Life Cycle Costing (LCC) as a contribution to sustainable construction: a common methodology

Transcription

1 Ref. Ares(2014) /04/2014 May 2007 Final Methodology Life Cycle Costing (LCC) as a contribution to sustainable construction: a common methodology

2 Contents Tables and figures... i 0 Introduction STEP 1: Identify the main purpose of the LCC analysis STEP 2: Identify the initial scope of the LCC analysis STEP 3: Identify the extent to which sustainability and specifically environmental analysis relates to LCC STEP 4: Identify the period of analysis and methods of economic evaluation STEP 5: Identify the need for additional analyses (risk/uncertainty and sensitivity analyses) STEP 6: Identify project and/or asset requirements confirm key parameters STEP 7: Identify options to be included in the LCC exercise STEP 8: Assemble cost and time data to be used in LCC analysis STEP 9: Verify values of financial parameters and period of analysis46 10 STEP 10 (Optional): Review risk strategy and carry out preliminary uncertainty/risk assessment STEP 11: Perform required economic evaluation STEP 12: Carry out detailed risk/uncertainty analysis (if required) STEP 13: Carry out sensitivity analysis (if required) STEP 14: Interpret and present initial results in required format STEP 15: Present final results in required format and prepare a final report Annex A: Sample tabular and graphical outputs from typical LCC exercises Annex B: Bibliography and references

3 i Tables and figures Tables 1 Summary and overview of steps 2 Typical applications of LCC 3 Impact of risk on decision-taking 4 Generic cost classification and check list 5 Factors affecting durability 6 Examples of the application of LCC analysis Figures 1 Core process of LCC 2 Methodology flow diagram 3 Risk management cycle 4 Common tools and techniques in risk/uncertainty analysis 5 Probability matrix 6 Calculation of NPV 7 Risk profile in histogram form 8 Risk profile in cumulative form 9 Spider diagram 10 Spider diagram with contour lines 11 Sample project data table 12 Sample annual expenditure table 13 Sample table of key parameters 14 Sample tabulation of total cost profile 15 Sample LCC model 16 Sample component replacement cost build-up 17 Sample cost profile chart 18 Sample cost profile chart 19 Sample cumulative cost chart 20 Sample component option appraisal cost chart

4 1 0 Introduction 0.1 Background In 2006 the European Commission appointed Davis Langdon from the UK to undertake a project (1) to develop a common European methodology for Life Cycle Costing (LCC) in construction. The origins of the project lay in the Commission s Communication The Competitiveness of the Construction Industry and, more specifically, in the recommendations of the Sustainable Construction Working Group established to help take forward key elements of the Competitiveness study. These recommendations proposed that a Task Group (TG4) be established to prepare a paper on how Life Cycle Costing could be integrated into European policy making. The Task Group s paper (2) recommended the development of a common LCC methodology at European level, incorporating the overall sustainability performance of building and construction. The project was undertaken in recognition that a common methodology for LCC in construction is required across Europe in order to: Improve the competitiveness of the construction industry Improve the industry s awareness of the influence of environmental goals on LCC Improve the performance of the supply chain, the value offered to clients, and clients confidence to invest through a robust and appropriate LCC approach Improve long-term cost optimisation and forecast certainties Improve the reliability of project information, predictive methods, risk assessment and innovation in decision-making for procurement involving the whole supply chain Generate comparable information without creating national barriers and also considering the most applicable international developments. 0.2 Purpose of this methodology It was recognised early on in the research process that LCC is applied in various ways and with differing parameters across the EU, and that a single prescriptive methodology would not be appropriate. Therefore this document provides a methodological framework for the common and consistent application of LCC across the EU without attempting to replace country-specific decision models and approaches. It identifies the key considerations to be taken into account at each stage in the LCC process and provides practical guidance on the application of LCC in a number of common scenarios. It is aimed primarily at public sector construction clients and their project advisors, but can also be used by private sector clients and their advisors, and by contractors. 0.3 Using this methodology LCC may be applied in a wide range of circumstances in construction, for example in a project to invest in: A single complete constructed facility such as a building or civil engineering structure An individual component or assembly within a facility A portfolio comprising a number of facilities. LCC may also be applied in the context of existing constructed assets, for example as a means of assessing future operational budgets or for evaluating refurbishment and renewal options.

5 2 The period of analysis adopted for an LCC exercise may similarly vary. LCC may be employed to inform decisions throughout the complete life cycle of a constructed asset or for a selected limited period within it. However, irrespective of how or when LCC is applied, the core evaluation process as summarised in Figure 1 below remains the same. (1): Life cycle costing (LCC) as a contribution to sustainable construction: a common methodology No. 30-CE / (2): Task Group 4: Life Cycle Costs in Construction; Version 29 October 2003, Enterprise Publications, European Commission. Endorsed during 3 rd Tripartite Meeting Group (Member States/Industry/Commission) on the Competitiveness of the Construction Industry.

6 3 Figure 1: Core process of LCC Defining the objective of the proposed LCC analysis Preliminary identification of parameters and analysis requirements Confirmation of project and facility requirements Assembly of cost and performance data Carry out analysis, iterating as required Interpreting and reporting results The purpose of the LCC analysis as defined in the first step in Figure 1 will determine the scope and detail of subsequent steps. To be effective, the process should be undertaken collaboratively between all key stakeholders in the project. The LCC process is essentially iterative, both in the context of assessing options for a decision at a specific point and of repeating the analysis at future points in the life cycle of a project in the light of increasingly detailed information or changing client requirements. The methodology does not seek to represent these potential iterations, rather it takes the user through a series of numbered steps that follow a logical train of thought, as shown on the flow diagram included as Figure 2 below. The steps in this methodology are not intended to reflect the actual chronology of a project to invest in a constructed asset. The accompanying guidance note contains a series of practical case studies that will assist the user in applying the methodology steps to the time line of an actual project. Figure 2 below summarises the methodology steps as a flow diagram. The following 15 sections of this document relate to the individual steps in the methodology and are numbered accordingly.. Section 0.4 below provides an overview of the outcomes for the user as a result of taking each step. A number of steps relating to uncertainty and risk are optional and shown to be taken if required, because their application depends on early decisions at Step 5, concerning the extent to LCC analysis will be supported by risk/uncertainty analyses. The steps generally use a vocabulary appropriate to a project to construct a facility but the essential principles set out are entirely applicable to any constructed asset. The methodology assumes that the user comes to it with a project in view for which the purpose, scale and initial capital cost have been broadly defined. The approach to the development of the LCC methodology was inspired by the Engineering Design Process (EDP). This is a structured decision-making process (often iterative), used in the development of engineering systems, components or processes to meet desired needs.

