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Quantifying the Life-Cycle Value of Service

Quantifying the Life-Cycle Value of Service. A Step-by-Step Approach to Total Cost of Ownership Or, “How to Hit the Economic Curve Ball” SERVICE GROWTH WORKSHOP SERIES PRESENTED BY: LOU RONSIVALLI, TCS-GLOBAL Version: 04-03-09. March 3, 2009: GE’s Focus on Services.

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Quantifying the Life-Cycle Value of Service

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  1. Quantifying the Life-Cycle Value of Service A Step-by-Step Approach to Total Cost of Ownership Or, “How to Hit the Economic Curve Ball” SERVICE GROWTH WORKSHOP SERIES PRESENTED BY: LOU RONSIVALLI, TCS-GLOBAL Version: 04-03-09

  2. March 3, 2009:GE’s Focus on Services Article from Wall Street Journal/Dow Jones… • Expects that “75% of it’s $85-billion industrial operation’s revenue will come from services in 2009” – up 65% from 2007! • “…Has sold $13 billion in aircraft engines since 2006. Over their 30-year life, those engines will generate about $90 billion in service revenue” • According to Accenture Ltd., “After-sales services and parts typically yield 25% of revenues and nearly 50% of profits for industrial companies”

  3. Life at TCS in 2009… • Internal restructuring and integration • Unprecedented energy volatility • oil from $75/bbl to $140/bbl to $39/bbl; 03/09: $52/bbl • Recessive global economy – impossible to project results • Financing dollars increasingly difficult to secure • Instability of stock market and corporate financial balance • Trane, customers need to cut costs, re-prioritize investments • Capital projects of all kinds - deferred indefinitely • Customer attention on critical needs only • EVERYTHING must be economically justifiable!

  4. Uncertain Economy… Understanding economic impact on customer Innovative Selling Creative Selling Drive OEM knowledge to customer Improve communication and demonstration of value Use “knowledge” Mindset Needed for Success in Economic Uncertainty During ‘Hot” Economy… • “Drive” projects • Assertive selling • Standardized selling tactics • React to OEM inquiries by customer • “Business as usual” • Use “speed” Be Aggressive! Be Opportunistic!

  5. Cost of Ownership – Take a Simple Approach • There are four primary cost components for an HVAC system over its life-cycle. Each has an objective and each can be annualized. Capital Costs –Preventing premature component replacement. Energy Costs –Managing energy commodity, output, efficiency. Repair/Failure Costs – Minimizing failures via pre-emptive service intervention. Cost of Services – PM, testing, monitoring, parts. 1 2 3 4

  6. Cost of Ownership – Take a Simple Approach • Simply, the Cost of Services should be negated by the ‘Cost Avoidance’ of the three other cost components: • Capital Costs • Energy Costs • Repair/Failure Costs • We can calculate benefits of service agreements and simple* life-cycle costs of various building components. *“Simple” calculations are those that do not include discount rates or the cost of money, i.e., “simple payback”

  7. Show Customers How to Self-Assess • Use very simple math to illustrate how to determine operating costs and calculate simple “cost avoidance” • Perform back-of-the-napkin calculations to elicit their participation • Provide some examples and opportunities to show how conservatively-measured costs avoided can justify service investments • Elevate customer awareness via use of formal tools and introducing cost of capital, etc. • Analyze short-term needs vs. budget restrictions • REAL example: a large number of organizations with 7/1 fiscal year have over-budgeted utility costs for fiscal 09!! How can you help them?

  8. Calculating Simple Annualized Capital Costs:First cost amortized over expected life Variables to approximate this are straightforward: Component’s installed cost per unit of size (per ton, HP, BTU, or kW) Size of component to be installed ÷ Expected life of component X EXAMPLE 1: Vermont-based Salem Bank has new 80-ton RTU installed, with an expected life of 15 years at a cost of $120,000 ($1,500/ton). What is the simpleannualized capital cost? 80 ton X $1,500/ton  15 years =$8,000/yr

  9. Calculating Capital Cost Avoidance • Capital Costs are the installed costs required for a new component or replacement component. Preventing premature degradation or early replacement results in Capital Cost Avoidance. • Variables: • Expected component life • Replacement or installed cost-per-size unit • Size of unit • Avoided Life deterioration

  10. FEMP’s “O&M Best Practices Guide” • A 215-page Guide to Operational Efficiency, updated July 2004 (release 2.0) http://www1.eere.energy.gov/femp/pdfs/omguide_complete.pdf

