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Discussion Forum

Calculating Payback……Like predict…

| Posted in General Discussion on February 16, 1999 09:39am

*
What an interesting conversation!!!!

Payback, Life Cycle Cost, Return on Investment or whatever you want to call it are real items that have their basis in the mathmatical sciences and are excellent tools to use to assist one in making and educated decision among different products to purchase. My experience in the last six years in working within the deregulation and performance contracting industries has shown me a great deal about what Jack refers to. However, let’s not through the baby out with the bathwater.

As the “Energy Services” industry is continuing to evolve, the marketing “spin doctors” within each of these companies repackages credible data into and almost unrecognizable form for presentation to the customer. It seems that a little knowledge in the hands of “creative” minds can be dangerous. Hence the VOODOO reputation properly earned by the industry.

There are variables in the payback analysis that are unpredictable, such as weather, interest rates, future equipment repair costs and inflation. If you could accurately predict any one of these items, you’d probably be paying someone to read this message to you. However, properly presented to the decisionmaker, these variables are known to fluctuate and the decisionmaker must weigh what value that is to him/her and make their decision accordingly.

The question as to whether or not to buy a 80% furnace vs. a 92% furnace is different for someone living in Maine than it is for someone living in southern Alabama. Since both furnaces would provide the same function, the only differences are the initial cost and the annual energy usage. The initial cost difference is known and the annual energy usage for both options can be reasonably estimated such that you can determine the difference between the two options given the same set of credible assumptions.

Here’s where the VOODOO usually gets complex. Assumptions must be made to determine applicable utility rates, avoided future maintenance repairs on the old equipment and possible inflation. Are these numbers ever exactly correct? NO, but they provide a basis for making and educated decision, that’s all. One problem is, specifically within the performance contracting industry, the buyer is usually not as sophisticated as the seller, therefore, providing opportunity to pull out the mirrors and get the smoke going.

Again, factually based, ethically presented payback analysis is used every day in our day to day decision process and can be used in the building trades. But, buyer beware, lest you entertain a wolf in sheep’s clothing!!!!!!!!

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Replies

  1. W_Nelms | Feb 17, 1999 07:53am | #14

    *
    Yeh, in some weird sort of way I probably fall on the same side of the fence as you when it comes to salesmen applying payback analysis to the sales process. If presented to me, I would probably try to blow as many holes in their presentation as possible just for entertainment. However, from an engineering perspective, life cycle cost analysis is an important asset in the decision process. It is nice to see someone bring to light some of the problems associated with this issue in today's business environment.

    W Nelms

  2. Guest_ | Feb 17, 1999 08:57pm | #15

    *
    W,

    b Yes & yes...

    Clearly two uses for "payback"....
    b Sales hype "spin"...
    and...
    b non-sales analysis (the better use, if any...)

    b Thanks for the gum ball,

    Jack : )

  3. Guest_ | Feb 17, 1999 09:01pm | #16

    *
    Everytime someone mentions figuring
    b "payback time"
    in regard to justifying a choice I flip!

    To me its
    b "snakeoil salesmanship"
    invented in recent history for doing something one doesn't want to do for any other logical reason.

    I run fast as soon as the "payb...." word starts its 700 mph trip toward my ears so as to protect the last few braincells I have since everything else I do should have destroyed them twice over already.

    The problem is too complex to figure by mere mortals or even pentium III chips.

    There's
    b too many variables
    to get it right and the variables all hinge on predicting where these variables will actually be in the
    b future.
    Check the cost of money for instance which is always a big part of the "formulas." Can you predict it? The past twenty years of huge fluctuations weren't picked to be by any majority.

    ie. How often does the weatherman get it right? Our local news show finally figured out how to do realtime forecasting. They added a "weather-balcony" to the station so as he stands there and is rained on he can accurately say "currently it's raining...."

    Jump in anytime!

