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May 2007
Final Methodology
Life Cycle Costing(LCC) as acontribution tosustainable
construction: acommonmethodology
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Contents
Tables and figures ............................................................................... i 0 Introduction ......................................................................................... 1 1 STEP 1: Identify the main purpose of the LCC analysis .................... 10 2 STEP 2: Identify the initial scope of the LCC analysis ....................... 13 3 STEP 3: Identify the extent to which sustainability – and specifically
environmental – analysis relates to LCC ...........................................17 4 STEP 4: Identify the period of analysis and methods of economic
evaluation.......................................................................................... 20 5 STEP 5: Identify the need for additional analyses (risk/uncertainty and
sensitivity analyses) .......................................................................... 26 6 STEP 6: Identify project and/or asset requirements – confirm key
parameters........................................................................................ 33 7 STEP 7: Identify options to be included in the LCC exercise ............ 38 8 STEP 8: Assemble cost and time data to be used in LCC analysis ... 40 9 STEP 9: Verify values of financial parameters and period of analysis46 10 STEP 10 (Optional): Review risk strategy and carry out preliminary
uncertainty/risk assessment ..............................................................49 11 STEP 11: Perform required economic evaluation. ............................ 50 12 STEP 12: Carry out detailed risk/uncertainty analysis (if required) ... 55 13 STEP 13: Carry out sensitivity analysis (if required) ......................... 58 14 STEP 14: Interpret and present initial results in required format....... 61 15 STEP 15: Present final results in required format and prepare a final
report. ...............................................................................................63
Annex A: Sample tabular and graphical outputs from typical LCC exercisesAnnex B: Bibliography and references
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Tables and figures
Tables
1 Summary and overview of steps2 Typical applications of LCC3 Impact of risk on decision-taking4 Generic cost classification and check list5 Factors affecting durability6 Examples of the application of LCC analysis
Figures
1 Core process of LCC2 Methodology flow diagram3 Risk management cycle4 Common tools and techniques in risk/uncertainty analysis
5 Probability matrix6 Calculation of NPV7 Risk profile in histogram form8 Risk profile in cumulative form9 Spider diagram10 Spider diagram with contour lines11 Sample project data table12 Sample annual expenditure table13 Sample table of key parameters14 Sample tabulation of total cost profile15 Sample LCC model
16 Sample component replacement cost build-up17 Sample cost profile chart18 Sample cost profile chart19 Sample cumulative cost chart20 Sample component option appraisal cost chart
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0 Introduction
0.1 Background
In 2006 the European Commission appointed Davis Langdon from the UK to undertake aproject
(1) to develop a common European methodology for Life Cycle Costing (LCC) in
construction.
The origins of the project lay in the Commission’s Communication ‘The Competitiveness of
the Construction Industry’ and, more specifically, in the recommendations of the
Sustainable Construction Working Group established to help take forward key elements of
the Competitiveness study. These recommendations proposed that a Task Group (TG4) be
established to prepare a paper on how Life Cycle Costing could be integrated into European
policy making. The Task Group’s paper(2)
recommended the development of a common
LCC methodology at European level, incorporating the overall sustainability performance
of building and construction.
The project was undertaken in recognition that a common methodology for LCC in
construction is required across Europe in order to:
Improve the competitiveness of the construction industry
Improve the industry’s awareness of the influence of environmental goals on LCC
Improve the performance of the supply chain, the value offered to clients, and clients’
confidence to invest through a robust and appropriate LCC approach
Improve long-term cost optimisation and forecast certainties
Improve the reliability of project information, predictive methods, risk assessment and
innovation in decision-making for procurement involving the whole supply chain
Generate comparable information without creating national barriers and also considering
the most applicable international developments.
0.2 Purpose of this methodology
It was recognised early on in the research process that LCC is applied in various ways and
with differing parameters across the EU, and that a single prescriptive methodology would
not be appropriate. Therefore this document provides a methodological framework for the
common and consistent application of LCC across the EU without attempting to replace
country-specific decision models and approaches. It identifies the key considerations to be
taken into account at each stage in the LCC process and provides practical guidance on the
application of LCC in a number of common scenarios. It is aimed primarily at public sector
construction clients and their project advisors, but can also be used by private sector clients
and their advisors, and by contractors.
0.3 Using this methodology
LCC may be applied in a wide range of circumstances in construction, for example in a
project to invest in:
A single complete constructed facility such as a building or civil engineering structure
An individual component or assembly within a facility
A portfolio comprising a number of facilities.
LCC may also be applied in the context of existing constructed assets, for example as a
means of assessing future operational budgets or for evaluating refurbishment and renewal
options.
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The period of analysis adopted for an LCC exercise may similarly vary. LCC may be
employed to inform decisions throughout the complete life cycle of a constructed asset or
for a selected limited period within it. However, irrespective of how or when LCC is
applied, the core evaluation process as summarised in Figure 1 below remains the same.
(1): Life cycle costing (LCC) as a contribution to sustainable construction: a common methodology’ No. 30-CE-0043513/00-47.(2): Task Group 4: Life Cycle Costs in Construction; Version 29 October 2003, Enterprise Publications, European Commission.Endorsed during 3
rd Tripartite Meeting Group (Member States/Industry/Commission) on the Competitiveness of the
Construction Industry.
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Figure 1: Core process of LCC
Defining the objective of the proposed LCC analysis
Preliminary identification of parameters and analysis
requirements
Confirmation of project and facility requirements
Assembly of cost and performance data
Carry out analysis, iterating as required
Interpreting and reporting results
The purpose of the LCC analysis as defined in the first step in Figure 1 will determine the
scope and detail of subsequent steps. To be effective, the process should be undertaken
collaboratively between all key stakeholders in the project.
The LCC process is essentially iterative, both in the context of assessing options for a
decision at a specific point and of repeating the analysis at future points in the life cycle of a
project in the light of increasingly detailed information or changing client requirements.
The methodology does not seek to represent these potential iterations, rather it takes the
user through a series of numbered steps that follow a logical train of thought, as shown onthe flow diagram included as Figure 2 below.
The steps in this methodology are not intended to reflect the actual chronology of a project
to invest in a constructed asset. The accompanying guidance note contains a series of
practical case studies that will assist the user in applying the methodology steps to the time
line of an actual project.
Figure 2 below summarises the methodology steps as a flow diagram. The following 15
sections of this document relate to the individual steps in the methodology and are
numbered accordingly.. Section 0.4 below provides an overview of the outcomes for the
user as a result of taking each step.
A number of steps relating to uncertainty and risk are optional and shown to be taken if
required, because their application depends on early decisions at Step 5, concerning the
extent to LCC analysis will be supported by risk/uncertainty analyses.
The steps generally use a vocabulary appropriate to a project to construct a facility but the
essential principles set out are entirely applicable to any constructed asset.
The methodology assumes that the user comes to it with a project in view for which the
purpose, scale and initial capital cost have been broadly defined.
The approach to the development of the LCC methodology was inspired by the Engineering
Design Process (EDP). This is a structured decision-making process (often iterative), used
in the development of engineering systems, components or processes to meet desired needs.
