Part 5: Life cycle costing analysis

• Introduction
• Background
• Use of life cycle costing analysis
• Recommendation

Introduction

5.1
In this Part we:

• explain life cycle costing analysis;
• discuss the analysis used by the Defence agencies to estimate the ongoing costs associated with the LAV project; and
• examine how life cycle costing analysis has been introduced to the Defence agencies, and how it is being used in relation to the generic military capability acquisition process.

Background

What is life cycle costing analysis?

5.2
Life cycle costing analysis identifies and documents all the costs involved throughout the life of a military capability.⁴¹ These include the cost of the initial acquisition of the equipment, and the amount required to operate, maintain, and eventually dispose of the equipment.

5.3
Life cycle costing analysis is important, and needs to be undertaken to give the Government the best possible estimate of the ongoing costs associated with a new military capability at the time the decision is made to approve the acquisition of equipment. It is also necessary for making accurate operating baseline adjustments throughout the life of the equipment.

Our first report

5.4
Our August 2001 report found that the capability requirements necessary for the Army to maintain 105 LAVs had not been fully assessed, costed, or provided for.

5.5
We also noted that there was doubt over the accuracy of the estimated annual operating costs of the LAVs. In January 2001, the steady-state annual operating costs were estimated to be $39 million⁴² for the life of all the vehicles.

Use of life cycle costing analysis

Life cycle costing analysis for the Light Armoured Vehicle project

5.6
In December 2001, Army Finance personnel began using life cycle costing analysis to conduct an in-depth study of the operating costs of the LAV.

5.7
The Army experienced difficulties obtaining the performance data required to perform its analysis. This was because the LAV is a relatively new piece of military equipment, so only limited performance data is available. In addition, there were communication problems between the Army and MoD (Acquisition) that we identified in our first report.

5.8
The Army obtained performance data⁴³ from General Dynamics and the Canadian and Australian armies (which have similar vehicles), and adjusted that data for New Zealand conditions. This information was used for Army Finance’s life cycle costing analysis, and to update the cost estimates included in the Army’s Five Year Operating Plan.

5.9
The 2003-04 version of the Army’s Five Year Operating Plan estimated the steady-state annual operating costs of the LAVs as $48.8 million a year. This is $9.8 million a year more than was estimated in January 2001. Depreciation accounts for a major portion of the cost estimate.

5.10
The Army’s current estimated annual operating costs (for the 5-year period 2003-04 to 2007-08) are shown in Figure 9 on the next page. The current steady-state figure is from 2007-08 onwards.

5.11
The Army considers that it will take at least 2 years of LAV use in New Zealand to collect enough performance data to produce more reliable cost estimates.

Figure 9
Current estimated annual operating costs for 105 Light Armoured Vehicles

* Related to reassignment of operating costs of the M113 and Scorpion vehicles that the LAV is replacing.

** The figures of $48.8 million for 2007-08 and 2008-09 reflect the ongoing steady-state costs for annual operation and maintenance of the 105 LAVs.

5.12
In our view, the Army followed a reasonable process in identifying the costs of operating and maintaining the LAVs to include in the Five Year Operating Plan through to 2008-09. However, the life cycle costing analysis for the LAV project has not yet been fully completed, and the costs have not been extrapolated for the life of the LAVs.

Introduction of life cycle costing analysis into the Defence agencies

5.13
In September 2002, the Chief of Defence Force issued Defence Force Order 10/2002, obliging the NZDF and the single armed services to use life cycle costing analysis as part of the military capability acquisition process.⁴⁴

5.14
The Defence Force Order applied to the LAV project, so a full life cycle costing analysis should have been completed for the LAVs by now (and not just a 5-year estimate).

5.15
In December 2003, the Foreign Affairs, Defence and Trade Select Committee reported on the 2002-03 Financial Review of the MoD and the NZDF. The Committee noted that life cycle costing is a crucial part of decision-making in regard to capability acquisition.

5.16
Life cycle costing analysis for all military capability acquisition projects was made compulsory for all of the Defence agencies when the Capability Management Framework was formally signed by the Secretary of Defence and the Chief of Defence Force in April 2004. The Capability Management Framework requires life cycle costing to be undertaken in accordance with the Defence Force Order.

Have the requirements of the Defence Force Order been met with respect to LAVs?

5.17
As noted in paragraph 5.6, the Army began using life cycle costing analysis of the LAVs in December 2001 – before the September 2002 Defence Force Order that made the use of life cycle costing mandatory throughout the NZDF.

5.18
Under the Defence Force Order, the Army must identify the cost implications of actual or planned modifications, upgrades or life extensions. This has not yet been done for the LAVs.

5.19
The Defence Force Order also notes that, historically, insufficient focus has been given to costs associated with disposal of military equipment. The Army’s life cycle costing analysis for the LAVs does not include likely disposal costs.

5.20
The Defence agencies informed us that their ability to make any meaningful assessment of upgrades to the LAVs, or the costs of disposal, is very limited, as these events are many years away.

5.21
We acknowledge that there may be difficulties at times in obtaining reliable data on which to base life cycle costing analysis. However, any limitations in the analysis, and assumptions made around it, can be highlighted at the time the analysis is presented to decision-makers.

5.22
We note the effort of the Defence agencies in relation to the introduction of life cycle costing analysis⁴⁵. Those involved in using the analysis process told us that there has been an increase in commitment by all of the Defence agencies to use life cycle costing analysis for acquisitions. They said that this has resulted in better working relationships between key people, and an improvement in the quality of the data obtained and its subsequent analysis. It has been a positive step forward from the communication problems (see paragraph 5.7) that existed when the Army was carrying out its in-depth study of LAV operating costs.

Recommendation

41: These costs are known as the through-life costs of a capability, and also as the total cost of ownership of a capability.

42: The January 2001 paper seeking the approval of the Ministers of Finance and Defence estimated the annual operating cost for the LAVs at $39 million a year (including depreciation of about $30 million a year) over the 25-year life of the vehicles.

43: The data included the number of training kilometres each vehicle travelled, the amount of ammunition required for training, failure rates of parts, and the average cost of repairs.

44: The MoD was not covered by this order, as Defence Force Orders apply only to the NZDF.

45: For example, a Life Cycle Costing Analysis Cell was established in the NZDF Resources Branch to act as a centre of excellence for life cycle costing analysis. Also, about 250 people from throughout the Defence agencies have attended life cycle costing analysis training courses.