Asset Management: A Life Cycle Costing Approach.
Rupin Soti
Grontmij Netherland BV
Harry Habing
Grontmij Netherland BV
Population growth and economic development have led to a steady increase in travel demand,
which has in turn ...
Grontmij has identified certain key concepts in its AM approach. One such approach is Life
Cycle Management (LCM).
Figure ...
8. Re-evaluate design strategies.
Step 1 - Establish alternative pavement design strategies for the analysis period.
Once ...
the end of the analysis period, Residual value and salvage value can generally be considered
mutually exclusive.
User cost...
Step 6 - Compute LCC
For LCCA, costs occasioned at different times must be converted to their value at a common
point in t...
value will actually occur. Therefore, while a deterministic LCCA approach provides
considerably more information about the...
Issues with LCCA
1. Performing a LCCA is resource and time intensive.
2. LCCA is data sensitive and thus the result depend...
directly related to physical parameters and can therefore not be determined applying LCCA
model. However, Cost Benefit Ana...
• The Handbook of Highway Engineering (T F Fwa).
• US Department of Transportation – Federal Highway Administra...
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  1. 1. Asset Management: A Life Cycle Costing Approach. Rupin Soti Grontmij Netherland BV Harry Habing Grontmij Netherland BV Summary It is a well known fact that transport infrastructure is vital to economic well being of a nation. And today companies (active in highway construction and management business) faces many challenges like: matured networks, increased accountability and public expectations. To cope up with these challenges, we see a world-wide trend towards a more structured approach to the management of road assets. Grontmij wants to explore the opportunities to move more into the direction of managing agent for highways, or in other words to be more active in asset management in the future. Also with fast changing business landscape, the company is getting larger projects which have a major maintenance element attached to it. The objective of this paper is to show Grontmij Asset Management approach within which we introduce the concept of Life Cycle Costing Analysis Keywords: Asset Management, Life Cycle Cost Analysis, Grontmij Netherlands B V
  2. 2. Introduction Population growth and economic development have led to a steady increase in travel demand, which has in turn led to accelerated deterioration of highway asset conditions and increased concerns over congestion, safety, and the environment. Consequently, there has been an increased pressure to upgrade physical asset conditions and to improve system operations within a constrained budget. The combination of mentioned factors along with ever growing public expectations has created a strong motivation towards aligning the business practices to a more structured performance oriented asset management framework. Further, it is observed that very often a parochial view on new businesses or contracts in highway industry may result in ineffective actions best characterized by short term cost advantages but long term costly decisions. A typical example in the highway engineering industry is, the Purchasing department tends to buy lower grade equipment to get favorable purchase price variances, Engineering division avoids specifying cost effective, redundant equipment needed to accommodate expected costly failures so as to meet capital budgets and Maintenance department defers required corrective/preventive actions to reduce budgets, and thus long term costs increase because of neglect for meeting short term management gains. In addition factors like environmental effects and social effects are mot catered to. Management is responsible for harmonizing these potential conflicts under the banner of operating for the lowest long term cost of ownership. The glue binding these issues together is a teamwork approach for minimizing Life Cycle Cost. The first part of this work contains introduction to Asset Management concept. Part II introduces the concept of Life Cycle Cost Analysis with detailed description and the paper concludes with comments on the future trends and outlook. I – Asset Management The concept of Asset Management has been around for many years, changing form to include changes in the operating environment. The focus earlier was more on the construction of new assets with maintenance & management of existing assets being a low priority. Recently, with increasing demand the focus has changed to maintenance and life extension with highway agencies being held more responsible and has to be cost effective to be in the market using Asset Management principles. There exist many definitions of the term Asset Management as transportation companies and agencies continuously keep refining the concept to meet specific need of the organization. Following are a few commonly used definitions: “A systematic process of maintaining, upgrading and operating assets, combining engineering principles with sound business practice and economic rationale, and providing tools to facilitate a more organized and flexible approach to making the decisions necessary to achieve the public’s expectations.” (International Organization for Economic Cooperation and Development) “A strategic approach to the optimal allocation of resources for the management, operation and preservation of transportation infrastructure” (Federal Highway Administration, USA). “Asset management may be defined as a comprehensive and structured approach to the long- term management of assets as tools for the efficient and effective delivery of community benefits.” (Austroads, Australia) “Asset management is a comprehensive process that allocates funds effectively and efficiently among competing pavement, structure, and other infrastructure needs.” (Transportation Association of Canada, Canada)