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Among the fundamental elements of the design process are the establishment of objectives
and criteria, synthesis, analysis, construction, testing, and evaluation. These broadly defined
stages can be further subdivided into a more detailed process, which includes identifying a
need, defining the problem, conducting research, narrowing the research, analysing set
criteria, finding alternative solutions, analysing possible solutions, making a decision,presenting the product, and communicating and selling the product. EDP is a well known
and established framework used world-wide, therefore applying it to the development of the
methodology ensured that there were no omissions of any activities and that a logical
sequence of steps was maintained.
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Figure 2: Methodology flow diagram
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0.4 Overview of outcomes
Table 1 below summarises the outcomes that can be expected on completion of each of the
steps in the methodology. Note that Steps 10, 12 and 13 are optional.
Table 1: Summary and overview of Steps
STEP OUTCOME / ACHIEVEMENT
1 Identify the mainpurpose of the LCCanalysis
Statement of purpose of analysisUnderstanding of appropriate application of LCC andrelated outcomes
2 Identify the initial scopeof the analysis
Understanding of:Scale of application of the LCC exerciseStages over which it will be applied
Issues and information likely to be relevantSpecific client reporting requirements
3 Identify the extent towhich sustainabilityanalysis relates to LCC
Understanding of:Relationship between sustainability assessment and LCCExtent to which the outputs from a sustainabilityassessment will form inputs into the LCC processExtent to which the outputs of the LCC exercise will feedinto a sustainability assessment
4 Identify the period ofanalysis and themethods of economicevaluation
Identification of the period of analysis and what governs itschoiceIdentification of appropriate techniques for assessinginvestment options
5 Identify the need foradditional analyses(risk/uncertainty andsensitivity analyses)
Completion of preliminary assessment of risks/uncertaintiesAssessment of whether a formal risk management planand/or register is requiredDecision on which risk assessment procedures should beapplied
6 Identify project andasset requirements -
Definition of the scope of the project and the key featuresof the assetStatement of project constraintsDefinitions of relevant performance and qualityrequirements
Confirmation of project budget and timescalesIncorporation of LCC timing into overall project plan
7 Identify options to beincluded in the LCCexercise and cost itemsto be considered
Identification of those elements of an asset that are to besubject to LCC analysisSelection of one or more options for each element to beanalysedIdentified which cost items are to be included
8 Assemble cost and time(asset performance andother) data to be usedin the LCC analysis
Identification of:All costs relevant to the LCC exerciseValues of each costAny on-costs to be appliedTime related data (e.g. service life/maintenance data)
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9 Verify values offinancial parametersand period of analysis
Period of analysis confirmedAppropriate values for the financial parameters confirmedTaxation issues consideredApplication of financial parameters within the costbreakdown structure decided
10 Review risk strategyand carry outpreliminary uncertainty/risk analysis
Schedule of identified risks verifiedQualitative risk analysis undertaken – risk register updatedScope and extent of quantitative risk assessmentconfirmed
11 Perform requiredeconomic evaluation
LCC analysis performedResults recorded for use at Step 14
12 Carry out detailedrisk/uncertainty analysis(if required)
Quantitative risk assessments undertakenResults interpreted
13 Carry out sensitivityanalyses (if required)
Sensitivity analyses undertakenResults interpreted
14 Interpret and presentinitial results in requiredformat
Initial results reviewed and interpretedResults presented using appropriate formatsNeed for further iterations of LCC exercise identified
15 Present final results inrequired format andprepare a final report
Final report issued, to agreed scope and formatComplete set of records prepared to ISO 15686 Part 3
0.5 Tailoring the methodology to the specific project circumstances
It is important to note that in practice it will often be possible for users to combine several
of the above steps in order to tailor the methodology to the size of the project, the project
stage and the level of detail required. For example, Steps 1 to 6 are concerned with
defining the objectives and the analysis parameters. On smaller projects this definition
exercise might typically take the form of a meeting or telephone discussion with the client
and/or an exchange of correspondence. Similarly, the risk and sensitivity analyses might be
incorporated into the economic evaluation exercise (Step 11) based on a small number of
agreed parameters and/or the practitioner’s experience of common risk issues. Regardless
of the scale or scope of the exercise, the guiding principle should always be that the key
issues identified in this methodology are all considered, albeit at a level of detail
appropriate to the particular exercise.
0.6 Definitions
This methodology is intended to be compatible with ISO 15686 Part 5 which is currently at
the DIS ballot stage and is likely to be adopted shortly. Definitions used in this
methodology are therefore as in ISO 15686 Part 5. For ease of use, key definitions are
reproduced below.
Life Cycle Costing
A technique which enables the systematic appraisal of life cycle costs over a period of analysis, as
defined in the agreed scope.
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Life Cycle Cost
Assessment expressed in monetary value taking into account all significant and relevant costs over
the life cycle, as defined in the agreed scope. The projected costs are those needed to achieve definedlevels of performance, including reliability, safety and availability over the period of analysis.
Life Cycle
Consecutive and interlinked periods of time between a selected date and the disposal of the asset,
over which the criteria (e.g., costs) are assessed. This period may be determined for the analysis
(e.g., to match the period of tenancy or ownership) or cover the entire life cycle. The life cycle period
shall be governed by defining the scope and the specific performance requirements for the particular
asset.
Nominal Cost
Expected price which will be paid when a cost is due to be paid, including estimated changes in price due to, for example, forecast change in efficiency, inflation or deflation and technology
Real Cost
Cost expressed as a value as at the base date, including estimated changes in price due to forecast
changes in efficiency and technology, but excluding general price inflation or deflation
Discounted Cost
Resulting cost when the real cost is discounted by the real discount rate or when the nominal cost is
discounted by the nominal discount rate
Discount Rate
Factor reflecting the time value of money that is used to convert cash flows occurring at different
times to a common time
NOTE This may be used to convert future values to Present Day Values and vice versa.
Nominal Discount Rate
Rate used to relate present and future money values in comparable terms taking into account the
general inflation/ deflation rate
Real Discount Rate
Rate used to relate present and future money values in comparable terms, not taking into account the
general or specific inflation in the cost of a particular asset under consideration
Net Present Value
Net Present Value is the sum of the discounted future cash flows. Where only costs are included this
may be termed Net Present Cost (NPC)
Present Day Value
Monies accruing in the future that have been discounted to account for the fact that they are worth
less at the time of calculation
Sensitivity Analysis
Test of the outcome of an analysis by altering one or more parameters from initial value(s)
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Residual Value
Value assigned to an asset at the end of the period of analysis.
0.7 Relationship with ISO 14040
It is important to note that the ISO 15686 definition of the term ‘life cycle’ differs from that
used in the environmental standard, ISO 14040. The latter adopts a broad ‘cradle to grave’
definition of life cycle, whereas the ISO 15686 definition can represent either ‘cradle to
grave’ or a shorter economic analysis timeframe driven by the specific client or project
needs.
The ISO 14040 definition of life cycle feeds into that of life cycle assessment (LCA) as
follows:
Life cycle
Consecutive and interlinked stages of a product system, from raw material acquisition or generation
of natural resources to the final disposal.
Life cycle assessment
Compilation and evaluation of the inputs, outputs and the potential environmental impacts of a
product system throughout its life cycle.
This methodology aligns with the ISO 15686 definition of life cycle. However, for the
purposes of consistency, users applying LCC to evaluate the outcomes of an LCA analysis
may wish to align with the broader ISO 14040 definition of life cycle. Further specific
public sector guidance on the appropriate parameters for carrying out an LCC analysis is
provided in the guidance note that accompanies this methodology.
