concept This publication The objective of Page

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2 The objective of this publication is to outline the cost component when calculating the total t cost of ownership of a piece of heavy equipment. We define the role of the stakeholders in equipment management and outline factors affecting production of a piece of equipment as welll as fleet optimization. Further in the document, we describe the various cost categories under ownership and operating costs. Some cost categories suchh as preventive maintenance and repair costs are described in more detail and models are drawn to help understand the concept of economic life. Finally, a spreadsheett model is included as an a example of how to calculate ownership and operating costs. This publication does not go into detail on productivity calculation in thee same manner as it treats cost categories. Page 2 TOTALL COST OF OWNERSHIP

3 1. SCOPE 2. STAKEHOLDERS Equipment management Business control 3. (TCO) Production (ton/h or m³/hr) Cost ($/hr) Unit cost ($/ton or $/m³) 4. PRODUCTION Measurements Equipment selection Equipment matching Fleet optimization 5. COST Owning cost Operating cost 6. ADVANCED DISCUSSION ON SELECTED TOPICS Preventive maintenance cost Repair cost 7. ECONOMIC LIFE The Repair Reserve Model The Classical Cost Minimization Model Cumulative Cost Model The Component Life Based Model 8. BUILDING AN OWNERSHIP AND OPERATING COST MODEL IN A SPREADSHEET 9. MAKING DECISIONS Buy, Rent or Lease? In house vs. outsourced repair & maintenance APPENDICES 1. Ownership and Operating Cost Template 2. Loader Production Estimator Template 3. TCO Template Page 3

4 In most organizations, equipment forms a separate department, the role of which is to provide the necessary equipment to the operations for a cost. Inherently embedded in the organization is an objective which requires the equipment department, as well as the operations, to be profitable. In some organizations with large operations, such as mines or quarries, the equipment department is the primary cost in the business, and therefore its efficient management is the key to the profitability of the organization. In the case of equipment rental houses, the objective is to be able to charge a profitable rental rate for the equipment while remaining competitive. This is also the case for an equipment dealer. This document will focus on understanding cost for a piece of equipment. It does not describe ways to develop a chargeable rate. The other dimension for the scope of this document is the focus on industry segment. Each industry (mining, quarrying, construction, utilities, forestry, material handling, waste handling, etc.) can be further broken down into specific work processes and machine applications. For example, in the case of mining, operations can be described as the processes of drilling, blasting, loading, hauling, crushing or processing, and material handling. There are other work processes or machine applications such as grading, paving, milling, compacting etc. which fall under the heading of construction or road building. In this document, we will concentrate on loading and hauling work processes. Some of the questions this document will attempt to answer: 1. What is TCO in the context of mobile equipment and why it is important? 2. What are the components of TCO? 3. What factors affect the selection of a machine and hence its production? 4. What is the difference between purchase price and life cycle cost of a piece of equipment? 5. How do we estimate some of the parameters of TCO? 6. What do we mean by economic life of a machine and what models can help us understand the concept? 7. How do we build a simple spreadsheet model to understand production and cost? Page 4

5 Heavy mobile equipment play a fundamental role in most industrial segments. They are necessary to complete work in an economic fashion and on a schedule. Yet they also comprise a large portion of the cost invested in such work. Mining and quarrying (ores, coal, aggregate and other minerals), construction (road, dam, tunnel, building etc.), utilities (gas lines, electricity grids, sewers), forestry work (tree harvesting, logging, timber handling, sawmill etc.), material handling (pallet, grains, construction materials), recycling or waste handling (transfer stations, landfills, scrap yards) are all examples of industries that are equipment intensive. Therefore the principles of equipment management are relevant in many cases. Although equipment management is not a required core competency in most operations, it plays a significant part in determining profitability and competitiveness. Therefore, the challenges within these organizations are twofold: a) The equipment management personnel should be able to understand all aspects of equipment cost and how it relates to the business as a whole. b) The general management should understand the intricacies that equipment managers face regarding equipment cost and decision making. Consequently, this paper has been written with at least two stakeholders in mind: equipment managers and business controllers. 2.1 Equipment management Effective equipment management involves a variety of activities which can be grouped under two broad headings: development of equipment/fleet policy, and project management and optimization. a) Development of policies involves setting guidelines and providing a central service to different company units (sites, projects, locations etc.). Therefore, activities are focused on long term strategies and big picture initiatives. A sample list of work processes involved under equipment policy could include capital and budget related decisionmaking (asset management), asset monitoring (job costing), analysis of fleet performance (age, cost, reliability), ownership period and economic decisions (Repair, Replace, Rebuild, Retire), financing methods, and preventive maintenance programs and repair guidelines. b) Project management and optimization, on the other hand, involves work processes that are limited to the life of a project. Therefore, these activities are focused on limited time strategies with clearly defined objectives. A sample list of work processes involved under project management and optimization could include machine selection, machine configuration, and fleet selection. 2.2 Business control The governing tenet of business control is based on profit and loss. However, not all aspects of business can be defined in black & white terms; most areas are gray. For example, with a piece of equipment the purchase price is the only aspect of cost that can be determined with certainty. All other costs, such as residual value, repair and maintenance, wear parts, etc, are at best guesses. Therefore, realizing the cost risk proposition in investment or other decisions, involves a basic understanding of various aspects of equipment related costs. Page 5

6 Life cycle costs can be viewed as all the costs from cradle to grave in the life of a piece of equipment. Typically, life cycle costs can be divided into two broad categories: ownership and operating costs. Although equipment managers have long considered the concept of ownership and operating costs, it has taken a while to formulate a systematic approach to use this as a measure while selecting between alternatives. Focusing only on initial cost does not necessarily produce the best alternative, as a piece of equipment with a lower purchase price could bleed the pockets due to high maintenance costs. However, comparing equipment only on operating costs does not facilitate the comparison of two alternatives similar in life cycle cost but differing in productivity. Thus the most recent step in this evolution is the use of total cost of ownership (TCO), which addresses both cost and productivity aspects. By moving to TCO, buyers are able to relate to profits rather than just cost. Although these considerations might seem obvious, it is interesting to note that only a small percentage of buyers sellers actually have the discipline and knowledge to perform this analysis. The difficulty has been in the collection and analysis of appropriate data. Three key elements of TCO are Production, Cost per Hour and Cost per Unit. 3.1 Production (ton/h or m 3 /h) Production per hour is the output of a single machine working by itself, or a fleet of machines working together. Depending on the type of work, production is typically calculated in a weight measurement (such as ton/hr) or a volume measurement (m 3 /h). Equipment capacity, configuration, loader hauler match, material to be moved, work schedule, haul distance and fleet size are some of the important factors which affect the production of a fleet of machines. 3.2 Cost ($/h) Cost per hour, including both ownership and operating costs will be dealt with in more detail in this document. Purchase price, residual value, economic life (ownership period), repair and maintenance policy and fuel consumption have a conspicuous effect on the cost per hour. 3.3 Unit Cost ($/ton or $/m 3 ) Unit Cost is a result of the two elements above. To calculate Unit Cost, we divide the cost per hour value for a machine or a fleet by the corresponding production per hour. The beauty of Unit Cost is that it allows the comparison of dissimilar units. In other words, one can compare a small loader with small trucks against a big loader and big trucks. This is the definition of TCO. The objective is to move a desired amount of material at the lowest Unit Cost, or the lowest TCO. $ / h $ TCO = = ton / h ton Various organizations use the term TCO in different ways. In some cases, TCO refers only to the total cost per hour when the equipment is not involved in measureable production. For example, if a piece of equipment is a utility machine involved in cleanup or diverse support activity, it is not easy to quantify a cyclical activity and hence a production. However, this document will focus on cases where the equipment is involved in production, so Unit Cost will be used. Page 6

7 Production refers to the output of a single machine or a fleet of machines working together. Typically we refer to loading production when we refer to the production of a single machine such as an excavator or a wheel loader. It is rather easy to determine the production of a loading unit simply by using the bucket capacity and average cycle time over a period of time. However, fleet production is a little more complicated: it is the throughput of the loading and the hauling units considered as one system. We will try to describe some of the aspects of production here. 4.1 Measurements The first step in understanding production is to understand the unit of measurement. Often, people focus on numbers and leave out the unit of measurements. The two standard units of measurements are volume (m3/h) and weight (ton/h). It is possible to translate one unit to the other using density. The relation between volume, weight and density is as follows: Density = Weight Volume For example, the density of blasted limestone is 1600 kg/m 3 or 1.6 ton/m 3. Therefore a production measurement of 300 m 3 /h is the same as 480 ton/h. It is obvious that if the unit of measurement is left out, then the number by itself becomes meaningless. Within the volume measurement, there exist two sub categories bank volume and loose volume. In simple terms, bank state of a material is the virgin state of occurrence, or in the ground. For example, limestone as it occurs in nature is a rock formation. The loose state of a material is the broken state in which it is loaded or hauled in a piece of equipment. For example, when we drill and blast limestone, it breaks up into small pieces. The volume of limestone expands and voids (spaces) are created. The increase in volume is often referred to as the swell factor. The relation between bank, loose volumes and the swell factor is as follows: Swell Factor = Loose Volume Bank Volume But even this definition is not enough, as loose volume can vary in different circumstances. A ton of limestone has one, bank, volume in the ground. It will have a different, loose, volume when blasted. It may have a different, loose, volume again after it is crushed and put in a stockpile. Therefore one must be aware of which state of condition is being used for calculation for any given material. 4.2 Equipment selection Equipment selection is a very complex subject and demands a detailed description. For our present purpose, we will focus on loading equipment. One question that is often asked is when to use an excavator and when to use a wheel loader? We present a simple table based on some job/project parameters. In addition to these parameters, there are several regional cultural as well as legal issues which determine the type of machine to be used on a project. Page 7

