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FedEx and the Life-Cycle Cost
Embry-Riddle University Worldwide
MGMT 422
Stephen Walker
26 January 2013
By
Ahmadou Diallo

Abstract
Life cycle cost LCC is a management accounting tool used is a method for assessing the total cost of system from costs of acquiring, owning, and disposing of it. This methodology is essential in predicting cost-effective solutions though it not guaranteeing a particular result; therefore allowing the firm initiate rational comparison between alternative solutions.

Introduction
Life Cycle Cost (LCC) is the total lifespan cost incurred by an organization in purchasing, installing, operating, maintaining, and disposing off any equipment used in daily operations of the firm. In regard to this, estimation of LCC encompasses using a particular approach in identifying and quantifying components of an LCC equation (Pehnt, 2006). The use of LCC as an assessment tool when selecting possible design alternatives results in the provision of a cost-effective solution within limits of available data. In addition, a standard LCC comprises initial and operation costs, installation and commissioning costs, energy costs as well as disposal costs among others.
System Requirements
The management of FedEx gives particular emphasis on the initial purchasing and installation cost of new systems. In line with this, the firm’s top managers are supposed to explain LCC of various solutions prior to the installation of new equipment. The initiation of strong LCC is essential in assisting FedEx achieve high financial strategies in the competitive market. Therefore, to maintain a competitive edge, the organization constantly initiates cost savings to improve its profitability (Hsu, 2012).
Life Cycle Cost Analysis
Before conducting the LCC analysis for the firm’s facilities, an evaluation of the entire set of alternative systems is required. In this situation, lifetime energy and maintenance costs take a greater part during LCC evaluating of the company’s facilities. According to this, FedEx is required to correctly calculate current energy costs, annual energy price increase for the estimated life, as well as expected maintenance and material costs. In addition, other requirements include lifetime costs of down time, decommissioning, and environmental protection, which are assessed based on historical data of the facility. Besides, careful consideration is undertaken when estimating productivity losses caused by equipment downtime.
LCC analysis is a management accounting tool used by companies in minimizing waste while maximizing energy efficiency for all types of systems. This methodology is essential in predicting cost-effective solutions though it not guaranteeing a particular result; therefore allowing the firm initiate rational comparison between alternative solutions. In conducting the evaluation, vital information is availed to avoid getting inaccurate results.
Most logistic and industrial systems used by FedEx have lifespans between 15 to 20 years. For this firm, cost elements are incurred during the installation period of the new equipment while others are realized at different times of solutions under evaluation (Hammond, 2004). Thus, it is essential to calculate LCC’s discounted value to accurately assess the different solutions.
In FedEx, LCC analysis compares maintenance and servicing costs, in situations whereby costs were subcontracted and machinery spares were issued during the initial supply of equipment. If maintenance costs are conducted by the specialist subcontractor, then costs appear against the evaluation of that system.
LCC = Cic + Cin + Ce + Co + Cm + Cs + Cenv+ Cd
From the above equation, LCC is the life cycle cost; Cic is initial costs, purchase price, Cin installation and commissioning cost and Ce being energy costs (predicted cost for system operation). In addition, Co is operation costs; Cm is maintenance and repair costs while Cs is downtime costs, Cenv includes environmental costs and Cd is the decommissioning and disposal costs.
According to the initial investment costs, there are several choices that should be initiated during the design stage that directly influence the initial investment costs. Therefore, at this stage, selecting equipment with low wear rates, heavy duty bearings, and extensive control packages increase the working life of the equipment (Malin, 2010). However, these considerations are likely to make the firm incur higher initial costs though reduced LCC costs. Examples of initial costs include purchase order administration, inventory of spare parts and training among others.
The next step is installation and commissioning which encompasses setting and cementing equipment as well as connection of auxiliary systems and other utilities. In this stage, installation is done by the equipment supplier; a decision dependent on skills, tools, and necessary equipment for completing the installation. To ensure the installation is complete, training of personnel responsible for system operation is initiated. In commissioning step, close attention is paid to manufacturer’s instruction regarding start-up and operation of the equipment. Thereafter, a worksheet is used to ensure that equipment and the system are operating within specified parameters.
Equipment energy usage is the larger cost elements dominating the LCC given the running of the firm’s equipment for more than 2,000 hours each subsequent year. The equipment’s energy consumption is estimated by gathering data on variations in the system’s output (Mathur, Bansal, & Wagner, 2004). A steady energy output initiates a simple calculation but, a varying output calls for the establishment of a time-based usage pattern to monitor the change. Highlighted below is the formula used in calculating equipment input power.
P = Q x H x s.g. 366 x ηp x ηm (kW - metric)
P = Q x H x s.g. 3960 x ηp x ηm (hp - U.S units)
From this equation P is power, Q the rate of flow, m3/hour while H denotes head in m (ft.). Besides, ηp is equipment efficiency; ηm is motor efficiency and finally s.g. connotes specific gravity. Prior to estimating power output, the plant manager is required to get data showing equipment performance. The performance is estimated in terms of energy used by the system at different output levels.
The equipment used by the firm incurs FedEx high operation costs; labor costs resulting from the operation of the system. However, the operation cost varies among machines used and the system’s complexity. The company’s fully automated and non-hazardous system requires low supervision but constant observation of their functioning is crucial in notifying operators of possible system malfunctioning. In this regard, changes in vibration and power consumption variations are some dimensions looked at when evaluating operation costs.
