Maryam Mirhadi, Ph.D., VMA
Amin Terouhid, Ph.D., CVS
Executive takeaway. The alternative with the lowest initial costs does not necessarily provide the lowest total cost or the best value. A sound value engineering (VE) comparison first confirms that each alternative performs the required functions at an acceptable level. It then evaluates the resources each alternative will consume over an appropriate period. Life-cycle cost analysis places costs occurring at different times on a common economic basis so owners can reasonably compare alternatives.
Begin with function and performance
VE is a structured process for improving value by analyzing required functions and developing alternatives. SAVE International’s Value Methodology places function, or the main purposes that a system aims to serve, at the center of the analysis. [1]
Initial costs are the cost required to design, purchase, install, test, or place an alternative into service, whereas life-cycle cost (LCC) is the total cost of acquiring, operating, maintaining, replacing, and disposing of an asset over a defined period. A future dollar is not economically equivalent to a dollar spent today. Therefore, life-cycle cost analysis (LCCA) can be used as an economic method to calculate and compare those costs. Before performing LCCA, the team should confirm functional equivalence, that the alternatives provide the same required functions or at an enhanced level, and satisfy the owner’s minimum performance criteria.
Test the assumptions, not only the arithmetic
An LCC result is only as reliable as its inputs. Owners should document the source, timing, and uncertainty of each cost. Energy prices, operating hours, maintenance labor, component life, replacement scope, loss of service, and price escalation may change the ranking. As such, sensitivity analysis can be used to perform the systematic testing of how results change when uncertain inputs vary. By varying service life, energy cost, or the discount rate, the team can identify the conditions under which the preferred alternative changes.
It is important to note, however, that not every important factor can be priced reliably. Nonmonetized effects can still be evaluated without assigning a dollar value. Examples may include factors such as reliability, occupant comfort, operational continuity, safety, adaptability, environmental performance, and stakeholder impacts. These effects should be documented and evaluated alongside LCC. A lower LCC is not a sound recommendation if the alternative impairs a required function or creates unacceptable performance risk.
Recommendations for owners
As a professional recommendation, owners should confirm functional equivalence and minimum performance; define a common analysis period, base date, and cost basis; and include all relevant costs including acquisition, operation, maintenance, replacement, loss-of-service, and disposal costs. They also need to use current owner-approved economic assumptions; document data sources and uncertainty; test influential variables; and report initial costs, LCC, and nonmonetized effects separately to ensure a reasonable LCCA can be performed for reasonably assessing and comparing alternatives. This approach makes the reasoning transparent and keeps VE focused on the life cycle costs, not initial costs of alternatives.
References
[1] SAVE International. About the Value Methodology.
[2] Federal Highway Administration. Life-Cycle Cost Analysis.