8 Table 1: Factors used in selecting the type of loading equipment Factor Excavator Wheel Loader Class of material Sand, gravel, shot rock, earth Sand, gravel, well shot rock, earth (overburden) (overburden) Digging envelope Below grade Above grade Angle of swing 30 to 180 degrees Y shaped travel path Space constraint Stationary Typically at least 1.5 machine length Floor condition Preferably flat and stable Preferably even and hard Position vs. hauler Above; end load or side load Same level; side load only Transport Travel speeds up to 6 km/h Travel speeds up 35 km/h Best suited for Truck loading, difficult digging, sorting material, trenching, maintaining slopes Truck loading, bin loading from multiple sources, digging loose(r) material, load & carry operations After selecting the type of equipment, it is important to understand the parameters that determine the machine size needed. Most often this is driven by production required for the job/project but may also depend on space limitations. Two machine related parameters important to calculate production are bucket capacity and average cycle time. Bucket capacity refers to the amount of material that can be carried by a bucket. By most standards, the capacity includes a measured heap of material over the water level surface of the bucket. Each material has a different slope characteristic that it can naturally sustain. For example, clay can sustain a higher slope compared to dry sand. Therefore, each of these materials has a different fill factor. Consider an example job where the target production is 200 m 3 /h, and based on the site configuration and the material of loading, our best estimate tells us that we can do three loading cycles in a minute. This means that each cycle takes 20 seconds on average. The production of the loading unit can be calculated using the following equation: It is possible to create a simple spreadsheet to determine the bucket size required to meet this production and hence the machine size. Loader Production Bucket = x capacity 60 x 60 cycle time in seconds x Efficiency Table 2: Selecting equipment based on production (example) Excavator Model Bucket EC220DL EC250DL EC300DL EC380DL EC480DL EC700CL 1.2 m3 1.5 m3 1.9 m3 2.6 m3 3.2 m3 4.5 m3 Avg Cycle Time (sec) Cycles per Hour* Maximum Production Rate (m 3 /h) * 60 working minutes/ hour Page 8

9 In this example, all production values equal to or greater than 200 m 3 /h are e highlighted blue. The table showss that we could use a 1.5 m3 bucket and achieve a production of 270 m 3 /h or downsize to 1.2 m 3 to achieve a production of 216 m 3 /h. This table also gives you the ability to perform a sensitivity analysis. For example, if digging becomes difficult and the cycle time increases from 20 to 24 seconds, the machine s productivity will be reduced. On the other hand, if the production requirement is expected to increase over time, then thee appropriate bucket size required to achieve the increased production can also be determined. One must understand thatt this is a very simple approach and does not take into account the density of the material, machine utilization nor the efficiency factor. This method cann be used too get an idea of the machine size that may be used for the job rather than which is be the best machine for the job. 4.3 Equipment matching Matching the right size hauler to the loading tool is important to maximizee fleet production. If each pass from the loading tool is too small, then the hauler will spend a substantial amount of time in the loading area. The hauler is productive only whenn it is hauling material and not standing still in the loading area. Similarly, having a big size loading tool may requiree several haulers to keep it busy. If a sufficient number of haulers is nott available, then the loading tool will be idle. One rule of thumb states that in a mass excavation type job, a hauler should be loaded in 2 minutes or less, provided there are enough haulers to keep the loading tool busy. This means three to five passes by a wheel loader, or four to six passes fromm an excavator. More time is acceptable in less demanding applications or if there is a shortage of haulers Fleet optimization Assume a job requires a fleet of machines, for example an excavator and some articulated haulers. Also assume that based on the production requirements wee have been able to identify the right excavator for the job. The next step is to select the rightt size and number of haulers so that the fleet is balanced. Thee old school of thought dictated d thatt the right number of haulers was that which kept the loading unit busy at all times. I Using this logic and lacking deeper analysis a simple rule of thumb can be used to determinee the hauler fleet size. Fleet Size = Overall cycle time of thee hauler Loading time of the haulerh It was assumed that the loading unit production determined thee best fleet production. Perhaps it indicates the most productive solutionn but in no way does thiss guarantee the lowest unit cost. Today, with the understanding of TCO we know thatt it is possible to determine the fleet size that will provide the lowest unit cost as the desired objective. This subject requires the discussion of various project and machine related parameters. Page 9 TOTALL COST OF OWNERSHIP

10 The total cost of a machine comprises both ownership and operating components. However, by considering one composite value, we lose the opportunity to understand the inherent differences between these components and the factors that affect each. Ownership cost, including depreciation and interest, can be viewed as fixed costs because they begin when the machine is purchased and end when it is sold. In between these two points, one must pay the ownership costs irrespective of the state of the machine. Whether it is working on a job, standing idle in the yard, or broken down for repairs, the ownership costs continue to accrue. On the other hand, operating costs, which include fuel, tires, maintenance and repair, and ground engaging tools, can be viewed as variable costs because they are incurred only when the machine is put to work. Thus, it makes a difference to the operating costs if the machine is working or standing idle. From this brief description, it is clear that there is a need to track owning and operating costs separately. Owning and operating costs are equally important. Unfortunately, the only clearly visible cost for a piece of equipment is the purchase price; thus, the tendency can be to neglect the impact of other costs. A common metaphor on this subject is that of an iceberg. The tip of an iceberg, like the purchase price, does not divulge the true nature of the impact it can create. Operating costs associated with life cycle usage can have a bigger impact and often lie hidden from view. Therefore, it is prudent for equipment managers to delve deep into the subject of owning and operating costs to truly understand the impact of each. Ownership cost is the cost of buying and keeping a machine in a fleet. It includes the purchase price, taxes, cost of borrowing capital to purchase the equipment, other financing costs, insurance, and the residual value at the time of sale. Almost all aspects of the ownership cost are related to accounting, not machine operation. A major part of the ownership cost is the depreciation, which is the difference between the original purchase price of the machine and the value at the end of its life. These accounting methods are related to time periods: ie. months or years. Yet ownership costs are commonly expressed in terms of cost per hour of operation. In this way, usage does have an impact on ownership cost (per hour). We need to divide it by the scheduled number of hours to be worked. Therefore, ownership cost per hour decreases as its scheduled time in the fleet increases. Operating cost, on the other hand, begins as soon as you start the machine. There are several ingredients to operating cost. Typically, we can divide them into the following categories: fuel consumption, preventive maintenance, repair, tires and GET (ground engaging tools). Operating cost is a function of age, application, work environment and preventive maintenance policies. Like every machine ever invented, the cost of maintaining a piece of construction equipment increases with age (otherwise we could have kept the machine forever!). All moving and load bearing components have a physical life and need to be replaced at some time to maintain a tolerable level of performance, reliability and safety. There is a point in the machine life when the ownership and operating costs combined produce the lowest total cost per hour. This is called the economic life, which is very different from the physical life of the machine. Determining the economic life of the machine can assist in equipment procurement as well as disposal. Also, it can provide the fleet management with an indication of the optimal duration of keeping the machine in the fleet. Can the ownership and operating costs be considered as one? The answer is yes, but is qualified by the ubiquitous caveat sometimes. Consider the occasion when you rent a piece of machine, say a skid steer. When the rental house quotes you a rate of $600 a week, all your costs are Page 10

