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Lifecycle Cost Analysis – Lite

Lifecycle cost analysis (LCA) is a commonly employed decision tool in private sector fleets. It is used to select between a few different vehicle choices and may also be used to determine the best vehicle replacement policy. However, the majority of law enforcement fleets do not employ this simple math comparison even though the data necessary for a LCA is available in many agencies.

A very basic LCA can serve as an effective tool and is simple to implement. The simple ingredients of a basic LCA are the collection of cost data such as vehicle purchase price and various operating costs, and a residual value. This article shows you how to perform a basic LCA where you can take into account your own circumstances and data without necessitating the use of sophisticated software.

 

Basic Assumptions

Assume that a law enforcement agency buys Dodge Charger Pursuit vehicles for patrol and traffic duties. Like many agencies, this agency buys its squads outright; therefore, there are no financing or leasing costs to consider. This agency employs shift rotation squads and not take-home vehicles. It retains its patrol squads in service for five years or about 100,000 miles before rotating them out of service and auctioning them off at public auction.

Based on these rotation criteria, the average annual miles driven are 20,000 miles per unit. The LCA then spans the five-year time frame from calendar year 2016 to the end of calendar year 2020. The Chargers procured are model year 2016 vehicles delivered in January of 2016.

In a LCA costs are analyzed in periodic time intervals such as on an annual basis in order to derive meaningful and readily to compare numbers. A basic LCA covers only actual vehicle cost data. It does not entertain overhead cost in order to keep the analysis simple. The cost data required for a basic LCA are: initial purchase price, upfitting cost, fuel cost, maintenance cost, repair cost, and residual value (or trade-in price).

 

Variable Cost

Variable costs or operating costs will change with the amount the vehicles are used. These operating costs include fuel use, routine maintenance costs, and unscheduled repair costs. Maintenance is different from repair and needs to be documented separately. Maintenance is anything scheduled, routine, and expected like new tires, brakes, rotors and oil changes. Repair is anything unexpected or the result of a part failure like a broken transmission or failed A/C compressor.

Pick a fuel price. Let’s assume an average price of fuel is $2.50 per gallon. Pick a fuel use. Let’s take 15 miles per gallon as the combined fuel efficiency figure for the V8 Charger AWD based on the EPA ratings of 15 mpg City/23 mpg Highway/18 mpg Combined. Of course, if you have actuals, use your documented numbers.

Dividing the 20,000 average annual miles driven by the 15 miles per gallon average fuel consumption results in 1,333 gallons of fuel consumed annually per squad. Multiplying this 1,333 gallons figure by the average price of fuel of $2.50 produces a rounded annual per unit fuel expenditure of $3,333.

Maintenance expenses usually cover fluid changes and other minor regularly scheduled service items, such as tires, brakes and oil changes. Repair expenses typically cover the costlier service items outside of scheduled service work because of impending or actual failure such as steering, suspension, cooling, electrical, transmission, and engine work.

A common sense way of identifying these costs for the future is by reviewing past agency experiences with the same or substantially similar make and model of squad, by gathering neighboring agencies’ experiences, and by obtaining and pricing out parts and labor expenses for necessary service work according to the vehicle manufacturer’s severe service maintenance schedule.

Agencies differ in their maintenance versus repair work classification. To keep it simple, this article’s underlying example subsumes both items under one cost heading. Assume that the combined maintenance and repair expenses are $1,000 during the first year of service in 2016; $1,300 for the second year; $1,600 for the third year; $2,200 for the fourth year; and finally $2,700 for the last year of service in 2020.

These figures are somewhat realistic based on past experiences with shift rotation squads in more urban and suburban patrol environments taking into account improvements in vehicle quality over the years as well as manufacturer provided bumper-to-bumper and extended powertrain warranties.

However, region, climate, number of drivers operating particular squads, type of service use, hours of service use, etc. influence such figures leading to varying operating cost numbers across agencies.

Selecting cost estimates according to your own circumstances and experiences is an appropriate way of achieving accurate LCA figures for your agency. Figures for fuel cost as well as maintenance and repair expenses are both shown by year in the LCA computation table below.

 

Fixed Cost

Fixed costs are incurred once. These are initial vehicle cost, and the cost of upfitted emergency equipment. While insurance is also considered a fixed cost, to keep things simple, let’s assume the agency is self-insured; therefore, there is no insurance cost to consider.

This agency participates in cooperative bidding or piggybacks on the state’s bid resulting in a purchase price of $25,000 per unit for its Chargers. Pick a residual value. Let’s use 25 percent or $6,250 after the five-year service life and 100,000 miles of use based on current and projected auction experiences. Again, if you have more solid numbers, use them.

This leads to a depreciation of $18,750 over five years. For LCA cost accounting purposes, this total depreciation is measured annually. Market experiences show that new vehicles depreciate the most during their first year of use.

To keep the underlying example realistic but still simple, assume the Chargers depreciate by $6,750 during the first year (27 percent initial depreciation) and by $4,500 during the second year (18 percent second year depreciation). This means the Chargers depreciate almost by half (45 percent) during the first two years of service.

Thereafter, assume the Chargers depreciate by $2,500 annually during each of the remaining three years of service leading to a straight line annual depreciation of 10 percent for service years three through five. The above assumed annual depreciation amounts sum up to the total depreciation of $18,750 over the life-cycle of the vehicles.