7 4 Among the fundamental elements of the design process are the establishment of objectives and criteria, synthesis, analysis, construction, testing, and evaluation. These broadly defined stages can be further subdivided into a more detailed process, which includes identifying a need, defining the problem, conducting research, narrowing the research, analysing set criteria, finding alternative solutions, analysing possible solutions, making a decision, presenting the product, and communicating and selling the product. EDP is a well known and established framework used world-wide, therefore applying it to the development of the methodology ensured that there were no omissions of any activities and that a logical sequence of steps was maintained.

8 5 Figure 2: Methodology flow diagram

9 6 0.4 Overview of outcomes Table 1 below summarises the outcomes that can be expected on completion of each of the steps in the methodology. Note that Steps 10, 12 and 13 are optional. Table 1: Summary and overview of Steps STEP OUTCOME / ACHIEVEMENT 1 Identify the main purpose of the LCC analysis 2 Identify the initial scope of the analysis 3 Identify the extent to which sustainability analysis relates to LCC 4 Identify the period of analysis and the methods of economic evaluation 5 Identify the need for additional analyses (risk/uncertainty and sensitivity analyses) 6 Identify project and asset requirements - 7 Identify options to be included in the LCC exercise and cost items to be considered 8 Assemble cost and time (asset performance and other) data to be used in the LCC analysis Statement of purpose of analysis Understanding of appropriate application of LCC and related outcomes Understanding of: Scale of application of the LCC exercise Stages over which it will be applied Issues and information likely to be relevant Specific client reporting requirements Understanding of: Relationship between sustainability assessment and LCC Extent to which the outputs from a sustainability assessment will form inputs into the LCC process Extent to which the outputs of the LCC exercise will feed into a sustainability assessment Identification of the period of analysis and what governs its choice Identification of appropriate techniques for assessing investment options Completion of preliminary assessment of risks/ uncertainties Assessment of whether a formal risk management plan and/or register is required Decision on which risk assessment procedures should be applied Definition of the scope of the project and the key features of the asset Statement of project constraints Definitions of relevant performance and quality requirements Confirmation of project budget and timescales Incorporation of LCC timing into overall project plan Identification of those elements of an asset that are to be subject to LCC analysis Selection of one or more options for each element to be analysed Identified which cost items are to be included Identification of: All costs relevant to the LCC exercise Values of each cost Any on-costs to be applied Time related data (e.g. service life/maintenance data)

10 7 9 Verify values of financial parameters and period of analysis 10 Review risk strategy and carry out preliminary uncertainty/ risk analysis 11 Perform required economic evaluation 12 Carry out detailed risk/uncertainty analysis (if required) 13 Carry out sensitivity analyses (if required) 14 Interpret and present initial results in required format 15 Present final results in required format and prepare a final report Period of analysis confirmed Appropriate values for the financial parameters confirmed Taxation issues considered Application of financial parameters within the cost breakdown structure decided Schedule of identified risks verified Qualitative risk analysis undertaken risk register updated Scope and extent of quantitative risk assessment confirmed LCC analysis performed Results recorded for use at Step 14 Quantitative risk assessments undertaken Results interpreted Sensitivity analyses undertaken Results interpreted Initial results reviewed and interpreted Results presented using appropriate formats Need for further iterations of LCC exercise identified Final report issued, to agreed scope and format Complete set of records prepared to ISO Part Tailoring the methodology to the specific project circumstances It is important to note that in practice it will often be possible for users to combine several of the above steps in order to tailor the methodology to the size of the project, the project stage and the level of detail required. For example, Steps 1 to 6 are concerned with defining the objectives and the analysis parameters. On smaller projects this definition exercise might typically take the form of a meeting or telephone discussion with the client and/or an exchange of correspondence. Similarly, the risk and sensitivity analyses might be incorporated into the economic evaluation exercise (Step 11) based on a small number of agreed parameters and/or the practitioner s experience of common risk issues. Regardless of the scale or scope of the exercise, the guiding principle should always be that the key issues identified in this methodology are all considered, albeit at a level of detail appropriate to the particular exercise. 0.6 Definitions This methodology is intended to be compatible with ISO Part 5 which is currently at the DIS ballot stage and is likely to be adopted shortly. Definitions used in this methodology are therefore as in ISO Part 5. For ease of use, key definitions are reproduced below. Life Cycle Costing A technique which enables the systematic appraisal of life cycle costs over a period of analysis, as defined in the agreed scope.

11 8 Life Cycle Cost Assessment expressed in monetary value taking into account all significant and relevant costs over the life cycle, as defined in the agreed scope. The projected costs are those needed to achieve defined levels of performance, including reliability, safety and availability over the period of analysis. Life Cycle Consecutive and interlinked periods of time between a selected date and the disposal of the asset, over which the criteria (e.g., costs) are assessed. This period may be determined for the analysis (e.g., to match the period of tenancy or ownership) or cover the entire life cycle. The life cycle period shall be governed by defining the scope and the specific performance requirements for the particular asset. Nominal Cost Expected price which will be paid when a cost is due to be paid, including estimated changes in price due to, for example, forecast change in efficiency, inflation or deflation and technology Real Cost Cost expressed as a value as at the base date, including estimated changes in price due to forecast changes in efficiency and technology, but excluding general price inflation or deflation Discounted Cost Resulting cost when the real cost is discounted by the real discount rate or when the nominal cost is discounted by the nominal discount rate Discount Rate Factor reflecting the time value of money that is used to convert cash flows occurring at different times to a common time NOTE This may be used to convert future values to Present Day Values and vice versa. Nominal Discount Rate Rate used to relate present and future money values in comparable terms taking into account the general inflation/ deflation rate Real Discount Rate Rate used to relate present and future money values in comparable terms, not taking into account the general or specific inflation in the cost of a particular asset under consideration Net Present Value Net Present Value is the sum of the discounted future cash flows. Where only costs are included this may be termed Net Present Cost (NPC) Present Day Value Monies accruing in the future that have been discounted to account for the fact that they are worth less at the time of calculation Sensitivity Analysis Test of the outcome of an analysis by altering one or more parameters from initial value(s)

12 9 Residual Value Value assigned to an asset at the end of the period of analysis. 0.7 Relationship with ISO It is important to note that the ISO definition of the term life cycle differs from that used in the environmental standard, ISO The latter adopts a broad cradle to grave definition of life cycle, whereas the ISO definition can represent either cradle to grave or a shorter economic analysis timeframe driven by the specific client or project needs. The ISO definition of life cycle feeds into that of life cycle assessment (LCA) as follows: Life cycle Consecutive and interlinked stages of a product system, from raw material acquisition or generation of natural resources to the final disposal. Life cycle assessment Compilation and evaluation of the inputs, outputs and the potential environmental impacts of a product system throughout its life cycle. This methodology aligns with the ISO definition of life cycle. However, for the purposes of consistency, users applying LCC to evaluate the outcomes of an LCA analysis may wish to align with the broader ISO definition of life cycle. Further specific public sector guidance on the appropriate parameters for carrying out an LCC analysis is provided in the guidance note that accompanies this methodology. 0.8 Companion documents This methodology is accompanied by a guidance note and a set of case studies of the common use of LCC in Europe. The guidance note is aimed at public sector clients and provides an introduction to LCC along with guidance on why it should be used, its benefits, the information to be gained from it, and its relationship with the EU procurement framework. The case studies are included as an appendix to the guidance note.

