Asset Management Fundamentals: Topic 8 – Optimised Decision Making Techniques

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Topic 8 – Optimised Decision Making Techniques

Table of Contents Preview …………………………………………………………………………………………………………………….. 2

Learning Objectives …………………………………………………………………………………………………. 2 Introduction ………………………………………………………………………………………………………………. 2

Optimised Decision Making for Asset Management ………………………………………………………. 2 Which Assets to Evaluate? ………………………………………………………………………………………… 4 What Options to Consider? ………………………………………………………………………………………… 5 Decision Techniques and Which to Use? …………………………………………………………………….. 7 Benefit Cost Analysis (BCA) ………………………………………………………………………………………. 8 Economic Analysis DCF and NPV ………………………………………………………………………………. 9

Reference rates for discount rates ……………………………………………………………………………… 9 Multi Criteria Analysis (MCA) ……………………………………………………………………………………..11 Risk Based Decision Making ………………………………………………………………………………………12 Cross Activity Optimisation ………………………………………………………………………………………..12 Some Other Decision Making Considerations ………………………………………………………………13 Summary ………………………………………………………………………………………………………………….14 Review Questions ……………………………………………………………………………………………………..14 Review Questions and Sample Answer Summary ………………………………………………………..15 References ……………………………………………………………………………………………………………….17

Readings ……………………………………………………………………………………………………………….17 Activities ………………………………………………………………………………………………………………..18

Asset Management Fundamentals: Topic 8 – Optimised Decision Making Techniques

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Preview Learning Objectives The learning objectives of this topic are as follows:

• Analyse the various evaluation methods commonly used for decision making about investments in assets with particular focus on benefit cost ratio and multi criteria analysis.

• Examine processes that inform decision makers about which asset classes should be subject to evaluation, utilising risk management techniques.

• Examine the various options available for a particular service delivery that might be applicable for evaluation analysis and discuss the various benefits and costs that need to be considered as part of the evaluation process

• Analyse economic and financial evaluation methods that take into account time value of money through net present value (NPV) and revisit in more detail lifecycle cost analysis (both tangible and intangible).

• Discuss the issues applicable in decision making about investment in competing asset classes, eg road investment versus recreation investment say.

Introduction

Optimised Decision Making for Asset Management As we launch into this Topic, it is important to note that this is a major body of work in its own right. There are many texts on this subject and over the last fifty years or more; it has become recognised as an important tool in the armoury of any well managed organisation that is committed to making decisions about investment, forward planning and strategies, based on rigorous analysis of all the available data that should impact on those decisions. It provides important transparency to that decision making and justification based on rational parameters that can be quantified, weighted and scored. The IIMM has a Section on this topic and will be our main source of reference for the material presented. It is worth noting however, that much of this section in the IIMM draws on material from a companion Manual to the IIMM called the “Optimised Decision Making Guidelines” produced by NAMS New Zealand. This provides a step by step guide to making optimum decisions for infrastructure acquisition, renewal, operations and maintenance. Importantly, it includes many case studies. For further detail, go to:- http://www.nams.org.nz/pages/74/optimised-decision-making-guidelines.htm (NAMS Group 2004) Optimised Decision Making (ODM) is defined in the IIMM as follows:

1. ODM is a formal process to identify and prioritise all potential solutions with consideration of financial viability, social and environmental responsibility and cultural outcomes.

2. An optimisation process for considering and prioritising all options to rectify existing or potential performance failure of assets. The process encompasses NPV analysis and risk assessment.

(IIMM 2015 p xx)