Pick a cost for upfitting. Let’s assume the modern emergency equipment such as lightbar, radio, siren, radar, cage, graphics, in-car digital video, and computer (installation labor and upfitted components) is $15,000. Technology items such as in-car digital video systems and computers as well as graphics may be purchased new every five years with the procurement of new squads.

Many agencies transfer other items such as lightbar, radio, siren, radar, and cage at least once from one squad to another leading to a service life of more than five years for some of these other items assuming compatibility between vehicles. However, to keep it simple, assume the agency buys new equipment every five years and the old equipment has no residual value.

Employing straightline depreciation by five years results in an annual depreciation of $3,000 ($15,000 of upfitting equipment divided by five years). The vehicle and equipment depreciation figures are both illustrated in the LCA computation table below.

 

Life-Cycle Cost Calculation

Once individual cost estimates for operating and fixed costs are obtained, they should be organized in table form by year and by general type of cost item as illustrated in the accompanying LCA table. This can be accomplished in spreadsheet format, in a word processor using the table command menu, or simply in plain pen and paper format.

Start out by listing the estimated annual costs for fuel, then for maintenance and repair before summing up these operating expenses in a third row of the LCA table. Next, list your annual vehicle depreciation and equipment depreciation numbers as well as the sum of these fixed costs in separate rows of your LCA table. Then, add up your sum of annual operating expenses and your sum of annual fixed expenses in a row called “Total Expenses” as illustrated in the accompanying LCA table.

 

TABLE: LIFE-CYCLE COST ANALYSIS COMPUTATION

Cost Items

2016

2017

2018

2019

2020

Fuel at $2.50 Per Gallon

$  3333

$  3333

$  3333

$  3333

$  3333

Maintenance & Repair

$  1000

$  1300

$  1600

$  2200

$  2700

Sum of Operating Expenses

$  4333

$  4633

$  4933

$  5533

$  6033

Vehicle Depreciation

$  6750

$  4500

$  2500

$  2500

$  2500

Equipment Depreciation

$  3000

$  3000

$  3000

$  3000

$  3000

Sum of Fixed Expenses

$  9750

$  7500

$  5500

$  5500

$  5500

Total Expenses

$14083

$12133

$10433

$11033

$11533

Life-Cycle Cost in Cents per Mile

0.704

0.607

0.522

0.552

0.577

 

The final step is to divide your total expenses by the average annual miles driven to easily compare LCA cents per mile figures. In this example, the total expenses are divided by 20,000 miles to obtain the cents per mile number shown in the table.

 

Life-Cycle Cost Interpretation

An important part of any LCA is to properly interpret the cents per mile figures. If the goal of your LCA is to select between alternative vehicle choices, then you need to conduct an LCA for every make and model under consideration. You then compare the respective LCA cents per mile figures to see which vehicle make and model has the lowest life-cycle cost.

As a general rule of thumb, consistent annual differences of 2 cents per mile or more between vehicle makes and models tend to indicate relevant cost differences. You select the vehicle with the lowest life-cycle cost for procurement if no other decision criteria play an important role in your agency’s decision-making process or if the vehicle meets your other specifications as well.

In addition, it is economically advisable to use LCA cents per mile figures to determine the best vehicle replacement policy as well. Keep in mind that high LCA cents per mile costs early on in a vehicle’s service life are not a reason to rotate such vehicles out unless one suspects to have a lemon. High LCA cents per mile costs represent sunk costs, money already spent and simply passed on to the buyer in case of a vehicle sale.

The concept of economic efficiency requires vehicles to be rotated out of service when the total life-cycle cost is at a minimum. The reason is that an economically forward-looking replacement policy rotates vehicles out before large amounts of funds are expended on vehicle repairs.

In this LCA example, the agency should rotate their Chargers out of service after three years and 60,000 miles of use because total LCA cents per mile costs are at a minimum in 2018. Thereafter, these costs increase due to higher fleet upkeep costs.

Other LCAs may have different results. Use the information provided here to conduct your own simple and basic LCA calculations with your own assumptions based on your own experiences and circumstances to see where your agency stands and how you can improve your fleet operations to the benefit of your agency and your taxpayers.

 

Giant Aryani is a law enforcement economics researcher and Professor of Economics at Collin College, Texas. He specializes in police vehicle procurement research and cost-benefit analyses of law enforcement programs. He can be reached at garyani@collin.edu.

 

SIDEBAR

Cost Escalation Rate and Discount Rate

Other data ordinarily required are figures for the cost escalation rate and the discount rate. A full and formal LCA is not complete without due consideration of escalation rates (a measure capturing future inflation) and discount rates (a measure clarifying today’s dollar value of a future expense or revenue item).

 

However, escalation and discount rates are not incorporated into this example of an LCA to keep it simple for quick comprehension and adoption. In fact, the escalation rate and the discount rate often cancel one another out.

 

Similarly, this article does not incorporate opportunity costs (a measure appraising the value of the sacrifice of the next best alternative use of the funds that have been spent purchasing police vehicles) in order to keep this basic LCA example simple.




Published in Police Fleet Manager, May/Jun 2016

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