  3. 3. Grontmij has identified certain key concepts in its AM approach. One such approach is Life Cycle Management (LCM). Figure 1: Grontmij Asset Management approach Life Cycle Management is the application of life cycle thinking to modern business practice, with the aim to manage the total life cycle of an organization’s product/services. It is the umbrella concept that integrates a variety of fundamentals, methods and tools from qualitative (life cycle thinking) to quantitative tools (Life Cycle Cost Analysis). The following section will introduce and elaborate this quantitative tool. II - Life Cycle Cost Analysis Remember the adage attributed to John Ruston: “It’s unwise to pay too much, but it’s foolish to spend too little”—this is the operating principle of Life Cycle Cost Analysis. As per NEN-ISO 15686-5 (Building & constructed assets – Service life planning – Life cycle costing), Life cycle costing is the “methodology for systematic economic evaluation of life cycle cost over a period of analysis, as defined in the agreed scope.” The concept of LCC is also defined in the International Standard IEC 60300-3-3 (Dependability management – Application guide – Life cycle costing) with the same definition as above but the code is more applicable for factory produced products. As per the Transportation Equity Act for the 21st Century (TEA-21) of US Federal Highway Authority, LCCA is "a process for evaluating the total economic worth of a usable project segment by analyzing initial costs and discounted future costs, such as maintenance, user costs, reconstruction, rehabilitation, restoring and resurfacing costs, over the life of the project segment." The following steps are involved for conducting highway LCC Analysis: 1. Establish alternative pavement design strategies for the analysis period. 2. Determine performance periods and activity timing. 3. Estimate agency costs. 4. Estimate user costs. 5. Develop expenditure stream diagrams. 6. Compute net present value. 7. Analyse results.
  4. 4. 8. Re-evaluate design strategies. Step 1 - Establish alternative pavement design strategies for the analysis period. Once decided to undertake the project, the first step is to establish different design alternatives to be compared. At least 2 mutually exclusive options must be considered. Each competing alternative, if properly designed, must be a viable pavement structure that is both constructible and cost effective for that type and life of pavement. The alternatives being evaluated must provide equivalent improvements or benefits. For example, comparison of 20-year and 40- year rehabilitation alternatives or comparison of new construction of flexible or rigid pavement alternatives is valid because the alternatives offer equivalent improvements. Conversely, comparing pavement overlay to pavement widening, rehabilitation work to new construction, or rehabilitations at different project locations do not result in equivalent benefits. Each of these alternatives is to be clearly defined. Initial construction or a major rehabilitation of an asset is only the first of these activities; other activities like periodic maintenance and succeeding rehabilitation are required for the alternative to provide a desired level of performance throughout its life. Different project alternatives will likely require different maintenance and rehabilitation activities. The identification of maintenance and rehabilitation activities should be based on our past practices, study, and company’s policies. We know that, transportation assets are constructed to provide service for many years. Competing design alternatives may each have a different service life, which is the time period that the asset will remain open for public use. Life-cycle cost analysis (LCCA), however, uses a common period of time to assess cost differences between these alternatives so that the results can be fairly compared. This time period is termed the “analysis period.” In other words, the analysis period is the period of time during which the initial and any future costs for the project alternatives will be evaluated. Step 2 - Determine performance periods and activity timing. Once the component activities for all competing project alternative have been identified, each alternative’s maintenance and rehabilitation plan is developed. The mentioned plan will result in a schedule of when the future maintenance and rehabilitation activities will occur, when agency funds will be spent, and when and for how long the agency will establish work zones. LCCA requires that the series of maintenance and rehabilitation activities forecasted for each improvement strategy be as accurate as possible because the expenses associated with these activities can account for a sizeable portion of a project’s total LCC. The timing of rehabilitation activities should be based on existing performance