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The management of infrastructure assets for service delivery requires decisions to be made regularly about either new assets or to do with existing assets. Often these decisions involve the investment of funds but as we will see in this Topic, other considerations, not only financial come into play. There are also typically environmental and social impacts as well as economic ones. The challenge then is to appropriately weigh up all of these factors and make the decision that best suits all stakeholder’s interests. But how do we quantify the competing issues so that anyone looking for transparency in the decision making process can be satisfied that the decision taken, is justified. Typically, proponents seek to reduce the costs and benefits into dollar values, however this is not always achievable. This Topic explores the various decision making techniques that are commonly employed with the spectrum covering a simple benefit/cost analysis (BCA) calculation through to the far more complex multi criteria analysis (MCA). Risk management principles that we covered in the previous Topic, come into play again here when it comes to the evaluation process. Firstly, we need to apply risk assessment when considering which assets or asset classes are to be subject to scrutiny for possible intervention. Next, we need to ascertain which options for “intervention” are going to be evaluated. That will help to then decide which evaluation techniques should be applied. Once the evaluation process commences, the next challenge is to identify the various benefits and costs that might be relevant for that asset class and service delivery. Remember, some of these will be obvious or “tangible” benefits and costs whereas others will be less so, or “intangible”. This leads to the problem identified earlier about then quantifying or assigning a dollar value to these various benefits and costs. Not all will be able to be so quantified and will need some other form of “scoring” to enable the various options to be fully tallied and compared. This becomes particularly critical for the MCA process. In relation to the financial analysis process, the time value of money must be taken into account. This is generally done by applying a discounted cash flow (DCF) process to calculate the net present value (NPV) of dollars to be spent at some future point in time. This is to recognise that the cost to the organisation of spending $1000 now will be higher than spending $1000 in say ten years’ time – the effects of inflation that devalues the dollar over time. Information about how assets perform over time is often critical to effective decision making about intervention in those assets. Hence the importance of the issues we covered in the previous topics, about condition assessment and performance monitoring. Often however, this information is lacking and can hamper the ODM process. Typically, assumptions have to be made and where done, should be clearly stated so that decisions can be revisited in the future as better or more complete information possibly comes to hand. This is where prediction modelling of how assets perform, can be of real value in the decision making process. A good example of this is road pavements where data has been collated over many years that allows some confidence in the predictions that can be made about how those pavements will likely perform into the future for given parameters such as pavement depth and type, climate, traffic volumes/type etc. Unfortunately, the same cannot be said of many other asset classes.

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Another area of infrastructure asset decision making relates to the forward planning and budgeting for capital expenditure on new assets or replacement of existing assets. Often there is “competition” for funds to be allocated to one class of assets over another. How can Councillors as the stewards of these assets, make the best and most informed decision about whether to invest scarce resources into say the road network in preference to say the stormwater drainage network. Each have pressing demands for upgrading but typically, available funds limitations mean that difficult choices need to be made about the relative investment in each. These optimised decision making techniques can be useful in providing some appropriate logic about making those choices. There are a number of key terms that you will need to be familiar with also as we work through this Topic. These are summarised in the IIMM. Reading 8.1 Go to the IIMM on p 3/3 and read over the Introduction at Section 3.1.1 and familiarise yourself with the ODM Process at figure 3.1.2. Which Assets to Evaluate? The ODM process obviously requires resources and staff with appropriate expertise to undertake the necessary data gathering and subsequent analysis. Accordingly, committing these resources should be done in a targeted way with some form of prioritisation applied to assess projects for the most “critical” assets or asset classes, first. This is where the risk assessment principles we covered in the previous Topic come into play. The organisation should focus firstly on those assets, assessed as being of highest consequence in the event of failure. i.e. most critical in terms of risk to the organisation. Next should be those assets that have biggest impact in terms of performance or reliability in that they will most adversely affect the ability to continue providing the requisite level of service, expected of the organisation. The next level of assets would be those which potentially could provide business opportunity gains through improved efficiency by possibly reducing the cost of operating or maintaining these assets. The suggested prioritisation for considering assets for evaluation, is as follows:

• Those assets with a high consequence of failure • Those assets with high utilisation • Those assets whose total value represents the greatest net value to the organisation • Those asset groups with the highest average age • Those asset groups that are identified in the total AM plan as key cost factors in the

long- term business plan.

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What Options to Consider? Having made the assessment about which assets or asset classes to focus on for project evaluation, the next step is to focus on what are the options that should be tested under the evaluation process. The trick here is to focus on the service being delivered by those assets. Only in this way can we be sure that we properly consider all possible options that might come into play. This is important, because some of these options might in fact not directly involve the assets at all. What do we mean by this? By focusing on the service to be delivered, we can see that there might be some “non- asset treatment” solutions. For instance:

• Reduce demand for the service. • Reduce the level of service (e.g. a pavement surface can be allowed to deteriorate to a

condition below a current level of service to achieve a lower lifecycle cost or cash flow or lower water pressure to reduce reticulation breaks, leakage etc.).

• Improve contingency planning, support systems, training and response times, to achieve an acceptable recovery time for re-establishment of service after an asset failure. It needs to be recognised there will likely be a greater number/frequency of failures because of delayed expenditure on replacement or upgrade of the assets.