  11. Calculating Capital Cost Avoidance • Estimate average “Avoided Life (& efficiency) Deterioration” (ALD) for large components, consistent with the FEMP* energy and maintenance cost models. As an OEM, Trane can provide periodic validation: • Scheduled Agreement (approx. 15% ALD) • Select Agreement (approx. 20% ALD) • Performance Based with PdM (approx. 30% ALD) * http://www1.eere.energy.gov/femp/pdfs/omguide_complete.pdf EXAMPLE 2: 500-ton chiller, expected life of 24 years, replacement cost of $1000/installed ton. What is simpleannualized avoided capital cost of a Select Agreement? 500 tons X $1000/ton X 20% ALD  24 yrs life expectancy =$4,167/yr

  12. The Reality of Saving Energy/Utility Dollars • Energy/Utility consumption and demand is measured in units: • Power demand in watts or kilowatts (kW) • Power consumption in watt-hours/kilowatt-hours (kWh) • Water (utility) or natural gas consumption in thousand cubic feet (mcf) • “Efficiency” measures thermal output per energy input such as tons-per-kWh. • “Cost Avoided” ($ savings) is measured in units of commodity saved at the current cost of that utility; as the cost of power increases, the “cost avoidance” increases for the same unit of energy saved. • 10 gallons of oil saved in 2005 ≠ 10 gallons of oil saved in 2008 in “Cost Avoidance”

  13. Variables that Determine Energy Costs and Savings • Several variables allow us to approximate annual “cost” to operate any equipment component (chiller, boiler, pump, tower, fan) including: • Number of operating hours per year • Average capacity delivered • Approx full-load operating efficiency of component • Average unit cost of utility • Create equivalent full-load hrs EXAMPLE 3:(Accurate to within 5-15% typically) Salem Bank has 500-ton chiller with avg. load 325 tons over 24 weeks, 96 hours per week. What is the annual operating cost at 8.0¢/kWh? 325/500 tons X 24 X 96 = 1,498 full load hrs 1,498 hrs 500 t X 0.58 avg. kW/ton X $0.08 avg./kWh =$34,754/year

  14. Calculating Avoided Energy Costs • “A sound PM program can save between 5% and 20% of the energy used in a typical facility”… FEMP 2004 Operations & Maintenance Best Practices Guide. • Efficiency has eroded in the absence of service. • Conservative savings estimates: • Trane Scheduled Service Agreement Energy Savings = 5-10% • Trane ‘Select’ Service Agreement Energy Savings = 10-15% • Trane Performance-Based Service Agreement Svgs = 15-20% • Based on the FEMP study, these savings estimates would be conservative as a starting point – don’t forget that inoperable equipment uses no energy!

  15. Identify thermal output of fuel type: #2 oil = 140,000 BTU/gallon #4, #6 oil = 120,000 BTU/gallon Propane = 91,600 BTU/gallon Natural gas = 100,000 BTU/therm Electricity = 3.413 BTU/kW Steam = 1,000,000 BTU/Mlb Easiest to first convert BTUs to fuel type (gallons, therms), then calculate the consumption and cost components One last conversion for power: 1 HP = 0.746 kW; use this for calculating fans, pumps, towers, air compressors; i.e.: A Note about Heating Costs:First:Determining thermal output I.e. : How much does it cost to operate a 25 HP H&V fan @ 80% load? 20 avg. HP fan X 168 hrs/wk X 52 weeks X .746 HP/kW X $.08/kWh =$10,427/year

  16. Examples:Energy Cost Avoidance due to service agreements EXAMPLE 4: 500 ton chiller – Trane ‘Select’ Agreement avoids 10% in performance erosion:$34,754/year X 10% recovery = $3,475/yr (most conservative figure) EXAMPLE 5: HEATING Salem Bank has #2 oil @ $2.20/gallon, 1.6 avg. MMBTU boiler (90% eff.) that runs 36 weeks and 120 hours per week. What is annual operating cost? 1,600,000 BTU/hr boiler X =12.7 gallons/hr 4320 hrs X 12.7 gals/hr X $2.20/gallon =$120,700/year (Note: In typical northern climate, annual heating costs run about 3X annual cooling costs) 1 gallon #2 oil 140,000 BTU x 0.90 efficiency

  17. Examples:Heating Cost Avoidance due to service agreements EXAMPLE 6: 1.6 MMBTU boiler – Trane Scheduled Agreement avoids 5% in performance erosion: $120,700/year X 5% recovery =$6,035/yr

  18. Repair & Downtime Costs:Annualizing non-scheduled repairs and downtime • The first attempts to capture projected repair costs should be via owner’s records. • If this is unavailable and owner cannot estimate costs of repairs, we can use R.S. Means data. • This could also be represented by the difference to the owner in the cost of a Scheduled Service Agreement vs. the cost of a ‘Select’ Service Agreement for any component.