For optimum working of machines, the firm should set aside maintenance and repair costs. Efficient and constant servicing of equipment reduces their downtime periods thus the firm is advised to initiate routine machine maintenance. Maintenance costs are dependent on time and frequency of service as well as material costs (Crawford, 2011). In addition, equipment design also influences costs depending on the ease of access to parts requiring servicing. However, these costs are reduced by conducting major maintenance during annual shut-downs and holidays.
Downtime costs result in loss of productivity and may have higher outcomes as opposed to energy and replacement parts costs. In spite of the high quality machines used by FedEx, there are always unexpected failure equipment malfunctioning. In such occurrences, production costs steadily rises but, spare machines should be installed in to reduce such risks. Though setting up spare machines makes the initial cost higher, they help reduce maintenance cost brought about by of sudden equipment failures. Thus, the cost of lost production depends on downtime though differing among the firm’s machines.
Machinery environmental contaminant disposal costs vary significantly during their lifetime depending on the nature of disposed products. In line with this, the firm’s choices greatly reduce the amount of contamination yet lead to increased investment costs (Zamagni, 2012). The firm’s potential environmental pollutants include used lubricants and contaminated used parts among others. Therefore, the firm should include costs for environmental inspection in their annual LCC.
Disposal of used machines and used parts varies among several firms. FedEx disposes off non-hazardous and in some cases hazardous materials. The disposals of these materials are monitored by government agencies; they have legally imposed protection requirements. However, differences are likely to occur if one system has disposal arrangements as part of its operating arrangements while another does not. In addition, expensive disposal of used parts makes LCC become more sensitive to useful life of the equipment.
Cost Breakdown Structure
Cost Breakdown Structure (CBS) a central part of LCC analysis entails breaking down a project into constituent cost elements and varies depending on companies’ purchasing decisions. CBS aims at identifying relevant cost elements and must have well-set boundaries to avoid errors. In this regard, CBS’s traits include cost estimation, discounting and inflations.
Cost Estimating
Following the estimation of the CBS, FedEx is required to determine the costs of each product category using at least one of the outlined methods highlighted in below paragraphs.
The first method is factors which are inputs in the LCC analysis having known accuracy. As an example, procurement costs are easily calculated if the unit production cost and the quantity are known. In another example, operator manpower costs are easy to find from known values of staff costs and equipment utilization; staff cost (per hour) x hours used per month = OMC);
The next method is Cost Estimating Relationships (CER) dealing with values derived from historical and experimental data. According to FedEx’s LCC, for items sharing the same characteristics, the initial spares cost is 20 percent of the UPC and is usable as CER for new purchases. However, CER’s results should be handled with care since inaccurate entities result in several LCC errors.
The last part is expert opinion used when real-time data is inaccessible. The use of expert opinion in LCC analysis takes into considerations assumptions and rationale supporting the opinion.
Iceberg Effect
Iceberg effect emanates from poor financial management only if apparent costs are taken in consideration. However, the visible costs are representation of a small proportion of the total cost of ownership (Curran, 1996). Prior to any major purchases, FedEx conducts evaluation of total ownership cost since maintenance costs greatly affect profitability and are budgeted in the total operation. In addition, FedEx has numerous departments responsible for monitoring acquisition cost and given the storage of support funding in different areas, the firm has little incentive to apply the principles of LCC to its purchasing policy. Therefore, the application of LCC does have a management implication because purchasing units are unlikely to apply the rigors of LCC analysis unless they see the benefit resulting from their efforts.
Application of LCC Analysis
LCC is vital for all FedEx’s purchasing decisions. Therefore, it is essential for presenting the specification in performance terms rather than design detail. In addition, purchasing decisions, are supposed to be appropriate to ensure products satisfy the company’s and clients’ needs (Trusty, 2010). However, the purchasing decision should not be rigid preventing negotiation and discouraging suppliers from using their expertise to initiate innovation.
In addition, for items having large values, LCC’s application techniques greatly influence contractual negotiation processes. As an example, LCC analysis should be initiated to find cost-effectiveness of warranty proposals.
Moreover, FedEx offers negotiable incentive contracts benefitting customers whenever the results of LCC analysis are availed. This allows purchaser to apply creative contractual approaches beneficial to users.
LCC Benefits
The first benefit of LCC analysis is evaluation of competing purchasing options. In this regard, LCC allows for easy evaluation of rival proposals on through life costs basis. Besides, LCC is relevant in essential when making purchasing decisions since it allows for both assessments of competing purchasing options as well as leasing.
The next advantage of is that LCC helps improve awareness of total costs. In this setting, LCC provides the firm’s management with knowledge of factors resulting in fluctuations in costs as well as requires necessary for making purchases.
Concurrently, the third merit of LCC is that it gives accurate forecasting of cost profiles. Applying LCC techniques in the firm’s daily operations makes estimation of purchase costs easy and accurate (Bowe, 2010). This results in improved decision making and establishment of cost-effective support.
The last benefit is that allows for the performance trade-off against cost. In this regard, since most purchasing decisions costs are supplementary factors during the assessment of the potential options, LCC analysis ensures cost trade-off is made against varying attributes of purchasing options.