0.8 Companion documents
This methodology is accompanied by a guidance note and a set of case studies of the
common use of LCC in Europe. The guidance note is aimed at public sector clients and
provides an introduction to LCC along with guidance on why it should be used, its benefits,
the information to be gained from it, and its relationship with the EU procurement
framework. The case studies are included as an appendix to the guidance note.
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1 STEP 1: Identify the main purpose of the LCC analysis
1.1 Purpose of this step
LCC is a versatile technique capable of being applied for a range of purposes and atdifferent stages in the project or asset life cycle. The purpose of this step is to clearly
identify the purpose of the proposed LCC analysis and to gain an understanding of how it
can be appropriately and successfully applied and of the outcomes that can be expected.
1.2 Purposes for which LCC may be employed
The purposes for which LCC may be employed can be divided into, in two broad
categories:
As an absolute analysis, when used to support the processes of planning, budgeting and
contracting for investment in constructed assets
As a relative analysis, when used to undertake robust financial option appraisals, for
example in relation to potential acquisition of assets, design approaches or alternative
technologies.
More specifically, LCC can be used to support decision-making in a number of ways:
In assessing the total cost commitment of investing in and owning an asset, either over
its complete life cycle (“cradle to grave”) or over a selected intermediate period
By improving understanding of the total cost of an asset, particularly by construction
clients, and improving the transparency of the composition of these costs
By facilitating effective choices between different means of achieving desired
objectives, for example reducing energy use or lengthening a maintenance cycle
By helping to achieve an appropriate balance between initial capital costs and future
revenue costs
In helping to identify opportunities for greater cost-effectiveness, for example selection
of components with a longer service life or reduced maintenance requirements
As a tool for the financial assessment of alternative options identified during a
sustainability analysis, for example components with less environmental impact or
HVAC systems with greater energy efficiency
Overall, by instilling greater confidence in decision-making in a project.
LCC can be employed throughout or at different stages of the life cycle of an asset or a
project to invest in construction; this is considered in detail at step 2.
Some examples of common applications of LCC follow below in this section to furtherillustrate these points.
1.3 Typical applications of LCC
Table 2 below illustrates how LCC can be applied in a variety of circumstances, with
examples drawn from a building development. The same principles apply in an
infrastructure or engineering context. The successive stages in the whole life cycle of a
scheme and the related need for decisions are considered in more detail in section 2
following. More detailed examples are provided in the Guide that accompanies this
methodology.
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Table 2: Typical applications of LCC
Context and need Typical application of LCCDuring investment planning, clientswill need to understand the full costimplications of operating as well asbuilding the scheme, to establish itsessential viability.
The analysis will be based on approximatedata, typically historical information fromsimilar projects, but sufficient for budgetingand option ranking to allow a decision onwhether to go ahead, to reduce the schemeor stop.
During the early stages of schemedesign, decisions will be required onthe fundamental elements –structure, envelope, services,finishes
The analysis can draw on feasibility studiesand pre-project professional advice, as wellhistorical information, to support decisions onthe key features of the scheme – its size,scope, method of construction and operation.
By detail design stage, the essential
cost parameters of the scheme willbe determined but decisions will stillbe required on details and whether,finally, to commit to construction.
Information can now be fed into the analysis
based on a clear view of all primary elementsof the scheme and access to related cost,service life and maintenance data frommanufacturers’ specifications, as well assimilar projects and national price books.This allows a detailed LCC breakdownconfirming the viability of the scheme andappraisal of detailed design options.Sensitivity and risk analyses may also becarried out.
Detailed design also requires finalselection of materials, componentsand systems. Potentially, similar
decisions will subsequently berequired in the event of theirreplacement during operation andmaintenance
LCC analysis can be focused on the specificcomponent or system with the benefit ofrelated cost, service life and maintenance
data from manufacturers’ specifications, aswell as from similar projects and nationalprice books. The main focus will be onoption evaluation, ranking and selection.
During the operation of thecompleted asset refurbishment andrenewal of some elements might berequired, driven by (for example):High operational costsHigh energy consumptionObsolescence (for example:physical, technical, economic,social)
Change in use of the assetComponents or systems reachingthe end of their service life
LCC can be applied in supporting selection ofthe most appropriate refurbishment orrenewal option, at either an asset orcomponent level. The analysis can be basedon historic or benchmark data, or on detaileddata derived from manufacturers’specifications and comparable cost-in-usedata. It is essential that the analysis takesinto account the impact on interdependent
systems and the overall asset.
1.4 The need for clarity of objectives
The different purposes for which LCC may be employed, and the different stages of the
asset life cycle at which it is used, imply the need for different levels of detail and accuracy
in the process, and in the inputs and outputs. For example, if LCC is employed to support
an early budgeting process, all relevant costs must be considered and the analysis may be
based on approximate data such as historic benchmark information. As the LCC analysis is
subsequently refined during the detailed design stages, further detail will be required on all
cost items, along with robust service life and maintenance data. The process may also need
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to support auxiliary outputs such as an estimate of resources or a reporting schedule to
provide all necessary support for decision-making.
If the primary purpose is to appraise options, the process of iteration will involve refining or
eliminating the available alternatives as they are measured against project objectives and
budget constraints. This process will include identification of those cost elements that do
not have a significant impact on the overall LCC or which do not vary between the
alternatives. These elements can be then be eliminated from further consideration.
Accordingly, clearly defining the objectives of a proposed LCC analysis must be seen as an
essential first step in ensuring that it will be fit for the user’s purpose.
1.5 The ingredients for success
Successful application of an LCC approach requires:
A team approach incorporating all key players in a project
Integration of the LCC exercise into the whole investment decision-making process
through the conception, design, construction and operation of a facility
Recognition that the robustness of the outputs of the LCC exercise is highly dependent
on the level of detail and certainty in the cost and time inputs used
Clear definition of scope and consideration of all relevant parameters (note that scoping
issues are covered in Step 2)
Recognition of the limitations of the techniques employed, leading to the proper exercise
of professional judgement.
1.6 At the end of Step 1
At the end of Step 1 the user will have developed:
A clear and comprehensive statement of the purpose of the proposed LCC analysis An understanding of how LCC analysis can be appropriately and successfully applied
and the outcomes that can be expected.
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2 STEP 2: Identify the initial scope of the LCC analysis
2.1 Purpose of this step
In step 1 the broad purpose and outcomes of the LCC exercise were identified. For theoutcomes to be achieved it is also important to identify the scope of the exercise, including
the stage(s) in the asset life cycle at which it is undertaken, the boundaries of the analysis
and whether there are any specific inclusions or exclusions.
2.2 The scale of application of LCC
LCC analysis may be undertaken to support a project to invest in:
A single complete constructed asset that comprises a usable facility such as a building or
civil engineering structure
An individual component , material or system within such an asset
A portfolio comprising a number of assets
For clarity, this methodology assumes the scenario of a project to construct and use a single
asset, but the same principles and basic processes apply whatever the scale of application of
LCC.
The scale of application for a proposed LCC analysis will be defined by the client, in the
light of the objectives defined as discussed in section 1 above.