• Educate customers to accept an appropriate degree of asset failures on the understanding that this is the most economic solution for them as customers.

• Consider providing the service by some other means altogether. Community halls are an example. It might be more beneficial for all concerned to sell off these halls and instead hire facilities at a local hotel or bowls club or the like, depending on the frequency and scale of use. Always a potentially contentious solution but if consultation with the community is handled properly, this can be a win-win solution. Surplus assets can then be disposed of with perhaps realisation of funds on sale of the assets.

Turning to the asset related treatment options, these contain those that would be expected.

• First there is the “do nothing” option but recognising this will likely lead to rapidly declining level of service.

• Operational enhancements to improve or maintain the level of service without investing in the assets themselves. This may lead to reduction in reactive failure.

• Maintenance enhancements – pro-active or reactive or both, to improve reliability and potentially extend asset life. Good maintenance practice such as repainting a roof on a regular basis will undoubtedly prolong the life of that roof. Remember the old adage “A stitch in time saves nine”.

• Asset renewals – This goes back to the sustainability issues we have covered in detail in earlier Topics and mentioned again here in this Topic. Unless adequate funding is provided to appropriately renew or replace assets at the optimum time to maintain the level of service required, any organisation runs the risk of not being financially sustainable in the long term. This is where the ODM process is so important. It will provide advice to the organisation as to when is the optimum time to renew or replace an asset such that the overall life cycle cost is minimised for the level of service required.

• New construction – typically driven by growth or obsolescence, it may be more economical to “retire” an existing asset and build new, higher capacity infrastructure that caters well into the future. This option which again can be well tested by the ODM process, might lead to an existing asset being retained well past its usual intervention

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point and allowing it to fail completely in the knowledge it will then be replaced by the new higher capacity alternative.

• Disposal – what is the best way of decommissioning and disposing of an asset? Remember, there may well be ongoing responsibilities for assets, even after they have been decommissioned. A closed down site still has costs of keeping it safe, clean et cetera.

Life Cycle Costing Analysis (LCCA) We have touched on this important concept that is so central to the whole asset management process, a number of times already in earlier Topics. It again raises its head because ODM is very much about assessing the cost impacts of decisions, over the whole life cycle of the assets. Accordingly, we will now address this aspect in some more detail. You will recall from the earlier Topics, we emphasised the point that the initial upfront capital cost (which many organisations focus on without fully considering the other flow on costs) is typically only of the order of 20% of what might be the ultimate “whole of life” cost. The following diagram demonstrates this point.

This figure graphically shows, as an example, how all the lifecycle cost

components can add up over the life of the asset.

20

Infrastructure Assets Typical Life Costs

Initial Cost 20%

Maintenance 35%

Disposal Operating

Costs 40%

Comprehend the whole of life cost to provide infrastructure & services

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When it comes to ODM, a full appreciation by all involved in the decision making process, of the total lifecycle costs is essential input to the process. This is all about quantifying and scoring based on all the costs relevant to the asset solution under consideration. In summary, these costs are necessary input to:

• Weighing up options for the procurement of new assets and whether in fact, proceeding with such a new asset is “affordable”.

• Making decisions about how best to operate and maintain the asset over its whole life. Too often this aspect is ignored with LCCA focusing only on the initial procurement and then not being used for subsequent ongoing management of the asset.

• Benchmarking the actual cost performance of the asset throughout its life. Again this is important to monitor to test whether the assumptions made at the procurement stage were in fact correct. Important lessons can be taken from such reviews for future LCCA exercises. It also challenges those responsible for operation and maintenance to consider possible options for doing so, more cost effectively.

We cover the issues of lifecycle costs in more detail in later Topics as part of the Asset Management Practices Unit. Decision Techniques and Which to Use? On a continuum of complexity, the simplest method is a typical benefit/cost ratio with which we are all familiar. These are often suitable for an organisation (or community) looking to weigh up a number of options where the other factors such as environmental and social consequences might be deemed to be all similar or close enough that they do not need to be included in the process. In this situation, it is simply a case of identifying all the benefits and costs for the various options and assigning values taking into account the net present value (NPV) through the discounted cash flow (DCF) process that we will cover later, to determine the Benefit/Cost ratio (BCR). The highest BCR becomes the favoured option. As the various options become more complex and perhaps need to address a triple bottom line with scoring of not only economic factors, but also social and environmental, a far more detailed Multi Criteria Analysis (MCA) becomes warranted. Remember however that the effort and cost of the analysis should always be commensurate with the scale of the project (risk and value) under consideration. It is pointless expending enormous effort on analysis for a relatively small value project outcome.Risk based evaluations, as touched on earlier, should be used in combination with these methods. Reading 8.2 Refer to Section 3.1.2 of the IIMM on page 3/5 for further commentary on decision techniques to be used in particular circumstances. Refer also to Table 3.1.1 on P 3/6 for examples of direct and indirect, tangible and intangible benefits and costs.

