Life-cycle costing strategy delivering financial benefit

What separates the top performers is a focus on the factors they can control - including maintaining efficient operations and analyzing the total life-cycle costs of their equipment

By Tom Dabbs, Plant Performance Services Group, ITT March 21, 2011

We can all hope that 2011 is the year that the Great Recession comes to an end. The global economic downturn has challenged companies in almost every industry, as market factors beyond their control have made it hard to sustain sales and revenues.

As the storm ends and economic growth returns, it’s likely that top-performing manufacturers will be in even stronger market positions, because many poorly performing companies can’t survive an extended recession or will emerge significantly weaker. Bad economic times are particularly punishing to plants that already are spending wastefully or otherwise behaving inefficiently. Worse yet, many organizations in this category don’t even know what’s happening to them until it’s too late.

Stressed manufacturing facilities can show common signs of a breakdown in best practices: equipment that’s operated and maintained improperly; atrocious housekeeping and poor equipment condition; excessive steam, air, and water leaks; and storerooms that appear to have suffered a recent detonation of a small nuclear device.

What separates the top performers is a focus on the factors they can control – including maintaining efficient operations and analyzing the total life-cycle costs of their equipment. While implementing a life-cycle costing methodology throughout an enterprise is a major undertaking, there are some industry benchmarks and relatively simple calculations to identify the potential areas for greatest cost reductions. This article will share some examples and show how plants can achieve a relatively quick return on investment by reducing costs in these priority areas.

Pumps: A prime opportunity to optimize

Because they represent such a large portion of a plant’s operation and maintenance costs (Pumps consume more energy than any other industrial equipment), pumps should be a main focus in any effort to improve overall cost efficiency. (Fig. 1) In fact, companies spend an average of 50% more on operating and maintaining centrifugal pumps than they do on any other rotating machine, and centrifugal pumps generally consume 20% to 60% of a given plant’s motor energy.

There’s definitely room for improvement. A survey revealed that more than 1,500 pumps at 20 plants had an average pumping efficiency of below 40%, and more than 10% of the pumps ran below 10% efficiency. Two major factors that contribute to inefficient pump operations include throttled valves and pump over-sizing. Seal leakage is the most consistent cause for pump downtime and maintenance spending.

Implementing a TCO approach

For pumps or any other equipment, it requires a lot of hard work and some upfront thinking to assess TCO as a matter of routine. First, managers must determine the most efficient way of collecting, organizing and maintaining data using life-cycle costing methodology. Then they must configure the systems and processes to capture the cost of the elements of TCO. To keep the data current, one needs to embed the methodology in daily work processes and systems. That is, once a company decides which TCO elements it wants to measure, managers must configure their systems and processes to routinely deliver that data with a minimum of extra work.

One of the best ways to manage this process is by using a fully functional Enterprise Resource Planning system (ERP) to collect and manage this data. The key elements of this method are making sure the systems are configured properly, sound work processes that fully enable the ERP are in place, ensuring that the process is always followed, and that an individual or group of individuals is responsible to review, analyze and act on the results. This may sound simple, but this is where the job becomes difficult, because it’s about behaviors – asking people to behave the same way and consistently follow the same work processes.

Cost of acquisition and commissioning (Ca and Cc) can be captured during the engineering and construction phases. By developing an equipment hierarchy and assigning each piece of equipment a unique number, we can create a record in the maintenance management module of the ERP that itemizes the cost of each element of acquisition and commissioning, and links it to that equipment number. Consider using some factoring for some of the sub-elements, e.g., procurement cost, inspection testing, training, documentation, etc. Pinpoint accuracy is not critical, so reasonably accurate estimates using factors will get the job done.

The energy consumption portion of Cost of Operations (Co) can be measured by proper configuration of some ERP systems or by utilizing data from more elaborate systems like Enterprise Energy Management (EEM) systems – on-board multi-functional condition monitors that track energy consumption – or other commercially available energy monitoring systems. Since energy represents the largest opportunity for savings, significant effort should be dedicated to selecting the most effective approach. Operating labor can be extracted from the human resource module of the ERP by equipment item, area, or system, if labor is properly charged in the work order system. Factors for facility and support, and material handling costs, can be assigned for this element.

Cost of Maintenance (Cm) should come directly from the work order system. Maintenance, labor and materials costs are automatically charged to the equipment if we consistently follow the proper work process. Again, the use of factors can be employed to cover facility, support and handling, and test equipment.

Cost of Production (Cp) can be expressed by tracking Overall Equipment Effectiveness (OEE), used to measure production losses. Commercially available systems can automate the measurement and reporting of OEE, or it can be measured manually in each area of the plant by operating supervisors using shift reports. By examining losses from speed, down time and quality, organizations can calculate their equipment productivity and express it in a single number that provides a complete measure of manufacturing efficiency and effectiveness:

Rate or speed percentage

x Operating time percentage

x Quality percentage


It’s important to calculate what each percentage of OEE is worth in a given operation. Also, while the OEE formula uses only scheduled time, organizations can use a formula for asset utilization to consider a 24-hour day.