2.3 Stages in the life cycle of an asset
For the purposes of this methodology the life-cycle of an asset is divided into the following
stages:
Investment planning, pre-construction
Design, construction
Operation, maintenance
End of life / disposal
Activities in the investment planning / pre-construction phase might typically include:
Business case preparation
Acquisition of site(s) or of existing asset(s)
Professional consultancy
Inspections and surveys
Arranging finance
Assembling the project team / consortium Procurement planning
Activities in the design and construction phase might include:
Scheme design
Detailed design
Site clearance
Placing contracts for construction
Construction of the fabric
Fitting out
Commissioning and handover
Landscaping
Activities in the operation and maintenance phase might include:
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Employing an FM team or placing an appropriate contract
Placing contracts for energy supply and other utilities
Arranging insurances and compliance with regulatory requirements, eg inspections
Planning and carrying out pre-planned (cyclical) maintenance and replacements
Carrying out unplanned (responsive) maintenance and replacements Planning and carrying out pre-planned refurbishment and/or adaptation (such works may
be better considered as separate projects subject to their own LCC considerations)
Cleaning
Redecoration
Grounds maintenance.
Activities in the end of life/disposal phase might include:
Sale of asset
Change of use of asset
Demolition
Site and land clearance and clean up Recycling of materials
A proposed LCC analysis might take place over one or more or all of these stages, as
discussed below. Its purpose must be defined by the client, in the light of the objectives
defined at step 1.
2.4 Use of LCC through successive stages.
LCC analysis can be used either as a one-off intervention to a project or, in a broader
context, to inform different decisions at different stages of the project or asset life cycle. In
the latter case, input data is progressively refined as the project moves through successive
stages. Accordingly, as calculations are based on increasingly detailed and reliable data andinitial assumptions are tested and validated, early strategic decisions are confirmed and
subsequent decisions taken at increasing levels of detail.
2.4.1 Investment planning / pre-construction
Decisions at planning / pre-construction stage are of a strategic nature relating to the
essential features of the proposed project, with data typically input at a low level of detail.
They typically cover the following considerations:
The essential features of the proposed scheme
Methods of investment appraisal
Finance – costs, budgets, cash flow, funding sources
Procurement policy and methods
Balance between economic, technical and sustainability considerations
Risk management strategies and techniques
Key project drivers and overall priorities.
The application of LCC at this stage in the in the project might include:
Identification of the purpose(s) of using LCC, both at this stage and in subsequent stages
Incorporating LCC requirements into business case, project documentation and supply
chain terms of reference
Identification of methods of analysis, required outcomes and reporting formats
Identification of required analysis period and/or design life for the proposed facility
Consideration of cost drivers, including capital v operating cost priorities
Use of LCC as an assessment criterion in project approval/gateway processes
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Use of LCC in assessing initial strategic project options such as whether to refurbish or
build new.
2.4.2 Design and construction
Design and construction is a broad stage with design decisions taken successively throughthree levels:
Scheme level, fixing the basic physical characteristics of the facility
System level, deciding the major installations and assemblies
Detail design.
The level of detail in the LCC analysis typically increases progressively though these levels
and its purpose and implementation should be kept under review as it is reiterated. LCC
considerations through this stage typically include:
LCC impact of high level design decisions such as format, composition, orientation and
layout of the proposed asset
Selection of components, materials and systems and assessment of their costs over thelife cycle (or part thereof)
Life cycle costing of sustainability options identified as part of a sustainability
assessment process
Assessment of future operating costs of the facility and its constituent parts
Contractual framework, both for construction and future operation and maintenance
Resource implications during the operational stages
Need for and ease of functional reconfiguration / adaptation during operation
Any planned replacement / refurbishment during operation
Ease of carrying out future maintenance, replacement and refurbishment, including
health and safety implications
Impact of future LCC works on the use and users of the asset
2.4.3 Operation and maintenance
The opportunities and need for LCC analysis continue into the operation and maintenance
stage and might typically relate to:
Cost and performance drivers during operation and maintenance
Assessment of options in relation to component replacements, refurbishment, adaptation
Financial framework and funding of LCC works, including use of sinking funds
Denial-of-use costs, whether loss of amenity or contractual penalties (such as in PPP or
other FM contractual payment mechanisms)
Strategies and planning for operation and related cost models:o FM
o Energy
o Other utilities
o Cleaning
o Waste disposal and recycling
Strategy and planning for maintenance, repair and replacement works:
o Contractual framework and responsibilities (for example in-house delivery or
outsourcing of some/all activities)
o Maintenance planning and management systems (including use of condition-based
monitoring)
Collection and use of feedback data
Risk allocation for operation, maintenance and finance costs
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2.4.4 End-of-life / disposal
LCC considerations at the end-of-life stage might include:
Strategy for disposal, including methods, costs, residual values
Evaluation of alternative uses of the facility
Evaluation of options for demolition and site / land clean up, including methods, costs
Strategy for salvage and recycling – opportunities, costs, potential value
Collection and use of feedback data
2.5 Identification of analysis boundaries
It is important during the early scoping exercise to identify the broad boundaries of the LCC
analysis, including:
Whether the analysis period is to include the entire asset life cycle or a defined part
thereof (see Step 3 below)
What costs (and revenues) are to be included or excluded from the analysis (for example
the client’s contractual or financial interest in the asset may require certain costs to beexcluded)
Whether there are particular project, contractual, regulatory or economic issues that will
influence key criteria (such as analysis period, method of economic evaluation) that are
to be defined in future steps.
2.6 Identification of analysis outputs
The required outputs and reporting format of the LCC analysis should be agreed in broad
terms at this stage. Clients may require the detailed analysis and/or the summary findings
to be presented in a particular format to suit their internal reporting processes or those of an
external regulatory or funding body. Early identification enables the user to address theseissues before the analysis has been undertaken, thereby eliminating unnecessary reworking
of reports at a later stage. LCC consultants often use in-house software with standard report
formats that might require amendment. Note that detailed reporting issues are considered in
Steps 14 and 15 of this methodology.
2.7 At the end of Step 2
At the end of step 2, the user will have developed a clear understanding of:
The scale of application of the LCC exercise
The stage(s) of the project or asset life cycle over which it is likely to be undertaken
The scope and nature of the issues and information likely to be relevant.
Any specific client reporting requirements that require early consideration.
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3 STEP 3: Identify the extent to which sustainability – and
specifically environmental – analysis relates to LCC
3.1 Purpose of this stepEnvironmental sustainability is becoming a key consideration in any long term assessment
of constructed assets. The relationship between LCC and sustainability assessment and the
extent to which the latter forms an input to the LCC analysis is defined at this step.
3.2 Assessing sustainability
Practitioners recognise three fundamental and interlinked sets of issues within the
‘sustainability’ agenda:
Environmental – relating typically to air quality, land use, use of natural resources (raw
materials, energy, water, waste etc), transportation, biodiversity, cultural heritage, etc.
Social – relating typically to access, amenity, user comfort and satisfaction, community
health and welfare
Economic – relating typically to opportunities for employment, skills development,
local businesses including SMEs,
Some sustainability issues are difficult to measure and to incorporate into a LCC analysis.