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Benefit Cost Analysis (BCA) Here, the first challenge is to identify all of the associated costs and benefits and seek to quantify these with again, due consideration of the whole of lifecycle approach. There will be direct and indirect benefits and costs and some for which a dollar value can be determined and some for which this will not be possible. This is particularly so for many public works type infrastructure projects which whilst providing significant benefits to the users, there is no “revenue stream” generated and accordingly a straight financial analysis becomes more difficult. The scope of the BCA needs consideration also in terms of whether to focus on an organisational BCA or community wide BCA. As the names imply, the former applies when analysing benefits and costs applicable only to the organisation. This is common for private sector operations, but can apply in the public sector if there is deemed to be no impact on external parties. Community BCA addresses impacts on both the organisation itself and the wider community. Obviously this is applicable if public funding is involved. All of the benefits and costs that can be assigned dollar values should be so quantified on a yearly basis to arrive at the yearly net benefit (benefit minus cost per annum) and by then applying a Discounted Cash Flow (DCF) approach which we will cover in more detail later, a net present value (NPV) can be determined for each option. This then becomes the economic analysis of the options under consideration. If this were to be the only method of evaluation to be applied, it would then be possible to calculate a Benefit Cost Ratio (BCR). BCR= NPV of net annual benefits NPV of investment costs The investment costs in the above calculation include the initial capital outlay for construction and all associated planning, design, administration costs etc., together with any subsequent capital outlays for renewals etc. (or disposal) over the life of the asset. These are generally easy to quantify in dollar terms, and include all of the initial capital costs to bring a project to operational phase. So costs like for planning/feasibility, design, consultation, consents/permits, actual construction and handover, are all included. The NPV of any future costs for refurbishment or replacement also need to be included. The net operational costs and benefits calculation typically involves a number of direct and indirect benefits and costs, as well as tangibles and intangibles. These are quantified by comparing the options under consideration to the status quo. The direct benefits commonly applicable would include any revenue generated, extending the life of the asset which has a financial benefit, reducing operation and maintenance costs, risk cost savings, and accident cost savings. A number of indirect benefits may also be able to be assigned dollar values such as noise amelioration, property value increases etc. Sometimes “willingness to pay” by the users of the service can be used as a proxy to quantify the dollar values of some of these intangible benefits. Operation and maintenance costs need to be estimated over the whole life and typically utilise historical data, extrapolated forward. Figures 3.1.5 and 3.1.6 of the IIMM on page 3/8 demonstrate some examples of these approaches, including caution about ensuring records over a long enough period are used to accurately developed trend lines.

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As indicated earlier, risk cost reduction is another tangible benefit that can be quantified and added into the overall benefits. The project may reduce the risk of failure and the savings in dollar terms on an annualised basis, can be accounted for. Community benefits typically involve some that can be quantified. (tangible) but many that are intangible. They are still important to be considered so the challenge is to convert these into measurable dollar values. A number of methods can typically be employed such as the mitigation cost method and the “willingness to pay” method. For the latter, community consultation techniques are employed to gauge to what extent, users may be prepared to pay for a change in the level of service. Reading 8.3 Go to the IIMM and read that part of Section 3.1.4 on assessing intangible benefits and the associated case study 3.4 on modelling willingness to pay to see how benefits and costs can be quantified and measured to provide a basis for comparing various options using the typical benefit/cost ratio approach. Economic Analysis DCF and NPV We have referred several times to Discounted Cash Flow (DCF) and Net Present Value (NPV) as a means of converting dollar amounts applicable at some time in the future, back to today’s dollar value. This is essential to ensure we are comparing apples with apples because money value fluctuates over time due to the effects of inflation etc. This is determined by the formula: Present Value (PV) = $ Expenditure in year “n” (1+ Discount Rate) (n) The challenge is in selecting what is the appropriate discount rate to use. The discount rate reflects the opportunity or weighted cost of capital. The following extract from The Cost-Benefit Analysis guidelines released as supplementary guidance material available under the Project Assurance Framework (Queensland Treasury, 2011) provides some further advice on this complex subject. “Use of nominal or real discount rates The choice of discount rate should be consistent with the basis for valuing costs and benefits in the analysis of project options:

• Where the flow of costs and benefits is expressed in real (constant dollar) terms, a real discount rate should be used

• Where the flow of costs and benefits is expressed in nominal (current dollar) terms, a nominal discount rate (including an allowance for inflation) should be used.

Reference rates for discount rates The following reference points may be used in determining the discount rates for projects:

• The interest rate for government borrowings for a term relevant to the expected duration of the project (e.g. for Queensland, this would be the interest rate for 10-year QTC bonds for a project expected to generate most costs and benefits within 10 years). An allowance for inflation can be deducted from this rate if costs and benefits are expressed in real terms

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• The long-term average real economic growth rate, with an additional allowance for major risks and time preference for current consumption. As this is a real discount rate, an allowance for inflation would need to be added to discount flows of costs and benefits expressed in nominal terms

• The rate of return on debt and equity for comparable private sector projects (as a public sector project would be competing with other activities for debt and equity capital).

Where any of these methods are used to determine a discount rate, sensitivity testing with higher or lower variations on the chosen rate should be used to allow for a margin for error, and the possibility of the project having unique characteristics which would limit the relevance of rates of return for other projects as a benchmark. A ready reference on discount rates is included in the UK Government, HM Treasury, “The Green Book, Appraisal and Evaluation in Central Government, 2003.” (UK Government, 2003) There are a variety of texts and recommended discount rates relevant to this topic. Victoria Treasury has similarly provided Guidelines on Discount rates. Also, it should be noted that applying DCF over a period of excessive number of years can make the results somewhat meaningless. It should only apply for periods going forward 20 to 30 years. Any present day costs for periods beyond that 30 year horizon become almost negligible and so irrelevant to the calculation. Often State Treasury Officers will provide advice as to the most appropriate discount rate to use for a particular project taking into account its inherent risk of capital. For instance, the Partnerships Victoria Paper suggests discount rates between 5% and 8% depending on the level of risk present. (Victorian Government, 2003) Reading 8.4 Refer to the case study 3.3 on page 3/11 of the IIMM to see how an NPV analysis can be carried out as part of a decision making process. Note that a 40 year life has been used which is stretching the application of NPV for expenditures that far out in time.

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Multi Criteria Analysis (MCA) As we have already intimated, the MCA approach comes into effect for the more complex analysis involving more of the “intangible” values that typically cannot be assigned dollar values and on projects that are more significant. The typical approach is to identify all of the economic or financial factors that can be quantified in dollars and carry out the DCF analysis that we have already talked about in the previous Section. The results of that are then scored ready for inclusion in the MCA. All of the other factors under the typical headings of social, environmental, cultural etc. are then considered and can be assigned a score of say 1 to 5 or 1 to 10 based on their impacts on the stakeholders. Weightings are also typically assigned based on importance given for each factor which can be tested by consultation with the stakeholders. Care must be taken to ensure there is no double counting of factors – particularly ones that may have been considered in the economic analysis and then potentially arise again in the social or environmental factors. For example, safety factors might be assessed as having a dollar value through reduction in accident costs. Accordingly, accident safety should then not be further considered under the heading of social factors. Having considered all the factors and their scores multiplied by their weighting, the results can be summed to come up with a total for comparison of each of the options. When comparing the scores for each of the options, do not rely only on a final single total but instead, consider each of the weighted totals for each of the main areas (social, environmental, economic) to properly account for the relative importance of each. The challenge when choosing indicators, is to make sure they are measurable and clearly understood by all the stakeholders. Sensitivity analysis is also important to test the impact of various weightings that have been assigned. In this way, the decision makers can be informed as to whether or not results are being unduly skewed by one or more of the weightings assigned. Sensitivity testing is a good practice to challenge the many estimates and assumptions that decision-makers are faced with. This allows for testing the resultant evaluation to see how the results might be impacted by changes in critical assumptions. The process is to address each of the critical variables, one at a time and by applying upper and lower bound values to that variable, see whether the evaluation result changes. There particular variables are found to be “sensitive”, i.e. varying these can alter the optimal solution, then it is prudent to put more effort into validating assumed values. Decision-makers need also to be informed about such sensitivity. Reading 8.5 Go to the IIMM and read Section 3.1.6 on pp 3/15 and 3/16 to see how the MCA approach can be applied. Activity 8.1 Select an infrastructure asset that you are familiar with, list out a number of possible options that you feel could be likely interventions that might apply to prolong the life of the asset or restore its service potential. Consider then how you might go about performing an MCA to test those options and list out the various factors that you would address in such including weightings you might assign to reflect their importance.

