ultimate criterion is cost-effectiveness leading to reduced life cycle

costs.

43

5.2 Technical Performance

Every system is designed and developed to perform a specific function. It must perform

this function as intended in its design and do it economically and effectively throughout

its life cycle (Blanchard, 1990:346). To do so, a set of quantitative measure needs to be

defined while designing the system to ensure operational excellence. The key measures

of a systems performance are reliability, availability and maintainability (Blanchard,

2004:46).

In the mists of it all it mainly comes down to availability from the user’s point of view.

The systems availability (as we will discover through the definition later on) reflects the

extent to which the needs of the user were met, while the reliability and maintainability

are the design engineers key inputs in the selection of equipment, materials and design

architecture to meet the predicted performance during the design phase.

5.2.1 Reliability

Reliability is all about the probability of a system to achieving specified requirements.

This makes it an inherent part of the design process as it was elaborated in Chapter 1

that a system is developed to satisfy a specific need. The definition of reliability stresses

that a system needs to operate under specified conditions, for a given time, and

satisfactorily meet a performance criteria. One can therefore safely say that a system's

reliability consists of 4 main elements namely; probability, time, performance and

operating conditions. (Blanchard, 1990:359-365)

To be able to ensure that these elements are satisfied in operation a few factors needs to

be considered.

a. Design Factors

System operating environment

Equipment rated capacity

Maintenance while in operation

Spares required

Redundant equipment

Simplicity of design

44

b. Maintenance Factors

Preventive maintenance based data analysis

Condition monitoring of equipment to anticipate maintenance needs

Quality of the maintenance task

Skills requirement

c. Operations Factors

Equipment utilisation compared to its rated capacity

Spares stock keeping

Procedures for starting up and shutting down the system

Raw materials selected

All of these reliability factors and elements are measured using this formula:

MTBF

1λwhere

λteR(t)

(5-1)

5.2.2 Availability

Blanchard (2004:46) explains that availability is the key measure of systems'

performance of which it is a function of both reliability and maintainability. Reliability and

maintainability are a function of the inherent design characteristics availability is a

function of what actually occurs in operating the system. This measure has 4 common

FOM’s (Figures of Merit) and they are presented on the next page.

a. Inherent Availability (Ai)

Inherent availability excludes preventive or scheduled maintenance actions, logistics

delay time, and administrative delay time.

ctMMTBF

MTBFiA

(5-2)

b. Achieved Availability (Aa)

Achieved availability excludes logistics delay time, and administrative delay time.

MMTBM

MTBMaA

(5-3)

45

c. Operational Availability (Ao)

Operational availability is defined as the probability of a system to operate satisfactorily

when called upon when used under stated conditions in an actual operational

environment. This is identified using the following formula.

MDTMTBM

MTBMoA

(5-4)

d. Throughput Availability

Throughput availability is the measure of availability that deals directly with production

volume or throughput.

ProductionLost tThroughtpu

ThroughputA p

(5-5)

5.2.3 Maintainability

Maintainability like reliability is an inherent design characteristic of a system and it refers

to the ease, accuracy, safety, and economy in the performance of maintenance actions.

System engineers are concerned with the design and development of a system that can

be maintained in the least amount of time, at the lowest possible cost and resource

requirements without affecting the intended performance of the system. As expressed

by Blanchard (1990:403-410) maintainability has a number of factors which helps design

it into a system.

a. Maintenance Factors

Maintenance philosophy

Cost

Quality of maintenance procedures

Availability of resources to perform a maintenance tasks

Training

Management, supervision, and organizational effectiveness

Availability of maintenance facilities

Effectiveness of test and support equipment

Transport time between maintenance facility and site

46

b. Design Factors

Accessibility

Ease of maintenance

Operating environment

Cost

c. Operations Factors

Troubleshooting process effectiveness

Availability of equipment for maintenance

These factors may be presented as different FOM’s such as:

Figure of Merit Description

M Mean active maintenance time

Mct Mean corrective maintenance time

MDT Maintenance down time

Mpt Mean preventative maintenance time

MTBM Mean time between maintenance

MTBR Mean time between replacements

MTTR Mean time to repair

MTBF Mean time before failure

TAT Turnaround time

LDT Logistics delay time

ADT Administrative delay time

(Source: Blanchard 2004:33-73)

47

5.3 Summary

The approach that the systems engineering process follow is one that ensures that the

final product is operationally fit. This process applies science and engineering in order to

achieve its quantitative objectives. As seen in this chapter, these objectives are

reliability, availability and maintainability.

This chapter has shown that there is a traceable relationship between LCC and technical

performance. The relationship is through the system engineering design process where

costs and performance have trade-offs to find a cost effective solution to meet the

identified need. The figure below explains this point illustrating that as the reliability

increases, the procurement cost increases accordingly. However, the increase in the

reliability decreases the ownership cost.

Figure 13: Relationship between Reliability and Total Cost (Source: Reliability HotWire, 2002:¶7)

Total cost

Ownership cost

Reliability

Procurement cost

Lif

e C

ycle

Co

st

Optimum Reliability

48

Chapter 6. Case Studies

6.1 Introduction

Two case studies were considered for this research. The 2 projects are all from a similar

industry as they involve equipment and systems utilised in the manufacturing of

packaging for FMCG related goods. The purpose of the case studies it to provide practical

circumstance’s where life cycle costs were established and to understand how best

where they managed thorough the life of a system or equipment.

49

6.2 Case Study 1 – Sheet Metal Print Modernization Project

6.2.1 Background

A flat sheet printing facility for aerosol cans established in 1952 had its printing line

installed in 1956. With time and increased demand 4 more machines were installed with

manufacture dates ranging from 1958 to 1972.

In the 1980’s the company decided not to invest in flat sheet printing as it was felt that

it was a trade that was fading. The reality at the time this project was identified was that

despite a global recession the demand for printed flat sheet is on the increase.