However, LCC practitioners widely accept that the environmental impact associated with
constructed assets can be significant and should always be considered. A range of
approaches to assessing environmental impact are available to suit the type of asset, the
aspects of the environment that are of concern and the particular parameters that are of
interest. The following are the most frequently used:
Life Cycle Assessment (LCA) – LCA addresses the environmental aspects and potential
environmental impacts (e.g. use of resources and the environmental consequences of
releases) throughout a product's life cycle from raw material acquisition through
production, use, end-of-life treatment, recycling and final disposal
Environmental Impact Assessment (EIA) – a process for informing decision-makers
of the local environmental consequences/effects potentially caused by different project
options
Multi-Criteria Analysis (MCA) – a process that initially identifies a set of goals or
objectives and then seeks to identify the trade-offs between those objectives for different
options. The 'best' environmental solution is identified by attaching weights (scores) to
the objectives.
While a number of approaches to assessing environmental impact are available to suit
individual requirements, LCA is one of the most versatile and widely recognised in
construction and is referred to in this methodology. It is also the only approach that is the
subject of International Standards (ISO 14040 and ISO 14044).
To be properly comprehensive, an environmental impact assessment of a constructed asset
must extend to the manufacturing process and transport of materials and components.
3.3 Measures employed in LCA
Environmental impact is caused primarily by the consumption and/or transformation of
materials and energy. Accordingly LCA measures the consumed and emitted flows (that is,
raw material and energy consumption, and emissions to air, water, soil) over the whole life
cycle of the asset from raw material acquisition through production, use, end-of-life
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treatment, recycling and final disposal of the asset. This compilation of inputs and outputs
is called Life Cycle Inventory (LCI).
The LCI is the basis for a later analysis and potential assessment of the environmental
effects related to the product or process. This aggregation of the many single resources and
emissions is then translated into indicators about the potential impacts on the environment,
health, and use of natural resources. This step is called Life Cycle Impact Assessment
(LCIA). In general, this process involves associating inventory data with specific
environmental impact categories and category indicators. The collection of indicator results
(LCIA results) or the LCIA profile provides information on the environmental issues
associated with the inputs and outputs of the system assessed.
Life Cycle Impact Assessment (LCIA) methods can be grouped into two families: classical
methods determining impact category indicators at an intermediate position of the impact
pathways (e.g. ozone depletion potentials) and damage-oriented methods aiming at more
easily interpretable results in the form of damage indicators at the level of the ultimate
societal concern (e.g. human health damage). Although users may choose to work at eitherthe midpoint or damage levels, a current tendency in LCIA method development aims at
reconciling these two approaches. Both of them have their merits, and optimal solutions can
be expected if the 'midpoint-oriented methods' and the 'damage-oriented methods' are fitted
into a consistent framework.
Because there is no single accepted method carrying out LCA, the European Commission
has provided a standardisation mandate M/350 to CEN in order to establish a set of specific
LCA rules for assessment of environmental performance of buildings and construction
products. The rules are to be based on the generic ISO standards 14040, 14044 and 14025
for Environmental Product Declarations and they are also in line with the building
construction sector specific standards under development in ISO. As a consequence CENhas established a technical committee CEN/TC350 “Sustainability of Construction Works”
to fulfil the work specified in the mandate M/350.
Note: Where the term LCA is used in the following sections it should be taken to
encompass all environmental sustainability assessment methods.
3.4 Interrelationship between LCC and sustainability analysis
Whilst LCC and LCA are two distinct and different processes that have developed and are
practised as separate disciplines in the construction industry, there are many parallels and
interrelationships between the two. For example, both:
Are concerned with assessing the long term impacts of decisions Require analysis of an often diverse range of inputs
Use similar data on inputs of materials and energy
Take into account operation and maintenance
Consider opportunities for recycling vs. disposal
Provide a basis for rational decision making, particularly in appraising options.
However, the two disciplines differ in the basis of the resulting decisions:
LCC combines all relevant costs associated with an asset into outputs expressed in
financial terms as a basis for making investment decisions
LCA enables decisions to be made on the basis of potential environmental impacts by
scoring and rating on environmental criteria. Whilst costs can be firmly attributed to
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some environmental factors there is currently no widely agreed methodology for others
and some cannot be quantified at all in cost terms.
As a result LCC and LCA do not necessarily produce a common output. Nevertheless
environmental impact assessment has a key place in overall long term decision-making and
consideration should be given to how to integrate it with the LCC process at the earliest
stages.
3.5 The use of LCA with LCC
As discussed above, in LCC the primary driver in decision-making is cost and LCA informs
decisions on the basis of potential environmental impacts. The use and sequence of LCC
and LCA will depend on the priorities of the decision-maker. The range of approaches
might cover, for example:
Use of LCC and LCA as two of the criteria in the evaluation of a single investment
option (such as the decision to construct an asset), where other evaluation criteria might
include functionality, aesthetics, speed of construction, future investment returns etc. Use of LCC and LCA as two of the criteria in the evaluation of a number of alternative
investment options (either entire constructed assets or specific components, materials
or assemblies within them)
Use of LCC to provide a financial/economic evaluation of those sustainability impacts
that have a widely agreed and readily calculated monetary value
Use of LCC to provide a financial/economic evaluation of alternative options identified
in a LCA assessment
Use of LCA as a means of identifying alternative options with a good environmental
performance and then carrying out a LCC analysis on those options only
Use of LCC to select cost effective options, then making a final decision in the light of a
process of LCA carried out on those options only.
Thus it can be seen that LCC and LCA can either be used alongside each other in a broader
evaluation process, or either process can form an input into the other.
3.6 At the end of Step 3
At the end of step 3 the user will have developed a clear understanding of:
The relationship between sustainability assessment and LCC
The extent to which the outputs of a sustainability assessment will form inputs into the
LCC analysis
The extent to which the outputs of the LCC analysis will feed into a sustainability
assessment
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4 STEP 4: Identify the period of analysis and methods of economic
evaluation.
4.1 Purpose of this stepThe selection of the appropriate period of analysis is fundamental to the outcome of a LCC
exercise. In step 2 the User identified the likely broad timescale of the LCC exercise. In
this step, the timescale over which the analysis takes place is confirmed as the ‘period of
analysis’.
4.2 Period of analysis
The period of analysis is formally defined in ISO15686 Part 5 as follows:
“The length of time over which an LCC assessment is analysed. This period of analysis
shall be determined by the client at the outset (e.g. to match the period of ownership) or
on the basis of the entire life cycle of the asset itself.”ISO 15686 Part 5 provides further definitions as follows:
Life Cycle as “Consecutive and interlinked periods of time between a selected date and
the disposal of the asset, over which the criteria (e.g., costs) are assessed. This period
may be determined for the analysis (e.g., to match the period of tenancy or ownership)
or cover the entire life cycle. The life cycle period shall be governed by defining the
scope and the specific performance requirements for the particular asset.”
Entire Life Cycle as “Consecutive and interlinked periods of time between a selected
date and the end of service life of the asset, including the end of life period.”
It should be noted that the ISO 15686 definition of life cycle differs from that in the
environmental standard, ISO 14040. The latter adopts a broad ‘cradle to grave’ definitionof life cycle, whereas the ISO 15686 definition can represent either ‘cradle to grave’ or a
shorter economic analysis timeframe driven by the specific client or project needs. Users
should confirm with the client which definition is to be adopted for their LCC analysis.