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Risk Based Decision Making We touched on risk issues, earlier in this topic, when addressing which assets to evaluate. We have also seen how risk reduction is a quantifiable benefit that can be included in a BCA. Hence it can be seen that risk management involves both positive and negative connotations. Net positive if risk is reduced, after allowing that there will be some cost involved in achieving a risk reduction. Negative if risk is not addressed, resulting in potential failures, damage or injury. The use of a risk – cost framework to address whole of life-cycle costs and benefits based on the organisation’s risk attitude, is one way of evaluating various options. Residual risks are considered in terms of the organisation’s risk attitude, to cull the options. Those still to be considered are then assessed by looking at the risk to NPV ratio to come up with the optimal solution. Reading 8.6 Refer to the IIMM on page 3/24 Figures 3.1.12 and 3.1.13 for examples of prioritisation based on risk. Also refer to case study 3.8 on 3/27 for an example from the health sector. Cross Activity Optimisation Many practitioners grapple with the need for some assistance in dealing with decision making about investment in “competing” asset classes. It helps decision makers weigh up the relative benefits of committing funds to say improving the road network vs. say improving the stormwater drainage system. Here, the challenge of “comparing apples with apples” is even more relevant. Hence consistent measures to score comparisons is critical and higher level whole of organisational and community measures should be the focus. It is often beneficial for an organisation to develop a pro-forma of standardised criteria across all of the community factors including economic, social, environmental, safety and cultural to require proponents, particularly for new projects, to quantify where possible, and qualify, the associated costs and benefits to allow comparisons to be made. Here it is also important to remember to apply the whole of life cycle costing approach to the economic analysis to ensure the real total cost to the organisation for a new project, is identified. The IIMM expands further on this subject with discussion on basic, intermediate and advanced approaches. The basic is useful in that it helps an organisation make a high level split up of its budget across the asset classes with at least some consideration of community benefits when doing so. The normal ODM process is then applied within each asset class to decide which projects should proceed. The intermediate and advanced approaches are more about selecting projects from a list of possible projects with, in the intermediate case, application of an ODM to firstly select projects within each asset class. It is suggested that stakeholders work with whichever level is deemed most appropriate for their own organisation. Reading 8.7 Refer to Section 3.1.5 of the IIMM at pages 3/30, 3/31 and 3/32 for further detail on this aspect.

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Some Other Decision Making Considerations We have touched on the importance of involving the decision makers throughout the process. The more they are involved in setting up and understanding the methodology to be employed, agreeing on parameters and having input into assumptions applied, the more committed, they will be to the solutions. We have also emphasised earlier, the importance of applying some sensitivity testing to ensure that those assumptions that if varied, will result in a different optimal solution, are considered as rigorously as possible to validate the assumed values to be applied. Poor quality data is another common challenge and it is important that decision-makers are made aware of just how good data is, that is being relied upon. This may result in a decision to gather more, or better, or more up-to-date data. As indicated earlier, sensitivity analysis is a good indicator of where the focus may need to be for better data. Declining demand is another important consideration. So many of our infrastructure management issues are predicated on an ever increasing demand for services driven by population growth or community expectations. There are many cases, however, in say declining rural towns, where the opposite applies. These situations create special challenges for asset managers and require significant lateral thinking with a long-term perspective, to ensure that today’s actions or decisions will be viewed by future generations, as being the most appropriate. Finally, financial viability linked to the whole question of financial sustainability that we emphasised at the beginning of this course, is critical to the whole asset management process. Accordingly, when making the final decision on all of the various options under consideration, it is imperative that a rigorous financial analysis is carried out to ensure that the cost implications of the project are financially sustainable. The IIMM sets out a good summary of the financial information that should typically be presented in such financial analysis. Reading 8.8 Refer to the IIMM at Section 3.1.8 on Pages 3/28 & 3/29 for a summary of other decision considerations and particularly the financial analysis information that should be considered.