11 included except fuel. Therefore, this cost represents both owning and operating components for the machine, as well as overhead costs and profit for the rental house. However, the difference between renting a machine and owning it is the same as between renting an apartment and owning it. Rental is subject to availability and price fluctuations; further, it does not offer an equity build up. On the other hand, ownership of a machine guarantees availability, price stability, tax benefits, and equity build up. 5.1 Owning costs The understanding of ownership costs parallels the development in financial transaction, accounting policies and risk management. If one was to review the evolution of the buyingselling process for any type of equipment (capital goods), it is possible to see a pattern. Since the middle of the twentieth century, most purchase decisions were based only on the initial price. Then the cost of borrowing capital, inflation and return on investment introduced the finance cost into the procurement process. Purchase price, depreciation and taxation became the key components in calculating equipment cost. Subsequent to that, buyers wanted to shield themselves from the uncertainty of the residual values, especially when the equipment cost was not written down to zero. The next step in the evolution process was based on accounting and financial targets as well as cash flow. This development endorsed leasing as the preferred method where the focus moved from purchase price or residual values to monthly payments. Of course, the accounting principles and financial policies were different in different countries and therefore adapting the leasing program to the local business environment was critical. The straight leasing programs were augmented with various flavors such as an optional buy out clause at the end of the period. Although lease payments created a certainty in the ownership component, the operating component of the cost was still subjected to uncertainties. In addition to this, most buyers realized that the lease programs did not necessarily produce the lowest cost. In reality, the buyers were paying more to reduce their risk or exposure. Those buyers who developed in house competency in equipment management and understood the cost risk propositions then began to follow a two step process : a) evaluating various alternatives in equipment selection based on both ownership and operating cost, and b) effecting the transaction based on the need demand situation (projects, work backlog, etc.) at the time of transaction Purchase price Purchase price or capital investment is the only factor that is known with certainty as it is defined when ownership begins. It is simply what you pay when you purchase the machine. As pointed out earlier, costs relating to purchase will affect the transaction process; for example, depending on whether you buy a machine with your own capital, buy it with financed capital, lease it or rent it, you will pay a different price. The only related costs to consider in addition to purchase price are delivery (freight), setup and installation, title/registration and any initial training. The freight cost will vary, depending upon the distance between the stock yard and the job site, and the weight to be transported. In some cases, machines can be larger than legal transportation limits and therefore must be transported in sections. This might lead to additional setup and installation cost. As a side note, the size of the machine (dimension and weight) may impact mobilization cost between sites. Legal transportation limits need to be considered in assessing this cost and should be accounted for in the equipment costing or job costing system. This cost will have an impact on equipment selection. The other aspect to consider is that the cost of the tires/tracks needs to be deducted from the purchase price of the machine while calculating the ownership cost per hour. The main reason is that the tires/tracks are treated as operating cost and so should not be counted twice. Moreover, the life of the machine is different from that of the tires. Therefore, by leaving the cost of the tires in the calculation, we make an implicit assumption that when the machine is sold, it will be delivered with a new set of tires or tracks. Page 11

12 Building on an example as we proceed, we can consider that we are buying an articulated hauler for the fleet. The cost of the hauler delivered to the site is $515,975. The cost of a set of tires is $37,400. Therefore, the purchase price excluding tires is $478,575. This is the value that will be used for calculating the ownership cost per hour Residual Value The residual value is the value that remains at the end of the ownership period. It is the value that is used to determine the capitalized amount or the equity to be recovered. The one issue about residual value that can be very deceptive is that it occurs in the future. Therefore, it cannot be treated in the same terms as the capital investment, which occurs in the present. E.g. an equipment salesman sets the price of an excavator at $10 million and then guarantees to buy it back from you for the same amount after four years. Therefore, from your viewpoint the residual value is $10 million. Does this mean that your capitalized amount is zero? Obviously, something is missing. There is an interest cost associated with it: the cost of borrowing money. The interest on your $10 million is going to pay for the cost of the machine and more. Your cost of capitalization should be calculated by bringing the residual value from the future to the present using the appropriate discount factor. Therefore, when you calculate the ownership cost of a machine, it is always necessary to bring the future values to the present*. The one other point to consider is the difference between fair market value (FMV) and guaranteed buy back value. FMV, as the name suggests, is the value that the market will pay for a piece of equipment. Auction results are the best indicator for this value. The guaranteed buy back value, on the other hand, is the wholesale value from an equipment retailer s perspective. The equipment retailer is ready to pay this value, perform any necessary work on the machine and then take on the carrying cost until the machine is sold. There is a difference between these two values. Understanding it is vital to calculation of ownership cost. It is misleading to use the FMV in estimating the ownership cost and then expect the buyback number to be the same. You can use the FMV to obtain an estimate of the residual value. However if you intend the equipment retailer to buy the machine back from you, then you should use the buyback value. It is important to maintain a realistic balance between the evaluation and actual transaction processs. The discussion on this subject, Time Value of Money, is beyond the scope of this material Depreciation cost Depreciation can be simply defined as the decrease in value of a product. If we know what we paid for a piece of equipment, and we have an idea as to what the equipment will fetch in the market after a period of time, then depreciation is the calculation by which we determine how we will recover this fall in value. There are three methods to calculate depreciation: market depreciation, book keeping based depreciation and tax laws based depreciation. The main difference between the methods is the basis for the residual value and the depreciation period. In our example, the residual value of the hauler is expected to be $154,793 after five years. Therefore, if we determine the present value of this sum based on five years and 6% interest rate, it works out to $20,123. If the truck operates 2000 hours a year for five years, the depreciation cost per hour works out to $ It is clear that as the interest rate becomes higher (like in some countries or markets) or if the ownership period is very long, the effect on present value becomes conspicuous. Page 12

13 5.1.4 Depreciation time or ownership period The depreciation time is the duration used as the basis for calculating the ownership cost per hour. This period has a lot of influence on the equipment selection and transaction process. Understanding the depreciation time or the right ownership period requires some discussion on the operating costs and so, we will re visit this subject in a later section. In the meantime, it is worthwhile to plant a few questions in the mind of the reader: a. Is ownership period a function of the economics or more so the physical capability of the machine? In other words, is the economical life different from the physical life? b. Are there any models which help us determine the economic life? c. Does the expected life of components affect the ownership period? d. Are there any legal statutory limits on the ownership period related to depreciation? e. How does economic life affect TCO? f. How does economic life affect operational decisions such as repair, rebuild, replace, retire? Interest cost or cost of capital Two parameters are important when it comes to calculating the cost of capital: a. The interest rate to be used. b. The average annual value of the machine. The interest rate depends on whether the machine is purchased with own capital or whether it is financed. When the owner s own capital is used for purchasing the piece of equipment, then the rate used for calculating the cost of capital should at least be equal to a rate which can be expected from an equal investment. However, if the equipment is purchased with financing, then the rate used in the financing calculation should be used for calculating the cost of capital. The average annual value (AAV) is simply the average between the first value: the purchase price, and the last value: the residual value. Assuming the purchase price of the machine is P, and the residual value at the end of its life (n years) is S, the average annual depreciation (d) can be expressed as d= (P S)/n. In other words, at the end of the first year, the machine has a value of P d, at the end of second year, its value is (P 2d), and so forth. The average annual value of the machine can then be stated as (P+S)/2. This method uses several approximations. Financial methods exist which can calculate accurately the interest cost using the time of value of money concepts. For the purpose of the present discussion, it is sufficient to use this simple formula. Page 13

14 Figure 1: Illustration of depreciation andd calculation of average annual value In our example of the articulated hauler, the purchase price iss $515,975 (we tend to use this figure rather than the one without tires because the interest cost starts with the down payment). The residual value is $154,793. Therefore the average annual value on a two year t period is $335,384. If we multiply this value by the interest rate of 6%, we get an annual interest cost of $20,123. If the hauler is put to work for 2000 hours a year, the interest cost per hour yields $ In this case, the interest cost is 31% of the depreciation cost. Therefore, it is important to understand the implicationn of the interest cost as part p of the overall cost Insurance and machine tax In almost all cases, a piece of construction equipment needs too carry insurance againstt theft or damage. Typically, the insurance for a piece of equipment is calculated based on the value of the equipment. If the equipment is permitted to run on public roads, then theree could be a machine tax associated with the piecee of equipment. 5.2 Operating costss Operating costs, the costs incurred as soon as the machine is started, include things such as fuel, tires or tracks, ground engaging tools, preventive maintenance, and repair. A lot of money is involved and good decisionss must be made on a day to day basiss if costs are e to be kept in line. As stated before, operating cost is affected by four factors: age, application, environment and preventive maintenance policies. Managing the acceleration of the increase in operating cost is the big challenge in equipment management. Most people associate ncreasing operating cost to age alone. Although this is partially correct, it does not present the total picture. Machines have moving parts and load bearing points and so wear out over time. However, good operator o care and maintenance programs can help to monitor and reduce this wear and tear. Operator care could have the single biggest impact on the operating cost of the machine. Application affects the wearr and tear of machines some jobs are easy and others are tough. On most occasions, applications impact external implements such as tires andd buckets more that Page 14 TOTALL COST OF OWNERSHIP