The decision on the appropriate analysis period for a LCC exercise may be driven by a
number of factors relating to the client, the project and/or asset, and the financial, legal and
regulatory framework in which they operate. Key drivers might include:
Design life of the asset
Project duration (for example PPP projects typically last for 20-30 years)
Period of economic interest in the asset (for example lease period)
Financial drivers (for example investment requirements, loan periods) Projected refurbishment/remodelling periods
Regulatory requirements (for example treasury guidance may stipulate analysis period)
Business planning cycle
Client requirement to adopt the ISO 14040 environmental definition of ‘life cycle’
The selected analysis period can have a fundamental impact on the outcome of a LCC
exercise and it is essential that the appropriate consideration is given to it. In particular, the
potential effects of selecting a particularly long or short analysis period should be
understood. Selection of a longer analysis period introduces higher levels of risk into the
analysis, as the long term impacts of issues such as inflation, future need for and use of the
asset, component maintenance and replacement requirements (i.e. service life) and system
obsolescence become more difficult to predict over time. This is not to suggest that users
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should not carry out LCC exercises over longer time periods, rather that the increased risks
need to be adequately understood and accounted for.
Users should also be aware of the impact of the chosen discount rate (see below) when
applied over different analysis periods. The longer the analysis period, the greater the
impact that the chosen discount rate will have on future costs. Conversely, the shorter the
analysis period, the less effect discount rates will have on the analysis outcome.
4.3 Asset and component life
In order to identify the appropriate analysis period users may need to make an assessment
of the expected life of the asset or its constituent parts. The first distinction that users
should understand is that of ‘design life’ and ‘service life’. ISO 15686 Part 1 defines the
terms as follows:
Service life: period of time after installation during which a building or its parts meets or
exceeds the performance requirements.
Design life: intended service life, or expected service life, or service life intended by the
designer.
In practice, the term “life” when applied to a constructed asset can be defined in a number
of ways depending on the interests and objectives of the user, as follows:
Physical life (from construction to demolition or replacement). Every asset has a
predicted length of life at the end of which a physical collapse is possible. However
most assets never reach that point and are demolished or replaced beforehand, generally
due to economic obsolescence. Note that physical life corresponds to the ISO 15686
definition of ‘service life’.
Economic life (from construction to economic obsolescence). Economic obsolescencehappens when the further use of an asset is no longer the most economic solution among
alternatives.
Functional life (from construction to the point when the asset ceases to function for its
intended purpose). An asset reaches the end of functional life when it can no longer
function for the purpose for which it was intended.
Technological life (from construction to the point when the asset is technologically
obsolete). End of technological life occurs when an asset, typically a system or
component, is no longer technologically equal to or better than available alternatives.
Social / legal life (from construction to the point when replacement is required for social
or regulatory reasons). An asset reaches the end of its social or legal life when
requirements other than economic dictate replacement or change, e.g. health and safetyor legislative issues.
Contractual / ‘duration of interest’ life (for any period of time during the duration of
the physical life of an asset). This period of analysis covers the length of a contract for a
particular service, e.g. construction, operation, etc.
Arbitrary life (length of time e.g. 25, 30, 50 years), assumed due to national practice,
local best practice, client’s stipulation, etc.
It can be seen from the above range of potential definitions of life that the period of analysis
for a LCC exercise can often be shorter than the physical life of an asset, that is, from
“cradle to the grave”. The ‘period of analysis’ must therefore be specifically defined for
each LCC exercise.
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4.4 Discounting
4.4.1 The purpose of discounting
Discounting is a widely used technique for comparing costs and revenues occurring at
different points in time on a common basis, normally the present time. It is based on theprinciple that a sum of money to hand at the present time has a higher value than the same
sum to hand at a future date, because of the earning power of that sum in the interim.
Discounting to present value makes an adjustment to the future costs of an asset that takes
account of inflation and the real earning power of money, allowing them to be compared
and evaluated on the same basis as costs incurred at the present.
The need to discount depends on the use to which the LCC analysis will be put. It is
necessary only where a series of costs over time has to be put onto a common basis for the
purpose of a decision, not where the objective is simply to project annual costs on a year by
year basis. Therefore when carrying out a LCC evaluation of two or more options with
different cost profiles over time it is likely that discounting will need to be applied, whereas
it may not be necessary if the aim is simply to prepare a cost profile for one option alone.
4.4.2 The effect of discount rates
A decision not to discount, that is, to apply a zero rate, implies that the timing of a cost (eg
for repair or renewal) is immaterial and disregards the earning power of money. However,
use of a zero rate presents the best case for spending a greater sum up front (i.e. capital
costs) in order to generate greater savings through the analysis period (e.g. operating,
maintenance, energy costs). It can therefore be argued that a zero discount rate should be
applied to all public sector investments intended to leave a lasting legacy for future
generations.
Conversely, a high discount rate will present options with low up-front costs as appearing
more desirable and it can be argued that this has the effect of sacrificing the interests of
future generations to those of the present decision-makers. However, future uncertainties
and external influences unrelated to the asset (eg budgetary constraints or changed political
priorities) may have an impact on the timing or extent of future costs. It can therefore be
argued that this represents an argument for affording future costs less weight in decision-
making and hence for discounting.
Further guidance on the selection of the appropriate discount rate is provided below.
4.4.3 The treatment of inflation
The discount rate is the investment premium over and above inflation and as such is a
separate concept and distinct from it. There are two possible approaches to dealing with
inflation:
Using a ‘nominal’ discount rate, that is a rate that is not adjusted to remove the effects of
actual or expected inflation. This means that inflation predictions are built into forecast
costs and prices
Using a ‘real’ discount rate, that is a rate that has been adjusted to remove the effect of
actual or expected inflation. This means that future costs and prices are estimated at
present day (‘real’) prices and inflation can be dealt with separately.
If inflation rates for all costs in the analysis are approximately equal, it is common practice
to exclude inflation from the LCC analysis (i.e. to adopt a ‘real’ discount rate). However, if
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the analysis includes commodities subject to widely differing rates of inflation, for example
energy prices and labour rates, inflation would have to be included (i.e. using a ‘nominal’
discount rate).
Because constructed assets typically have long service lives and it is difficult to predict
inflation in the long term, it is generally recommended to carry out LCC analyses on using
real costs and discount rates. It is further often recommended that results should be tested
by applying at least two real discount rates, including one relatively lower rate, and
appraising the difference in outcomes (see Step 13 guidance on sensitivity analysis).
4.4.4 Selecting the discount rate
Selecting the most appropriate discount rate is critical to the success of an LCC exercise. In
the private sector, selecting the rate can be a highly judgemental process with reference to
the financial status of the client and the circumstances of the particular project, and in
practice rates can vary widely. Key considerations will be the cost of capital, the perceived
level of project risk and the opportunity cost of capital (i.e. the level of return that could begenerated by investing the capital elsewhere).
In the public sector, national ministries of finance generally specify the discount rates to be
used in the economic analysis of publicly funded projects. These typically fall into the
range of 3 to 5%. The rate may also be assessed on a case by case basis by reference to:
The opportunity cost of capital
The societal rate of time preference
The cost of borrowing funds.
The ‘opportunity cost of capital’ is the cost of foregoing an alternative investment. This
approach assumes that finance for public sector projects is withdrawn from private savings
and which would otherwise have gone into private investment. Hence the discount rate is
equated to the pre-tax rate of return available to private capital.
