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Use Economic Analysis to Evaluate Design Alternatives

by the WBDG Cost-Effective Committee

Last updated: 07-05-2011

Overview

The economic analysis of projects goes back at least to the 1930's with the evaluation of U.S. federal water development projects. Since that time, economic analysis has been integrated into the decision making process of most if not all U.S. federal agencies and influenced issues ranging from nuclear power to environmental regulation. Building owners use of economic analysis to determine the most economically efficient or cost-effective choice among building alternatives.

Formally defined, economic analysis is the monetary evaluation of alternatives for meeting a given objective. For example, to meet the need for additional office space a decision maker might consider new construction, renovating an existing facility, or leasing another building. The evaluation is based on a comparison of discounted costs and benefits over a fixed time period of time. Alternatives can be summarized in terms of the ratio of total benefits to total cost (benefit-cost ratio) or equivalently, the total net benefits (net present value).

The Economic Analysis Process

Photo of Flowchart of the economic analysis process. Chart flows in the following order: Objective to Alternatives to Assumptions to Cost/Benefit to Compare Costs/Benefits.

The steps to estimate the economic consequences of a decision, as listed in Ruegg's and Marshall's Building Economics—Theory and Practice, are summarized below:

  1. Define the problem and the objective.
  2. Identify feasible alternatives for accomplishing the objective, taking into account any constraints.
  3. Determine whether an economic analysis is necessary, and if so, the level of effort which is warranted.
  4. Select a method or methods of economic analysis.
  5. Select a technique that accounts for uncertainty and/or risk if the data to be used with the economic method are uncertain.
  6. Compile data and make assumptions called for by the economic analysis method(s) and risk analysis technique.
  7. Compute a measure of economic performance.
  8. Compare the economic consequences of alternatives and make a decision, taking into account any non-quantified effects and the risk attitude of the decision maker.

Types of Economic Analysis Methods

The process described above is cost-benefit analysis, and is appropriate where both the costs and benefits can differ among alternatives. When the benefits are equivalent, the evaluation of alternatives is simplified to a cost comparison, or cost- effectiveness analysis, as described in OMB Circular A-94.

Life-Cycle Cost Analysis

Photo of Alameda County's Santa Rita Jail

The solar photovoltaic system, cool roofing, and energy efficiency upgrades installed at Alameda County's Santa Rita Jail have resulted in net savings of $410,000 in its first year of operation.
(Courtesy of R. Solari)

Life-Cycle Cost Analysis (LCCA) is a type of cost-effectiveness study common in the comparison of building projects or, as described in 10 CFR 436A , for the evaluation of energy and water conservation measures. Life cycle costs can include all costs of building ownership over its service life, including construction, maintenance & operation, recapitalization, and disposal. Alternatives can be evaluated on the basis of discounted total cost, or the net savings relative to a "do nothing" alternative such as the savings-to-investment ratio, internal rate of return, or time to payback.

Value Engineering

Value Engineering is a systematic evaluation procedure directed at analyzing the function of materials, systems, processes, and building equipment for the purpose of achieving required functions at the lowest total cost of ownership.

According to VE experts Kirk and Dell'Isola, "Value Engineering is a team approach that analyzes a function by systematically developing the answers to such questions as: what is it?; what does it do?; what must it do?; what does it cost?; what other material or method could be used to do the same job without sacrificing required performance or degradation to safety, reliability, or maintainability?" VE is concerned with elimination or modification of anything that adds costs without contributing to the program functional requirements. Reductions in a project's scope or quality to get it into budget are not considered VE—those decisions are simply "cost cutting".

Major public works projects may undergo both VE studies and LCCA, and while the two practices serve separate purposes, their consideration of design alternatives is often interrelated. For example, value engineering can be used to complement a life-cycle cost analysis when selected LCC alternatives cannot be adopted without exceeding the project budget. VE can be utilized to reduce initial costs of design features other than those under study in a LCCA. If the VE effort results in sufficient reduction in initial costs, savings may allow selected LCC alternatives to be adopted within the overall program budget, thus optimizing the long-term cost-effectiveness of the project as a whole.

Limits of Economic Analysis

Perhaps the most challenging aspect of economic analysis is identifying those benefits and costs that resist quantification. These typically include aesthetics, safety, environmental impact, historic preservation. Refer to the WBDG page on "Consider Non-Monetary Benefits such as Aesthetics, Historic Preservation, Security, and Safety."

Sensitivity analysis should be considered when running the numbers and evaluating alternatives. Effects of discount rates, escalation rates, utility costs, etc., can be overlooked. A rigorous sensitivity analysis can help establish which factors are most important in the life cycle analysis and accurate impacts on the decision-making.

Relevant Codes and Standards

In varying degrees, the federal government, state and municipal entities have all ratified legislative mandates requiring economic analysis be performed on most capital investment programs. Some of the key federal mandates and standards are listed below.

Life-Cycle Cost Analysis (LCCA)

Value Engineering (VE)

Major Resources

WBDG

Design Objectives

Cost-Effective—Utilize Cost Management Throughout the Planning, Design, and Development Process, Cost-Effective—Consider Non-Monetary Benefits such as Aesthetics, Historic Preservation, Security, and Safety

Publications

Others