Manufacturers of printing equipment have invested heavily with the focus on quick

change high speed technology which meets the requirements of short lead times and

high repeatable quality at the lowest cost. The current volume of printed aerosols is

approximately 40 million units at a value R300 per 1000 cans.

6.2.2 Problem Statement

The printed sheets manufacturer had continued to come under pressure from customers

with regards to lead time reduction, print quality and cost of the print. The major cause

for these customer frustrations is the inability of the manufacturer to meet these

demands. Some multinational customers moved away from printed cans toward sleeves.

They believed this will relieve them of the inflexibility and long lead times from the

manufacturer. Some of the customers left also indicated that they are exploring this

move to sleeves, while the paint customers have moved to plastic containers for the

similar reasons.

With the printing technology changing since the 1950’s to the 1970’s when the machines

were purchased, the following drawbacks were realised by the manufacturer:

Old Technology

New Multi-Colour

Printing Technology Benefits with new technology

Manual Sheet size set. Automated Sheet size

set.

Reduced change time with

accurate setting.

Manual Ink colour

setting.

Computerised Ink

colour setting.

Reduced change time and with

quality consistent, order to order.

Manual machine plate

fitting.

Automated machine

plate fitting.

Reduced change time and damage

to image area.

Manual wash up. Automated wash up. Reduced change time with no

manual adjustment to wash setting

50

Old Technology

New Multi-Colour

Printing Technology Benefits with new technology

Manual registration and

design fitment setting.

Computerised

registration and

design fitment setting.

Reduced change time and set up

waste.

Colour variation grip to

tail.

Colour consistency

grip to tail.

Colour consistency resulting in

higher quality, less can print

variation

Low crank speed. High crank speed. Increased sheets per hour with

accurate registration. Increased

capacity.

Manual water/ink

control.

Automated water/ink

control.

Reduced waste. Improved quality.

High dependency on

printer skill.

Low dependency on

printer skill.

Ability to operate with lower skill

and still ensure quality and speed.

Old technology. Latest Technology. Ability to offer Photographic print.

Table 1: Sheet Metal Printing Old Technology vs. New Technology

6.2.3 Proposed Solution

Doing nothing was an option but not a viable option as it will mean further loss in

printing business. The number of sheet passes in the operation has decreased from 54

million in 2006 to 36 million in the 2009/2010 financial year due to unreliable plant

equipment. And commitments were made to one of the big customers and the

manufacturer stood to lose the printing contribution of about 40 million Aerosol cans if

the commitment is not honoured. This potential loss could mean R6m loss in profits.

The second option was to look at what developments are available in the market. New

technologies were investigated and various suppliers and factories in Europe were visited

to explore the options available. The following Suppliers were visited:

KBA (Germany)

FUJI ex Japan (Wales)

Crabtree (Belgium and UK)

And the following factories where new technology has been implemented:

Print Services in Coburg, Germany (KBA is running for 6 years)

Crown Cork in Antwerp, Belgium (Crabtree installed February 2010)

The conclusion of the various European visits narrowed down the options to two

alternatives namely a second hand KBA (6 colour) or a new 5 colour Crabtree machine.

51

6.2.4 System Description

Second Hand KBA (6 colour) at Print Services (Germany)

The KBA machine has a single grip system with a quite complicated printing

cylinder/printing deck configuration. Once a tinplate sheet enters the machine via its

stream feed table, it travels through a series of cylinders and emerges only at the back

of the Lacquering tower (after deck 6). Only two decks can be changed at a time

(increased change over time), but the colour matching and the fit is very simple. The

KBA machine was developed from a paper press and its ideal for long-running printing

jobs.

Because of the complexity of the KBA, Print Services decided to use KBA as the supplier

to service their machine three times a year. The machine is stopped for a week each

time to allow KBA technicians to service the machine.

New Crabtree (5 colour)

52

The Crabtree Fastready Generation 3 is a high speed metal decorating press and as the

name suggests is a fast change machine. Crabtree has many years of experience in

metal deck printing equipment. The machine is not as complex as the KBA. The sheet

feed and transfer is on a flat tin line.

On visits to evaluate the KBA and the Fastready Crabtree, it became clear that although

there is a place for the KBA machine in metal printing assuming high quality tinplate and

long run orders, this machine would not be recommended for the manufacturer. Tinplate

was sent from South Africa to Germany to trial and this trial failed due to the quality of

available material.

As a result of the above, it was recommended to pursue the New 5 colour Crabtree

(Fastready) option for the following reasons:

The change of a successful project implementation was far greater with the

Crabtree Fastready as the KBA is a far more complex machine.

The KBA is a more expensive option, especially if more production lines are

required in the future.

The Crabtree Fastready was a more familiar technology and it was believed that

operators will make an easy transition to the new technology.

The Crabtree Fastready is more forgiving towards tin-plate quality.

The product change over time for the Fastready was 45 minutes compared to 70

minutes on the KBA.

53

6.2.5 Life Cycle Costing

Summary of project costs (R’000)

1. Crabtree Fastready with 5 Printing decks and FOV R26 277

Freight Cost (Fastready) R1 200

Installation cost (Fastready) R1 000

Removal of old production lines R2 100

Computer to Plate Technology costs R3 693

Civil work for the rest of the assembly R600

Civil work for new Fastready/Air-conditioning R2 500

Buy-off Cost R698

Sub Total R38 068

Contingency @ 7.5% R2 855

Grand Total R40 923

Projects Savings per Annum (R’000)

2. Printing Labour R1 797

Coating Labour R1 402

Installation cost (Fastready) R882

Maintenance Labour R150

Rebuilds R6 000

Electricity R167

Gas R4 542

Spoilage -R107

Consumables R2 607

Sorting R0

Packing R0

Total R17 441

The below table illustrates the maintenance spend per production line. The average

maintenance spend of the last three years (last column) was used in the savings

calculation. Lines highlighted in lightest grey shades represent phase 1, while lines

highlighted in green phase 2.