13 10 1 STEP 1: Identify the main purpose of the LCC analysis 1.1 Purpose of this step LCC is a versatile technique capable of being applied for a range of purposes and at different stages in the project or asset life cycle. The purpose of this step is to clearly identify the purpose of the proposed LCC analysis and to gain an understanding of how it can be appropriately and successfully applied and of the outcomes that can be expected. 1.2 Purposes for which LCC may be employed The purposes for which LCC may be employed can be divided into, in two broad categories: As an absolute analysis, when used to support the processes of planning, budgeting and contracting for investment in constructed assets As a relative analysis, when used to undertake robust financial option appraisals, for example in relation to potential acquisition of assets, design approaches or alternative technologies. More specifically, LCC can be used to support decision-making in a number of ways: In assessing the total cost commitment of investing in and owning an asset, either over its complete life cycle ( cradle to grave ) or over a selected intermediate period By improving understanding of the total cost of an asset, particularly by construction clients, and improving the transparency of the composition of these costs By facilitating effective choices between different means of achieving desired objectives, for example reducing energy use or lengthening a maintenance cycle By helping to achieve an appropriate balance between initial capital costs and future revenue costs In helping to identify opportunities for greater cost-effectiveness, for example selection of components with a longer service life or reduced maintenance requirements As a tool for the financial assessment of alternative options identified during a sustainability analysis, for example components with less environmental impact or HVAC systems with greater energy efficiency Overall, by instilling greater confidence in decision-making in a project. LCC can be employed throughout or at different stages of the life cycle of an asset or a project to invest in construction; this is considered in detail at step 2. Some examples of common applications of LCC follow below in this section to further illustrate these points. 1.3 Typical applications of LCC Table 2 below illustrates how LCC can be applied in a variety of circumstances, with examples drawn from a building development. The same principles apply in an infrastructure or engineering context. The successive stages in the whole life cycle of a scheme and the related need for decisions are considered in more detail in section 2 following. More detailed examples are provided in the Guide that accompanies this methodology.

14 11 Table 2: Typical applications of LCC Context and need During investment planning, clients will need to understand the full cost implications of operating as well as building the scheme, to establish its essential viability. During the early stages of scheme design, decisions will be required on the fundamental elements structure, envelope, services, finishes By detail design stage, the essential cost parameters of the scheme will be determined but decisions will still be required on details and whether, finally, to commit to construction. Detailed design also requires final selection of materials, components and systems. Potentially, similar decisions will subsequently be required in the event of their replacement during operation and maintenance During the operation of the completed asset refurbishment and renewal of some elements might be required, driven by (for example): High operational costs High energy consumption Obsolescence (for example: physical, technical, economic, social) Change in use of the asset Components or systems reaching the end of their service life Typical application of LCC The analysis will be based on approximate data, typically historical information from similar projects, but sufficient for budgeting and option ranking to allow a decision on whether to go ahead, to reduce the scheme or stop. The analysis can draw on feasibility studies and pre-project professional advice, as well historical information, to support decisions on the key features of the scheme its size, scope, method of construction and operation. Information can now be fed into the analysis based on a clear view of all primary elements of the scheme and access to related cost, service life and maintenance data from manufacturers specifications, as well as similar projects and national price books. This allows a detailed LCC breakdown confirming the viability of the scheme and appraisal of detailed design options. Sensitivity and risk analyses may also be carried out. LCC analysis can be focused on the specific component or system with the benefit of related cost, service life and maintenance data from manufacturers specifications, as well as from similar projects and national price books. The main focus will be on option evaluation, ranking and selection. LCC can be applied in supporting selection of the most appropriate refurbishment or renewal option, at either an asset or component level. The analysis can be based on historic or benchmark data, or on detailed data derived from manufacturers specifications and comparable cost-in-use data. It is essential that the analysis takes into account the impact on interdependent systems and the overall asset. 1.4 The need for clarity of objectives The different purposes for which LCC may be employed, and the different stages of the asset life cycle at which it is used, imply the need for different levels of detail and accuracy in the process, and in the inputs and outputs. For example, if LCC is employed to support an early budgeting process, all relevant costs must be considered and the analysis may be based on approximate data such as historic benchmark information. As the LCC analysis is subsequently refined during the detailed design stages, further detail will be required on all cost items, along with robust service life and maintenance data. The process may also need

15 12 to support auxiliary outputs such as an estimate of resources or a reporting schedule to provide all necessary support for decision-making. If the primary purpose is to appraise options, the process of iteration will involve refining or eliminating the available alternatives as they are measured against project objectives and budget constraints. This process will include identification of those cost elements that do not have a significant impact on the overall LCC or which do not vary between the alternatives. These elements can be then be eliminated from further consideration. Accordingly, clearly defining the objectives of a proposed LCC analysis must be seen as an essential first step in ensuring that it will be fit for the user s purpose. 1.5 The ingredients for success Successful application of an LCC approach requires: A team approach incorporating all key players in a project Integration of the LCC exercise into the whole investment decision-making process through the conception, design, construction and operation of a facility Recognition that the robustness of the outputs of the LCC exercise is highly dependent on the level of detail and certainty in the cost and time inputs used Clear definition of scope and consideration of all relevant parameters (note that scoping issues are covered in Step 2) Recognition of the limitations of the techniques employed, leading to the proper exercise of professional judgement. 1.6 At the end of Step 1 At the end of Step 1 the user will have developed: A clear and comprehensive statement of the purpose of the proposed LCC analysis An understanding of how LCC analysis can be appropriately and successfully applied and the outcomes that can be expected.