The ‘societal rate of time preference’ is the interest rate that reflects a government’s
judgment about the relative value which society as a whole assigns (or which the
government feels it ought to assign) to present versus future consumption. The societal
time preference rate is not observed in the market and bears no relation to the rates of return
in the private sector, interest rates, or any other measurable market phenomena.
The rationale of the ‘Cost of Borrowing Funds’ approach is that the interest rate should
match the rate paid by government for borrowed money. This approach is favoured by
many agencies and is supported by the argument that government bonds are in direct
competition with other investment opportunities available in the private sector.
Some advocate use of a zero interest rate in the public sector, arguing that when tax monies
(eg road tax) are used, such funds are “free money” because no principal or interest
payments are required. A counter-argument is that zero or very low interest rates can
produce positive cost/benefit ratios for even very marginal projects and thereby take money
away from more worthwhile projects. A zero interest rate also fails to discount future
expenditure, making tomorrow’s relatively uncertain predicted costs as significant in the
decision as today’s known costs.
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4.5 Methods of economic evaluation
A number of widely used financial analysis techniques are available for the assessment of
alternative investment options. Using two or more techniques together provides a broader
picture of value implications.
4.5.1 Net Present Value (NPV), Net Present Cost (NPC)
The NPV is the sum of the discounted future cash flows, both costs and benefits/revenues.
Where only costs are included this may be termed Net Present Cost (NPC).
NPV is a standard measure in LCC analyses, used to determine and compare the cost
effectiveness of proposed options. It can be applied across the full range of construction
investments, covering whole investment programmes, assets, systems, components and
operating and maintenance models. The costs and revenues/benefits to be included in each
analysis are defined according to its objectives. For example, revenues from recycling of
materials or from surplus energy generation are typically included in a LCC analysis of
alternative sustainability options.
4.5.2 Payback (PB)
The PB period is the measure of how long it takes to recover initial investment costs and is
a useful basis for evaluating alternative investment options. It may be calculated using
either real (non-discounted) values for future costs, that is ‘Simple PB’, or present
(discounted) values, that is ‘Discounted PB’. PB in general ignores all costs and savings
after the payback point has been reached and it is possible that an investment with a short
PB is a poorer option than one with a longer payback over the entire period of analysis.
PB is a useful technique for assessing whether additional investment in, for example, lower
energy plant, is worthwhile. It enables users to weigh the additional capital costs against
the time it takes for these costs to be recouped through savings or income during the
operational period. This may be a useful means of judging whether an investment
represents good value for money, although the subjective nature of the value for money
assessment may make it inappropriate for some public sector investment decisions.
4.5.3 Net Savings (NS), Net Benefit (NB)
NS/NB is the present value of savings/benefits in the operation phase less the present value
of the additional investment costs to achieve them. It provides a measure of cost-
effectiveness and of the benefits to be achieved from investment options. NS/NB greater
than 0 indicates positive cost-effectiveness.
4.5.4 Savings to Investment Ratio (SIR)
The SIR is a measure of the cost-effectiveness of a proposed investment (an SIR greater
than 1 is positive) and can be used to prioritise and select investment options.
4.5.5 Adjusted Internal Rate of Return (AIRR)
The AIRR is a measure of the annual yield from a project over the period of analysis taking
into account reinvestments of interim receipts, indicating projects with greater net savings.
An AIRR greater than the minimum acceptable rate of return (ie the discount rate) is
positive.
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4.5.6 Annual Cost and Annual Equivalent Value (AC or AEV)
The AC or AEV is a uniform annual amount that, when totalled over the period of analysis,
equals the total net cost of the project taking into account the time value of money over the
period. It is used to compare investment options where the natural replacement cycle
cannot easily be directly related to the period of analysis. The lowest AEV indicates the
lowest cost option.
4.6 Guidance on which evaluation technique(s) to use
Further guidance on which evaluation techniques are most appropriate in a public sector
context is provided in the Guidance Note that accompanies this methodology.
4.7 Taxation issues
Fiscal considerations can be highly significant in LCC analyses, particularly in the private
sector, with tax efficiency a major objective in designing investment portfolios, finance
arrangements and individual projects. Taxation is a complex area, varying between
member states. Accordingly it is important at this step to develop a strategy for managing
fiscal issues, seeking at the earliest stage the specialist professional advice which is
available in this area. Such a strategy should be designed to minimise the tax burden on the
project by identifying appropriate innovative and practical tax and business solutions.
Key considerations in the strategy include:
The tax relief or offsets which may be available against certain costs in the overall CBS,
e.g. typically for repairs and maintenance, which would tend to favour options with
lower initial costs
Similarly the tax penalties which might apply to the use of certain materials or have an
indirect impact, e.g. through higher energy costs.
Tax can also represent an area of risk, for example in:
The probability of environmentally inefficient structures attracting current or future
environmental taxes
The possibility of tax rates changing.
Value added tax (VAT is subject to similar considerations. Both the rate and accounting
methods vary between member states and specialist advice is again likely to be essential.
4.8 At the end of Step 4
At the end of Step 4 the user will have: Identified and confirmed with the client the period of analysis and the considerations
governing its choice
Identified and confirmed with the client the appropriate technique(s) for assessing
investment options, including the discount rate(s) to be used and the implications
therein.
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5 STEP 5: Identify the need for additional analyses (risk/uncertainty
and sensitivity analyses)
5.1 The purpose of this stepRisk and uncertainty analysis is a body of theory and practice which has been developed to
help decision-makers assess their risk exposure and attitudes in a systematic manner. At
this step the user considers how and why it can be applied in conjunction with LCC
analyses to support decision-making and in particular, which risk assessment methodologies
will be most appropriate.
5.2 Risk and uncertainty in LCC
Ownership, investment and occupation of constructed assets are by nature long-term
activities and as such are characterised by a range of uncertainties, principally in the value
and timing of future costs and revenues. Within this context, LCC is a forward lookingprocess that requires predictions of these variables to be made in order that robust decisions
can be taken. Consequently, certain risks are inherent in the LCC assessment process,
namely:
That the total life cycle costs in a given period exceed those calculated, and;
That the life cycle cost profile over a given period differs from that predicted (e.g. the
total costs may be the same, but the distribution of those costs over time differs from
that predicted).
These key risks can arise as a result of variability in one or more of the predicted values or
assumptions in the LCC model (see Sec.5.4 below).
While robust assessment of the key cost and time variables can help reduce the risksinherent in the LCC process, the fact that LCC is concerned with predicting future costs and
activities means that an element of risk will almost always be built into the calculations. It
is therefore important that clients are made aware of this issue and of the steps that can be
taken to quantify and in some cases mitigate the risks.
Often, the identification and assessment of LCC related risks can have a significant
influence on decision-making process, with a resulting impact on the LCC of a project –
examples are given in table 3 below.