records such as those available from the earlier mentioned asset management system. This information may be supplemented with findings from outside research such as the national long-term pavement performance effort. Other data are available from local, regional, and national sources. When actual data are unavailable or not applicable, the judgment of experienced engineers may be particularly useful. Step 3 & 4 - Estimate Cost In general, life-cycle cost of pavement is usually categorized into three major components: agency cost, user cost and external cost. Agency cost is the cost directly paid by the company for the project, which includes expenditures for preliminary engineering, contract administration, the initial construction/rehabilitation, all future maintenance costs of pavement and salvage value or residual value. It is important here to note that, residual value is different from salvage value. Residual value exists only if the alternative will continue in operation after the end of the analysis period, whereas salvage value requires termination. Salvage value is obtained only when some actual value is realized from the sale or reuse of scrap materials. When applied at
  5. 5. the end of the analysis period, Residual value and salvage value can generally be considered mutually exclusive. User costs are social costs incurred by the asset users. Best-practice LCCA calls for including both the costs accruing to the transportation agency, described above, and costs incurred by the traveling public. Since a construction activity (new or major rehabilitation) restricts normal working operations causing speed changes, stops, delays, detours, and incidents, it results in some user costs. User costs include vehicle operating costs, User delay costs (or travel time costs), and crash costs. They are based on predicted traffic volumes, stage construction, traffic handling, user delay cost rates, and additional vehicle operating costs. User costs are related to project activities but are an indirect cost (not born directly by the company). Incorporating user costs into LCCA enhances the validity of the results, but at the same time is a challenging task. External costs pertain to the remaining indirect costs incurred by the non-user public. Its boundary is not well defined, but pollution damage cost, noise-pollution cost, agricultural crops damage from pollutants and visibility losses are examples of external costs. They are referred to “externalities” of road construction that are not reflected in market prices but incurred by the non-user public. Step 5 - Develop expenditure stream diagrams Expenditure stream diagrams are then developed to assist the analyst in visualizing the expenditure’s quantity and time of occurrence which are anticipated over the life of the analysis period. An expenditure diagram (see Figure 2) depicts a design alternative’s (1) initial and future activities; (2) agency and user costs associated with these activities; and (3) the timing of these activities and costs. The horizontal-axis shows the timing of the work zone activities and the periods of normal operations between them while the vertical-axis shows the activity costs. Upward arrows on the diagram are expenditures with the relative costs reflected in the length of each arrow. The RSL value (or the salvage value, if case the asset is to be terminated) is represented as a downward arrow and reflects a negative cost accruing at the end of the analysis period. Figure 2: Expenditure Stream diagram
  6. 6. Step 6 - Compute LCC For LCCA, costs occasioned at different times must be converted to their value at a common point in time. We know that the value of money changes over time due to at least the following two factors: Inflation and Discount rate. Inflation indexes are available for every possible products and services and thus can be used to generate the results more realistically. In our research of various LCC analyses, a 3-6 % discount rate was used representing the prevailing rate of interest on borrowed funds minus the inflation rate. For calculating, a number of techniques based on the concept of discounting are available. We will consider the two most commonly used methods, the present value (PV) approach (also known as “present worth”) and the equivalent uniform annual cost (EUAC) approach. Either method is suitable as a measure of LCC. Present Value - The PV approach brings initial and future dollar costs to a single point in time, usually the present or the time of the first cost outlay. Net Present value is calculated as follows: NPV = Initial cost + All future costs x (1/1+ r)n where, r = real discount rate. n = no. of years in the future when the cost will be incurred. The term (1/1+ r)n is also known as the discount factor. Equivalent Uniform Annual Cost Analysis - The equivalent uniform annual cost (EUAC) analysis method produces the yearly costs of an alternative as if they occurred uniformly throughout the analysis period. The present value (PV) of this stream of uniform annual costs is the same as the PV of the actual cost stream. EUAC is another way to look at the results of a life-cycle cost analysis. Whether PV or EUAC is used, the decision supported by the analysis will be the same. The decision to use EUAC or PV is up to the analyst. Further, there are two approaches to preparing an LCCA: deterministic and probabilistic. The difference