Why LCC for procurement?

Pär Sandin, Senior Partner at Systecon, gives his view on why LCC is of paramount importance in procurement and shares some examples from the recent procurement of subway trains in Stockholm, a process in which Systecon took part.

My starting point is that products and systems, in any type of business, are supposed to deliver the best possible use at the lowest possible cost. This is particularly true when dealing with systems for the public benefit, such as trains, which are expected to operate over a long period of time.

Pär Sandin, Senior Partner at Systecon.

In my view, all costs are of equal value, whether they are associated directly with a procurement or arising from operations and maintenance. At an early stage, the challenge is to get an idea of the costs that arise over the lifespan of a system and what factors drive these costs. If you manage to do that it will give you an opportunity to control the factors that will influence the cost and thus control the costs in the long run.

However, cost is only half of the equation. It's as much about valuing what you get for your money, such as traffic production, availability, capacity and comfort. Sometimes it is challenging to put values on these "revenues" in order to balance them against costs, albeit necessary in order to make the right decisions.

LCC as procurement method

Using the concept of Life Cycle Cost (LCC) for investment valuation is neither unique nor new. It is actually not much different from calculating personal housing costs when acquiring a new home. Mortgage cost, electricity, heating, water, renovations and household services such as cleaning and gardening may all be included when trying to predict monthly costs. In this sense, LCC is a conventional investment calculus, but with an explicit focus on quantifying and transferring a system's technical properties and it’s operation and maintenance to economic terms. This allows the complete cost commitment of an investment to be brought to light and evaluated.

Furthermore, EU procurement legislation at least provides the opportunity to choose “the most economically advantageous” solution, enabling evaluation of more than just the purchase price. Consequently, it becomes natural to include all major cost contributors and also consider how desired properties should be evaluated. This requires a structured approach, something the LCC concept offers.

An LCC-model?

It is important to understand that LCC is not just a cost model but a procurement strategy or an entire process. This is not to say that models are superfluous. We need models to quantify costs and also to value properties that are hard to express in economic terms. Often, a cost evaluation is combined with an evaluation of the tender quality. These parts are then weighed together into a common comparable measurement. But in order not to exceed estimated costs, it is essential to decide how all costs are to be valued in a procurement situation.

Systecon was recently chosen to take the LCC lead in the procurement of new subway trains (C30) for the Stockholm County Council. The explicit strategy of the C30 project was to make LCC the backbone of the tender evaluation. In practice, this meant that the bidders used an extended LCC model to describe all price and cost information. The basis of the model was a “normal” vehicle LCC model, which was extended with additional properties to enable the calculation of the total tender price. By this, the supplier has agreed to guarantee that a certain level of LCC according to the model is not exceeded. However, one should not be fooled into thinking that models themselves give the required results unless you also have processes in place to ensure that they are met during the subsequent project and during delivery.

What does the process look like? 

All acquisitions begin with the specification of the properties the product or system should have. For this, you must consider the current situation and what you want to achieve. In real life, there are often conditions that limit your options. For example, there is a certain maintenance capability, the infrastructure has limitations and the power supply has capacity constraints. This means that you either have to stay within these boundaries or include the cost of changing them in the calculations. In addition, there are requirements on future capacity, service levels in terms of reliability and increased demands on functionality, etc. At this point you can start using the LCC methodology to get an idea of the best overall strategy. Early in the C30 project simulations were used to determine the type of vehicle that would generate the lowest LCC per transported passenger. Gradually, you get a clearer picture of what you want to achieve and the ability to define how the functional performance can be evaluated.

Regarding costs, one has to consider how they can be quantified and what is required to ensure future verification. A preconception we often encounter is that operating and maintenance costs are difficult to value because they are so uncertain. It may well be that they are more difficult to precisely determine than items with a clear price tag, but it does not mean they are less real. If you buy a car you know that it needs to be refuelled and maintained. When evaluating which car is the cheapest, you can break down the cost elements and identify measurable parameters that affect them and then find ways to control and verify these parameters. The same procedure applies to the procurement of trains.

In the train context, we put high demands on manufacturers to identify the factors that affect maintenance: intervals, tasks, spare parts etc. In addition, we require that there are methods or basic data to demonstrate that the submitted information is credible and that we as a customer can see how our interests are taken into account.

One challenge is the long life and service intervals for subway trains. The warranty is often only valid a few years, and during this period it is not possible to verify all the costs that will arise due to future operation and maintenance. In some cases, the only way to control the cost is to do it at “the drawing board." In fact, a substantial part of the procurement process aims at establishing how this can be achieved. We usually say that we buy two different things: the hardware  (i.e. trains, documentation and so on) and the service (what the manufacturer promises regarding methods, monitoring and reporting). In addition, a structured method will result in better documentation. In order to convince the manufacturer of the importance of following the process we usually make sure that the payment is tied to the accounting of the project progress. In other words, "no bang - no bucks."

LCC procurement is in itself actually a project management method, which includes the assessment of performance requirements, implementation processes, commercial requirements and documentation with an overarching key ratio expressed as the total cost. This insight has come to be both appreciated and adopted by our customers.

But isn’t the initial investment still the most important cost?

An investment is actually not a cost; it is a redistribution of property. The cost arises when you use, consume or dispose of an asset and is therefore spread out over time, just like any other cost we value. Moreover, the investment cost is just as uncertain as any other future cost. The interest rate changes and a choice of a bad system could perhaps shorten the life length, leaving us with a higher capital cost. Hence, it is entirely relevant to compare it with any other annual cost. And it is the total cost we pay, whether it's in the ticket price or through taxes.