15 they do transmission and turbo charger. However, choosing the right machine for the application is, without doubt, the most important factor in reducing operating cost. Environment cannot be controlled we have to live with it. But although we cannot control it, we need to provide for it to keep the operating cost under control. When working in hot and dusty conditions, pre cleaners and secondary cooling kits must be installed. When working in abrasive environment, heavy duty components are required. Finally, equipment policies which include maintenance and repair practices, operator care, walk around instructions and training are very important when managing operating costs. Most equipment managers split total operating costs into four major categories: fuel consumption, wear parts (ground engaging tools and tires), preventive maintenance and repair. The best indicator for these categories is in past records. However, application, environment and age of machine are never the same in two instances. Therefore, it is important to understand the basis of these categories and manage them Fuel consumption Fuel consumption cost is a critical component of the operating cost. Traditionally, performance was the sole or primary criteria for engines. As the price of diesel increased fuel economy became a second primary criteria. Over the last two decades government regulation has added a third criteria, environmental impact, to the equation. Government regulations on emissions continue to tighten, and the price of diesel seems only to increase Therefore equipment manufacturers have a difficult task to develop new technologies to control and reduce fuel consumption and emissions without compromising performance. For example, load sensing hydraulics draws power only when required. The torque curves are being improved to provide torque rise at low RPM and hence reduce fuel consumption. Electronic control systems offer better gear shifting patterns. Having a driveline where the different components are matched and communicate with one another can have a favorable impact on fuel consumption. In a situation of fluctuating oil prices, paying attention to the fuel consumption and its impact on overall cost is critical. In the articulated hauler example, let us assume that the fuel consumption is 21.2 liters per hour and that the cost of diesel is around $1.06/liter this means $22.47/h. Comparing this with depreciation cost of $32.38, it works out to 69%. The important conclusions from this discussion on fuel consumption are: a. It is important to consider the cost benefit analysis of purchasing a higher priced machine which may have lower fuel consumption. In some cases, the saving in fuel cost can pay for the higher initial price within a year or two. This is the application of a TCO mindset. b. Even between comparable machines, a difference in fuel consumption can lead to significant difference in operating cost and the total cost. c. It is important to analyze the effect of changes in oil prices before making procurement decisions this helps to understand the risk involved. In some parts of the world, the cost of diesel is so high that the fuel consumption cost is actually greater than the depreciation cost. It is surprising to note that many companies do not keep track of fuel consumed per machine. Typically, the fuel truck makes a round on the job and fills up all the equipment. The total fuel consumed is then charged to the job. When data on fuel consumption is not tracked on a machine by machine basis, it becomes difficult to identify inefficiencies. Also, there is a school of thought which recommends that the preventive maintenance program be based on fuel consumed rather than clock hours. The reasoning behind this approach is that, if the machine consumes fuel, then it has to be working. Page 15

16 5.2.2 Wear parts ground engaging tools and tires As the name indicates, wear parts includes wear items such as bucket, teeth and segments, cutting edges, rippers, tracks, and tires. The life of these wear items are typically dependent on the environment and application. For example, an abrasive environment may lead to increased wear and tear compared to a normal one. The operator s training level and commitment also impacts performance and life of the wear items. There are occasions when hauler tires with 1500 hours have no tread left on them. Engaging the 6x6 modes on flat and even surfaces only accelerates wear unnecessarily. Similarly, choosing the right type of bucket (and cutting edges) can help increase the life of the bucket Preventive maintenance Some of the synonyms for the word preventive are precautionary and protective. Therefore, preventive maintenance for a piece of equipment can be viewed as an investment to protect the equipment rather than a necessary cost to run the machine. Many people in the industry believe that preventive maintenance of mobile equipment simply involves changing of oils, fluids and filters and lubricating pivot points on a regular basis. The truth is that while these are important segments of a properly planned and practiced preventive maintenance program, there are many additional elements that must be part of a successful program. A generally accepted definition of preventive maintenance is: The care and servicing by trained personnel of mobile equipment in satisfactory operating conditions by providing systematic inspections, and detecting and correcting potential failures either before they occur or before they develop into significant defects that may cause machine downtime and additional cost. Detecting and correcting failures before they occur can mean that we may have to replace a component before it actually fails. In other words, the old adage gives way to a new mantra If it ain t broke, change it anyway. The worst thing about a downtime (due to repair) is the collateral damage caused by the breakdown. A $500 bearing can ruin a $7,000 transmission; a $100 hose can cause a $2,000 loss in production and idle the rest of the fleet. Collateral costs are extremely difficult to measure, as they do not appear in cost reports and are easily disregarded. Equipment managers in the current world of mobile equipment must have skills that are equal to the technology of the machines that they will be supporting. It is not in the best interest of equipment managers, the company, or the machines themselves to have preventive maintenance carried out in a non regulated or non controlled way. Nor is it advisable that unqualified and non trained service personnel do maintenance of any kind on these types of machines. Equipment will continue to become more sophisticated; it will, therefore, require higher levels of skill and technology to continue to perform at all levels of maintenance. Preventive maintenance is mandatory; companies must identify and define the policies, practices, procedures, measurements and systems that will provide the company owners the best machine availability, the lowest cost and the best return on their investment. Page 16

17 5.2.4 Repair Repair is the action required to get a machine from a non operable state to an operable state. It is generally assumed that the machine is down during this state. Since repairs are visible and cause a disruption, this gets the attention of everyone on the job. Repairs can be classified as those that occur without prior indication a sudden failure; and those that occur due to deterioration aging failure. For example, a tire could fail suddenly when it hits a piece of rock or a sharp object. On other hand, the same tire could experience wear and become weak and fail over a period of time. Some of the signs of deterioration are easy to observe, especially for external components such as tires. On the other hand, detecting need of repair for a transmission or a turbo charger is more difficult. Modern technologies such as oil analysis and thermograph analysis help us to track deterioration levels. Elimination of the repair involves replacing the failed component with a new one. Typically, the cost of doing the repair in an unplanned manner in the middle of a job is high. This is called an unscheduled failure resulting in unscheduled downtime. First, it involves troubleshooting, then obtaining the right parts and then fixing with minimal support equipment. Sudden repairs also pull mechanics from their routine work and hence are very disruptive. All the other equipment in the fleet also comes to a standstill. On the other hand, the concept of repair before failure allows for a planned approach to maintaining the machine. A machine can be scheduled for repair over a weekend or during the night. Moreover, these repairs can be done in a workshop, which is a more controlled environment for the mechanics. Collateral damage (and related cost) is avoided. Downtime occurs but it is planned and less disruptive of operations. In a word, the repair is managed. Some managers estimate that on shift failures cost up to six times as much as planned repair. Page 17

18 Having reviewed components of both ownership and operating costs, developed an understanding of these costs, their impact on our decisions and a concept of how to manage them, we will now increase our understanding of some of the cost categories and ways to estimate them. 6.1 Preventive maintenance cost The methodology to estimate preventive maintenance cost may vary depending upon the relevant organizations, applications, and practices. There are two types of practices: some equipment owners estimate the preventive maintenance cost on an hourly basis, while others use intervals (daily, 250 hr, 500 hr etc.). The hourly cost of preventive maintenance is inclusive of the interval basis and is the preferred method. However, the interval based method is useful from an invoicing/cash flow perspective, especially if the utilization of the machine is minimal. Cost estimates can be grouped four ways: Material, Labor, Travel time & mileage, and Miscellaneous. Material The items included under the heading of material are filters and lubricants (oils & grease). We can further group filters into engine filters (engine oil filter, bypass filter, fuel filter, extra fuel filters, air filter, coolant filter, safety air filter), transmission filters (trans filter, breather), drive axle filters (breathers), cab filters (ventilation filter, pre filter), and hydraulic filters (return filter, filter insert, ventilation filter). Each of these filters, in turn, has an interval for replacement. Therefore, the extended cost for particular preventive maintenance (for example 250 hr) can be calculated by multiplying the number of filters, cost of each filter and interval of replacement. The other component of material cost is lubricants. A typical list of lubricants includes engine oil, transmission oil, hydraulic oil, axle oil, and engine coolant. The capacity of each housing mechanism (engine, transmission, etc.) can be obtained from manufacturer s specifications. Therefore, the extended cost can be calculated based on the unit cost of lubricant multiplied by the capacity. The cost of grease fittings is constantly changing. With new developments in machine design, the greasing requirements can vary. Additionally, with the rise of automatic greasing systems, it may be possible to estimate a machine s grease consumption and thus cost. Without going into too much detail, it is not wrong to use a proportion of other material costs to estimate greasing costs. Labor The items included under the heading of labor are both technical labor (mechanics) and nontechnical labor (helpers). Typically, there are established rates for the labor in an area. One rate may apply to preventive maintenance while a different rate prevails for more involved repair or shop work. In each case, the rate should include direct wages as well as any benefits which may be applicable. The duration of work from a labor standpoint can be obtained from time guides provided by the manufacturer as well as from established practices in the company. It is important to be realistic rather than simply conservative. Travel time and mileage This item of work is important, especially because preventive maintenance work occurs on the job site. This means that the mechanic needs to drive to the work shop on the job site and be paid for the time he spends in transit, although this does not produce quantifiable work. The cost of travel time and mileage is dependent on the number of visits to the site to perform Page 18