Asset Management Fundamentals: Topic 8 – Optimised Decision Making Techniques

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Summary In this topic our aim has been to look at the available tools to assist decision makers in the process of deciding between various options all aimed at getting best value out of our infrastructure assets. When faced with a range of possible solutions as to how best to manage the infrastructure assets that are delivering services to the community, the challenge is to prioritise those options to optimise the outcome for the community across all the factors that are of value to that community. When it comes to community benefit, there are not only economic factors that translate into an impact on the hip pocket, but also factors that will be important to the community in terms of social, environmental and cultural issues. Tools such as the MCA process are one way of seeking to measure all of these factors in making decisions about how best to manage the assets. Again we have seen in this topic the importance of considering the whole of life of the asset life cycle (the Life Cycle Cost Analysis approach). We looked at direct and indirect costs and benefits and tangible and intangible costs and benefits as part of the assessment process. Financial analysis using discounted cash flows to arrive at present day dollar values for the various options to be compared was explained. Finally, this topic also addressed the often political question of how best to allocate funds between competing asset classes by applying logic based on high level community needs being measured for possible projects within those asset classes. It will have been noted that throughout this topic the concepts of risk management kept arising with the process looking to focus on those assets deemed most critical and important from a risk assessment perspective. This is relevant in terms of both which assets to address and which options for treatment, to analyse. This concludes the Asset Management Fundamentals Unit. Having now considered many of the factors that need to be analysed when looking to optimise decisions about future investment in the assets, we will turn in the Practices Unit to some operational issues throughout the life of the asset whilst in service. The first topic in the Practices Unit, will look particularly at operational strategies and the important role such plays in ensuring the assets meet expectation in their service delivery. Review Questions

1. List and discuss the various options typically available for infrastructure assets when it comes to optimising intervention to maintain or enhance their service delivery capability.

2. Whatdecision making techniques are available and how would you go about identifying all the relevant factors that might need to be considered as part of the various evaluation processes?

3. Life Cycle Cost Analysis is a very important part of the ODM process. Briefly explain why including reference to financial analysis as part of the process.

4. What is meant by DCF and how is this used in the ODM process? Why is risk based decision making important in the ODM process?

Asset Management Fundamentals: Topic 8 – Optimised Decision Making Techniques

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Review Questions and Sample Answer Summary 1. List and discuss the various options typically available for infrastructure assets when it

comes to optimising intervention to maintain or enhance their service delivery capability.

Answer Summary dot points; • The following are possible “non- asset treatment” solutions.

o Reduce demand for the service o Reduce the level of service o Improve contingency planning, support systems, training and response times, to

achieve an acceptable recovery time for re-establishment of service after an asset failure.

o Educate customers to accept an appropriate degree of asset failures. • Consider providing the service by some other means altogether.

o The following are typical “asset related treatment” solutions. o The “do nothing” option. o Operational enhancements to improve or maintain the level of service without

investing in the assets themselves. o Maintenance enhancements – pro-active or reactive or both. o Asset renewals. Unless adequate funding is provided to appropriately renew or

replace assets at the optimum time to maintain the level of service required, any organisation runs the risk of not being financially sustainable in the long term.

Briefly discuss the ramifications of each of the above.

2. What evaluation methods are available and how would you go about identifying all the relevant factors that might need to be considered as part of the various evaluation processes?

Answer Summary dot points; List and explain briefly the following methods • Benefit/cost ratio (BCR) – Organisational and Community • Multi Criteria Analysis (MCA) • Risk Based Decision Making

List out some typical factors that would apply under the broad headings of: • Economic

o Operations cost o Maintenance cost o Risk cost

• Social o Community welfare o Accident reduction o Public safety/security

• Environmental o Energy efficiency o Greenhouse gas emission o Flora/fauna sensitivity

• Cultural o Protection of significant heritage site

Asset Management Fundamentals: Topic 8 – Optimised Decision Making Techniques

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o Multicultural promotion 3. Life Cycle Cost Analysis is a very important part of the ODM process. Briefly explain why

including reference to financial analysis as part of the process.

Answer Summary dot points; • When it comes to ODM, a full appreciation of the total lifecycle costs is essential input to

the process which is all about quantifying and scoring based on all the costs relevant to the asset solution under consideration.