16 13 2 STEP 2: Identify the initial scope of the LCC analysis 2.1 Purpose of this step In step 1 the broad purpose and outcomes of the LCC exercise were identified. For the outcomes to be achieved it is also important to identify the scope of the exercise, including the stage(s) in the asset life cycle at which it is undertaken, the boundaries of the analysis and whether there are any specific inclusions or exclusions. 2.2 The scale of application of LCC LCC analysis may be undertaken to support a project to invest in: A single complete constructed asset that comprises a usable facility such as a building or civil engineering structure An individual component, material or system within such an asset A portfolio comprising a number of assets For clarity, this methodology assumes the scenario of a project to construct and use a single asset, but the same principles and basic processes apply whatever the scale of application of LCC. The scale of application for a proposed LCC analysis will be defined by the client, in the light of the objectives defined as discussed in section 1 above. 2.3 Stages in the life cycle of an asset For the purposes of this methodology the life-cycle of an asset is divided into the following stages: Investment planning, pre-construction Design, construction Operation, maintenance End of life / disposal Activities in the investment planning / pre-construction phase might typically include: Business case preparation Acquisition of site(s) or of existing asset(s) Professional consultancy Inspections and surveys Arranging finance Assembling the project team / consortium Procurement planning Activities in the design and construction phase might include: Scheme design Detailed design Site clearance Placing contracts for construction Construction of the fabric Fitting out Commissioning and handover Landscaping Activities in the operation and maintenance phase might include:

17 14 Employing an FM team or placing an appropriate contract Placing contracts for energy supply and other utilities Arranging insurances and compliance with regulatory requirements, eg inspections Planning and carrying out pre-planned (cyclical) maintenance and replacements Carrying out unplanned (responsive) maintenance and replacements Planning and carrying out pre-planned refurbishment and/or adaptation (such works may be better considered as separate projects subject to their own LCC considerations) Cleaning Redecoration Grounds maintenance. Activities in the end of life/disposal phase might include: Sale of asset Change of use of asset Demolition Site and land clearance and clean up Recycling of materials A proposed LCC analysis might take place over one or more or all of these stages, as discussed below. Its purpose must be defined by the client, in the light of the objectives defined at step Use of LCC through successive stages. LCC analysis can be used either as a one-off intervention to a project or, in a broader context, to inform different decisions at different stages of the project or asset life cycle. In the latter case, input data is progressively refined as the project moves through successive stages. Accordingly, as calculations are based on increasingly detailed and reliable data and initial assumptions are tested and validated, early strategic decisions are confirmed and subsequent decisions taken at increasing levels of detail Investment planning / pre-construction Decisions at planning / pre-construction stage are of a strategic nature relating to the essential features of the proposed project, with data typically input at a low level of detail. They typically cover the following considerations: The essential features of the proposed scheme Methods of investment appraisal Finance costs, budgets, cash flow, funding sources Procurement policy and methods Balance between economic, technical and sustainability considerations Risk management strategies and techniques Key project drivers and overall priorities. The application of LCC at this stage in the in the project might include: Identification of the purpose(s) of using LCC, both at this stage and in subsequent stages Incorporating LCC requirements into business case, project documentation and supply chain terms of reference Identification of methods of analysis, required outcomes and reporting formats Identification of required analysis period and/or design life for the proposed facility Consideration of cost drivers, including capital v operating cost priorities Use of LCC as an assessment criterion in project approval/gateway processes

18 15 Use of LCC in assessing initial strategic project options such as whether to refurbish or build new Design and construction Design and construction is a broad stage with design decisions taken successively through three levels: Scheme level, fixing the basic physical characteristics of the facility System level, deciding the major installations and assemblies Detail design. The level of detail in the LCC analysis typically increases progressively though these levels and its purpose and implementation should be kept under review as it is reiterated. LCC considerations through this stage typically include: LCC impact of high level design decisions such as format, composition, orientation and layout of the proposed asset Selection of components, materials and systems and assessment of their costs over the life cycle (or part thereof) Life cycle costing of sustainability options identified as part of a sustainability assessment process Assessment of future operating costs of the facility and its constituent parts Contractual framework, both for construction and future operation and maintenance Resource implications during the operational stages Need for and ease of functional reconfiguration / adaptation during operation Any planned replacement / refurbishment during operation Ease of carrying out future maintenance, replacement and refurbishment, including health and safety implications Impact of future LCC works on the use and users of the asset Operation and maintenance The opportunities and need for LCC analysis continue into the operation and maintenance stage and might typically relate to: Cost and performance drivers during operation and maintenance Assessment of options in relation to component replacements, refurbishment, adaptation Financial framework and funding of LCC works, including use of sinking funds Denial-of-use costs, whether loss of amenity or contractual penalties (such as in PPP or other FM contractual payment mechanisms) Strategies and planning for operation and related cost models: o FM o Energy o Other utilities o Cleaning o Waste disposal and recycling Strategy and planning for maintenance, repair and replacement works: o Contractual framework and responsibilities (for example in-house delivery or outsourcing of some/all activities) o Maintenance planning and management systems (including use of condition-based monitoring) Collection and use of feedback data Risk allocation for operation, maintenance and finance costs

19 End-of-life / disposal LCC considerations at the end-of-life stage might include: Strategy for disposal, including methods, costs, residual values Evaluation of alternative uses of the facility Evaluation of options for demolition and site / land clean up, including methods, costs Strategy for salvage and recycling opportunities, costs, potential value Collection and use of feedback data 2.5 Identification of analysis boundaries It is important during the early scoping exercise to identify the broad boundaries of the LCC analysis, including: Whether the analysis period is to include the entire asset life cycle or a defined part thereof (see Step 3 below) What costs (and revenues) are to be included or excluded from the analysis (for example the client s contractual or financial interest in the asset may require certain costs to be excluded) Whether there are particular project, contractual, regulatory or economic issues that will influence key criteria (such as analysis period, method of economic evaluation) that are to be defined in future steps. 2.6 Identification of analysis outputs The required outputs and reporting format of the LCC analysis should be agreed in broad terms at this stage. Clients may require the detailed analysis and/or the summary findings to be presented in a particular format to suit their internal reporting processes or those of an external regulatory or funding body. Early identification enables the user to address these issues before the analysis has been undertaken, thereby eliminating unnecessary reworking of reports at a later stage. LCC consultants often use in-house software with standard report formats that might require amendment. Note that detailed reporting issues are considered in Steps 14 and 15 of this methodology. 2.7 At the end of Step 2 At the end of step 2, the user will have developed a clear understanding of: The scale of application of the LCC exercise The stage(s) of the project or asset life cycle over which it is likely to be undertaken The scope and nature of the issues and information likely to be relevant. Any specific client reporting requirements that require early consideration.