19 actions. Some companies tend to keep the cost of lube truck/repair truck as an overall cost of doing business item. Others include it as part of labor charges, considering that these vehicles do not come for free. In the same manner, the amortized cost of the workshop and the carrying cost of parts inventory should be included in the calculation somewhere. Miscellaneous There is one more item that typically falls in between the cracks: the cost for performing oil sampling and analysis. Although one can view this as either a preventive maintenance or a repair cost, it is important that the cost for this action is taken into account. Also, it may be advisable to set aside a small proportion of the cost for unforeseen actions. 6.2 Repair cost Estimating repair cost is the most challenging part of defining the operating cost. Repair cost is a function of several aspects including application, preventive maintenance program, operator training and care, and commitment. Therefore, we should consider some related concepts Measurements When it comes to repair, it is important to track two sets of measurements: interval between actions, and cost of action. It is possible that a machine might have few failures in it s economic life, but the cost to repair each failure may be high. On the other hand, small but frequent failures could result in low reliability and high indirect cost. In a more technical world, these factors are referred to as mean time between failure (MTBF) and mean time to repair (MTTR). Reliability is directly related to MTBF, while availability is determined by the following equation: Availability = MTBF MTBF + MTTR Some companies keep track of availability in terms of the calendar time, idle time, working time and down time. In that case, we can use a schematic structure shown below for defining availability. Figure 2 : Defining availability in terms of planned time, uptime and downtime Total Calendar Time (Available) Planned Time (Scheduled) Idle Time Operating Time Repair Time Preventive Maintenance Time Uptime Downtime Availability = Operating Time (Planned Time PM Time) The risk from an owner s perspective can be related to reliability and availability. A low risk proposition should involve high reliability and high availability. Therefore, the key to understanding repairs is the COST RISK proposition. There is a clear balance between cost and risk. For example, a low risk option generally comes with a high cost. One could build an engine that lasts for 60,000 hours, but then the cost of such an engine (probably made of an exotic metal such as titanium) would be much higher. On the other hand, if one is ready to take some risk, the cost of repair can be lowered. One example of such an approach is to budget a cost of Page 19

20 the expected repair; if the machine is maintained well on the job and the repairs do not exceed the budget, then the surpluss could be shared between the equipment division and the project. It is futile to argue for a low risk, low cost proposition Maintenance practices There are several ways to classify c the maintenancee practices adopted a by an organization. One classification includes: operate to failure (OTF), fixed time based maintenance (FTBM), and condition based maintenance (CBM). Operate to failure, as the name indicates, entails running the piece of machine until a failure has occurred, and then making repairs so that the machine is operable again. Additionally, an on shift failure can cost up to six times as much as an off shift repair. It is possible to follow the OTF practice when the criticality of the operation is not very important. For example, consider how we treat a light bulb. We run r to a point until it fails before replacing r it; we don t bother to replace it based on the number of hourss we have used the bulb. Now, depending upon luck, the interval between failures can be long or short. In the world of capital equipment, this practice can result in cost extremes but with highh risk proposition. Fixed time based maintenance replaces major components on fixed time intervals. In this case, the component is replaced irrespective of whether it has failed. This approach is followed underr circumstances when the operation is critical to the overall organization. For example, FTBM is usedd in military machines, aircraft, etc. The cost of this approach is high, but brings withh it comfort of low risk. Under conditionn based maintenance, the condition of the machine is assessed before any corrective action is performed. This approach is a balance between the OTFF and FTBM. Modern technologies, such as oil sampling, s thermography, and vibrational analysis provide good information about the condition of components. These analyses become particularly handy when the machine approaches the expected life of major components. The cost and risk of this approach is reasonable Component life Component life is the basiss of budgeting for repair cost. Mostt people typically ask about the average life of any given component, butt the answer could be a single number which may or may not mean much. The reason for the lack of value in this information lies inn the statistics behind the calculation of the average. Assume that we have 100 transmissions that t have failed and that we also have the data regarding the lifee at which they failed: the average has a 50% chance c of failure. In other words, the chance c of failure is 50 50, which means that the transmission may or may not fail at end of its average life. Thiss does not provide us with useful information. On the other hand, most manufacturingg industries state their expected life in terms of t20 that is the life at which the chance of failuree is 20% or less. Therefore, when youu calculate the repair cost, you budget for a component based on its expected life. In practice, the component may last much longer than the expected life; ; in fact, it is expected too last longer.. However, the key is to understand that this is a budgeting process with an embedded cost riskk proposition. If one desires low risk, then it comes with a high cost. Page 20 TOTALL COST OF OWNERSHIP

21 Figure 3 : Illustration of component life as a probability Calculating repair costt In the modern world of spreadsheets it is possible to list all the components in a machine, their expected life, the cost of each component, and labor required too replace it. As for the expected life of a component, c a single deterministic value can be used. Using this setup, it is easy to calculate the frequency with which components are equired to bee changed for a given time period. It is possible to simulate repair cost by consideringg different component lives. This provides a range of scenarios. The next section will consider additional details of this subject. Page 21 TOTALL COST OF OWNERSHIP

22 Figure 4: Illustration of spreadsheet used for repair calculations Evaluation Period Beginning 0 hrs Ending 10,000 hrs (example) Component Qty Hrs Occurances Labor Charges Parts Hrs Total Cost Unit Cost Total Cost Total Cost BRAKES Accumulator 1 15, $0.00 $ $0.00 $0.00 Accumulator 2 15, $0.00 $ $0.00 $0.00 Solenoid Valve 1 12, $0.00 $ $0.00 $0.00 Sealing Ring 2 8, $0.00 $43.63 $87.26 $87.26 Sealing Ring 2 8, $0.00 $45.79 $91.58 $91.58 Cprsn Spring 32 8, $0.00 $1.20 $38.40 $38.40 Press Monitor 1 5, $60.00 $ $ $ Press Monitor 1 5, $60.00 $ $ $ Footbreak Valve 1 15, $0.00 $ $0.00 $0.00 Brake Plate 2 24, $0.00 $ $0.00 $0.00 Brake Plate 2 24, $0.00 $ $0.00 $0.00 Brake Piston 2 24, $0.00 $ $0.00 $0.00 Brake Plate 2 24, $0.00 $ $0.00 $0.00 The discussion presented previously is for repairing and maintaining one machine. When we have a fleet of machines operating in one location, then the travel time and mileage need not be added to each machine. Further, the risk of failure can be allocated to the fleet rather than just one machine. For instance, the chance of a transmission failure at 14,000 hours may be around 60% for one machine. On the other hand, in a fleet of 10 machines, the chance of all the 10 transmissions failing at 14,000 hours is lower than 60%. Therefore, the cost budget on a machine basis can be lowered. It is important to understand this risk cost proposition, especially when outsourcing equipment maintenance. Page 22

23 Four different models can help investigate the economic life or ownership period. Although not disconnected, they have appropriate merits and data requirements. 7.1 The Repair Reserve Model As the name implies, the Repair Reserve Model involves setting aside a reserve for repair works, drawing on the reserves when repair is required, and making a decision based on the reserve level. You can visualize this as an operating bank account for a piece of equipment or a fleet. As the machine starts to work, you deposit money into the account. This amount varies with the type, class, and size of the machine. Let us say, for example, that we deposit $5 every hour. After the first 2,000 hours, the bank account will contain $10,000. Let us assume that at 2,000 hours, you need to perform some repair work costing around $4,000. In this case, at the end of 2,000 hours, your bank balance would be $6,000. Thereafter you would continue to build on this reserve when the machine was put to work again. This method produces an excess in the early hours which is used to cover normal increases in actual repair costs as the machine ages. It does not use purchase price, market value or other related factors. Therefore, it can be viewed as purely an internal method that requires only in house data. Repair costs typically have two components, cost of action and interval between actions. Cost of action is the actual amount of money that needs to be invested on the machine. A major repair will produce a higher cost of action than a smaller one. However, if the interval of action is short, it will bleed the repair reserve account faster than the high cost actions. This method can monitor both cost of action and interval between actions. There are some advantages and disadvantages for using this method. The advantages are that the method is very easy, requiring just one estimate and in house data. There is very little speculation, and calculation is fairly straightforward. On the other hand, by ignoring ownership related parameters, this method does not use any of the market related parameters. Therefore, the opportunities associated with market information are lost. It is also important to point out that the repair cost is a function of the preventive maintenance practice in the company. Therefore, this model justifies studying repair in isolation without preventive maintenance. Page 23

