I’m fortunate to have made the acquaintance of Dr. Mike Vorster a few years back. Mike is the David H. Burrows Professor Emeritus of Construction Engineering at Virginia Tech and is author of Construction Equipment Economics, a handbook on the management of construction equipment fleets. His ideas and methods regarding the management of heavy equipment are, in my opinion, the gospel for the industry. I’ve even incorporated them in to the software we develop for equipment management.
Over the next few weeks, I’d like to touch on a few of the ideas that are central to Mike’s approach to optimizing investment in and management of heavy equipment. Needless to say my explanations are going to barely scratch the surface, but the good news is that there are a number of ways to learn more—I’ll provide them at the end of the blog.
Rate Splits: Owning vs. Operating Costs
Most of us know that there are two separate costs types involved with heavy equipment—the capital expenses of purchasing and the operational expenses of operating that equipment. Next week I’ll talk about how we should consider both together when making important equipment decisions. For now, let’s look at both independently and see how their costs tend to change over time.
At first blush, and particularly if you don’t have a background in accounting, owning wouldn’t seem to have a rate. You purchase a machine, you own it, end of story. In reality, your cost of ownership does change over time. Immediately after buying a brand new machine, a number of continuing costs of ownership kick in. Depreciation, interest, licenses, insurance, and so on. Your rate of ownership cost generally starts higher then decreases over time as a function of the residual market value and the number of hours the piece of equipment is used. Again, the interested reader may refer to the links below for a detailed explanation, but the graph in figure 1 shows a typical rate of ownership cost graph.
The costs of operating heavy equipment are more intuitive. We all get that there are some fairly predictable costs such as fuel, wearable part replacement, etc., and less predictable ones such as breakdown repair. And we all understand that over time the cost of operating a piece of equipment goes up. In fact, studies show that the predictable costs stay fairly steady over time while less predictable repair costs increase linearly. The result is a rate curve as shown in figure 2.
Next week I’ll discuss why breaking your equipment costs into these two categories is important and how to use information about owning and operating costs to make better informed decisions.
Do you track owning and operating costs separately? How do you use the information to make equipment fleet decisions?
To learn more about rate splits for equipment, visit www.cempcentral.com