20 17 3 STEP 3: Identify the extent to which sustainability and specifically environmental analysis relates to LCC 3.1 Purpose of this step Environmental sustainability is becoming a key consideration in any long term assessment of constructed assets. The relationship between LCC and sustainability assessment and the extent to which the latter forms an input to the LCC analysis is defined at this step. 3.2 Assessing sustainability Practitioners recognise three fundamental and interlinked sets of issues within the sustainability agenda: Environmental relating typically to air quality, land use, use of natural resources (raw materials, energy, water, waste etc), transportation, biodiversity, cultural heritage, etc. Social relating typically to access, amenity, user comfort and satisfaction, community health and welfare Economic relating typically to opportunities for employment, skills development, local businesses including SMEs, Some sustainability issues are difficult to measure and to incorporate into a LCC analysis. However, LCC practitioners widely accept that the environmental impact associated with constructed assets can be significant and should always be considered. A range of approaches to assessing environmental impact are available to suit the type of asset, the aspects of the environment that are of concern and the particular parameters that are of interest. The following are the most frequently used: Life Cycle Assessment (LCA) LCA addresses the environmental aspects and potential environmental impacts (e.g. use of resources and the environmental consequences of releases) throughout a product's life cycle from raw material acquisition through production, use, end-of-life treatment, recycling and final disposal Environmental Impact Assessment (EIA) a process for informing decision-makers of the local environmental consequences/effects potentially caused by different project options Multi-Criteria Analysis (MCA) a process that initially identifies a set of goals or objectives and then seeks to identify the trade-offs between those objectives for different options. The 'best' environmental solution is identified by attaching weights (scores) to the objectives. While a number of approaches to assessing environmental impact are available to suit individual requirements, LCA is one of the most versatile and widely recognised in construction and is referred to in this methodology. It is also the only approach that is the subject of International Standards (ISO and ISO 14044). To be properly comprehensive, an environmental impact assessment of a constructed asset must extend to the manufacturing process and transport of materials and components. 3.3 Measures employed in LCA Environmental impact is caused primarily by the consumption and/or transformation of materials and energy. Accordingly LCA measures the consumed and emitted flows (that is, raw material and energy consumption, and emissions to air, water, soil) over the whole life cycle of the asset from raw material acquisition through production, use, end-of-life

21 18 treatment, recycling and final disposal of the asset. This compilation of inputs and outputs is called Life Cycle Inventory (LCI). The LCI is the basis for a later analysis and potential assessment of the environmental effects related to the product or process. This aggregation of the many single resources and emissions is then translated into indicators about the potential impacts on the environment, health, and use of natural resources. This step is called Life Cycle Impact Assessment (LCIA). In general, this process involves associating inventory data with specific environmental impact categories and category indicators. The collection of indicator results (LCIA results) or the LCIA profile provides information on the environmental issues associated with the inputs and outputs of the system assessed. Life Cycle Impact Assessment (LCIA) methods can be grouped into two families: classical methods determining impact category indicators at an intermediate position of the impact pathways (e.g. ozone depletion potentials) and damage-oriented methods aiming at more easily interpretable results in the form of damage indicators at the level of the ultimate societal concern (e.g. human health damage). Although users may choose to work at either the midpoint or damage levels, a current tendency in LCIA method development aims at reconciling these two approaches. Both of them have their merits, and optimal solutions can be expected if the 'midpoint-oriented methods' and the 'damage-oriented methods' are fitted into a consistent framework. Because there is no single accepted method carrying out LCA, the European Commission has provided a standardisation mandate M/350 to CEN in order to establish a set of specific LCA rules for assessment of environmental performance of buildings and construction products. The rules are to be based on the generic ISO standards 14040, and for Environmental Product Declarations and they are also in line with the building construction sector specific standards under development in ISO. As a consequence CEN has established a technical committee CEN/TC350 Sustainability of Construction Works to fulfil the work specified in the mandate M/350. Note: Where the term LCA is used in the following sections it should be taken to encompass all environmental sustainability assessment methods. 3.4 Interrelationship between LCC and sustainability analysis Whilst LCC and LCA are two distinct and different processes that have developed and are practised as separate disciplines in the construction industry, there are many parallels and interrelationships between the two. For example, both: Are concerned with assessing the long term impacts of decisions Require analysis of an often diverse range of inputs Use similar data on inputs of materials and energy Take into account operation and maintenance Consider opportunities for recycling vs. disposal Provide a basis for rational decision making, particularly in appraising options. However, the two disciplines differ in the basis of the resulting decisions: LCC combines all relevant costs associated with an asset into outputs expressed in financial terms as a basis for making investment decisions LCA enables decisions to be made on the basis of potential environmental impacts by scoring and rating on environmental criteria. Whilst costs can be firmly attributed to

22 19 some environmental factors there is currently no widely agreed methodology for others and some cannot be quantified at all in cost terms. As a result LCC and LCA do not necessarily produce a common output. Nevertheless environmental impact assessment has a key place in overall long term decision-making and consideration should be given to how to integrate it with the LCC process at the earliest stages. 3.5 The use of LCA with LCC As discussed above, in LCC the primary driver in decision-making is cost and LCA informs decisions on the basis of potential environmental impacts. The use and sequence of LCC and LCA will depend on the priorities of the decision-maker. The range of approaches might cover, for example: Use of LCC and LCA as two of the criteria in the evaluation of a single investment option (such as the decision to construct an asset), where other evaluation criteria might include functionality, aesthetics, speed of construction, future investment returns etc. Use of LCC and LCA as two of the criteria in the evaluation of a number of alternative investment options (either entire constructed assets or specific components, materials or assemblies within them) Use of LCC to provide a financial/economic evaluation of those sustainability impacts that have a widely agreed and readily calculated monetary value Use of LCC to provide a financial/economic evaluation of alternative options identified in a LCA assessment Use of LCA as a means of identifying alternative options with a good environmental performance and then carrying out a LCC analysis on those options only Use of LCC to select cost effective options, then making a final decision in the light of a process of LCA carried out on those options only. Thus it can be seen that LCC and LCA can either be used alongside each other in a broader evaluation process, or either process can form an input into the other. 3.6 At the end of Step 3 At the end of step 3 the user will have developed a clear understanding of: The relationship between sustainability assessment and LCC The extent to which the outputs of a sustainability assessment will form inputs into the LCC analysis The extent to which the outputs of the LCC analysis will feed into a sustainability assessment