24 How can we make decisions based on this method? Based on historical data, it is possible to define certain rules, which can c then be used to monitor the equipment andd make decisions. For example, if the repair reserve in the above example never goes above $4,000, then it is worth monitoring the reliability of the machine. We can also use this method to determine when it is advisable to sell the machine. For example, if past records indicate thatt the average repair reserve is around $10,000 att 10,000 hours, before major repairs start to bring the balance down, then we can use a rule thatt suggests that the machine can be traded at around 10,000 hours. Some owners will argue that they have built up the reservee through a good maintenance practice and that they should reap the benefit of continuing to own the machine (for secondary application) by using up the reserve. Some will argue that it is better to o get the machine in someone else s fleet when it is time for repairs and then use thee reserve as a down payment for the next machine they buy.. Others will note that the machine may bring better resalee value if they can fix the repairs using the reservee and then sell it. There is no single answer as to which is the best method; each organization decides the best approach at any givenn point of time based on their circumstance and outlook. 7.2 The Classical Cost Minimization Model The Classical Cost Minimization Model considers both the ownership and operating costs. The ownership cost per hour component decreases with an increasee in machinee life. This is because in the calculation of the depreciation cost, we divide by the utilization; as utilization increases, it lowers the depreciation cost. Operating cost, on the other hand, increases with a longer machine life. As the machine starts to age, all moving and loadd bearing parts start to approach limits on their durability and need to bee replaced. The total cost of operation, which is the sum of all owning and operating costs, startss at a high value (due to high ownership cost), then drops to a low value (balance between owningg and operating cost) before rising too a higher value (due to high repair cost). The lowest pointt on the total cost curve identifiess the period of the economic life of the machine in which the total cost per hour is the t lowest. Page 24 TOTALL COST OF OWNERSHIP

25 Figure 5 : Illustration of Classical Cost Minimization Model This method uses both market and machine related parameters, and involves several judgment factors. Therefore, it is important to understand the assumptions and data. This model can be used for estimating (looking forward) or o analyzingg on going (current) operations. One needs to be careful andd not fall into the trap of o making misleading judgments. For example, it is not correct to assumee that a used machine purchased p att five years of its life will only cost $0.44/hr to operate for the next year. Nor it is logical to assume that a four f year old machine will actually produce $0.12/hr when sold after one o year! The complexity of the relationship between owning and operating cost and machine age requires that we check our assumptions by assuming a range of values and letting our knowledge k of how owning costs decrease and operating costs increase determine both the magnitude and the timing of the minimum cost point. You can use this model to help in decision making by creating rules r which draw your attention. In some cases, the trough of total costt curve is rather flat; in other cases the trough is rather narrow. Timing of decisions in the narrow trough curve is important 7.3 Cumulative Cost Model The Cumulative Cost Model was developed by Dr. Mitchell at Virginia Tech. The Cumulative Cost Model incorporates both ownership and operating costs as a function of f the purchase price. Therefore, if the purchase price of a piece of equipment is $1, then the repair cost in terms of the purchase price is tracked during itss life. In other words, the cost curve shown in Figure 5 starts out at 1 rather than 0. This curvee is not linear. The increase in cost in the early stages s of life is gradual. The costs then start to accelerate as the machinee ages. The important point is to note that there exists only one point in a machine s life (on the non linear cost curve) which will produce the lowest total cost; the costs are higher both below and above this point. Thiss point in the life of the machine is its economic life. A graphical representation of the classical cost minimization and cumulative cost model is presented below. Page 25 TOTALL COST OF OWNERSHIP

26 Figure 6 : Classical Cost Minimization and Cumulative Cost Models As mentioned earlier, the cumulative c cost curve consists of two components: the increase in costs, or speed of costs, and acceleration of costs. As a machine is put too work, the speed of costs, or the money that needs to bee spent now, will start to rise. The speed of costs is dependent on size/class of machine and type of application and environment. The more critical component is the acceleration of costs. Thiss acceleration is the factor that makes it unbearable to hold on to the machine in your fleet. The acceleration of cost is dependent of the equipment design philosophy, preventive maintenance program, and operator care. As you can see, any of these factors will determine the amount of money that you will spend in keeping the machine working in its later stages of life. Managingg this acceleration of cost is the biggest challenge for equipment managers. In fact,, it is possible to determine the economic life based on the acceleration of cost. Research done at Virginia Tech showedd that the cumulative cost spent on a machine ( different types, classes, sizes ranging from dozers, scrapers, articulated haulers, excavators etc) was about two. In other words, if the purchase price was $1, then equipment owners spent another $1 on repairs before they replaced the machine. This is an important observation, as itt reflects conventional wisdom used by experienced equipment managers, thereby validating the scientific foundations of thiss method. It is also interesting to note that the life corresponding to a repair cost of $1 was different for different machines; smaller machines m (with lower costs) were expected to have a shorter economic life compared to bigger machines (with higher costs). Another way of looking at this t observation is that bigger machines are required to be kept in fleet longer before it is economical to replace them. This is a key decision making factorr when it comes to selecting machines. Page 26 TOTALL COST OF OWNERSHIP

27 7.4 The Component Life Based Model Although component life is an implicit assumption in the calculation of repair cost and hence a part of all the models described earlier, this model helps us to understand a very important aspect of equipment management: the relationship between cost and risk. This method uses an estimate of component life (of major components), frequency of action required, and the cost of action to fix the components. Although this method can be used for both estimating and managing ongoing costs, its relevance is more pronounced in the estimating stage. Average component life is rather useless in calculating the repair costs. For example, if one weatherman states that the chance of rain is 20% and another one says 50%, which weatherman is giving you useful information? Most people would immediate choose the 50%, as it is a higher number (thinking that they are taking a conservative approach). Let us take a step back for a moment and think: what does 50% chance of rain mean? It means that it may rain or not. One does not need to rely on supercomputers, satellites, or any other technical gadgets to make such a profound statement. You could do that lying in bed. In the same vein, the average life of a component, say a transmission, does not provide any useful information. An average life of 10,000 hours really states that some of the transmissions will fail before 10,000 hours and others will fail afterwards. But this does not provide you with any useful information. Therefore, we refer to the use of expected life, which in most cases in the industry refers to t20 or B20, or the chance that 20% or fewer of the population of the components will fail at a given life or less. It is important to know the likelihood of failure, especially for critical operations. The deterministic approach uses a single point estimate for component life. In other words, the life of the component is a single value. Based on this assumption, we can construct a worksheet that includes the name of the component, the number of components in the machine, and the expected life. The frequency of action within a given time window can be calculated by dividing the time window by the component life. The cost of action can be calculated using the price of the component and the labor cost required to perform the action. By adding these costs for all components, it is possible to arrive at the repair costs. You can then use the observation from the research at Virginia Tech to arrive at the economic life by comparing the repair cost and purchase price of the piece of equipment. The likelihood of failure (probability) approach uses an instance of life based on pre defined parameters. This approach requires the simulation of multiple instances with different component lives based on the pre defined distribution. For example, if we know that the chance of failure of a transmission around 8,000 hours is 20%, around 12,000 hours is 50% and around 18,000 hours is 90%, then we can construct a distribution (which is often a bell shaped curve). Using this data in a simulation, it is possible that the repair costs can be as high as $20/h (when a component life of 8,000 hours is used) and low as $10/h (when a component life of 18,000 hours is used). Warranty information can also be incorporated in the distribution by stating that the chance of failure, at for example less than 2,000 hours, is zero. Let us look at the result of 1,000 simulations for a piece of equipment. Page 27

28 Figure 7: Illustration of repair cost whenn using likelihood approach for component life The inferences one draw from this exercise are that the repair cost for anyy one machine in the fleet can be anywhere from $13/hr to $ 25/hr (see above). The lower side represents a favorable f scenario, while the higher side represents an unfavorable scenario. Although the s shaped curved represents the cumulative occurrences of the cost, it can also be viewed as the risk line. In other words, if the equipment user (say a project, operationn etc.) is willing to share the risk (downtime, loss of production, etc.), then the cost of repairs cann be low (noo need to stock parts, emergency labor etc.). On the other hand, if the operation is critical and it iss not possible to take on any risk, repair costs will be high (including hiring replacement machines) ). Understanding this cost risk proposition is important, considering thatt this affectss the repair cost, which,, in turn, affects the economic life and purchase decision. When component life, cost of rebuild and/or secondary life are important, the component life model becomes helpful. Page 28 TOTALL COST OF OWNERSHIP

29 Now let us try to apply the subject that we have discussed so far and create a simple spreadsheet to estimate the owning and operating cost. a. The purchase price of the machine; including all options, delivery and set up costs. b. The purchase price without tires/tracks (calculated); the cost of the tires is included in the operating cost and, therefore, removed from the owning side. Leaving the cost of the tires/tracks in the purchase price would relate to selling the machine with a new set of tires or tracks. c. Depreciation time or ownership period is the economical life of the machine in the fleet. d. Residual value is expected fair market value at the end of the intended life. As explained earlier, this is a future cost and, therefore, must be treated in terms of net present value. e. Annual depreciation cost (calculated) based on purchase price, residual value, and depreciation time. f. Interest rate to be used in calculating the cost of capital. g. Calculation of interest cost based on average annual value. h. Machine tax (if any). i. Insurance cost: on an annual basis. j. Fuel cost per volume. It is difficult to estimate the cost of diesel over the life of the machine; as a starting point, the present cost of fuel can be used. The sensitivity of fuel cost towards the total cost can be studied after setting up the spreadsheet. k. Fuel consumption per hour; this is based on application, environment, operator efficiency, and machine design. l. The preventive maintenance cost; this should include material, labor, travel time and mileage. m. Interval in hours corresponding to cost as stated above (l). n. Replacement cost of a set of tires/tracks. o. Lifetime for a set of replacement tires/tracks for the given application. p. Repair cost for the intended life. This is calculated by setting up a separate spreadsheet for the components, their lives, parts, and labor cost. q. Operator cost on an annual basis; this can be omitted if only the machine cost is desired. r. Expected utilization in terms of working hours in a year (this will impact the economical life, repair cost). Various cost categories under owning and operating cost can be calculated as shown in the example. This method gives a simple way to estimate the ownership and operating cost. The total ownership and operating cost (without the operator cost) can be defined as the internal recovery rate that, when paid for, accounts for the fall in value as well as the ability to operate the machine during its intended life. Page 29

