Two Questions Define Equipment Cost

By Mike Vorster, Contributing Editor | August 23, 2017
Each cost calculation is based on hours worked, yet each has a different factor lending uncertainty to estimating the cost.

Accurate equipment cost hinges on the answers to two different questions: What does it cost to bring the machine into your fleet and keep it there, and what does it cost to put it to work? To answer the first, you must know and understand owning costs. To answer the second, you must know and understand operating costs.

Above: Each cost calculation is based on hours worked, yet each has a different factor lending uncertainty to estimating the cost.

Let’s look at each of these principal cost types in turn to see how we can improve our ability to analyze and manage equipment cost.

Owning costs are the province of the specialists in accounting and finance. They are largely fixed when you ink the deal, and they have little to do with parts, labor, oil, and grease. They are set by the quality of the deal you struck when you acquired the machine and depend upon decisions regarding depreciation and return on capital or statutory requirements such as licenses, insurance, and property tax. They are therefore relatively easy to estimate, and most occur on an annual basis.

Day-to-day operating decisions have little impact on owning costs. If you bought a machine for $250,000 and estimate that you will sell it for $50,000 in five years when it has worked 9,000 hours, then there are only two things you can do. First, hope that the used equipment market holds up so that you capture the estimated residual value, and second, work it as hard as you can and hope that you will achieve 9,000 hours in five years. You cannot renegotiate the $250,000 purchase price. It is now a matter of making good on the purchase decision and utilizing the machine as much as possible in order to depreciate the purchase price or “buy back the new” at a minimum hourly rate.

Know the Differences

Characteristics of owning costs

  • Province of specialists in accounting and finance
  • Largely fixed when you ink the deal
  • Set by the quality of the deal when you acquired the machine
  • Most can be easily estimated and occur on an annual basis           

Characteristics of operating costs

  • Province of specialists in day-to-day equipment operations
  • Depend on day-to-day operating decisions
  • Depend on the age, application, and operation of the machine
  • Most are proportional to the number of hours worked

Similarly, if you bring an excavator into your fleet by entering into a 36-month lease agreement, then there is little you can do except ensure that the utilization is as high as possible in order to make the lease cost per hour as low as possible.

The fact that owning costs are mostly fixed, predetermined annual costs means that the hourly owning cost is dependent on the number of hours the machine is expected to work in a given period. With owning costs per hour, utilization is the big uncertainty.

Operating costs are the province of specialists in day-to-day equipment operations and depend upon day-to-day operating decisions. They are definitely not known in advance and are dependent on the age, application, and operation of the machine. Almost all operating cost categories (wear parts, tires and tracks, preventive maintenance, repair parts and labor) are proportional to the number of hours worked by the machine, and thus utilization is not a big risk. Two uncertainties, however, make it difficult to estimate operating costs. First, the quantity of the resources (parts, labor, fuel, oil, consumables) required to keep the machine up and running can vary tremendously, and second, the unit cost of these resources can vary. Resource cost rather than machine utilization is, therefore, the major uncertainty when it comes to estimating owning cost per hour.

How to use the differences

1) Know what is important. With owning costs, make the best selection and acquisition decision possible and focus on utilization, utilization, and utilization. With operating costs, spend money wisely, manage resources, and eliminate waste.

2) Know the uncertainties. With owning costs, the amount spent on depreciation, lease or loan payments, licenses, and property taxes in a given period can be estimated a year in advance. The uncertainty is in estimating the number of hours the machine is likely to work. With operating costs, the uncertainty is in estimating the cost of the resources required to keep the machine up and running. These costs are largely proportional to the number of hours worked and therefore utilization is not an issue.

3) Know what action to take. With owning costs, budget problems arise because the number of hours worked has not been sufficient to recover the fixed cost of ownership. Improve utilization or reduce the size of the fleet. With operating costs, budget problems arise because day-to-day expenditure on parts and labor is too high. Improve application and operation, eliminate waste, and reduce spending.

For more asset management, visit the Construction Equipment Executive Institute.

4) Know who calls the shots. Most, if not all the decisions that determine hourly owning costs fall outside the sphere of influence of the equipment manager, who cannot manage utilization once a machine is on site. Recovering the fixed costs of ownership must therefore be defined as a site responsibility and the necessary protocols must be in place to ensure that responsibility remains with the site. The decisions that determine hourly operating costs fall within the sphere of influence of the equipment manager, and the responsibility to manage operating costs over the full lifecycle of the machine must remain clearly with the equipment specialists.

5) Know about economic life. Hourly owning costs go down as the machine ages and accumulates an ever larger number of hours over which to recover the initial acquisition costs. Hourly operating costs go up as the machine ages and both the frequency and the magnitude of repair actions increase. This fundamental difference between owning and operating costs lies at the heart of the economic life, or “sweet spot,” calculation required to manage fleet average age. It certainly is possible to minimize the cost of bringing a machine into your fleet and keeping it there if you do not worry about the cost of putting it to work. It is possible to do the opposite as well.

The fundamental differences between owning costs and operating costs lie at the heart of many fleet-management decisions. The differences improve budgeting, focus action in the cost-control process, and help define economic life. It is difficult to imagine how to manage a fleet and make all the required complex decisions if you do not see owning and operating costs as two separate but interdependent cost types and if you do not manage each with the skill, care, and attention it deserves. Yet, we still see many single-line cost reports and many organizations that do not make a clear distinction between the cost of owning their fleet and the cost of running their fleet. Much can be achieved by changing this and separating the challenges of fixed owning cost recovery from the day-to-day challenges of managing operating cost.

 

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