23 20 4 STEP 4: Identify the period of analysis and methods of economic evaluation. 4.1 Purpose of this step The selection of the appropriate period of analysis is fundamental to the outcome of a LCC exercise. In step 2 the User identified the likely broad timescale of the LCC exercise. In this step, the timescale over which the analysis takes place is confirmed as the period of analysis. 4.2 Period of analysis The period of analysis is formally defined in ISO15686 Part 5 as follows: The length of time over which an LCC assessment is analysed. This period of analysis shall be determined by the client at the outset (e.g. to match the period of ownership) or on the basis of the entire life cycle of the asset itself. ISO Part 5 provides further definitions as follows: Life Cycle as Consecutive and interlinked periods of time between a selected date and the disposal of the asset, over which the criteria (e.g., costs) are assessed. This period may be determined for the analysis (e.g., to match the period of tenancy or ownership) or cover the entire life cycle. The life cycle period shall be governed by defining the scope and the specific performance requirements for the particular asset. Entire Life Cycle as Consecutive and interlinked periods of time between a selected date and the end of service life of the asset, including the end of life period. It should be noted that the ISO definition of life cycle differs from that in the environmental standard, ISO The latter adopts a broad cradle to grave definition of life cycle, whereas the ISO definition can represent either cradle to grave or a shorter economic analysis timeframe driven by the specific client or project needs. Users should confirm with the client which definition is to be adopted for their LCC analysis. The decision on the appropriate analysis period for a LCC exercise may be driven by a number of factors relating to the client, the project and/or asset, and the financial, legal and regulatory framework in which they operate. Key drivers might include: Design life of the asset Project duration (for example PPP projects typically last for years) Period of economic interest in the asset (for example lease period) Financial drivers (for example investment requirements, loan periods) Projected refurbishment/remodelling periods Regulatory requirements (for example treasury guidance may stipulate analysis period) Business planning cycle Client requirement to adopt the ISO environmental definition of life cycle The selected analysis period can have a fundamental impact on the outcome of a LCC exercise and it is essential that the appropriate consideration is given to it. In particular, the potential effects of selecting a particularly long or short analysis period should be understood. Selection of a longer analysis period introduces higher levels of risk into the analysis, as the long term impacts of issues such as inflation, future need for and use of the asset, component maintenance and replacement requirements (i.e. service life) and system obsolescence become more difficult to predict over time. This is not to suggest that users

24 21 should not carry out LCC exercises over longer time periods, rather that the increased risks need to be adequately understood and accounted for. Users should also be aware of the impact of the chosen discount rate (see below) when applied over different analysis periods. The longer the analysis period, the greater the impact that the chosen discount rate will have on future costs. Conversely, the shorter the analysis period, the less effect discount rates will have on the analysis outcome. 4.3 Asset and component life In order to identify the appropriate analysis period users may need to make an assessment of the expected life of the asset or its constituent parts. The first distinction that users should understand is that of design life and service life. ISO Part 1 defines the terms as follows: Service life: period of time after installation during which a building or its parts meets or exceeds the performance requirements. Design life: intended service life, or expected service life, or service life intended by the designer. In practice, the term life when applied to a constructed asset can be defined in a number of ways depending on the interests and objectives of the user, as follows: Physical life (from construction to demolition or replacement). Every asset has a predicted length of life at the end of which a physical collapse is possible. However most assets never reach that point and are demolished or replaced beforehand, generally due to economic obsolescence. Note that physical life corresponds to the ISO definition of service life. Economic life (from construction to economic obsolescence). Economic obsolescence happens when the further use of an asset is no longer the most economic solution among alternatives. Functional life (from construction to the point when the asset ceases to function for its intended purpose). An asset reaches the end of functional life when it can no longer function for the purpose for which it was intended. Technological life (from construction to the point when the asset is technologically obsolete). End of technological life occurs when an asset, typically a system or component, is no longer technologically equal to or better than available alternatives. Social / legal life (from construction to the point when replacement is required for social or regulatory reasons). An asset reaches the end of its social or legal life when requirements other than economic dictate replacement or change, e.g. health and safety or legislative issues. Contractual / duration of interest life (for any period of time during the duration of the physical life of an asset). This period of analysis covers the length of a contract for a particular service, e.g. construction, operation, etc. Arbitrary life (length of time e.g. 25, 30, 50 years), assumed due to national practice, local best practice, client s stipulation, etc. It can be seen from the above range of potential definitions of life that the period of analysis for a LCC exercise can often be shorter than the physical life of an asset, that is, from cradle to the grave. The period of analysis must therefore be specifically defined for each LCC exercise.

25 Discounting The purpose of discounting Discounting is a widely used technique for comparing costs and revenues occurring at different points in time on a common basis, normally the present time. It is based on the principle that a sum of money to hand at the present time has a higher value than the same sum to hand at a future date, because of the earning power of that sum in the interim. Discounting to present value makes an adjustment to the future costs of an asset that takes account of inflation and the real earning power of money, allowing them to be compared and evaluated on the same basis as costs incurred at the present. The need to discount depends on the use to which the LCC analysis will be put. It is necessary only where a series of costs over time has to be put onto a common basis for the purpose of a decision, not where the objective is simply to project annual costs on a year by year basis. Therefore when carrying out a LCC evaluation of two or more options with different cost profiles over time it is likely that discounting will need to be applied, whereas it may not be necessary if the aim is simply to prepare a cost profile for one option alone The effect of discount rates A decision not to discount, that is, to apply a zero rate, implies that the timing of a cost (eg for repair or renewal) is immaterial and disregards the earning power of money. However, use of a zero rate presents the best case for spending a greater sum up front (i.e. capital costs) in order to generate greater savings through the analysis period (e.g. operating, maintenance, energy costs). It can therefore be argued that a zero discount rate should be applied to all public sector investments intended to leave a lasting legacy for future generations. Conversely, a high discount rate will present options with low up-front costs as appearing more desirable and it can be argued that this has the effect of sacrificing the interests of future generations to those of the present decision-makers. However, future uncertainties and external influences unrelated to the asset (eg budgetary constraints or changed political priorities) may have an impact on the timing or extent of future costs. It can therefore be argued that this represents an argument for affording future costs less weight in decisionmaking and hence for discounting. Further guidance on the selection of the appropriate discount rate is provided below The treatment of inflation The discount rate is the investment premium over and above inflation and as such is a separate concept and distinct from it. There are two possible approaches to dealing with inflation: Using a nominal discount rate, that is a rate that is not adjusted to remove the effects of actual or expected inflation. This means that inflation predictions are built into forecast costs and prices Using a real discount rate, that is a rate that has been adjusted to remove the effect of actual or expected inflation. This means that future costs and prices are estimated at present day ( real ) prices and inflation can be dealt with separately. If inflation rates for all costs in the analysis are approximately equal, it is common practice to exclude inflation from the LCC analysis (i.e. to adopt a real discount rate). However, if

