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Evaluating life cycle cost

Understanding how to evaluate the life cycle cost of equipment is a key consideration when looking to purchase items that will be in service for a long period of time, with substantial through-life operation and maintenance costs. It plays a part in your decision of who to award your contract to, regardless of whether the technical or quality part of the evaluation is being done in a quantitative manor, with weights and numerical scores, or in a more qualitative way that looks at the strengths, weaknesses and risk associated with each of the solutions. But it’s not easy to accurately evaluate just how much a solution might cost you, beyond the initial acquisition costs. It can be all too easy to inadvertently choose a much more expensive option.

In this article I’ll talk about this issue in the context of the trends and challenges we’re seeing in the marketplace, as well as sharing our best practice approach to evaluating life cycle cost. 

The challenge

Commerce Decisions has seen an increasing desire by governments procuring complex military platforms to select solutions and suppliers partly on the basis of the likely whole life cost of ownership, even when not including the through-life operation and maintenance of the platforms in the initial acquisition contract. This introduces a number of challenges.

The planned in-service life of military platforms is normally measured in decades, with 30+ years the norm. This has several implications for assessment of life cycle costs.

Throughout the life of the platform, a significant degree of modification can be expected to meet threats that emerge during its in-service life, and these were likely to be unknown or uncertain at the time of acquisition. The ability of the equipment to accommodate modification and adaption is therefore of interest and something that should either form part of the technical assessment or be “monetised” by inclusion of broad cost assumptions regarding upgradeability into the whole life cost model. In addition, particularly in a military context, it can be important to consider what other nations operate the same equipment and what their likely future needs will be. This will improve understanding of the likelihood of being able to share future development and “mid-life update” costs, which can also be incorporated into either the technical part of the evaluation or into the whole life cost model.

Ongoing support costs are normally a considerable part of the overall cost of ownership (often greater than the original acquisition costs) and therefore something that is important to include. It’s possible – even likely – that suppliers will have differing support philosophies for their equipment or platforms with different costs associated with them, so it may be important to build a cost model for the evaluation of the life cycle costs that is agnostic, to support the solution whilst still capable of providing a comparable and objective evaluation of support costs.

Finally, costs obviously become more uncertain the further into the future you look. Developing a life cycle cost evaluation methodology that can incorporate uncertainty and risk into the evaluation of cost in a way that produces comparable results – and is objective – is therefore critical to running a fair competition.

Building a life cycle cost evaluation methodology that objectively and fairly assesses the likely through-life costs is also challenging for a number of other reasons:

  • It can be difficult to source objective data about operation and maintenance costs – as critical cost-driver data can be in the hands of owner-operators of the equipment or platforms and not necessarily available to the bidding OEMs.  
  • Procurement teams do not necessarily have the deep subject matter expertise needed to determine accurate estimates of cost themselves or have the competence to make adjustments to estimates provided by suppliers. 
  • In a competition where through life costs are being considered as part of the acquisition decision without the inclusion of through life support in the contract at an agreed cost, suppliers have a clear motivation to downplay these costs to maximise their chances of winning. This will make the procurement team nervous about any methodology that doesn’t produce a fair, objective and defendable result.

It’s easy to see why so many procurement teams decide it’s too difficult to make an accurate assessment and give up, making the acquisition decision without comprehensively considering the likely through-life costs.

The approach we’ve taken with clients

The approach we’ve adopted on recent platform acquisition projects is based on working with the buyer to construct a common high-level cost model (for purposes of establishing comparability). This is populated by bidders with lower-level detail specific to their solution and backed up with data and assumptions that is either provided by the bidders or sourced by bidders from other owner-operators of their platforms as part of the bid process. We’ve developed methods for the buyer to evaluate the confidence they have in the suppliers’ cost estimates, risk analysis and supporting data. You can then use this confidence “rating” to adjust the projected life cycle cost of the solution up towards a “worst case should cost” estimate prepared and published by the buyer.

This gives bidders the motivation to seek out and propose lower life cycle cost solutions to buyers, but only when they can provide sound cost projections with robust evidence and data. Using this approach, solutions will score poorly for cost in the event that they’re either known to be expensive, or where poor evidence and immature data is available to justify a lower cost estimate. Only solutions that can demonstrate with mature data and robust evidence that they are likely to be cheaper over their life cycles, will be rewarded with a higher cost score.

The method we’ve developed to evaluate confidence in the suppliers’ cost estimates examines the providence behind the data being provided, analyses the process and tools used to prepare the cost estimates and also considers the training, experience and qualification of the cost estimation team.

By evaluating confidence in the suppliers’ own cost estimates and having an objective adjustment mechanism to apply, buying teams avoid the need to adjust the suppliers’ cost estimates themselves, meaning they don’t have the problem of proving their competence to do so. All they need to do is apply the confidence scoring and adjustment mechanism which is much easier for them to do with the expertise available to the buying team.

With a greater understanding of the through-life costs of equipment supported by risk analysis and robust data, buyers are able to make informed decisions and confidently award their contract. Sign up for our newsletter or contact us to hear our latest insights and best practice advice on getting the best possible outcomes from your complex procurements.