Printer Modernization (5 Colour Machine) R ‘000.00

Tax Allowance

Year: 1 2 3 4 5 6 7 8 9 10

Plant and Machinery:

a. New Plant 40,923

b. Balance at Beginning of Year 40,923 40,923 24,554 16,368 8,184 - - - - - -

c. Wear and Tear allowance 16,369 8,185 8,185 8,184 - - - - - -

d. Scrapping Allowance - - - - - - - - - -

Total Tax Allowance 16,369 8,185 8,185 8,184 - - - - - -

Written down tax value 40,923 24,554 16,368 8,184 - - - - - - -

Discounted Cash Flow

Year: 1 2 3 4 5 6 7 8 9 10

Net Profit 4,363 14,729 13,604 15,804 15,804 15,804 15,804 15,804 15,804 15,804 Depreciation 1,637 1,637 1,637 1,637 1,637 1,637 1,637 1,637 1,637 1,637 Gross Cash Inflow 6,000 16,366 15,241 17,411 17,411 17,411 17,411 17,411 17,411 17,411 Tax Allowance 16,369 8,185 8,185 8,184 - - - - - -

Taxable Income (10,396) 11,894 11,894 11,895 12,037 12,037 12,037 12,037 12,037 12,037

Tax (3,538) 4,058 4,059 4,059 4,107 4,107 4,107 4,107 4,107 4,107

Capital 40,923

Net Cash Flow (40,923) 8,028 7,979 7,979 7,979 7,930 7,930 7,930 7,930 7,930 7,930

Cumulative Cash flow (40,923) 2,291 2,407 3,158 9,951 9,951 9,951 9,951 9,951 9,951 9,951

Internal Rate of Return 26.35 %

Simple Rate of Return 35.02 %

Payback Period 3.3 Years

Source: Technical Appraisal Document: Anonymous. (Due to confidentiality of the information)

Table 2: LCC for Case Study 1

6.2.6 Conclusion

a. Economic considerations (Interest and inflation)

The achieved payback period in this case study is 3.3 years which is less that the

internally set target of 5 years. And the simple rate of return being 26.35%, this was a

value adding project. This project provided way above inflation results and as such made

a good engineering investment.

b. Costing and analysis

The total manning of the printing department including both direct and indirect

operations employees’ totals 129. With the installation of the 5 Colour Crabtree

Fastready machine the total reduction of heads is 20. The maintenance labour

complement was 23 people and with the implementation of the new printing machinery

only 14 people are needed. In total a 19% reduction in labour costs will be realized.

The data analysed from this case study indicated that since the commissioning of the

new printing system, actual maintenance spent on the new printing machine has been R

57, 345.00 (from February 2012 to September 2012). This compared to the

maintenance costs of the old printing process shown on page 53 is a much lower cost.

Therefore, the costs predicted where close to accurate as the maintenance savings have

been realised. But since the plant is fairly new the accuracy of the costs will be of

interest as the system ages.

c. Technical performance

Complete change over time: 55 minutes from product to product.

22.5 operating Hours per day.

Three shift system.

Days per year: 215. Derived from = 260 - 12 Proofing days – 14 Public Holiday

days – 14 Planned Maintenance days – 5 Annual shut down days.

Resulting productive capacity: 5, 1 million sheets per annum.

Running efficiency: 80%.

Average running speed: 4700 sheets per hour.

56

6.3 Case Study 2 – High Pressure Compressor Replacement

6.3.1 Background

A manufacturing facility produces 130 million Aerosol cans in its diversified factory

ranging in diameter sizes from 52mm to 65mm. Part of the quality offer to customers, is

a promise that every can will be 100% pressure tested. For this, the manufacturer

employs Wilco testers which test each can at a pressure of 10 Bar.

In this manufacturing facility 3 testers are installed. Feeding the three Wilco testers with

compressed air is two Ingersoll Rand compressors, an MU55 and an MU90. The MU55

was bought in 1999/2000 when a 36 head Wilco tester was installed. In 2004 two more

testers where installed and it was at that point the bigger Ingersoll Rand MU90 was

bought to supply the demand for the three Testers.

6.3.2 Problem Statement

In 2004 when the MU90 was new it was able to supply the demand of the three testers,

with the MU55 as standby. It was only on the odd occasion in summer when the

temperature rose above 30 degrees Celsius or when the humidity was above 60%, when

the MU55 was started. The following problems were experienced with the installation:

Both compressors have run up a significant number of hours; the MU55: 59,617

hours and the MU90: 49,349 hours.

Both have undergone two air end overhauls which have reduced their capacity to

only 72% of a new compressor – 15% loss per overhaul. This implies that both

compressors currently run all the time (all year round) with supply problems

during hot summer days - exactly during the aerosol production peak season. A

failure/stoppage of any one of the compressors reduces the supply to the air

testers significantly and results in only one of the three Aerosol assembly lines

being able to run.

Both the MU55 and MU90 is part of the maintenance contract and all services to the

compressors are part of the contract. But additional maintenance necessary to repair

these two compressors has cost additional amounts below since 2007:

Ingersoll Rand MU55: R 87, 000.00

Ingersoll Rand MU90: R 162, 500.00

57

With the main cause of failure identified as being the repair or replacement of the oil

cooler system. It was envisaged that the trend of maintenance cost will continue and

escalate further. Every breakdown interrupted production for as long as 2 days at a

time, as the agents do not hold stock of major spares like coolers. Thus repairs have to

be done instead of replacements. Delivery of coolers is usually 6 to 10 weeks from the

manufacturer.

With both compressors running, spare capacity exits, especially during cooler dry days.

This means that each one is loaded only about 50% of the time. The following illustrates

the loading per compressor as on the 9th of November 2011:

Ingersoll Rand MU55

Total hours: 59,617 hours

On load hours: 25,080 hours

% Loaded: 42%

Ingersoll Rand MU90

Total hours: 49,349 hours

On load hours: 26,218 hours

% Loaded: 53%

Because the manufacturer cannot run one compressor at a time, it means with both

running 50% of the time the compressors are in idling/off-load condition, resulting in

20% energy wastage (conservatively speaking).

