Sustainable supply chain practices have become a critical to how companies are measuring and defining success. Sustainable practices not only increase efficiency and decrease environmental impact, but they can also open doors to new sales opportunities and provide options for reducing costs. Many energy managers and efficiency face challenges convincing the C-Suite of the benefits of upgrading core systems, especially when many projects are competing for CapEx budget. In order to get executive approval, you need to use the language they are most comfortable with to make your case. Meaning, you have to talk numbers.
Decision makers want to understand not only the basic financial information, like savings and cost implications, but also less obvious financial implications. The trick is to present as many factors as possible in quantifiable financial terms, through a metric like total cost of use or total cost of ownership.
Go Beyond Payback Period, ROI and IRR
Traditionally, energy technology projects have been pitched to the C-Suite using non-comprehensive metrics, like simple payback period, return on investment (ROI) and internal rate of return (IRR). However, if air quality goes up and results in higher productivity, that doesn’t get reflected in the payback time. Rising maintenance costs for dated equipment might add to the cost of inaction, but that won’t find its way into ROI calculations.
“It’s important to speak the language of the C-Suite,” explains Cliff Majersik, executive director at the Institute for Market Transformation. “For example, salary and benefits typically make up more than 85 percent of expenses for businesses occupying offices, so attracting and retaining talent is typically a top priority. Studies have found benefits in this realm that relate to building performance; one study found that companies that adopt more rigorous environmental standards are associated with higher labor productivity – an average of 16 percent higher – than non-green firms.”
The result is that beneficial investments in energy technology are passed over because they aren’t fully compatible with the metrics that employees use to “sell up” to decision makers. A more comprehensive metric – one that incorporates the total cost of ownership or use – can enable your CEO to weigh the long-term benefits of an upgrade.
Understanding Cost Calculations
So, what makes up the cost of using building equipment? For a total cost of use model, you need to fold in ongoing costs and those that will be eliminated by making the investment.
“It’s been my experience that the metrics initially provided are almost never comprehensive enough for leaders to make truly informed decisions,” says Peter Kelly-Detwiler, co-founder of NorthBridge Energy Partners. “Simple ROI or IRR calculations often fail to account for important variables such as reductions in maintenance costs.”
Upfront costs should include installation costs, less any applicable rebates, and procurement costs if you’re planning a cash purchase. There may also be tax benefits that result from the retirement of the asset being replaced that shouldn’t be overlooked.
Ongoing costs get a bit trickier. Start simple with recurring equipment payments if you plan to finance, lease, or subscribe to the new equipment.
Next up, calculate the energy costs to operate the new equipment and the predicted maintenance costs. Some LED lights require almost no maintenance for years and use considerably less energy than older series lights. Maintenance costs vary significantly by technology type and costs tend to be higher for older systems.
Important, but more complicated to evaluate, is the opportunity cost that comes with making an investment. Cash that is spent on an energy project can’t then be used elsewhere in the business. Balance sheet spending is more flexible, but if you aren’t Apple or Microsoft, the amount of money your business can borrow is finite.
Finally, you should consider income tax implications. The method your business uses to pay for energy upgrades could change the picture from a tax perspective.
For cash purchases, assets are assigned a depreciation schedule that determines how much of the asset’s value can be deducted from the business’s taxable income each year. The idea is that, as the asset is used, it becomes less valuable. This loss of value counts as a deductible business expense.
Equipment purchased with borrowed money follows the same depreciation schedule, but now the business is paying interest on the loan. That interest is a business expense, and so it, too, can be deducted.
For a final option, we have OpEx-based procurement strategies, like technology subscriptions. In this case, the entirety of the recurring payments is a business expense. As such, they can be wholly deducted from taxable income.
How Should Costs be Presented?
Total cost of use is a cumulative measure; it builds on itself every year that the technology is in service.
Start by presenting the costs after the first year and then move to the costs after the fifth or tenth year. This helps to paint a picture of each procurement option.
Different options tend to look very different over the lifetime of an investment. Cash purchases have high upfront costs and lower ongoing costs, but this may be mitigated when you factor in opportunity costs. Leases, loans and OpEx-based options will have minimal upfront costs, but larger ongoing costs that add up over time. Finally, the cost of inaction has no upfront costs, but incurs increasing ongoing costs as maintenance becomes more expensive and alternatives become more efficient.
To make a compelling case to the C-Suite and move from analysis to action, a model that accurately describes how new technology and the mode of payment will impact the business over 5-10 years is far more valuable than simple payback.