Conclusion
Acquiring product costs is a representation of a small proportion of total ownership costs. Additionally, according to the above discussion, purchasing decisions are dependent on the acquisition price after ignoring the long-term costs. Therefore, the real value of invested capital is achievable after fully understanding the total cost of ownership.

References
Bowe, S. (2010). A Gate-to-Gate Life-Cycle Inventory of Solid Hardwood Flooring in the Eastern US. Wood and Fiber Science.
Crawford, R. H. (2011). Life Cycle Assessment in the Built Environment. London: Taylor and Francis.
Curran, M. A. (1996). Environmental Life-Cycle Assessment. McGraw-Hill Professional Publishing.
Hammond, G. P. (2004). Engineering Sustainability: Thermodynamics, Energy Systems, and the Environment. International Journal of Energy Research 28 (7), 613-639.
Hsu, T. (2012, August 13). FedEx offers Buyouts to Cut Costs. The Los Angeles Times.
Malin, N. (2010). Life Cycle Assessment for Buildings: Seeking the Holy Grail. Building Green.
Mathur, J., Bansal, N. K., & Wagner, H.-J. (2004). Dynamic Energy Analysis to Assess Maximum Growth Rates in Developing Power Generation Capacity: Case Study of India. Energy Policy 32 (2), 281-287.
Pehnt, M. (2006). Dynamic Life Cycle Assessment (LCA) of Renewable Energy Technologies. Renewable Energy: An International Journal 31 (1), 55-71.
Trusty, W. (2010). An Overview of Life Cycle Assessments: Part One. International Code Council Building Safety Journal Online.
Zamagni, A. (2012). Life Cycle Sustainability Assessment. The International Journal of Life Cycle Assessment, 17 (4), 373-376.

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