To make an economically correct choice in real terms, it is necessary to consider a set of parameters that, in addition to the costs of purchasing materials and those related to the technological phases, also refer to the operating costs, namely:
- Maintenance costs and checks carried out during the system's lifecycle;
- Loss costs of system functionality caused by "downtime" related to breakdowns, repairs, checks, and maintenance;
- Replacement costs of the components that make up the system;
- Other direct costs of operation (cost of fuel during the use phase of a car);
- Residual value of a system that has completed its economic lifecycle.
It is possible to evaluate a function, indicated by the acronym LCC (Life Cycle Costing) during the design phase, which, by discounting these parameters in the design phase, allows for choosing the most cost-effective subsystems to create the complete system. When considering the possible adoption of alternative materials for a product, the economically correct choice will occur when LCC is minimized based on the various possible options. In general, it can be written as follows:
LCC = CI + pv(CE)
Where:
CI = the set of initial costs determinable in monetary units at their real value at the time of determination;
pv(CE) = the set of operating costs discounted at the time of material selection, always expressed in monetary units
This approach is based on the adoption of the accounting principle of discounted cash flow, which brings the costs incurred during the product or service's lifecycle period to present values to make realistic comparisons among different available options. The discounting of operating costs is evidently necessary as it is about making uniform costs that are spread out over the lifecycle. Once the calculation terms of LCC for a specific system are defined, it is clear that choosing a product configuration, a material, or a combination of materials can be done by calculating LCC, directing the choice towards the solution capable of minimizing the result. In general, one of the methods available to evaluate the economic implications of a long-term investment project throughout its probable lifespan is given by the NPV obtained by summing for n, the ratio between CF and the parameter (1+i); where:
NPV = Net present value of the project (or discounted economic result)
n = Predicted economic life, in years, of the analyzed asset or service
(CF)n = Incremental cash flows to be realized over n years
i = Percentage interest rate on the capital cost at which cash flows are discounted
In simpler terms, the concept can be summarized as:
NPV = (Lifecycle benefits) - (Lifecycle costs)
Thus, an approximate model for evaluating the costs of a production's lifecycle of goods is defined. The costs of products or services are assessed with all their present and future implications: for example, in an industrial system LCC assessment, initial material purchase expenses, maintenance expenses, production loss expenses, replacements, labor, energy costs, etc., are considered. Regarding materials, a choice made in the present implies commitments for the future: the choice binds the designer to estimate the total lifecycle costs, understood as the period during which the material fulfills all its functions, in safe conditions, before becoming obsolete and therefore economically unmanageable. How can we estimate the present value of all costs related to each factor under consideration? Here is a possible solution that, however, does not take into account the residual value of a system that has completed its lifecycle.
Where:
N = Useful life duration of the system
i = Interest rate
n = Year in which the event under consideration occurs (maintenance, losses, replacement, etc.)
AC = Initial purchase costs
IC = Manufacturing and system installation costs
OC = Operating and maintenance costs
LP = Production loss costs
RC = Material replacement costs
If it is believed that companies tend to feel increasingly responsible for the externalities they generate, it is worth asking whether it is possible to add this parameter to the above-described equation. The answer is, of course, yes; it means adding the so-called "Environmental costs", i.e., the environmental costs derived from LCA studies. The formula becomes:
One of the methodologies for the monetary evaluation of environmental impacts (EC) is the Swedish EPS system. In the next lesson, we will apply LCC principles to analyze an automotive component.
Next lesson: Practical application example of LCC
