(January 2011) Gold Mine or Fool’s Gold?: Debt is recorded on the right side of the balance sheet in recognition that it’s a source of capital, but users of financial statements...
Reducing Lifecycle Expenditures
Total cost of ownership accounting optimizes long-term costs.
A large regional utility forfeited significant operating revenues after it replaced pulverizers at several of its coal-fired power plants. Because the replacement pulverizers were sized to operate at 100-percent capacity during operations using the coal typically procured by the utility, upgraded plants had to be derated following a change to lower BTU-rated fuel.
If utility decision makers had used a total cost of ownership (TCO) framework, they could have avoided this situation. An operations and maintenance cost assessment would have revealed the operational effect of the fuel change, allowing the company to consider oversized pulverizers to accommodate lower-grade fuels and thereby maintain the power plant’s capacity.
A confluence of market, regulatory, and technical factors will drive sustained levels of capital investment across each segment in the utility value chain for the next 10 years. The ongoing credit crisis significantly increases both the cost of, and competition for, capital that will force numerous utilities to reevaluate near-term capital expenditures. 1 During these unprecedented times, it’s increasingly important that utilities focus on reducing lifecycle expenditures, while executing capital projects and not narrowly focusing on short-term procurement gains. A near-term focus on acquisition costs can result in uninformed decision making that is misaligned with corporate goals, regulatory requirements and investor demands.
The implementation of the TCO method during a long-term capital project’s planning phase (see Figure 1) ensures asset-expenditure decisions are well informed and balanced with corporate, regulatory and investor demands. This method is a supply-chain management leading practice; providing a wide-ranging view of the costs associated with asset ownership. TCO classifies costs, direct or indirect, incurred throughout the acquisition, operation and maintenance, or retirement of an asset (see Figure 2) . Traditionally, there has been little difficulty in identifying acquisition costs. In fact, acquisition costs (specifically purchase price) are frequently the sole basis for making purchasing decisions, while often accounting for less than half of total asset costs. 2 Employing TCO to identify less obvious lifecycle costs aids in early identification of best-fit purchasing decisions and long-term cost savings across the project and ultimately the asset lifecycle. 3
A cross-functional team of supply chain, operations, maintenance, engineering, finance, and project-management personnel should conduct the TCO analysis. The team works collaboratively to develop a comprehensive cost model for the asset to be installed during the project and provides estimates for each relevant cost category (see Figure 3) . A distinct cost model is developed for each supplier and scenario under consideration while estimates are based upon historical data and detailed market analysis. After completing this detailed analysis, the team is capable of making well-informed purchasing recommendations, identifying areas for potential cost reductions, and quantifying the long-term value associated with their recommendations. Furthermore, cost model completion enables the team clearly to communicate the rationale behind specific purchasing decisions to key stakeholders so they understand the key elements that have been considered.
Employing this structured