  19. Calculating Avoided Repair & Downtime Costs via Service • Repair costs and downtime (indirect) costs can be estimated per unit for size of a component. Typical of the HVAC industry*, conservatively: • Cooling equipment annual repair costs = $10.00/ton • Cooling equipment annual downtime costs = $5.00/ton * Mechanical Service Contractors of America (MSCA) http://www.mcaa.org/msca/ • Required repairs are most often the direct result of the absence of, or deferred maintenance. • Typically, the “run-to-fail” mode, according to FEMP can cost a facility approximately $18/HP/year over the life of a building. (Note: FEMP numbers estimated prior to 2004)

  20. Sidebar: MCAA/MSCA… http://www.mcaa.org/msca/ • Trane is an associate member!

  21. Preventive Maintenance, FEMP Guide: • Reactive = ~$18/HP/Yr • Preventive = ~$13/HP/Yr • Predictive = ~$9/HP/Yr • Reliability Centered =~$6/HP/Yr --- FEMP Guide 2004, pages 5.6, 5.7, and 5.8 • I.e., Savings over Reactive Maintenance: 28% - 66% Annually So, with some “simple” math manipulation…

  22. Calculating Avoided Repair & Downtime Costs via Service …we can conservatively approximate the impact of service on annual repair costs:

  23. EXAMPLE 7: 500-ton chiller; Trane ‘Select’ Agreement avoids 50% of repair and downtime costs to owner 500-ton chiller X ($10/ton repairs + $5/ton downtime) X 50% reduction = $3,750/year Examples:Avoided Repair & Downtime Costs Due to Service EXAMPLE 8: 80-ton RTU; Trane Scheduled Agreement avoids 30% of repair and downtime costs to owner 80-ton RTU X ($10/ton repairs + $5/ton downtime) X 30% reduction =$360/year Without actual repair cost history, number may be conservative... If the RTU loses 1 compressor requiring an off-hours crane, that could be a $2,500+ repair!

  24. Economic Justification of Service • The Benefits of a Service Agreement are: • Avoided capital costs by preventing premature reduction in equipment life • Avoided energy costs be preventing degradation of efficiency • Avoided repair and downtime costs by minimizing unplanned failure and downtime • Adding calculated avoided costs and comparingto cost of a service agreement provides economic justification • Finally, we can calculate the life-cycle cost of a component that helps with decision-making

  25. Total Annual Cost Avoidance: EXAMPLE 9: • a) What is the totalsimpleannual avoided cost that can be achieved with a Trane Select Agreement for a 500-ton chiller at Salem Bank? • b) What is the simple annual net economic benefit of a Select Agreement, if it costs $10,250/year? • Avoided Capital Cost = $4,167/year (Ex 2) • Avoided Energy Cost = $3,475/year (Ex 4) • Avoided Repair & Downtime Cost = $3,750/year (Ex 7) Total Simple Annual Cost Avoidance:$11,392 Total Simple Annual NetEconomicBenefit:+$1,142/year

  26. The Bottom Line to Salem Bank… • Simply put, by entering into a Select Service Agreement with Trane, Salem Bank can avoid an average of$1,142in operating costs for as long as they own and operate this chiller • If the life of the chiller is 24 years, the netsimpleeconomicbenefit to Salem Bank in present dollars is $27,408 • If the chiller lasts an additional five years, the service agreement allows Salem Bank to defer capital outlay for the next chiller at whatever the installed cost per ton will be …in24 years!

  27. Summary and Conclusions… • We can use real data, third-party data, Trane knowledge and reasonable assumptions with basic variables to perform simple calculations to support decision-making • We can use life-cycle costs to provide context for decision-making and justifying service options that extend life, improve efficiency, reduce downtime and deliver High Performance Buildings! • What else can we show customers?...

  28. Simple Life-Cycle Costs • Life cycle costs are total costs over expected life of equipment. • We can calculate the life-cycle costs for equipment that is replaced prematurely, meets life expectancy or exceeds it. • Calculating simple life-cycle costs helps with decision-making

  29. Simple Life-Cycle Costs • Elements: • Installed costs (capital) per unit • Size of unit • Expected life of component • Total Energy costs over life • Total Repair and Downtime costs over life • Total Service Costs over life • We can annualize simple life-cycle costs • We can calculate the first cost as a % of total life cycle costs to show owners why “first cost” is a poor decision-making criteria.

