Warming to whole life costs

After the first couple of chapters, I thought this book wouldn’t stand a chance of living up to its ambitious title. And if I were to quibble with the title, I would say it should be ‘New Generation Whole Life Value’ rather than ‘Costing’. However, by the time I’d finished reading it I was sufficiently enthused to be looking for an excuse to calculate binomial trees in Excel.

The first part explains the basics of WLC, and the explanation of the payback method of appraisal and its shortcomings are good. But the first quarter of the book included some things that were confusing, and some which I believe are wrong, such as:

• The effect of inflation on the real discount rate. We discount because we prefer to have the money now rather than later, and so future sums are discounted or deflated, partly because the money could otherwise be invested, so committing it to a maintenance fund is an opportunity cost. The effect of inflation counters this and if we ignore risk, then the amount needed now to pay for something in the future depends on the rate at which you could invest the money, minus the rate at which inflation erodes the worth of that money. The difference is the real discount rate. However, in a worked example, they have added inflation and confirm this in the text. Yet a few pages later, under ‘Summing up’, they correctly recommend deducting inflation from the nominal rates to calculate the real discount rate
• The authors recommend increasing the discount to account for risk. At the point this idea is first introduced, this appears to apply to costs. A higher rate would reduce the calculation of the net present cost (NPC) and normally one would add costs to allow for risk, not reduce costs. Although in the later worked examples they apply the risk factor to the calculation of benefits, rather than to costs where the approach does make sense. It didn’t help that the authors consistently use the term NPV for (net present value) when they are only discussing costs only, and so should use NPC. NPV is for evaluation of benefits or a mix of benefits and costs. I was also disappointed at some significant gaps that I thought were worth mentioning, such as the lack of any mention of landfill tax in connection with replacing components. And the book was weak regarding sources of data.

The first quarter included some things that were confusing, and some which I believe are wrong

Despite the above, the book is full of many good ideas. There is lot of philosophy in this book, some supported by quotes by famous writers, statesmen or economists such as giants like Galbraith and Keynes. These quotes are often interesting and provide some light relief.

The authors show how to calculate and use weighted average cost of capital for a company as its opportunity cost, which is key to choosing the discount rate.

But the book really takes off when looking at case studies, including: ability to extend upwards or sideways; change of use; refurbishment; and reconfiguration, which considered whether to build to suit one large tenant or pay extra to enable a mix of smaller tenancies.

The book really takes off when looking at case studies

These examples are used to illustrate the limitations of conventionally applied whole life costing and instead, propose a new technique for strategic appraisal which they call ‘life cycle options’. By ‘options’, they mean not just a choice now, but retaining the ability to choose in the future. The principle mathematical tool is binomial trees in which the root node is now, and further nodes and choices occur with each year. The tool is a variant of decision trees in which each node is associated with its NPV.

The authors show examples where the ability to enhance a building in the future was prevented by a relatively small cost at the outset. They contrast these with other examples in which investment was made to enable changes which were never made. The example that best showed the advantage of the LCC options technique, over a reliance on a conventional WLC approach, was a study on photo-voltaics (PV). A WLC study showed that PV was not viable. However, future scenarios were considered in which it was assumed that fuel costs were more likely to rise rather than fall relative to inflation. Also these costs, like other innovative electrical technologies, would fall in real terms. They concluded that the houses should be PV enabled, so PV panels could be fitted in the future.

The self assessment matrix for whole life evaluation is also useful and serves as an excellent toolkit for considering whether, and in what ways, it may be appropriate to invest to enable future improvements and adaptions to a building.

The authors state the book arose from the Partners in Innovation programme for construction industry research from 1998 to 2002. I wouldn’t recommend this book to practitioners who want help with conventional WLC for work like PFI bids, but I would recommend it to property managers, project managers and surveyors involved in value management and WLC in a more strategic sense.