Table 3: Potential impact of risk on decision-making
Examples of risks identified Possible decisions taken in response
Risk of more demandingenvironmental legislation
Selection of higher capital cost HVACsystem with improved environmentalperformanceSelection of lower capital cost HVACsystem with shorter life and due forreplacement in short period of time
Risk of LCC increases and/ordisruption due to high cost/quantitycomponents requiring earlyreplacement
Selection of alternative components withlonger service life or improved warrantiesImprove planned maintenance regime toprevent early failures
Risk that labour costs will rise in
excess of inflation allowances inmodel
Selection of less labour intensive
materials and systems (e.g. requiring lesscleaning and maintenance)
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Increase inflation allowances in model.Risk of increased land-fill/waste taxes Selection of longer-life components in
order to minimise wasteSpecify greater proportion of recyclablematerials
5.3 Managing risk/uncertainty
The management of risk is fundamentally a three stage process:
Identifying the risk
Assessing the risk in terms of its likelihood and impact
Taking appropriate action in response, which might variously be to accept, mitigate,
transfer or avoid the risk.
The extent to which the above process is applied and whether it is undertaken for LCC in
isolation or as part of a wider, formalised risk management process is a matter of judgement
for the client in the light of the scope and complexity of the project. This decision should
be taken at this step in the LCC methodology. For a major investment a risk management
plan should be formally established with clear objectives and success criteria, proper
planning and resourcing, and effective management and control.
The risk management plan should be progressively updated as a project moves through its
stages. The overall process is illustrated in figure 3 below.
Figure 3: Risk management cycle.
PeriodicUpdate
5.4 Identifying causes of variability in the LCC analysis
A number of common risk identification methods can be used for identifying potential
causes of variability in the LCC analysis including:
Accessing relevant databases, where available
Obtaining feedback from past projects
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Drawing out the knowledge and experience of individuals within the team, eg by
‘brainstorming’ techniques
Conducting interviews
The ‘Delphi’ method, gathering information from project participants by email or post
Checklists of variability factors commonly associated with particular tasks.
Common causes of variability in LCC include:
Capital costs (actual v predicted)
Operational costs, including maintenance, FM, energy, component replacements
Costs of refurbishment/upgrading
Disposal costs
Future levels of inflation (labour and materials) underpinning the above costs
Interest rates (in relation to loan payments)
The service lives of the components, systems and materials that make up the asset
The extent and timings of planned (cyclical) maintenance and refurbishment works
required The extent and timings of unplanned (responsive) maintenance required
Energy consumption levels
Changes in the use of the asset
Obsolescence / technological development
Change in the fiscal regime
New legislation, for example on sustainability issues
Only risks that are strictly relevant to the LCC exercise in hand should be considered.
Some risks such as future obsolescence and legislative changes are almost impossible to
assess and the decision may be taken to discount them.
Further guidance on the prediction of service lives of constructed assets and theircomponents, and the factors affecting service lives is provided in ISO 15686 Part 1.
During this risk identification process initial views may be formed on the probability of
occurrence, impact, ownership and possible actions to address or mitigate the risks.
A preliminary LCC risk/variability identification process should be carried out on every
project at this step, unless the scope of the project is such that risk is manifestly very low.
The depth and rigour of the process should be appropriate for the scope and nature of the
project. The results should be recorded on the first draft of a risk register (see section 5.6.1
following).
5.5 Assessing variability
Having identified potential causes of variability in the LCC assessment it is then necessary
to assess their potential likelihood and extent, for which a variety of risk assessment tools
and techniques is available. These fall into two broad categories:
Qualitative, employing subjective scoring techniques
Quantitative, using mathematical approaches.
Quantitative techniques fall into two further categories:
Statistical and probabilistic (stochastic) approaches
Deterministic, with numerical computation of risk.
The range of approaches is illustrated in figure 4 below, with those most widely applied toLCC highlighted.
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The choice of an appropriate methodology depends not only on the scope and rigour of the
analysis required but also on the quality and extent of data available. Relevant historical
data might be available in databases, or from organisations involved in the project.
However, there is little reliable historical LCC data held at a national or international level,
accordingly the availability and quality of relevant data should be reviewed beforeundertaking a risk assessment exercise.
When undertaking the risk assessment it is important to distinguish between planned costs
(which assume everything goes well) and expected costs (which include an allowance based
on experience for problems such as cost and time over-runs).
Figure 4: Common tools and techniques in risk/uncertainty analysis
Techniques for risk and
uncertainty assessments
Deterministic (numerical
computation of risk)
Qualitative (using subjective
scoring techniques)
Quantitative (statistical &probabilistic approaches)
Benefit and cost estimating
Break-even analysis
Risk-adjusted discount rate
Certainty equivalent technique
Sensitivity analysisVariance & standard deviation
Net present value
Other
Mean-variance criterion
Decision tree analysis
Monte Carlo simulation
Artificial Intelligence
Fuzzy set theory
Event trees
Confidence modelling
Other
Risk matrices
Risk registers
Event trees
SWOT analysis
Brainstorming
Likelihood/consequence assessment
Other
5.6 Qualitative risk assessment
Qualitative risk assessment is essentially a subjective process relying on the knowledge,
skills and experience of the participants, but undertaken in a managed manner. Methods of
drawing out this information are broadly similar to those used for risk identification, that is,brainstorming, reference to databases, interviews, etc. For each of the identified risks the
team will typically consider:
Their likelihood
Who / what is likely to be affected and to what extent
Who owns them
How important it is to mitigate them
What action should be taken.
A number of tools are available for qualitative risk assessment, of which risk registers are
the most user-friendly and commonly used. Compiling a risk register is normally the first
step in risk management and provides a format for systematically recording the outcomes ofrisk identification and assessment. The register should be regularly updated to contribute to
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risk management throughout the project life cycle. The information available in risk
registers can be used to initiate quantitative risk analysis and to support subsequent risk
mitigation.
The typical headings used in compiling a risk register include:
title and description of risk
description of causes
dates when the risk was identified / modified
risk code
ownership of the risk
likelihood of occurrence
potential impact
ranking
mitigation action plan and timescale
residual risk effects.
The level of detail on the risk register is a matter for judgement with reference to the scopeand complexity of the project.
Other qualitative tools which may be applicable include probability matrices and impact
assessment matrices, which can be used by the team to facilitate the related assessments for
entry onto the risk register.
A probability matrix facilitates the essentially subjective process of assessing the likelihood
of a risk event occurring by clarifying the concept of ‘probability’. A typical matrix is
illustrated in figure 5 below. The process depends fundamentally on the project team and
key stakeholders contributing to the process – knowledge of the project and related
activities within it, experience and historical data will all be relevant.
Figure 5: Probability matrix
An impact assessment matrix similarly facilitates the process of assessing the impact of
each risk, requiring a comparable contribution of knowledge and experience.
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5.7 Quantitative risk assessment
Quantitative risk analysis involves formulation of a model for computing the risk impacts
on quantifiable project performance measures such as cost and duration. In theory
quantitative assessment provides much better insights into risk and risk management, but it
can be difficult to apply in a construction context and expert advice is an essential
prerequisite, both for setting up models and selecting relevant data and interpreting the
results.
In practice, two techniques are likely to be of particular value in the LCC context and are
identified as such in ISO 15686 Part 5, namely sensitivity analysis and Monte Carlo
simulation.
5.7.1 Sensitivity analysis
Sensitivity analysis measures the impact on project outcomes of changing key input values
about which there is uncertainty, typically:
discount rate
future inflation assumptions
period of analysis
service life or maintenance, repair or replacement cycles
operational cost data.
For
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