26 23 the analysis includes commodities subject to widely differing rates of inflation, for example energy prices and labour rates, inflation would have to be included (i.e. using a nominal discount rate). Because constructed assets typically have long service lives and it is difficult to predict inflation in the long term, it is generally recommended to carry out LCC analyses on using real costs and discount rates. It is further often recommended that results should be tested by applying at least two real discount rates, including one relatively lower rate, and appraising the difference in outcomes (see Step 13 guidance on sensitivity analysis) Selecting the discount rate Selecting the most appropriate discount rate is critical to the success of an LCC exercise. In the private sector, selecting the rate can be a highly judgemental process with reference to the financial status of the client and the circumstances of the particular project, and in practice rates can vary widely. Key considerations will be the cost of capital, the perceived level of project risk and the opportunity cost of capital (i.e. the level of return that could be generated by investing the capital elsewhere). In the public sector, national ministries of finance generally specify the discount rates to be used in the economic analysis of publicly funded projects. These typically fall into the range of 3 to 5%. The rate may also be assessed on a case by case basis by reference to: The opportunity cost of capital The societal rate of time preference The cost of borrowing funds. The opportunity cost of capital is the cost of foregoing an alternative investment. This approach assumes that finance for public sector projects is withdrawn from private savings and which would otherwise have gone into private investment. Hence the discount rate is equated to the pre-tax rate of return available to private capital. The societal rate of time preference is the interest rate that reflects a government s judgment about the relative value which society as a whole assigns (or which the government feels it ought to assign) to present versus future consumption. The societal time preference rate is not observed in the market and bears no relation to the rates of return in the private sector, interest rates, or any other measurable market phenomena. The rationale of the Cost of Borrowing Funds approach is that the interest rate should match the rate paid by government for borrowed money. This approach is favoured by many agencies and is supported by the argument that government bonds are in direct competition with other investment opportunities available in the private sector. Some advocate use of a zero interest rate in the public sector, arguing that when tax monies (eg road tax) are used, such funds are free money because no principal or interest payments are required. A counter-argument is that zero or very low interest rates can produce positive cost/benefit ratios for even very marginal projects and thereby take money away from more worthwhile projects. A zero interest rate also fails to discount future expenditure, making tomorrow s relatively uncertain predicted costs as significant in the decision as today s known costs.

27 Methods of economic evaluation A number of widely used financial analysis techniques are available for the assessment of alternative investment options. Using two or more techniques together provides a broader picture of value implications Net Present Value (NPV), Net Present Cost (NPC) The NPV is the sum of the discounted future cash flows, both costs and benefits/revenues. Where only costs are included this may be termed Net Present Cost (NPC). NPV is a standard measure in LCC analyses, used to determine and compare the cost effectiveness of proposed options. It can be applied across the full range of construction investments, covering whole investment programmes, assets, systems, components and operating and maintenance models. The costs and revenues/benefits to be included in each analysis are defined according to its objectives. For example, revenues from recycling of materials or from surplus energy generation are typically included in a LCC analysis of alternative sustainability options Payback (PB) The PB period is the measure of how long it takes to recover initial investment costs and is a useful basis for evaluating alternative investment options. It may be calculated using either real (non-discounted) values for future costs, that is Simple PB, or present (discounted) values, that is Discounted PB. PB in general ignores all costs and savings after the payback point has been reached and it is possible that an investment with a short PB is a poorer option than one with a longer payback over the entire period of analysis. PB is a useful technique for assessing whether additional investment in, for example, lower energy plant, is worthwhile. It enables users to weigh the additional capital costs against the time it takes for these costs to be recouped through savings or income during the operational period. This may be a useful means of judging whether an investment represents good value for money, although the subjective nature of the value for money assessment may make it inappropriate for some public sector investment decisions Net Savings (NS), Net Benefit (NB) NS/NB is the present value of savings/benefits in the operation phase less the present value of the additional investment costs to achieve them. It provides a measure of costeffectiveness and of the benefits to be achieved from investment options. NS/NB greater than 0 indicates positive cost-effectiveness Savings to Investment Ratio (SIR) The SIR is a measure of the cost-effectiveness of a proposed investment (an SIR greater than 1 is positive) and can be used to prioritise and select investment options Adjusted Internal Rate of Return (AIRR) The AIRR is a measure of the annual yield from a project over the period of analysis taking into account reinvestments of interim receipts, indicating projects with greater net savings. An AIRR greater than the minimum acceptable rate of return (ie the discount rate) is positive.

28 Annual Cost and Annual Equivalent Value (AC or AEV) The AC or AEV is a uniform annual amount that, when totalled over the period of analysis, equals the total net cost of the project taking into account the time value of money over the period. It is used to compare investment options where the natural replacement cycle cannot easily be directly related to the period of analysis. The lowest AEV indicates the lowest cost option. 4.6 Guidance on which evaluation technique(s) to use Further guidance on which evaluation techniques are most appropriate in a public sector context is provided in the Guidance Note that accompanies this methodology. 4.7 Taxation issues Fiscal considerations can be highly significant in LCC analyses, particularly in the private sector, with tax efficiency a major objective in designing investment portfolios, finance arrangements and individual projects. Taxation is a complex area, varying between member states. Accordingly it is important at this step to develop a strategy for managing fiscal issues, seeking at the earliest stage the specialist professional advice which is available in this area. Such a strategy should be designed to minimise the tax burden on the project by identifying appropriate innovative and practical tax and business solutions. Key considerations in the strategy include: The tax relief or offsets which may be available against certain costs in the overall CBS, e.g. typically for repairs and maintenance, which would tend to favour options with lower initial costs Similarly the tax penalties which might apply to the use of certain materials or have an indirect impact, e.g. through higher energy costs. Tax can also represent an area of risk, for example in: The probability of environmentally inefficient structures attracting current or future environmental taxes The possibility of tax rates changing. Value added tax (VAT is subject to similar considerations. Both the rate and accounting methods vary between member states and specialist advice is again likely to be essential. 4.8 At the end of Step 4 At the end of Step 4 the user will have: Identified and confirmed with the client the period of analysis and the considerations governing its choice Identified and confirmed with the client the appropriate technique(s) for assessing investment options, including the discount rate(s) to be used and the implications therein.

29 26 5 STEP 5: Identify the need for additional analyses (risk/uncertainty and sensitivity analyses) 5.1 The purpose of this step Risk and uncertainty analysis is a body of theory and practice which has been developed to help decision-makers assess their risk exposure and attitudes in a systematic manner. At this step the user considers how and why it can be applied in conjunction with LCC analyses to support decision-making and in particular, which risk assessment methodologies will be most appropriate. 5.2 Risk and uncertainty in LCC Ownership, investment and occupation of constructed assets are by nature long-term activities and as such are characterised by a range of uncertainties, principally in the value and timing of future costs and revenues. Within this context, LCC is a forward looking process that requires predictions of these variables to be made in order that robust decisions can be taken. Consequently, certain risks are inherent in the LCC assessment process, namely: That the total life cycle costs in a given period exceed those calculated, and; That the life cycle cost profile over a given period differs from that predicted (e.g. the total costs may be the same, but the distribution of those costs over time differs from that predicted). These key risks can arise as a result of variability in one or more of the predicted values or assumptions in the LCC model (see Sec.5.4 below). While robust assessment of the key cost and time variables can help reduce the risks inherent in the LCC process, the fact that LCC is concerned with predicting future costs and activities means that an element of risk will almost always be built into the calculations. It is therefore important that clients are made aware of this issue and of the steps that can be taken to quantify and in some cases mitigate the risks. Often, the identification and assessment of LCC related risks can have a significant influence on decision-making process, with a resulting impact on the LCC of a project examples are given in table 3 below. Table 3: Potential impact of risk on decision-making Examples of risks identified Risk of more demanding environmental legislation Risk of LCC increases and/or disruption due to high cost/quantity components requiring early replacement Risk that labour costs will rise in excess of inflation allowances in model Possible decisions taken in response Selection of higher capital cost HVAC system with improved environmental performance Selection of lower capital cost HVAC system with shorter life and due for replacement in short period of time Selection of alternative components with longer service life or improved warranties Improve planned maintenance regime to prevent early failures Selection of less labour intensive materials and systems (e.g. requiring less cleaning and maintenance)