  30. Life-Cycle Calculation Example EXAMPLE 10: a) Salem Bank has asked Trane to calculate the simple life cycle cost (exclusive of service agreements) of its 500-ton chiller to determine how much they should budget in their 5-year plan for a new installation. Chiller has an expected life of 24 years • Replacement installed cost ($1000/ton) = $500,000 • Chiller = ~$125,000; Installation = ~~375,000 • Energy costs (24 years X $34,754) = $834,096 • Repair & Downtime costs (24 X $7,500) = $180,000 Total Simple Costs for 24-year life of chiller:$1,514,096

  31. Life-Cycle Calculation Example EXAMPLE 10 CONTINUED… b) If the chiller has a first cost of $125,000, what does this represent as a percent of the life cycle costs over 24 years? • Chiller: $125,000  $1,514,096 = 8.3% • Installation: $375,000 = 24.8% • Energy: $834,096 = 55.1% • Repair & Downtime: $180,000 = 11.9% How should they make their decision for a new chiller in the future? Which of the above factors is most likely to increase in percentage of total?

  32. What’s next for Economic Justification of Service? • Trane ERS Cost of Ownership Tool – Nick Ibarra; take operating cost justification to the next level of detail for decision-making • Will be creating a prompted menu worksheet for discussing economic justification • Will be creating a graph to show the costs of capital, utility and repair/downtime vs. cost of service to show break-even points, plus-side economic benefit • Will be creating indices for costs such as cost/ton/year

  33. Summary • As a leading OEM service provider, we must seize the opportunity to help guide customer decision-making and we must help justify business decisions in a tough economy • Applying new technologies • Innovation • Creativity • Demonstrating Value • Opportunism • Educating Customer • Accelerated communication • Embracing Trane’s OEM status • Positioning Trane’s service future!

  34. Your Assignment…

  35. Life Expectancy: 24 years Weekly Operation: 120 hrs Annualized Operation: 42 weeks Average Load/Chiller: 200 tons FL. Efficiency: .60 kW/ton-hour Avg. blended cost of power: $.073/kWh including demand charge Because of their condition, we will assume that our Select Agreement can produce avoided repair/downtime costs of 65% instead of our baseline of 50% In-Class Exercise A. Salem Bank has asked Trane for some economic justification for its service agreement at their Tennessee location. The chillers are in slightly less than average shape. We are proposing $21,500 for an annual Select Agreement for two, 400-ton electric chillers. Details on chillers below: B. Can we justify the cost of the service agreement? How can we convince the customer that we should also include in our scope the two 50-HP CDW pumps, two 40-HP CHW pumps and 30-HP Tower for an additional $2,000? (Note: Assume that one CHW pump, one CDW and one tower fan operates for each hour)

  36. Exercise Calculations: A. • Annual Avoided Capital Costs of chiller: 800 tons X $1000/ton X 20% ALD  24 yrs life expectancy = $6,667/yr • Annual Energy Costs - chiller 400/800 tons X 5040 hrs X 800 FL tons X 0.60 avg. kW/ton X $0.073 avg./kWh =$88,300/year • Annual Avoided Energy Costs: $88,300/year X 10% recovery = $8,830/yr • Annual Avoided Repairs/Downtime Costs: 800-tons X ($10/ton repairs + $5/ton downtime) X 65% reduction = $7,800/year Total Simple Annual Cost Avoidance w/Trane Select Agreement:$23,297/yr

  37. What These Calculations Mean to Your Customer Total Simple Annual Cost Avoidance w/Trane Select Agreement:$23,297/yr • Service Agreement is fully justified at $21,500/yr. with ~$1,797 in positive economic benefit • We can now do calculations for the pumps and tower separately to justify including them (using .746 HP/kW)…

  38. B. Towers and Pumps Calcs… • While the chiller is running, we can approximate how many hours the pumps and tower are required to run • We can also approximate the average “load” on the motors at ~85% (BHP), but you can amp them and use as approximation of % load • Therefore a rough estimate on the simple annual “cost to operate” is: 4200 hrs x (30HP + 40HP +50HP) x.85 load X .746 kW/HP X $.073/kW = $23,330/year • Select Agreement saves additional 10% on energy – i.e., power factor correction, drive alignment, lubrication, bearings: ($23,330 x 10% = $2,333/yr); justifies the $2,000 SA additional cost with $333+ economic benefit • Note: add something for percent-of-repair cost avoidance if this figure is available from customer (bearing failures, dynamic balance, motor repairs)

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