between the two methods is in the way they address the variability and uncertainty associated with LCCA input parameters such as activity cost, activity timing, and discount rate. Deterministic Approach- The deterministic approach assigns each LCCA input variable a fixed, discrete value. It is the analyst’s job to determine the value most likely to occur for each input parameter. This determination is usually based on historical evidence or professional judgment. These input values are used to compute a single LCC estimate. Traditionally, applications of LCCA have been deterministic ones. A deterministic LCC computation is straightforward and can be conducted manually using a calculator or automatically with a spreadsheet. However, it fails to convey the degree of uncertainty associated with the PV estimate. The results of deterministic analysis can be enhanced through the use of a technique called sensitivity analysis. This procedure involves changing a single input parameter of interest, such as the discount rate or initial cost, over the range of its possible values while holding all other inputs constant, and estimating a series of PVs (output values). Each PV result will reflect the effect of the input change. In this way input variables may be ranked according to their impacts on the bottom-line conclusions. This information is important as it helps to understand the variability associated with alternative choices. It also allows the company to identify those input factors or economic conditions that warrant special attention in terms of their estimation procedures. Deterministic sensitivity analysis is not well suited to measuring the impact that a simultaneous change of several inputs would have on a particular LCCA outcome. In addition, it does not give any information on the likelihood that a selected input
  7. 7. value will actually occur. Therefore, while a deterministic LCCA approach provides considerably more information about the economic reasonableness of a project than just its initial cost, it does not offer decision-makers a complete picture of the expected PVs. Probabilistic Approach - With deterministic LCCA, discrete values are assigned to individual parameters. In contrast, probabilistic LCCA allows the value of individual analysis inputs to be defined by a frequency (probability) distribution. For a given project alternative, the uncertain input parameters are identified. Then, for each uncertain parameter, a sampling distribution of possible values is developed. Simulation programming randomly draws values from the probabilistic description of each input variable and uses these values to compute a single forecasted PV output value. This sampling process is repeated through thousands of iterations. From this iterative process, an entire probability distribution of PVs is generated for the project alternative along with the mean or average PV for that alternative. The resulting PV distribution can then be compared with the projected PVs for alternatives, and the most economical option for implementing the project may be determined for any given risk level. Probabilistic LCCA accounts for uncertainty and variation in individual input parameters. It also allows for the simultaneous computation of differing assumptions for many different variables. It conveys the likelihood that a particular LCC forecast will actually occur. Step 7 - Analysis of result Now that LCCs of alternatives are calculated, the next step is analyzing and interpreting the results. Since deterministic approach results in a single PV while probabilistic LCC yield a distribution of results, the analysis procedures are different. Analysis of Deterministic LCCA results - The most basic analysis of a deterministic LCCA is to compare the agency and user cost PVs among alternatives. However, this comparison does not address the uncertainty contained in those outputs. As noted above, application of sensitivity analysis can reveal where analysis results may be subject to uncertainty. Deterministic sensitivity analysis is helpful in determining the “most likely” scenario where the selected input values are most likely to occur (based on objective data or expert opinions). Analysis of Probabilistic LCCA results – With Probabilistic LCCA results one can attempt to model and report on the full range of possible PV outcomes. It also shows the estimated likelihood that any given outcome will actually occur. Step 8 - Revaluate design strategies. Finally, a review of the results is done to determine if any adjustments or modification is required before zeroing on an alternative. Adjustment can be some minor design change, new defined work zone criteria or alternate traffic plans. Major advantages of using LCCA In addition to the benefits mentioned earlier, the following are some advantages of using LCCA: 1. Since it uses familiar unit, money, in calculation it is easy for decision-makers to evaluate. 2. Since LCCA takes whole life cycle perspective, road managers can more reliably assess alternative preservation strategies and thus promotes innovation. 3. Typically in an organization, accounts department only wants to maximize projects NPV, maintenance engineer’s only criteria is to minimize repair costs while the stakeholders want to increase wealth. With the whole life cycle perspective, LCCA helps resolving these internal conflicts within an organization.