    Have a good day'

    Jack : )

    1. Guest_ | Feb 06, 1999 06:00pm | #1

      *I don't see payback as any different than figuring return on investment - like will it payback to buy a power saw or should I keep cutting all the framing with a handsaw. I'd guess the investment in a powersaw will payback for most people who use a saw regularily.Now, if you mean the term is often used inapproriately, I'm sure it is. What isn't?

      1. Guest_ | Feb 06, 1999 07:35pm | #2

        *Jack,It's me, Ken, your old volleyball buddy. Hope you're feeling better this morning, and that your remaining brain cells have returned to normal position.If you get a chance, e-mail me and let me know just exactly what you are talking about in this thread. Must have been a good party.

        1. Guest_ | Feb 07, 1999 09:35am | #3

          *You are correct in stating "return on investment" to be of equal dubious value.I think it is b "voodoo science."People take whatever variables suit their purpose, pretend they can predict future changes in their supposedly correct present figures, do some math and eureka! It pays to do what they want to do!In most cases b it just ain't so.It always comes back to an individuals choices and preferences combined. It is pure uncontrolled b bad science.Well?b Jump in "justifier, return on investment, paybacktime practitioners"Have a good day,Jack : )

          1. Guest_ | Feb 07, 1999 09:43pm | #4

            *I wouldn't ever listen to the "payback" speal from a salesman, but as one component of calculating the worth of a project for my house - which is all I'm really interested in - it's a useful component. I may ignore it or do what I want for the enjoyment - but it is useful.And like figuring my retirement in 10-12 years - it's based on history and asumptions and is subjet to recalculating or updating on a periodic basis.I suppose since most of the time looking at payback only proves that it won't - like the window salesman who says $10,000 in new windows will payback in energy savings with an annual heating bill of $1000 - NOT!And I don't think payback is strictly in dollars - paybacks come in comfort, enjoyment, more leisure time, prestige, efficiency, productivity, etc. I think good planning looks at all those returns on investment no matter how they are measured.

          2. Guest_ | Feb 09, 1999 05:19pm | #5

            *Jack,Just because of an aversion to payback would you avoid upgrading? Let's be realistic - utility prices will al go up, inflation is always there, though to lesser degrees. Maintenance and operating costs seem quite predictable because the raw materials are all guaranteed to go up. I say the hell with payback, look at life cycle costs. If nothing else, these are all not absolute numbers but they do make good relative numbers for comparison.-Rob

          3. Guest_ | Feb 10, 1999 01:01am | #6

            *Rob,I still say "Create any formula you want," to feel good about your choices....label it statistics, payback, life cycles, motorcycles....whatever makes one feeeeel gooooood and sleep at night.Its allb VoodooTill death do us part,Jack : )b Nike!

          4. Guest_ | Feb 10, 1999 03:25pm | #7

            *I had a student in a CPR class who gave up smoking when he realized that, with what he spent on smokes, he could make payments on a motorcycle. An interesting choice from a public health perspective. And one applauded loudly by anyone awaiting a donated organ. -David

          5. Guest_ | Feb 10, 1999 03:37pm | #8

            *Jack: When I'm asked to do cost projections on toxic waste sites for the next 30 years, I think how much technology and regulations have changed in the last 3 years and conclude that it is pointless. But the bean counters can not be denied and the calculations are done.But I'd argue that payback over short time frames can be both valid (because the assumptions won't change much) and illustrative. Do I leave an 75-watt incandescent bulb burning 24 hours a day on the porch for convenience and safety or do I replace it with a 22-watt flourescent? Nine 75-watt bulb at $1 each and $66 in electricity over the next year for a total of $75. Or one 22-watt bulb for $12 and $19 in electricity for a total of $31. A no brainer. Payback after 3 months. Do it. (And put a timer on it or a light-sensitive switch). But do I replace a top-loading clothes washer with a more efficient but more expensive front loader? If the payback is 5 years, I should do all the faster payback items first and then look at what my money would earn in the bank or mutual fund. -David

