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A comprehensive look at the factors involved

By Daniel C. Brown


	Calculating Life Cycle Costs

In recent years most contractors have sharpened their pencils to ever-finer points when analyzing the ideal time to replace a machine. Naturally, replacement calculations are heavily influenced by the company’s business plan, equipment budget, and expected workload for the machines.

Let’s assume that you’ve got plenty of work. Your equipment is busy and some of it is wearing out. What goes into the replacement analysis?

The most effective way to analyze equipment replacement is through life cycle cost analysis (LCA), says John Brewington of Brewington & Co., a fleet management consultant based in Mt. Airy, NC. By looking at all costs over the life cycle of a machine, you can analyze the real hourly owning and operating costs.

The goal is to find the ideal ownership period for which total owning and operating costs are minimal. For young machines, high depreciation dominates the ownership cost. For older machines, repair costs will soar. You want to find the ownership period of lowest cost—the time before the piece needs major component rebuilds or replacements.

All of your costs must be accounted for someplace, and different contractors count various items into their hourly equipment rental rates. In its internal rental rate charged by the equipment department to projects, Zachry Construction Corp. counts direct equipment costs such as depreciation, repair parts, and undercarriage components, says Mike Monnot, the firm’s director of equipment. Not included in the rate—yet billed by the equipment department to the projects—are such costs as fuel trucks, oil analysis, field repair labor, and project-requested modifications. Based in San Antonio, TX, Zachry is a large construction business with a fleet valued at more than $180 million.

Brewington divides equipment costs into three categories: fixed, variable (or operating), and incidental. Fixed costs include depreciation, the cost of money, any up-fitting required on a new machine, insurance, licenses, taxes, fees, and overhead. Variable or operating costs include repairs and maintenance, fuel and oil, tires and undercarriages, transportation and setup, and any unreimbursed damage repair. Incidental costs include such items as cleaning, storage fees, operator or mechanic training, specialized tools, and carrying costs for parts inventories.

Most fleet asset management software packages give you a view of your current costs by current month, previous three months, year to date, and life to date. If you tell the software to divide the hours used (or miles driven) into each period’s cost, you’ll get the cost per mile or per hour for that period. Some systems will break these costs down by some coding convention so that the fleet manager can compare cost per hour for systems or components (such as undercarriages) for this month, the previous three months, year to date, and life to date.

Triggers for Replacement
“Replacements are most often based on the avoidance of expensive repairs, keeping pace with technology, past experience with similar models, peer experience with similar models, tracking downtime or lost revenue, and the equipment manager’s intuition,” says Brewington. “Once the hourly cost of a unit makes a significant jump, it is most likely not the ideal time to sell or trade the unit. That’s usually because you’ve spent money to make significant repairs or rebuild major components on the unit. Then, the recapitalized value of the machine—book value plus major repair costs—will exceed the market value of the machine.”

Besides life cycle cost analysis, Brewington says other “triggers” for replacing a unit are reaching a predetermined value at which a unit is sold or traded; nearing a major expenditure, such as a component rebuild; reaching a usage threshold in hours or miles; or reaching some measure of downtime or lost revenue.

“If everything is normal and we see no spikes in repair costs, we may keep a machine for 15,000 to 18,000 hours—to the cusp of needing major components,” says Monnot. “So far, we’ve been able to do that and get good salvage value.”

In setting your cost per hour—often the internal rental rates used for your machines—you want to be realistic in figuring utilization. Higher expected utilization will drive down the cost per hour, and lower utilization will raise the cost per hour.

“Anything above 75% utilization is good for us,” says Monnot. “Each class of equipment has a different utilization rate. We look at historical utilization and lay that against our expected workload for the next couple of years.

“You don’t want to be too optimistic with utilization figures, but you also don’t want to be too conservative, because that will raise the rental rate to the point that you’re not competitive,” Monnot says.

Age of Your Fleet
“The goal is to keep a balanced fleet,” says Monnot. “You want to have some older machines, some young ones, and some middle-aged because, if you don’t have a mixed fleet, it will all age at the same rate and all your repairs will fall at the same time.”

The advantages of a young fleet, says Brewington, are

to have the benefits of the latest technology: increased productivity with operator safety and comfort;
enhanced tax write-offs against profits;
projecting a positive, progressive image to customers and prospective customers;
less downtime and lower repair costs;
a sense of pride gained by the operators, mechanics, and owners;
more environmental friendliness than older units; and
attractiveness to prospective employees.

On the other hand, a young fleet carries high depreciation costs. “If everything is new, it’s like having a taxicab sitting outside your house with the meter running,” says Dave Markey, vice president of equipment services for American Infrastructure.