  8. 8. Issues with LCCA 1. Performing a LCCA is resource and time intensive. 2. LCCA is data sensitive and thus the result depends largely on quality of input data. Although transportation companies do collect data of their assets and its repairs, but specific data for example, long term maintenance data may not be directly available. Moreover, it is due to this dependence on accurate and precise data, LCCA can be manipulated and can also be used as a sales tool. 3. LCCA is a tool for comparing alternatives and it is not a tool for budgeting. It is based on estimates and current & future spending power of money. 4. There exist uncertainty around assigning engineering and economic values to input data and the resulting outputs. This is an issue because the level of confidence that decision-makers have in the analytical results is based upon their faith in the accuracy and precision of the data used to generate them. LCCA in practice Various LCCA methodologies exists, few of them are listed below: • LCCA model of Fabrycky & Blanchard • LCCA model of Woodward • Activity Based Costing (ABC) model • Economic Input Output (EIO) LCA model • Design to Cost (DOC) model • Total Cost Assessment (TCA) model In the US since the early 1990s, FHWA has encouraged a policy of encouraging the use of LCCA for transportation decision. Many states’ Department of Transportation (DOTs) have incorporated LCCA in their respective pavement selection method. LCCA can be performed in the following ways: 1. Using an Excel spreadsheet function. This is beneficial only when dealing with small product/service system. 2. Using dedicated LCCA software. Many such software solutions are available in the market today like RealCost (developed by FHWA, USA), RELEX Life Cycle Cost (developed by PTC Corp, USA). 3. Once an organization has developed the expertise, they may decide to develop their own software. Even though it gives a lot of scope for customization it is very resource intensive. Future Prospects and Conclusion Since the last decade, researchers have begun to utilize the risk-based life-cycle cost analysis approach to establish mathematical expectations of highway project benefits. For example, Tighe (2001) performed a probabilistic life-cycle cost analysis of pavement projects by incorporating mean, variance, and probability distribution for typical construction variables, such as pavement structural thickness and costs. Setunge et al. (2005) developed a methodology for risk based life-cycle cost analysis of alternative rehabilitation treatments for highway bridges using Monte Carlo simulation. Reigle et al. (2005) incorporated risk considerations into the pavement life-cycle cost analysis model. As per Li & Madanu (2008), use of Shackle’s model overcomes the limitation of inability to establish the mathematical expectation of possible outcomes of all input factor for project level life-cycle benefit/cost analysis. There is also the concern that the customer value performance and features is not
  9. 9. directly related to physical parameters and can therefore not be determined applying LCCA model. However, Cost Benefit Analysis in the form of a questionnaire can indicate the value that customers attach to a change in performance or feature level. The LCCA technique provides a structured approach to evaluating design alternatives and thus managing assets. It addresses not only the initial costs of a project, but the timing, and resources required for future rehabilitation and maintenance activities since it focuses on project life cycle. LCCA also allows in quantifying and comparing the effects of different project implementation options on highway users, who experience significant costs due to congestion and safety issues associated with work zones. Thus, it would be right to say that LCCA gives the means of identifying the most cost-effective investment options and optimally manage the assets. This remains a primer work on the mentioned concept and further research is required for its implementation within the organization.
  10. 10. References • The Handbook of Highway Engineering (T F Fwa). • US Department of Transportation – Federal Highway Administration ( • Highway Project Level Life Cycle Benefit/Cost Analysis under certainty, risk and uncertainty: A methodology with case study (Li and Madanu). • Economic and Environmental Evaluations of Life Cycle Cost practices : A case study of Michigan DOT Pavement Projects (Arthur Wai Cheung Chan) • Road Network Asset Management as a Business Process, Florentina Mihai, Neville Binning & Laurie Dowling, 2000. • Life Cycle Costing for Construction, J W Bull, 1993 • Life Cycle Cost Analysis in Pavement Design – In Search of Better Investment Decision US FHWA 1998.