Cost of Disposal (Cd) can be performed using a work order that will tie the cost directly to the equipment item or system. Any reclamation amounts can be applied to the work order when the items have been sold.

Industry benchmarks

With the TCO equation in hand, organizations can take a look at how their processes measure up to industry standards. Even without implementing an Enterprise Resource Planning system, organizations that are willing to gather readily available data can analyze how their costs and productivity compare to generally accepted benchmarks.

These four benchmarks are worth using and tracking:

  • Maintenance spending – should be 2% to 4% of replacement asset value (RAV), which is the value of your plant after it’s been depreciated. You can also use the insured value.
  • Inventory value – should be between .5% and .75% of RAV.
  • Inventory carrying cost – should range from 17% to 23% of inventory value.
  • Overtime – should be 5% to 10% of straight-time labor cost.

Data Requirements and Definitions

The components needed to calculate potential savings include these measures:

  • Replacement Asset Value (RAV) – the replacement value or insured value of the plant
  • Total maintenance spending – includes direct and indirect labor, contractor cost, materials usage cost and overtime cost
  • Maintenance overtime percentage – total overtime hours divided by total labor hours
  • Hourly overtime cost – straight-time labor cost plus overtime premium
  • MRO inventory value – value of inventory minus carrying costs
  • MRO carrying cost – cost of overhead and taxes for MRO inventory
  • Target or best-demonstrated production rate – design rate or best demonstrated rate, such as tons per day, tones per hour, feet per minute, etc.
  • Revenue or margin per unit of production
  • Average availability percentage – actual run time divided by the scheduled time
  • Average production rate percentage – the actual production rate divided by the target rate
  • Average quality rate percentage – actual first-pass quality product divided by total product produced

The Cost of Doing Nothing

Faltering manufacturers often say that they can’t afford to improve. What’s interesting about this response is that so little consideration is given to the fact that the money is already being spent as a result of their situations – sometimes at an alarming rate and many times under the radar. This article provides some illustrations of companies that are performing poorly and don’t think they have the cash flow to improve.

In reality, they have the money, but they are simply spending it in the wrong ways. As the noted Quality guru Dr. W. Edwards Deming said, “Your system is perfectly designed to give you the results you are getting.”

Life-cycle costing – An effort worth making

Taking the time and effort to measure TCO as part of life-cycle costing is not done for passive record-keeping purposes. It is a rigorous process aimed at optimizing the costs to operate a business. It requires unwavering support by senior managers, and subject-matter expertise to perform the analysis and ensure that conclusions and recommendations are feasible.

Some may want to deny that poor operation and maintenance practices caused these companies’ unpleasant outcomes, rather than viewing these simply as symptoms of inevitable death spirals. Either way, any company with similar symptoms is going down the wrong path. Resolving these types of issues makes more profit in good market conditions, and positions companies to survive economic recessions. Organizations that use life-cycle costing and Total Cost of Ownership can make their manufacturing plants significantly more efficient, so that when the next economic downturn comes – and another one will come – they will be better prepared – to ride out the storm.

Tom Dabbs is a reliability specialist for the Plant Performance Services Group of ITT. This article is based on a Plant Engineering webcast presented by Mr. Dabbs in late 2010. Readers can find the presentation slides and audio under the media resources section of

Applying the formula

In this fictitious example of a troubled plant, we assume a set of operational statistics, which reflect actual conditions that ITT engineers have observed at customer sites.

The ROI of TCO

These four examples illustrate how some plants have improved efficiency and saved money by using life-cycle costing methods.

  • A multibillion-dollar chemical manufacturer improved the mean time between failure rate for its pumps by 71%, resulting in a savings of $1.5 million in operations and maintenance. This was accomplished by embedding a pump specialist in the facility to work with the local maintenance and operations team to identify and resolve issues on a daily basis. Root cause analysis was performed on bad actors and causes were eliminated. Inefficient pumping systems were identified and either replaced or reconfigured with a more efficient control system. The embedded engineer has been on site at this location for more than seven years and his existence is evaluated and justified annually.
  • A paper company using more than 4,000 centrifugal pumps saved more than $500,000 by reducing its pump-parts inventory. The company now uses the former spare-parts storage area for paper stock. This was accomplished by an in-depth evaluation of the existing spare parts inventories at four locations. Excessive quantities, obsolete parts and duplications were identified and eliminated at all four locations.
  • After implementing life-cycle costing measures on just 23 pumps, Appleton Coated, a paper manufacturer with more than 1,000 centrifugal pumps, saved more than $1 million on a capital investment of $591,000. This was accomplished with modifications to the control systems on these pumps to move the pumping systems to BEP (best efficiency point) on the pump curves and replacement of over-sized pumps with proper sizes. The savings came from avoided energy costs on these systems.
  • Pasadena Refining Systems processes up to 120,000 barrels of oil per day. Within two years after conducting a root-cause analysis on 30 bad-actor pumps, the company has reduced repair costs by 75% and emissions by 95%. Findings from Root Cause Failure Analysis on these pumps were implemented as soon as possible, and performance of the pumps was monitored and reported to management to track improvements.