6.3.3 Proposed Solution

It was proposed to replace the existing two High Pressure compressors with one new

Variable speed drive compressor. In choosing the correct compressor for the application,

various experts were consulted and the following well known research has been used to

decide on the correct compressor:

Typical Life Cycle Cost of a Compressed Air System

Energy Costs (75%)

Maintenance Costs (10%)

Equipment Acquisition

Costs (15%)

58

6.3.4 System Description

From the above pie-chart one can see that energy cost plays a significant role in the

service life of a compressor. The following comparison was made between three well

know compressor manufacturers, Ingersoll Rand, Atlas Copco and Kaeser compressors:

Manufacturer Compressor

Model

Air delivery

cubic feet per

minute (cfm)

Cost per m3

@ R0.6/kWh

Current Installation MU55 & MU90 433 cfm R0.0884

Ingersoll Rand SSR M110 475 cfm R0.0870

Atlas Copco GA110VCS 535 cfm R0.0787

Kaerser DSD202 SFC 528 cfm R0.0752

One can see that the Kaeser is much more energy efficient and the user will save 1.3

cents/m3. It is estimated that the user consumes 5.76 million m3 per annum. This will

realise a saving of R74 880 per year.

Other considerations in choosing the Kaeser compressor above the Ingersoll Rand/Atlas

Copco compressors are:

A specific drive power can be used to turn a smaller airend at higher speed or a

larger airend at lower speed. Larger, low speed airends are more efficient,

delivering more compressed air for the same drive power. The slightly higher

investment cost of the larger airend is quickly recovered by the energy saved

during operation. Ingersoll Rand and Atlas Copco uses lighter, high speed

airends.

Standard electrical motors are used in Kaeser compressors, which mean it is easy

and quicker to replace because they are available off the shelf. These motors are

also guaranteed for 5 years, while both Ingersoll Rand and Atlas Copco can only

guarantee their specialized motors (unique to them) for 1 year with a lead time of

8 to 16 weeks.

Air delivery from a Kaeser compressor can be matched to actual air demand,

according to required system pressure, by continuously adjusting drive motor

speed (and therefore the airend) with its specific control range. Depending on

the buffer capacity of the downstream air network, the working pressure can be

precisely maintained to +/- 0.1bar. This means the system maximum pressure

can be reduced, which leads to significant savings, as each 1 bar reduction

amounts to 7% reduction in energy cost.

59

6.3.5 Life Cycle Costing

Summary of project costs

1 x Kaeser DSD 202 oil injected rotary screw compressor. R 648 000

1 x Kaeser DC133E heatless adsorption dryer R 305 000

Installation and pipe work Included

5 year guarantee Included

Total R 953 000

Unforeseen Costs 2% R 19 000

Grand Total R 972 000

Project Savings Per Annum

Projected energy savings R 76 500

Maintenance cost maintaining two old compressors R 62 000

Once off cost to overhaul air-end on the MU90 R 90 000

Difference in the maintenance contracts. R 50 000

Total Project Savings Per Annum R 278 500

Project Returns

Equipment Cost R 972 000

Payback Period 3.5 Years

6.3.6 Conclusion

a. Economic considerations (Interest and Inflation)

The achieved payback period in this case study is 3.5 years which is less that the

internally set target of 5 years. With this criterion the project makes financial sense and

is a good investment.

b. Costing and analysis

The costing model for the project took into account the costs from design into operation.

The costs of unanticipated failures and of disposal were not included as they were not

concrete at the point of design and making the investment decision. Saving from the old

system to the newly installed one are very evident proving that the investment decision

was sound. Now with the new system having been installed recently, there are not

sufficient ownership costs to analyse to see if the LCC in the justification of the project

are being met.

c. Technical performance

Improving the efficiency of the production equipment required supplying better quality

air, without rust particles and moisture from compressed air. This means fewer

breakdowns and fewer interruptions to production. The new system does not have leaks

and because of the standard sizes used, the flow of compressed air is better. This means

that fewer compressors will run, saving money on electricity and maintenance costs.

The compressors will also run more efficiently reducing maintenance and increasing their

life span.

61

Chapter 7. Research Findings

7.1 Introduction

At the beginning of this research the following questions were mentioned as being the

fundamental purpose of the literature review and field research:

What are life cycle costs and what are the benefits of costing them?

When and where are costs incurred in a systems life cycle?

What are the key variables in establishing life cycle costs?

How can these variables be better defined to ensure that the life cycle costs are

sustained through the entire life of a system?

Can the engineering inflation be defined and be used instead of the general

inflation rate?

Chapter 7 is a consolidation of the findings for these questions.

62

7.2 What are life cycle costs and what are the benefits of costing them?

LCC's have various interpretations and the details of what they involve differ from case

to case. Ultimately they systematically make a consideration of all relevant costs

associated with the acquiring and ownership of an asset. The costs are established

through an iterative costing process of estimating, planning and monitoring costs and

revenues throughout an asset's life. This process is used in decision making by

evaluating alternative options and performing trade-off studies. The costing process also

known as LCCA is critical in early project stages for evaluating possible solutions, but it

is also applicable to all stages of the a systems life cycle.

The main benefits of life cycle costing as expressed and uncovered in Chapter 1 are

expected to be:

Reduced Ownership Costs – With considerations of operating costs made before

making procurement decisions, the supply industry has taken different approaches to

quality and service. This has benefited the customer/user as now they can realise the

maximum benefits of a selected solution.

The alignment of engineering decisions with business objectives – Engineering

decisions need to be aligned with what the business is aiming to achieve. This will make

sure that the decisions will have fewer consequences on operating costs and revenue.

Reduced risk of operating cost surprises – When new assets are being considered

and there is little information on operating costs, it is important to apply LCC

methodologies which enable high operating cost elements to be identified at an early

stage. The applied LCC methodology will systematically quantify all costs to reduce the

risk of cost underestimation.