30 Table 3: An example of ownership and operating cost calculations Machine Model Item Units Costs A Purchase price $ 515,975 B Purchase price, excluding Tires / Tracks $ 478,575 C Depreciation time years 5.0 D Residual value $ 154,793 E Depreciation cost ((B D)/C) per year $ 64,757 F Interest % 6.0% G Interest cost (F x (A+D)/2) per year $ 20,123 H Machine tax per year excl. I Insurance per year $ 9,774 J Fuel Cost per liter $ 1.06 K Fuel Consumption Rate (Medium Duty Cycle) liter/hour 21.2 L PM Cost (per visit) per visit $ 800 M PM Interval hours 500 N Cost of Tires / Tracks per set $ 37,400 O Lifetime of Tires / Tracks hours 5,000 P Repairs and Maintenance (RMC) per year $ 13,320 Q Operator Cost per year excl. R Operating Hours per year 2,000 Note: In most cases, Preventive Maintenance cost is included in (P) repair and maintenance. Machine Model X Owning Cost per Hour Depreciation (E/R) $ Interest (G/R) $ Machine Tax (H/R) excl. Insurance (I/R) $ 4.89 X1 TOTAL FIXED COST PER HOUR $ Y Operating Cost per Hour Fuel (J x K) $ Oil, Grease, & Filters (L/M) $ 1.60 Tires / Tracks (N/O) $ 7.48 Repair & Maintenance (P/R) $ 6.66 Y1 TOTAL VARIABLE COST PER HOUR $ Z Operator Cost per Hour (Q/R) excl. TOTAL COST PER HOUR (X1+Y1+Z)) $ It is interesting to study the impact of certain variables once the spreadsheet is set up. For example, assume that the price of diesel were to go up to $1.35 per liter. What happens? The fuel cost per hour now goes up to $28.62 per hour, impacting the total cost by $6.15 per hour. Similarly, one can study the impact of residual value, repair cost, and ownership period on the total cost of ownership. Page 30

31 The reason we spend so much time and effort in understanding the various concepts in total cost of ownership is to be able to make good decisions. This is a step by step process. The first step is data collection because without data, we will spend too much time relying on our gut feelings. The second step is analysis converting data into information. We can have lots of data but if it is not converted into practical information, it becomes useless. The third step is knowledge development here we look for patterns in the analysis, a cause and effect relationship, trend etc. to develop insights into the operation. The final step is enlightenment where we use several experiences and the knowledge gained through analysis to develop rules to manage our equipment. The rules can sometimes be in the form of policies, threshold limits, timely review and action etc. In fact this process can be applied to any type of business operation. In the equipment world, we sometimes skip steps and make decisions based on our instinct or experience. Although this might lead to successful decisions, in the long term it fails to beat the odds. Therefore, decisions are best made based on facts rather than judgment. 9.1 Buy, Rent or Lease? The decision to a buy a piece of equipment stems from the fact that you believe that you can earn a better return from the investment than from other alternatives. The decision to buy can be broken down further into whether you want to buy with your own money or borrow it. This decision should be based on the condition that the money the equipment generates is greater than if the money had been invested elsewhere (the opportunity cost ). The money the equipment makes can come from direct sources (such as renting it out) or indirect sources (such as work done by the machine material excavated by the excavator). The cost of capital (interest) should be included as part of the ownership cost, as it defines the opportunity cost of money if it were invested elsewhere. This becomes clear in the case of borrowed money the equipment should pay for the interest on the borrowed money as well as create earnings for its owner. The difference in the two options is the risk factor. When you pay with your own money, then you must consider the timing of the investment as well as its cash flow. The decision to rent depends on the size of the work backlog and the rental rate including the number of hours. Rental is very much a short term solution, when there is uncertainty about workload. For example, if you have a six month work backlog, then it may not be prudent to buy a piece of equipment. In order to compare the rental rate, we can use the previously used example of the articulated hauler. The owning and operating cost of the articulated hauler is $ Supposing the rental rate for an equivalent hauler is $10,000 per month. Given that the number of hours allowed under a rental contract is typically about 200 hours, this works out to $50.00 per hour. Additionally, the rental contract would specify that the user is responsible for daily preventive maintenance work and fuel with a requirement on balance tire life. Thus if we add these costs to the rental rate it works out to $62.00 (assuming that the tire cost need not be included at this time). This is the total cost per hour that must be used to compare if the same machine were to be purchased by the user. The reason that the rental rate is higher than buying is that a rental company bears the risk of utilization (the machine may not rent out every month of the year) as well as the risk of repair (of the machine after it comes back from rent). In addition, a rental company must include a return on investment when calculating the rental rate. Page 31

32 The leasing solution is like a long term rental, the difference being that with leasing the contract stipulates a time period, a total limit on hours (not per individual month), and an optional buy out price. The user of the machine has the incentive to maintain the machine if the buy out clause is exercised. In most cases, the user would like to purchase the machine but does not have the money to pay for a new one. He is also interested in positive cash flow, especially in the beginning of the project. Therefore, leasing allows the user to establish the project by paying monthly fees with the option of buying the machine at a later date and at an affordable price. From a leasing company perspective, the monthly fees and the residual value are important. If the leasing company were to set a low residual value on the machine, then the monthly rate would not be competitive. Similarly, if the residual value was set at an artificially high level, the monthly rate could be low but stand the risk of the renter not buying the machine, or of a loss if the leasing company had to sell it on the second hand market. 9.2 In house vs. outsourced repair & maintenance When the repair and maintenance of a machine is outsourced, the company involved (typically a dealer) will be able to provide a good estimate on an hourly basis. Now, if we were to develop an estimate for in house repair, we must consider the following: 1. The consumables delivered at the site. 2. The full burden rate for the labor (including benefits, coverage etc.). 3. A good budget for the major components based on the usage. 4. A cost for the facilities. In addition to these, there are other soft issues that need to be considered: a) The ability to maintain and repair different makes of machines. b) The training required to keep up to date with technology. c) The ability to stock parts of different makes. d) The risk of downtime. When repair and maintenance are outsourced, the dealer is likely to include travel time and mileage, as the mechanic will spend considerable time traveling to the site. Therefore, it would be prudent to have all the machines serviced in one visit. However, the same is not the case with repairs they aren t all required at the same time. Finally, risk management with a fleet of equipment is important. As pointed out previously, when we develop the repair cost of one machine, we will budget for a major component based on its expected life. However, if there is a fleet of similar machines, then it is not necessary to budget for the same component for all machines (of course, this is dependent on the machine hours and likelihood of failure). Therefore, the outsourced repair cost for one machine will be higher than the average repair cost of a fleet of similar machines. Page 32

33 Below is a list of questions to ponder in relation to equipment costs. 1. What is the process involved in selecting machine requirements for a particular operation (site, plant)? 2. How do you arrive at the ownership period in the RFP / RFQ / tender? 3. What assessment model do you use in selecting manufacturer, make, and model? 4. What are the most important parameters regarding purchase of a piece of equipment? 5. How do you decide whether you want to purchase/lease or rent equipment? 6. How do you determine fleet, productivity, and cost of machines required for a particular job site? 7. How do you view fixed guaranteed repair and maintenance cost from the dealer vs. inhouse maintenance? 8. In the maintenance of a piece of equipment, there are two elements risk and cost. Which is more important to you and why? 9. What sort of data do you keep for your equipment (repair, maintenance, fuel, etc.)? 10. Typically, what are the most important inputs and outputs of a job study? 11. What is the relation between bank density and loose density? 12. If an excavator bucket is rated as a 4 m 3 bucket, can it hold 4 m 3 of water? If no, will it hold more or less? 13. What is meant by bucket fill factor? What is the assumption on the heap (slope) of the material for an excavator bucket and a loader bucket? 14. When we talk of material we mention 2:1 slope. When we talk of haul roads we mention 5% slope. What is the relationship between the two approaches? 15. What is meant by excavation class and how does it impact the bucket fill factor? 16. How is 50 min/hr rating different from long term mechanical availability and utilization? 17. How does one determine the best match between a loading unit and a hauler (any rules of thumb)? 18. How will you determine which is the best size bucket for a loading unit? 19. What are the components of a cycle for a wheel loader operation? 20. What factors affect the cycle time of an excavator? 21. What are the principal parameters defining a haul road? 22. What is meant by ground structure and how does it impact a hauler cycle time? 23. What is the rule of thumb to calculate the number of haulers required for a particular haul? 24. Does the type of material and transport surface impact the fuel consumption of the excavator and the wheel loader? 25. What is the difference between the loading strategy full buckets and full hauler? Page 33

