CBS is central to LCC analysis. It will vary in complexity depending on the purchasing decision. Its aim is to identify all the relevant cost elements and it must have well defined boundaries to avoid omission or duplication. Whatever the complexity any CBS should have the following basic characteristics:
it must include all cost elements that are relevant to the option under consideration including internal costs;
each cost element must be well defined so that all involvedhave a clear understanding of what is to be included in that element;
each cost element should be identifiable with a significant level of activity or major item of equipment or software;
the cost breakdown should be structured in such a way as to allow analysis of specific areas. For example, the purchaser might need to compare spares costs for each option; these costs should therefore be identified within the structure;
the CBS should be compatible, through cross indexing, with the management accounting procedures used in collecting costs. This will allow costs to be fed directly to the LCC analysis;
for programmes with subcontractors, these costs should have separate cost categories to allow close control and monitoring; and
the CBS should be designed to allow different levels of data within various cost categories. For example, the analyst may wish to examine in considerable detail the operator manpower cost whilst only roughly estimating the maintenance manpower contribution. The CBS should be sufficiently flexible to allow cost allocation both horizontally and vertically.
Having produced a CBS, it is necessary to calculate the costs of each category. These are determined by one of the following methods:
known factors or rates: are inputs to the LCC analysis which have a known accuracy. For example, if the Unit Production Cost and quantity are known, then the Procurement Cost can be calculated. Equally, if costs of different grades of staff and the numbers employed delivering the service are known, the staff cost of service delivery can be calculated;
cost estimating relationships (CERs): are derived from historical or empirical data. For example, if experience had shown that for similar items the cost of Initial Spares was 20 per cent of the UPC, this could be used as a CER for the new purchase. CERs can become very complex but, in general, the simpler the relationship the more effective the CER. The results produced by CERs must be treated with caution as incorrect relationships can lead to large LCC errors. Sources can include experience of similar procurements in-house and in other organisations. Care should be taken with historical data, particularly in rapidly changing industries such as IT where can soon become out of date; and.
expert opinion: although open to debate, it is often the only method available when real data is unobtainable. When expert opinion is used in an LCC analysis it should include the assumptions and rationale that support the opinion.
Discounting is a technique used to compare costs and benefits that occur in different time periods. It is a separate concept from inflation, and is based on the principle that, generally, people prefer to receive goods and services now rather than later. This is known as ‗time preference‘. This guidance does not cover the topic in great detail as it is a procedure common to many cost appraisal methods and well understood by purchasing officers. When comparing two or more options, a common base is necessary to ensure fair evaluation. As the present is the most suitable time reference, all future costs must be adjusted to their present value. Discounting refers to the application of a selected discount rate such that each future cost is adjusted to present time, i.e. the time when the decision is made. Discounting reduces the impact of downstream savings and as such acts as a disincentive to improving the reliability of the product.
The procedure for discounting is straightforward and discount rates for government purchases are published in the Green Book. Discount rates used by industry will vary considerably and care must be taken when comparing LCC analyses which are commercially prepared to ensure a common discount rate is used.