Economic Cost Models

Developing Models

The key issues in developing an economic cost model are:

Risk analysis

Risk Analysis must be strictly applied to the model development, and take into account:

• Pre-event influences
• Control influences
• Outcomes or consequences
• Post-event influences.

Risk Analysis must be applied across all asset groups controlled by the organization, such as dynamic mechanical/electrical and passive civil assets.

Rating system

After developing all the base data influences, controls and outcomes of a failure, a rating system is used by operational staff to score each asset.

It is important that the rating system can be used by staff with basic training because the results will need to be reviewed over the years.

Uniformity of approach and scoring will need to be monitored to ensure the validity of the data.

This can be assisted by the production of training videos, and manuals. Examples of rating scores can be built into the computer system, with photographs, to assist staff to produce uniform ratings.

Economic cost (weighting)

Assumptions or estimates must be made to derive the actual "costs" of the outcomes or consequence of failure.

The direct costs (repair or replace) are relatively easy. It is the indirect costs such as loss of public image, inconvenience to local residents, etc that are difficult to estimate.

Developing a sophisticated database

System failures need to be costed as they occur. This can be done as part of normal activities if a maintenance management system is in place and all costs are attributed to the asset failure.

These then need to be costed on a scale determined by customer expectation surveys.

Cost/benefit ratios are then continually reviewed, and when an adequate return on investment is reached, the works can justifiably be placed on works programs.

Assessment Factors Relevant to The Estimation of Risk Cost

An Example of A Sophisticated Computerized Economic Model

Water Industry Failures Weighting of Asset Types/Degrees of Failure

Sources of cost data

It is absolutely essential that service providers who hold a monopoly start to include the assessment of the impacts of their failures, as though they were operating in a competitive market and fighting for market share and income. Until we measure our failures in terms of their total effect on our customer base, we will not make the right decisions in asset management. Our analysis must include a full commercial assessment of the risks.

A comprehensive economic analysis of the consequences of failure requires full information. In many cases the outcomes can be easily identified, and accurate estimates can be made of their impact and costs. However, it is difficult to estimate the intangible and indirect ancillary costs.

The difficult areas to assess include:

• Environmental impact
• Public image of the organization
• Political sensitivity.

The organization needs to develop a series of assumptions and processes by which it can identify the order of costs of the different failures and use these to drive the economic evaluation of its renewal options.

The sources of data fall into two main categories:

• Subjective sources
• Objective sources.

Subjective sources

Subjective data will be derived from:

• Customer surveys
• Specialist advisory groups
• Special interest groups
• Customers who have experienced failures
• Customer services staff
• Failure repair staff.

The organization should include all of these sources to develop assumptions for the valid costs of failure, in terms of the impact on customers, the environment or political scene in general.

Examples of A Public Image Rating System

Examples of An Environmental Impact Rating System

Surveys can ask customers and special groups what they would be prepared to pay to avoid the types of failures the organization has experienced or expects to experience as the assets age.

In some cases the data will be quite valid and can be used to assess the ancillary costs.

The problem is that very few people have experienced ageing asset failure and therefore the figures they imagine may differ quite radically from what they might say if they had experienced the failure.

Objective sources

Information may be available on not only the actual costs of failure, but also the number of events that have occurred of this nature and their relative probability. The sources for objective data are:

• Insurance brokers and underwriters
• Risk assessors and risk engineers
• Insurance officers and claims records
• Legal claims records
• Workers compensation and occupational health and safety claims
• Marketing consultants
• Failure histories and cost records.

These specialist groups can work with the organization to help derive realistic figures for the costs of the consequences of failure and the probability of failure.

Expert advisers may be useful. Better risk assessment and management may have implications for the organization’s insurance policy.

Most large organizations and their underwriters have significant records relating to the:

• Causes of failure
• Incidents or events that occurred
• Losses, damage and costs associated with the failure.

Examples of the type of data recorded in large organizations as incident reports are shown below.

In the municipal sector, claim records provide a valuable source of data. They enable staff to address the key cost centers (or loss centers) for their organization.

It is vitally important that the organization develops a uniform and valid economic approach for all their assets and the types of failures of those assets. The integrated approach will affect investment decision making for organizations with a multitude of assets and a multitude of risks.