The identification of cost reduction opportunities – When compiling a technical

solution for a problem, one looks at the costs as well as the technologies available. With

life cycle costing there needs to be involvements at the point of use with operators to

have first-hand understand to assist in making the correct decisions.

Providing a framework within which to compare options – LCC defines planning

needs and resource requirements to ensure studies are carried out at the right time, to

the right depth and within planned resource budgets and targets.

Providing a mechanism by which major cost drivers can be identified, targeted

and reduced – Having identified the cost drivers of a system, a sensitivity analysis can

be carried out to establish critical areas where improvement will lead to increased cost

effectiveness.

63

Collective Experience – By utilising the collective experience of technical team

members, the best suited option can be selected. This will also allow for valuable

knowledge transfer amongst employees.

7.3 When and where are costs incurred in a systems life cycle?

Life cycle costs are incurred throughout the life of a system. The phases where costs are

experienced are as follows:

Conceptual design phase

Preliminary design phase

Detailed design and development phase

Production and construction phase

Utilization and support phase

Phase out and disposal phase

This cradle to the crave process initially involves systems design costs. These are the

costs which shape the finished products and they enable an opportunity for the overall

cost effectiveness of the system. As shown in the figure below, these costs are

experienced before the actual use of the system and can help determine the optimum

and cost effective solution.

Figure 14: Cost Phasing in System Life Cycle (Figure 2.2 Blanchard, 1990:18 combined with Figure 3.1 Blanchard 2004:82)

The production and construction costs are the beginning of the major part of the LCC

expenditure. These costs are for the procurement and installation of the newly acquired

system. The rest of the costs are for running and maintaining the operation till its use is

terminated.

Conceptual – Preliminary

Design

Detail Design and

Development

Production and/or

Construction

Product use, Phase out, and Disposal

Acquisition Phase Utilisation Phase

Acquisition Costs

Sustaining Costs

Research and development Costs

Production and/or

Construction Costs

Retirement and Disposal Costs

Operation and Support Costs

64

7.4 What are the key variables in establishing life cycle costs?

To be able to achieve this optimum or cost effective solution which was elaborated on in

the previous question, LCCA is conducted. The analysis involves the assessment and

comparison of possible alternative solutions. The process utilised economic principles to

discount future forecasted cash flow to a present value. Then these discounted amounts

are computed in a suitable and predetermined LCC model to summate a comparative

value of applicable alternatives. These involve the costs as broken down in the cost tree

on pages 35 and 36.

Therefore, the key variables involved in life cycle costing will include and involve

elements which will have an impact on the cost tree. These are listed as follows:

Costs (Chapter 4)

Acquisition

Training

Transportation

Test equipment

Installation

Research and Development

LCC management

Support

Labour

Maintenance

Operating

Inventory (Repairs and spare

parts)

Reliability, and maintainability

improvement

Disposal

Economics (Chapter 1 and 3) Technical Performance

(Chapter 5)

Inflation

Interest Rate

Exchange rates

Taxes

Reliability

Availability

Maintainability

Machine Operating Efficiency

Table 3: LCC Key Variables

One of the other key variables is the time period. All of the above measures of merit are

based on a relative time period, therefore making time the key to any life cycle costing

process. Therefore in summary, the key variables can be grouped into 4; namely cost,

economics, technical performance and time period.

65

7.5 How can these variables be better defined to ensure that the life

cycle costs are sustained through the entire life of a system?

a. Costs

To start off, all costs need to be classified and categorised throughout the life cycle

phases using a CBS. The level to which costs in the CBS are broken down will depend on

the objective and scope of LCCA, and the resource availability to conduct the work. In

most cases the CBS will drill down costs to significant levels of activity or with the major

item of material. But ultimately, the CBS must provide management with a sufficient

amount of data to identify high-cost areas.

There are a few methods which can be used to generate the appropriate cost data for

each alternative being considered in LCCA.

Engineering costing – With engineering costing experts opinions are used, and/or a

catalogue price is used and historic capital and operational cost of the system under

assessment.

Analogue Costing This method draws an analogy of equipment under study to some

earlier similar type of product. It uses the operating, design, and performance

characteristics for predicting costs.

Parametric Costing - With this method the product costs are estimated as a function of

one or more of product parameters such as performance size, weight or operating

characteristics. Or a percentage of specific product cost and important equipment cost

are used.

The main purpose of identifying the costs as stipulated above is to make comparisons

amongst alternative solutions to a problem. This is done by selecting a model suitable for

the cost data available. The analysis should be done using a simple yet comprehensive

model with fewer input requirements. The selected model should highlight important

factors and be flexible and be able to accommodate changes in the systems

characteristics.

66

b. Economics

The 4 key economic variables are inflation, interest rates, exchange rates and taxes as

highlighted earlier on. These economic variables are lagging indicators as they cannot be

accurately predicted. They need to be understood in order to make a sound financial

evaluation of the benefits of correct LCC.

The first variable is inflation. This deals with the increase in prices of goods and services.

The inflation rate has not been stable as shown on Figure 1 and Figure 4 in chapter 1.

The graph indicates the volatility of this measure as it is targeted for a figure between

3% and 6%. It has bounced from 5.8% in 2003; to 1.4% in 2004; to 3.4 % in 2005, to

4.6% in 2006, to 5.2% in 2007, to 10.3% in 2008, to 6.16% in 2009, to 5.4% in 2010

and 4.5% to in 2011. Therefore this has had a direct impact on the LCC for many

systems (http://www.eskom.co.za/c/article/143/average-price-increases/ Accessed: 15

October 2012).

Interest rates are a percentage at which lenders borrow money. This figure is internally

decided by the SARB (South African Reserve Bank) periodically based on economic and

financial statistics. These rates affect LCC as money borrowed from financial institutions

is based the interest rate at that point in time of the borrowing. This changes with time

and can be tricky to predict. The best way to manage this uncertainty is for an

organisation to have a higher expected rate of return (known as the IRR) when deciding

on projects to embark on.