34 Templates are provided which may be useful for calculation of a project TCO. Appendix 1 Ownership and Operating Cost Template This can be used to calculate the total cost/hour of a given machine, by combining the fixed (ownership) costs with variable (operating) costs. Appendix 2 Loading Production Estimator Template This can be used to estimate the production capacity for a given loading tool when presented with an unlimited number of haulers to fill. Production rate is expressed as tons/hour or a quantity of trucks that can be loaded within an hour. The template is set up for an excavator but with minor modification can apply to wheel loaders as well. This is just one example: Alternative calculation methods are available to estimate production capacity of loaders or haulers on a fleet basis. Appendix 3 TCO: Total Cost of Ownership Template TCO is the combination of fleet performance or production with the hourly cost calculation related to the fleet operation. It is not sufficient to look only at the hourly cost or production. They go together to derive the cost of work performed, i.e. cost per transported unit. Such a calculation can guide different conclusions: Machine purchase. By comparing alternative machine types, it is possible to choose the most suitable machines for carrying out the work. Machine distribution. A large contractor may have several different machine types or sizes, and different types of work to complete. By suitable calculation he can decide which machines should be placed on which jobs so the total cost of the job can be reduced to a minimum. Cost forecast. Before starting a job it is desirable to calculate how much it will cost, as it may form the basis for a bid. Whatever the purpose, the calculation process is the same: 1 Calculate hourly cost, 2 Calculate hourly production, and 3 Combine (1) and (2) to arrive at a unit cost for the work to be performed. Sometimes extenuating factors may require a certain combination of machines even though it is not the lowest cost solution for the project. Such factors are outside the calculation of TCO and should be considered at a different stage of project evaluation. Page 34

35 Appendix 1 Ownership & Operating Cost Template DATA INPUT FORM duplicate for each machine under consideration Machine Model Item Units Costs Comments A Purchase price enter initial machine value B Purchase price, excl. Tires / Tracks (A N) net initial machine value C Depreciation time years period under consideration D Residual value choose a preferred formula E Depreciation cost ((B D)/C) per year F Interest % enter annual cost of money G Interest cost (F x (A+D)/2) per year H Machine tax per year enter if applicable I Insurance per year enter if applicable J Fuel Cost per liter enter unit cost of diesel K Fuel Consumption Rate liter/hour specific to each machine L PM Cost (per visit) ** per visit enter consumables M PM Interval hours enter scheduled interval N Cost of Tires / Tracks per set enter replacement cost O Lifetime of Tires / Tracks hours application dependent P Repairs and Maintenance (RMC) per year Q Operator Cost per year enter cost of the operator R Operating Hours per year enter schedules hours ** Note: In many cases, Preventive Maintenance cost is included in (P) repair and maintenance. CALCULATION FORM base on data input listed above Machine Model Comments X Owning Cost per Hour Depreciation (E/R) Interest (G/R) Machine Tax (H/R) Insurance (I/R) X1 TOTAL FIXED COST PER HOUR Y Operating Cost per Hour Fuel (J x K) Oil, Grease, & Filters (L/M) Tires / Tracks (N/O) Repair & Maintenance (P/R) Y1 TOTAL VARIABLE COST PER HOUR Z Operator Cost per Hour (Q/R) if applicable TOTAL COST PER HOUR (X1+Y1+Z)) if applicable if applicable if applicable total ownership cost/hour total operating cost/hour total O&O cost/hour Page 35

36 Appendix 2 Loading Production Estimator Template User Jobsite Loaded Material Properties Ref Material Density (Banked) A kg/m 3 Material Swell Factor B % Material Density (Loose) C = A/(1+B) kg/m 3 Material Class Loading Unit Rated Bucket Capacity D m 3 Average Bucket Fill Factor E % Average Bucket Volume / Pass F = D x E m 3 Average Swing Angle (if appl.) G degrees Average Cycle Time / Pass H sec Bench, Working Height I m Date Description Model Loading Style Loading Unit Hourly Production Estimate Volume Vexc = (3600 / H) x F x T m 3 /hr Weight Pexc = Vexc x C ton/hr Hauling Unit Model Payload Capacity, Rated J tons Volume Capacity, Heaped K m 3 Calculated Bucket Passes L1 = J / (F x C / 1000) passes Whole Bucket Passes L = round (L1) % of rated Payload per Truck M = F x C x L / 1000 tons 0% Volume per Truck N = F x L m 3 0% Hauler Loading Time Quick 1st Pass Load O sec Time for Other Passes P = ((L) 1) x H) sec Truck Spotting Time Q sec Total Truck Load Time R = O + P + Q sec min Estimated Maximum Hourly Production Operating Efficiency S % min/hr Excavator Availability T % Effective Utilisation U % Trucks per Operating Hour V = ((3600 x S / R) xt) xu Estimated Hourly Production X = round( V ) x M x U ton/hr bcm/hr NOTE: The above figures assume "unlimited" truck presentation. Excavator delays waiting for trucks are not taken into account and will, if incurred, reduce total production. NOTE: Production figures indicated above are estimates only. No guarantee is given or implied that these production levels will be achieved in practice. Key Data to input Data to calculate using formulas Page 36

37 Appendix 3 TCO: Total Cost of Ownership Template TCO TEMPLATE duplicate form for each machine combination consideration Project Outline A B Production Target or Goal Timeframe or Limit (if any) Loader(s) Hauler(s) Item Units Fleet Total C Quantity of machines in fleet D Fleet Production rate E Cost per hour F Cost per unit production E / D G Total Cost F x A H Project duration, work hours A / D Guidance: A Enter the production goal, typically a quantity of tons, bank cubic meters, or loose cubic meters. B Enter the timeframe in which to complete the project (if any), typically days/months/years. C Enter the number of machines (loaders and haulers) to be considered in the project. D Enter the production rate derived for the fleet, typically tons/hour, bcm/hour, or similar. (see Appendix 2, for example template). E Enter the cost/ hour derived for each machine type, typically $/hour or similar. (see Appendix 1, for example template). F Calculate the cost/unit production, line E / line D, typically $/ton, $/bcm or similar. G Calculate the total cost for the project, line F x line A, typically $ or similar. H Calculate the project duration, line A / line D, for the machine combination and compare to line B. When evaluating multiple machine combination scenarios, the results in lines G and H are used to find the most cost effective within the appropriate timeframe. Page 37

38 The original material contained in this document was developed through research and various forms of inputs and discussions within Volvo CE as well as outside experts. The guidance and advice providedd by Dr. Michael Vorster of Virginia Polytechnic Institute and State University (Virginia Tech) is greatly appreciated.. The contribution made by individuals within Volvo Construction Equipment cannot be over emphasized. Although naming individuals could become a long list in itself, the discussions and insights providedd by Randy Bushelli B and Jim Leroy are worth a special mention. Finally, Volvo Construction Equipment regularlyy presents seminars to global key customers and inputs, questions, suggestions and advice from many participating industry players have shaped the author s thoughts overr a period of years to all those who have shared their mind, a special thanks. Author biography The original material contained in this document was authored by b Dr. Govindan Kannan. Dr. GOVINDAN KANNAN works as the Senior Vice President of Strategy and Business Development within Volvo Group North America, a global manufacturer of transport solutions. Prior to his present role, Dr. Kannan wass Vice President North East Asia within Volvo Construction Equipment, as well as Globall Key Account Manager where he was involved with the management of large fleet accounts around the world. Dr. Kannan worked with the procurement specialists, fleet managers and operations managers in defining various elements of total cost of ownership (TCO). Previous to this assignment, he was involved in the development of an earthmoving operations modeling tool called Volvo Construction Equipment Sitee Simulation. Dr. Kannan received his Ph.D. degree from the Via Department off Civil Engineering at Virginia Tech in May He received a Masters Degree in Civil Engineeringg from the National University of Singapore in 1995 and a Bachelors Degree in Civil Engineeringg from the Regional Engineering College, India in He has also worked as a site engineer for Larsen & Toubro Ltd. in India for two years. His address is govi.kannan@volvo.com. Endorsement. The views and opinions of author expressed in this document doo not necessarily state or reflect those of Volvoo Construction Equipment (Volvo CE) and they may not be used for advertising or product endorsementt purposes. Written permission is required from Volvo CE andd the author for any form of reproduction. Liability. Volvo CE and the author hereby disclaimm any and all express or implied warranties regarding this document, the results contained herein, or the appropriateness of examples used in the document including, without limitation, any warranties of merchantability or fitness for a particular purpose. In no event shall Volvo CE or the author be liable to the entity that uses this document for any indirect, incidental, consequential, or special damages, including without limitation, lost revenues or profits. Page 38 TOTALL COST OF OWNERSHIP