          6. Guest_ | Feb 10, 1999 05:01pm | #9

            *Jack,Instead of providing questions, why not provide answers.How then do you propose to compare furnace A to furnace B? Or Cellulose to fiberglass? Or foam to cellolose? Or engine A to engine B? If initial cost were the only consideration would you even bother insulating walls?-Rob

          7. Guest_ | Feb 11, 1999 11:45pm | #10

            *Rob,Every person's choice is just that. What "data" that's used and how you construct your little "magic formula" is just that, unique. Decisions always have to be made; what is relevant, what's not, and even things like predicting future values based on best guesses. Did b you know that gas prices would be this low a few years ago? So if your model for predicting what's best for you relies in part on unpredictable data then what's happening? Is it a righteous guessing game? Look into the crystal......I see thy fortune! For fifty clams a person used to be able to have the birth of their baby predicted.... Fully half of the clients were happy, not too shabby.Someone earlier spotted what really ruffles my feathers in all this. It's the second and third hand quoting by us all (to the point of it becoming gospel truths) a companies "sales and marketing" literature. Or as the press now fondly calls it "b spin."IE-Great example...The government/utility energy marketing business.... and all the misinformation spun over the last few years in regard to building tighter more energy efficient better homes, is the best of example of how whats supposedly right b just might be totally wrong.Aside from picking and weighing the "numbers".....Making forward moving decisions is part of living life and may get one on down the road as well. Are not those less traveled roads interesting ventures?And what about gut instincts, intuition sort of an analog approach, artsy, bigger risks but kinda fun...."The shepherd with no sheep, is a free man"Jack : )

          8. Guest_ | Feb 12, 1999 12:20am | #11

            *David,A shepherd.....OK...b No brainer...Not from the brain, possibly of the heart, the gut, instinctive, not of long drawn out calculation...not part of a multi-million dollar marketing campaign to enhance company stockholder value.b That be worthy!The Jackman : )

          9. W_Nelms | Feb 16, 1999 09:39pm | #12

            *What an interesting conversation!!!!Payback, Life Cycle Cost, Return on Investment or whatever you want to call it are real items that have their basis in the mathmatical sciences and are excellent tools to use to assist one in making and educated decision among different products to purchase. My experience in the last six years in working within the deregulation and performance contracting industries has shown me a great deal about what Jack refers to. However, let's not through the baby out with the bathwater.As the "Energy Services" industry is continuing to evolve, the marketing "spin doctors" within each of these companies repackages credible data into and almost unrecognizable form for presentation to the customer. It seems that a little knowledge in the hands of "creative" minds can be dangerous. Hence the VOODOO reputation properly earned by the industry.There are variables in the payback analysis that are unpredictable, such as weather, interest rates, future equipment repair costs and inflation. If you could accurately predict any one of these items, you'd probably be paying someone to read this message to you. However, properly presented to the decisionmaker, these variables are known to fluctuate and the decisionmaker must weigh what value that is to him/her and make their decision accordingly. The question as to whether or not to buy a 80% furnace vs. a 92% furnace is different for someone living in Maine than it is for someone living in southern Alabama. Since both furnaces would provide the same function, the only differences are the initial cost and the annual energy usage. The initial cost difference is known and the annual energy usage for both options can be reasonably estimated such that you can determine the difference between the two options given the same set of credible assumptions. Here's where the VOODOO usually gets complex. Assumptions must be made to determine applicable utility rates, avoided future maintenance repairs on the old equipment and possible inflation. Are these numbers ever exactly correct? NO, but they provide a basis for making and educated decision, that's all. One problem is, specifically within the performance contracting industry, the buyer is usually not as sophisticated as the seller, therefore, providing opportunity to pull out the mirrors and get the smoke going.Again, factually based, ethically presented payback analysis is used every day in our day to day decision process and can be used in the building trades. But, buyer beware, lest you entertain a wolf in sheep's clothing!!!!!!!!

          10. Guest_ | Feb 17, 1999 05:24am | #13

            *W,If you listen to what you are saying, you are saying exactly what I've said.b Intuitively Aligned,Jack : )

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