As shown in Figure 4, South African currency rises and falls all the time versus the US

dollar which is used as a comparative currency globally. In the global range, South

African currency has been one of the most unstable of the world’s major currencies. This

poses a threat to organisations exporting products that receive payments in dollars or

euros, but pay their employees and suppliers in ZAR. But also for organisations that

import supplies and machinery as the rise in interest rates will force rise in selling prices

i.e. Brand Crude Oil - see Figure 2. Therefore, LCC will be affected by exchange rates as

many of the recurring costs in the cost tree are based on this factor.

With regards to the South African taxes, it is the responsibility of the National Treasury

to advise the Minister of Finance on the tax-policy. Then the Treasury and SARS (South

African Revenue Service) co-operate in compiling the tax policies for the upcoming year.

The taxes that directly affect LCC of a system include income tax, secondary companies’

tax, VAT (Value Added Tax) and capital gains tax. These have an effect on the recurring

costs of LCC due to the uncertainty of the changes of taxes each year.

67

c. Technical Performance

Technical performance is an assessment and monitoring of a system or equipment to see

what is achieved versus the intended design. The measures used are an input to the

design process and they are integrated into the LCC as they not only help meet the

customer’s initial need, but shape the utilization and disposal phases of the systems life

cycle.

To get a firm grasp of the technical performance parameters, the system and equipment

reliability patterns need to be assessed. These patterns are also referred to as Bath tub

curves and an illustration of a typical curve is shown below (Blanchard, 2004:53).

Figure 15: Bath Tub Curve

With the fundamental laws of physics one can safely assume that random events do not

exist. This means that random and unexpected occurrences shouldn’t exist in mechanical

and electronic systems. If and when they do, they appear as failures. Failures in these

systems are not spontaneous but are preceded by some form of a sequence of events.

And events can be predicted by defining and using appropriate measures and models.

To manage the impact of low technical performance, potential system failures are

analysed to understand the causes and the consequences of the failure. Based on the

profiles of the failures, maintenance strategies are put in place. The strategies include

planned maintenance; Condition Monitoring (Predictive maintenance); corrective

maintenance; breakdown maintenance; RBI (Risk Based Inspections) and run to failure.

Constant failure

probability Region

Infant

Mortality

Period

Time

Wear out

Period

Reli

ab

ilit

y

68

Based on these strategies, certain tasks are performed by operational staff, maintenance

staff and external service technicians. The tasks include the following:

Lubrication

Cleaning

Servicing

Inspections

Testing

Condition Monitoring

Restorations or overhauling

Discarding

Design modification

In support of the execution of these tasks, all the logistics needs to be in place. They

includes trained and skilled personnel, spares inventory, facilities to execute repairs and

maintenance, communication and Information systems, reliable transportation, handling

equipment, test and support equipment, technical data and maintenance plans.

Some of the known measures and indicators which can be used for performance

measurement include the following:

Aa – Achieved Availability

Ai – Inherent Availability

Ao – Operational Availability

ADT – Administrative delay time

LDT – Logistics delay time

M – Mean active maintenance time

Mct – Mean corrective maintenance time

MDT – Maintenance down time

Mpt – Mean preventative maintenance time

MTBM – Mean time between maintenance

MTBR – Mean time between replacements

MTTR – Mean time to repair

MTBF – Mean time before failure

TAT – Turnaround time

λ – Failure Rate

69

7.6 Can the engineering inflation be defined and be used instead of the

general inflation rate?

The value of money erodes over time as a result of increases in the prices of various

goods and services. This erosion has been coined as inflation. This phenomenon also has

an effect on engineering systems as they have a cost element for acquiring and keeping

them operational. The difference between the change in the prices of engineering good

and general goods is the rate of inflation applicable. For general good one needs to

understand the CPI, while with engineering goods also need to take a closer look needs

to be taken towards the PPI.

It is important to note that not all cash flow increases for engineering systems and

equipment are as a result of general inflation. There are cost increases due to wear and

tear, increased labour skills, material demand, changes in logistics support capabilities,

energy/electricity consumption and initial estimate inaccuracies. So when preparing cash

flows for LCC purposes over a life of a system, the interest used must cover these costs.

This is done by evaluating the general inflation rate represented by

1N

1NN

CPICPICPIf

,

and the market interest rate represented by '' iffii to get to a specific inflation

which will look at the changes in prices of an engineering item.

70

Chapter 8. Conclusions & Recommendations

8.1 Introduction

From the literature review and the two case studies in this research, it was clear that the

life cycle costing processes associated with the systems engineering phases (Conceptual

design, preliminary design, detailed design and development, production and

construction, operation and disposal) are well defined and understood. There was a lack

of supporting evidence to show that when a system is in use (utilization phase), there is

still emphasis on maintaining the predefined LCC. And having established that most of

the systems’ LCC will be experienced during operation phase, it is imperative to be able

to sustain and manage them.

To attempt to keep the notion of having value in establishing life cycle costs of a system

(Chapter 2 sections 2.2 and 2.3) before making decisions on which alternative to select,

a management system is developed to ensure continuity of managed LCC post the

acquisition and project implementation phase. This is a necessity on the basis that the

economic environment constantly changes and it has a direct impact on operating costs

of many systems.

71

8.2 Management of Life Cycle Costing

8.2.1 Objectives

The purpose of putting together a LCC management programme is to maintain and

potentially exceed the cost effectiveness of an investment decision made on a system or

equipment. It forms part and parcel of the business environment requirement of

continuously eradicates financial risks. For such a programme to have meaning and for it

to succeed, senior management of an organisation will need to endorse it. This will help

in clarifying the role of LCC management as part of the organisations goals and

objectives, and the importance thereof will need to be communicated throughout the

organisation.