The higher cost of younger equipment provides a strong incentive to keep it active, and that can lead to cutting margins on work or taking projects that are outside of your company’s area of expertise, says Brewington. Or projects may not be a good fit for your fleet or may be located where the fleet will not be adequately supervised and maintained.

Older equipment carries lower depreciation charges and ownership costs are less. ”If you have some older machines that are working well, you can keep hourly costs down,” says Markey.

Operators are familiar with older equipment, and you may already have parts in inventory to service those machines. You know where to get service for them. Your transport trailers match up well with the older machines.

The disadvantages of older machines include more downtime, lost production, a negative perception by customers and prospects, and increased repair costs, says Brewington. At some point, access to parts or technical support may be limited by the age of the equipment. Resale values decline.

Rebuilt Components
When a machine goes down, the cost of lost production can be high. If an articulated dump truck, for example, breaks down in the middle of its work, you lose production. You have to move the unit for repair, and you may need to rent a replacement machine. For those reasons, many contractors simply exchange the broken component for a rebuilt one, which can often be done in a few days.

Often it pays to buy rebuilt components or even rebuild them yourself, as one large South Carolina contractor does. “When I rebuild a powertrain, I figure to get half of the first life the second time around,” this contractor says. “We rebuild components, and sometimes Caterpillar rebuilds them.”

Manufacturer rebuilds offer the advantage of a warranty, Monnot points out. Plus, buying manufacturer rebuilds means you don’t have to stay current on engine tooling and technology: You buy it.

The cost advantage of rebuilding a larger machine will always exceed the benefit of rebuilding a smaller one. That’s because the new cost of a larger machine is relatively higher than the cost of its rebuild. For a smaller machine, the difference between the new and rebuilt cost is less. “It doesn’t pay to rebuild a Cat D6R, but it does pay to rebuild a D9R because the new cost of a D9R is so much more expensive,” says the South Carolina earthmover.

Fuel-Based Replacement
At C.J. Miller LLC, a large excavating and paving contractor based in Hampstead, MD, Equipment Manager Dale Warner bases preventive maintenance intervals—and flags his equipment life cycles—on fuel usage. “I don’t know how a person can judge severity of use by any other method,” says Warner.

He cites the example of two Caterpillar 988 wheel loaders. One worked extremely hard and burned almost 20 gallons of fuel per hour. At 7,800 hours, Warner replaced its engine. On another project, the same machine and same engine racked up 16,800 hours of usage before replacement. Both machines had burned about 135,000 gallons of fuel.

Photo: Case

Crossing a miles threshold may trigger vehicle replacement.

Photo: C.J. Miller

C.J. Miller bases PM intervals on fuel usage.

When a Caterpillar 3408 engine has burned 135,000 gallons of fuel, Warner figures it’s time to watch the machine’s oil samples carefully for problems. It’s probably about time to replace the engine, but he says the 135,000 gallons may be conservative.

Warner even has a sliding scale of fuel usage versus engine life. For wet-sleeved engines up to 150 horsepower, he figures the useful life at roughly the cubic inches times 100 gallons. For solid-block engines up to 150 horsepower, Warner uses 75 gallons of fuel times the cubic inches of displacement. So a solid-block 400-cubic-inch engine, for example, needs to be earmarked at 400 times 75 gallons or about 30,000 gallons of fuel.

For engines between 150 horsepower and 500 horsepower, Warner’s multiplier is 140 gallons per cubic inch. And for engines of more than 500 horsepower, the multiplier is about 150 gallons. In other words, larger engines can burn more fuel in their lifetimes.

A Caterpillar 3412 engine, for example, has 1,647 cubic inches. If you multiply that by 140 gallons, the useful life of the engine is about 230,000 gallons of fuel. “I use those numbers across a variety of engines—not just Caterpillar,” says Warner. “We have engines from Cummins, Deere, Volvo, Detroit Diesel, and Mercedes, and I use those fuel usage numbers as indicators on all of them. I only use those indicators on four-cycle engines, not on two-cycle or air-cooled engines. For them, all you can do is to watch the oil samples.”

Nearly all equipment from reputable manufacturers is well built for a long and useful life. If you can keep it busy and productive, it will make you money. When should you replace it? The trick is to find what some industry analysts call the sweet spot—the length of life for which owning and operating costs are minimized. And to do that, you must track costs carefully.

Contributing writer Daniel C. Brown is the owner of TechniComm, a communications business located in Des Plaines, IL.

GEC - Buyers Guide 2008

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