30 27 Risk of increased land-fill/waste taxes Increase inflation allowances in model. Selection of longer-life components in order to minimise waste Specify greater proportion of recyclable materials 5.3 Managing risk/uncertainty The management of risk is fundamentally a three stage process: Identifying the risk Assessing the risk in terms of its likelihood and impact Taking appropriate action in response, which might variously be to accept, mitigate, transfer or avoid the risk. The extent to which the above process is applied and whether it is undertaken for LCC in isolation or as part of a wider, formalised risk management process is a matter of judgement for the client in the light of the scope and complexity of the project. This decision should be taken at this step in the LCC methodology. For a major investment a risk management plan should be formally established with clear objectives and success criteria, proper planning and resourcing, and effective management and control. The risk management plan should be progressively updated as a project moves through its stages. The overall process is illustrated in figure 3 below. Figure 3: Risk management cycle. Periodic Update 5.4 Identifying causes of variability in the LCC analysis A number of common risk identification methods can be used for identifying potential causes of variability in the LCC analysis including: Accessing relevant databases, where available Obtaining feedback from past projects

31 28 Drawing out the knowledge and experience of individuals within the team, eg by brainstorming techniques Conducting interviews The Delphi method, gathering information from project participants by or post Checklists of variability factors commonly associated with particular tasks. Common causes of variability in LCC include: Capital costs (actual v predicted) Operational costs, including maintenance, FM, energy, component replacements Costs of refurbishment/upgrading Disposal costs Future levels of inflation (labour and materials) underpinning the above costs Interest rates (in relation to loan payments) The service lives of the components, systems and materials that make up the asset The extent and timings of planned (cyclical) maintenance and refurbishment works required The extent and timings of unplanned (responsive) maintenance required Energy consumption levels Changes in the use of the asset Obsolescence / technological development Change in the fiscal regime New legislation, for example on sustainability issues Only risks that are strictly relevant to the LCC exercise in hand should be considered. Some risks such as future obsolescence and legislative changes are almost impossible to assess and the decision may be taken to discount them. Further guidance on the prediction of service lives of constructed assets and their components, and the factors affecting service lives is provided in ISO Part 1. During this risk identification process initial views may be formed on the probability of occurrence, impact, ownership and possible actions to address or mitigate the risks. A preliminary LCC risk/variability identification process should be carried out on every project at this step, unless the scope of the project is such that risk is manifestly very low. The depth and rigour of the process should be appropriate for the scope and nature of the project. The results should be recorded on the first draft of a risk register (see section following). 5.5 Assessing variability Having identified potential causes of variability in the LCC assessment it is then necessary to assess their potential likelihood and extent, for which a variety of risk assessment tools and techniques is available. These fall into two broad categories: Qualitative, employing subjective scoring techniques Quantitative, using mathematical approaches. Quantitative techniques fall into two further categories: Statistical and probabilistic (stochastic) approaches Deterministic, with numerical computation of risk. The range of approaches is illustrated in figure 4 below, with those most widely applied to LCC highlighted.

32 29 The choice of an appropriate methodology depends not only on the scope and rigour of the analysis required but also on the quality and extent of data available. Relevant historical data might be available in databases, or from organisations involved in the project. However, there is little reliable historical LCC data held at a national or international level, accordingly the availability and quality of relevant data should be reviewed before undertaking a risk assessment exercise. When undertaking the risk assessment it is important to distinguish between planned costs (which assume everything goes well) and expected costs (which include an allowance based on experience for problems such as cost and time over-runs). Figure 4: Common tools and techniques in risk/uncertainty analysis Deterministic (numerical computation of risk) Benefit and cost estimating Break-even analysis Risk-adjusted discount rate Certainty equivalent technique Sensitivity analysis Variance & standard deviation Net present value Other Techniques for risk and uncertainty assessments Qualitative (using subjective scoring techniques) Risk matrices Risk registers Event trees SWOT analysis Brainstorming Likelihood/consequence assessment Other Quantitative (statistical & probabilistic approaches) Mean-variance criterion Decision tree analysis Monte Carlo simulation Artificial Intelligence Fuzzy set theory Event trees Confidence modelling Other 5.6 Qualitative risk assessment Qualitative risk assessment is essentially a subjective process relying on the knowledge, skills and experience of the participants, but undertaken in a managed manner. Methods of drawing out this information are broadly similar to those used for risk identification, that is, brainstorming, reference to databases, interviews, etc. For each of the identified risks the team will typically consider: Their likelihood Who / what is likely to be affected and to what extent Who owns them How important it is to mitigate them What action should be taken. A number of tools are available for qualitative risk assessment, of which risk registers are the most user-friendly and commonly used. Compiling a risk register is normally the first step in risk management and provides a format for systematically recording the outcomes of risk identification and assessment. The register should be regularly updated to contribute to

33 30 risk management throughout the project life cycle. The information available in risk registers can be used to initiate quantitative risk analysis and to support subsequent risk mitigation. The typical headings used in compiling a risk register include: title and description of risk description of causes dates when the risk was identified / modified risk code ownership of the risk likelihood of occurrence potential impact ranking mitigation action plan and timescale residual risk effects. The level of detail on the risk register is a matter for judgement with reference to the scope and complexity of the project. Other qualitative tools which may be applicable include probability matrices and impact assessment matrices, which can be used by the team to facilitate the related assessments for entry onto the risk register. A probability matrix facilitates the essentially subjective process of assessing the likelihood of a risk event occurring by clarifying the concept of probability. A typical matrix is illustrated in figure 5 below. The process depends fundamentally on the project team and key stakeholders contributing to the process knowledge of the project and related activities within it, experience and historical data will all be relevant. Figure 5: Probability matrix An impact assessment matrix similarly facilitates the process of assessing the impact of each risk, requiring a comparable contribution of knowledge and experience.