8.2.2 Planning

A LCC management plan needs to be in place for organisations with significant asset

investments in order to ensure that the above objective is achieved. The plan should

outline all life cycle cost management activities and milestones anticipated to be

necessary throughout an assets' (system or equipment) life. The plan should cover the

following:

Resources required

Training needs for the organisational resources

Data collection activities

Specific requirements for tools to be used

Technical performance management processes and activities

Requirements for monitoring and audits

8.2.3 Organisation

After LCC are made a priority by adopting them as part of the organisations objectives,

the need for clarifying roles and responsibilities arises. Those that have a part to play in

managing LCC must be identified and informed of the responsibilities assigned to them.

There also needs to be either a team or individual who shall be assigned the role of co-

ordinating LCC for the organisation. Policies and Procedures for LCC will also need to be

established to govern the entire programme and to provide a means to evaluate if the

objectives of LCC management are being met. The actual LCC management

organisational structure will differ from organisation to organisation based on resources

available and benefit to be gained.

72

8.2.4 Calculation of Life Cycle Costs

During the selection of alternatives in the systems engineering process LCCA is followed

as a method to objectively make a technically and economically informed decision. Once

the initial calculations have been carried out as part of the LCCA during the project

implementation, there will be a need to assess the actual LCC result after each period.

So during actual operation the LCCA needs to be followed through by continuously

assessing and managing the costs as they form part of the original of the investment

decision.

To do the follow on analysis, the future values of all the recurring and nonrecurring costs

will need to be established based on current costs and the anticipated inflation and

interest rates. Where the analysis shows that a single cost element dominates the

calculation it may be necessary to break this down into sub-elements. The idea with the

calculation is to establish a LCC to use as a means of budgeting for a system. This will

form the basis for the yearly cost control. Inputs required into the calculation are listed

below.

The operating period and profile

The utilisation factors

All the cost elements

The critical parameters that affect the equipment’s life cycle costs

Costs at current prices

Inflation and interest rate

With this information, all costs will then be discounted and the discounted costs summed

up. The discounting process will take all relevant current costs and provide a future cost

which will be influenced by potential economic fluctuations which have been accounted

for. This LCC calculation for reviewing and realigning yearly budgeting can be viewed as

follows:

)]i (C)i (Ci))(1CCC(C[LCC jLjE LE

N

PMOCFactorn Utilizatio (8-1)

Where;

LCC = Life Cycle Cost for one cost cycle (Year)

N = 1 Year

CC = Annual Capital expenditure (Systems upgrades and modifications)

CO = Operation expenditure (fixed value or variable)

CM = Maintenance and repair costs

CP = Lost production costs (Downtime, quality defects and idle time)

73

CE = Energy costs (Gas, diesel, petrol, coal and electricity)

CL = Logistic Support costs

i = annual market discount rate

jEi = specific discounting rate for energy

jLi = specific discounting rate based on PPI

8.2.5 Monitoring

In order to ensure that the management system is effective, an annual assessment will

need to be carried out. The purpose of the assessment is to ensure that planned LCC are

maintained and control measures are adequate. This assessment should be in a form of

an audit which is appropriate for the corrective actions required to meet LCC targets. As

to when, how and who conducts the audit it will be at the discretion of management

based on available resources.

a. Audit Scope

The audit needs to be executed in 2 distinct sections namely financial and utilisation

review aspects. The financial aspect needs to focus on the actual cash flows and item

costs associated with a system or equipment while the utilisation aspect will look at the

operating and maintenance practices. The 2 aspects of the audit are detailed as follows.

1. Finance

Summary of the LCC

Fluctuation in inflation and interest rates

Actual costs vs. Forecasted Costs

Validity and of the interest calculations

Spares stock volumes

Spares costs

2. Utilisation

Equipment Efficiency (Availability)

Maintenance effectiveness

Spares utilisation

Operating and maintenance personnel skills levels and training requirements

Quality of inputs (Electricity, water, chemicals, raw materials, etc.)

Availability and quality of maintenance facilities

Effectiveness of test and support equipment

Transport time between maintenance facility and site

74

b. Deliverables of the Audit

The outcomes of the Auditing process should include the following:

An assessment report that identifies specific gaps between the current LCC

program and best practices

Analysis of the relevance and effectiveness of LCC models used

Asset Reliability Management gaps

Summary of recommendations

Prioritized action plan

8.2.6 Controlling

As systems and equipment ages, their reliability reduces and to improve it or maintain it

more costs will be incurred. This makes the reliability management curtail in ensuring

that the LCC are maintained as per the forecast done using the LCC calculations/models.

To bring more control from a reliability point of view, reliability engineering principle and

practices will need to be introduced.

a. RCM (Reliability Centred Maintenance)

In order to have a systematic and logical way of controlling the reliability of a system,

the very well-known theory of RCM needs to be employed. With the application of RCM,

the failures which could potentially result in higher LCC will be managed by together a

set of system and equipment maintenance strategies. The strategies must be honoured

by continuously monitoring execution and reviewing their effectiveness.

b. FMECA (Failure Mode, Effects and Criticality Analysis)

To decide on which maintenance strategy is best suited for the each type of failure

FMECA need to be carried out. The FMECA will assist to identify the root cause of a

failure for every maintenance significant item by analysing the failure cause and effect.

Based on the criticality and frequency of failures, the analysis will lead to a selection of

tasks or activities to prevent the failure form occurring, and subsequently eliminate

unplanned, high maintenance costs.

75

c. Continuous Improvement Process

To support the effectiveness of the FMECA and to ensure that there is continuous system

improvement, a failure reporting and corrective action system needs to be in place.

FRACAS (Failure reporting, analysis and corrective action system) is a platform for the

collection of data, record and to analyse system failures. This is done in a close loop

process as displayed below, to ensure failures do not recur and that there is continued

improvement.

d. Training and Succession Planning

To be able to execute the reliability and improvement plans above a skills labour force is

a necessity. All identified labour resources need to be competent to execute their job

requirements. This will require a comprehensive training programme to ensure that

critical activities are executed effectively.

To ensure continuity and to sustain corporate memory, there needs to be sharing of

learning’s. To gain value from this, there needs to be people being trained in the

requirements and competencies of all identified critical jobs. This will ensure that there

will not be interruptions in the delivery of a reliable system environment even if the

appointed person is no longer in their job.

Process Analysis

Process Control

Performance Improvement

Figure 16: Double Loop Reliability Management Process

76

e. Performance Management

In order to align the organisations goals and priorities with the resources available, a

performance management structure needs to be in place. This will help in ensuring that

individuals and groups within the organisation know what is expected of them and to

ensure that they take responsibility to ensure that costs are met and that systems

operate at their optimum.

f. Process Capability Studies

In industrial engineering, processes are monitored by use of an approach called

statistical quality control. This allows identification of areas of waste and put together

plans for improvement. This will be of value to engineering systems as if done regularly

the need for engineering improvements will be identified before costs of running

escalates.

8.3 Conclusion

LCC has been established to be a never ending journey. Therefore management

processes which provide the necessary tools to engineer in order to manage costs of

ownership and decision making is crucial.

In conclusion, the following key outcomes of the study are noted:

Each system or equipment needs to be treated as being unique to eliminate

assumptions towards life cycle costing.

The systems engineering phase is the most critical as this is where life cycle costs

are established.

The LCC models selected during LCCA needs to be appropriate.

LCC needs to be continually managed and maintained.

Competency is important in establishing LCC and maintaining it. Therefore,

personnel appropriately skilled for the task are critical to the success of this

process.

Management processes need to be implemented to ensure that the LCC are

adequately controlled throughout the systems life cycle.

Life cycle costing encourages the consideration of alternative reliability

management strategies by evaluating their impact on the systems LCC.

Inflation plays a real and significant role in LCC and cannot be ignored when

discounting cash flows.

77

Bibliography

1. 36 year gold price history in US Dollars/ounce. Available from:

http://goldprice.org/gold-price-history.html#10_year_gold_price (Accessed 15 August

2012)

2. Barringer, P. (2003). A Life Cycle Cost Summary. Conference proceedings of the

International Conference of Maintenance Societies (ICOMS®-2003). Conducted by the

Maintenance Engineering Society of Australia. Perth: Engineering Society.

3. Blanchard, B.S. (2004). Logistics Engineering and Management. 6th Edition. New

Jersey: Pearson Prentice Hall.

4. Blanchard, B.S. & Fabrycky, W.J. (1990). Systems Engineering and Analysis. 2nd

Edition. New Jersey: Pearson Prentice Hall.

5. Brent Crude Oil Price (2000 to 2010). Available from:

http://www.shell.com/home/content/bitumen/risk_marketing/ (Accessed 16 August

2012).

6. Bienen H.S. & Gersovitz M. (1985). Economic Stabilization, Conditionality, and

Political Stability. International Organization 39(4):729-754. Available from:

http://www.jstor.org/stable/2706721 (Accessed 09 October 2012).

7. Currency Exchange Rate of US Dollars vs. South African Rand. Available from:

http://www.tradingeconomics.com/south-africa/currency (Accessed 15 August 2012).

8. Dhillon, B.S. (2010). Life Cycle Costing for Engineers. Boca Raton: Taylor and

Francis.

78

9. Eskom’s average tariff adjustment for the last 15 years. Available from:

http://www.eskom.co.za/c/article/143/average-price-increases/ (Accessed 15 October

2012).

10. Financial Stability. (n.d.). Available from:

http://www.resbank.co.za/Financial%20Stability/Pages/FinancialStability-Home.aspx

(Accessed 09 October 2012).

11. Firer, C., Ross, S.A., Westerfield, R.W. & Jordan B.D. (2004). Fundamentals of

Corporate Finance. 3rd Edition. Berkshire: McGraw Hill.

12. Fuller, K.S. & Petersen, R.S. (1996). NIST Handbook 135: Life Cycle Costing Manual

for the Federal Energy Management Program. Washington: U.S Government Printing

Office.

13. Gitman, L.J. (2009). Principles of Management Finance. 12th Edition. Boston:

Pearson Prentice Hall.

14. History of the South African Inflation Rate. Available from:

http://www.tradingeconomics.com/south-africa/inflation-cpi (Accessed 16 August 2012).

15. HSRC (Human Science Research Council). (2008). The Impact of Electricity Price

Increases. Available from:

http://www.hsrc.ac.za/research/output/outputDocuments/5687_Altman_Theimpactofele

ctricitypriceincreases.pdf (Accessed 15 October 2012)

16. Kothari, C.R. (1985). Research Methodology - Methods and Techniques. New Delhi:

Wiley Eastern Limited.

79

17. Kumar, R. (2005). Research Methodology - A Step-by-Step Guide for Beginners. 2nd

Edition. Singapore: Pearson Education.

18. New South Wales Treasury. Total Asset Management. Life Cycle Costing Guide,

TAM04-10. (September 2004). Available from:

http://www.treasury.nsw.gov.au/__data/assets/pdf_file/0005/5099/life_cycle_costings.p

df (Accessed 11 July 2012).

19. Park, C.S. (2009). Fundamentals of Engineering Economics. 2nd Edition. New Jersey:

Pearson Prentice Hall.

20. Ramakumar, R. (1993). Engineering Reliability: Fundamentals and Applications.

New Jersey: Pearson Prentice Hall.

21. Reliability Hot Wire: The eMagazine for the Reliability Professional. Using Reliability

Information Throughout the Organization. Issue 13. (March 2002). Available from:

http://www.weibull.com/hotwire/issue13/hottopics13.htm (Accessed 16 October 2012).

22. University of Johannesburg. (2008). Reference Techniques: Harvard Method and

APA Style. 2nd Edition. Available from:

http://www.uj.ac.za/EN/Library/Documents/REFERENCE%20TECHNIQUES%202008%20

Harvard%20Method%20and%20APA%20Style.pdf (Accessed 09 October 2012).

23. Van Tender, B.J.E. (1993). RSA-MIL-PRAC-175, Life Cycle Cost Management of

Complex Systems. Pretoria: Armscor.