• The following are benefits of LCCA o Weighing up options for the procurement of new assets and whether in fact,

proceeding with such a new asset is “affordable”. o Making decisions about how best to operate and maintain the asset over its

whole life. o Benchmarking the actual cost performance of the asset throughout its life. o Challenging those responsible for operation and maintenance to consider

possible options for doing so, more cost effectively. • Comment on the need for decision makers to have an appreciation of whole of life costs

of the options under consideration and the importance of weighing that up against just the initial capital outlay.

4. Comment on the need for a rigorous financial analysis as part of the ODM process and list

the critical information to be considered as part of such. What is meant by DCF and how is this used in the ODM process? Why is risk based decision making important in the ODM process?

Answer Summary dot points; • Explain how Discounted Cash Flow (DCF) is used in calculating Net Present Value

(NPV) as a means of converting dollar amounts applicable at some time in the future, back to today’s dollar value.

• Comment on the use of nominal or real discount rates and explain how nominal includes allowance for inflation.

• Comment on the possible different indicators for setting discount rates, such as: o The interest rate for government borrowings for a term relevant to the expected

duration of the project o The long-term average real economic growth rate, with an additional allowance

for major risks and time preference for current consumption. As this is a real discount rate, an allowance for inflation would need to be added to discount flows of costs and benefits expressed in nominal terms.

o The rate of return on debt and equity for comparable private sector projects

For the risk based decision making part, explain the value of informing an organisation about using an appropriate risk – cost framework to address whole of life-cycle costs and benefits based on the organisation’s risk attitude, as one way of evaluating various options. Comment on residual risks being considered in terms of the organisation’s risk attitude to cull the options. Those still to be considered are then assessed by looking at the risk to NPV ratio to come up with the optimal solution.

Asset Management Fundamentals: Topic 8 – Optimised Decision Making Techniques

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References IPWEA (2015) International Infrastructure Management Manual V 5.0

NAMS Group 2004, “Optimised Decision Making Guidelines”, C/- INGENIUM, Thames, New

Zealand.

Queensland Government – Department of Treasury Project assurance framework guidelines –

Cost Benefit Analysis July 2011 at

http://www.treasury.qld.gov.au/office/knowledge/docs/project-assurance-framework- guidelines/index.shtml

UK Government, HM Treasury, The Green Book, Appraisal and Evaluation in Central

Government, 2003 United Kingdom Government, HM Treasury,

http://www.hm-treasury.gov.uk/data_greenbook_index.htm

Victorian Government, Partnerships Victoria “Use of Discount Rates in the Partnerships Victoria

Process” Victoria Government Technical Note 2003 at

http://www.partnerships.vic.gov.au/CA25708500035EB6/WebObj/UseofDiscountRatesint hePartnershipsVictoriaProcess/$File/Use%20of%20Discount%20Rates%20in%20the%2 0Partnerships%20Victoria%20Process.pdf

Readings Reading 8.1 Go to the IIMM on p 3/3 and read over the Introduction at Section 3.1.1 and

familiarise yourself with the ODM Process at figure 3.1.2. Reading 8.2 Refer to Section 3.1.2 of the IIMM on page 3/5 for further commentary on

decision techniques to be used in particular circumstances. Refer also to Table 3.1.1 on P 3/6 for examples of direct and indirect, tangible and intangible benefits and costs.

Reading 8.3 Go to the IIMM and read that part of Section 3.1.4 on assessing intangible benefits and the associated case study 3.4 on modelling willingness to pay to see how benefits and costs can be quantified and measured to provide a basis for comparing various options using the typical benefit/cost ratio approach.

Reading 8.4 Refer to the case study 3.3 on page 3/11 of the IIMM to see how an NPV analysis can be carried out as part of a decision making process. Note that a 40 year life has been used which is stretching the application of NPV for expenditures that far out in time.

Reading 8.5 Go to the IIMM and read Section 3.1.6 on pp 3/15 and 3/16 to see how the MCA approach can be applied.

Reading 8.6 Refer to the IIMM on page 3/24 Figures 3.1.12 and 3.1.13 for examples of

prioritisation based on risk. Also refer to case study 3.8 on 3/27 for an example from the health sector.

Asset Management Fundamentals: Topic 8 – Optimised Decision Making Techniques

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Reading 8.7 Refer to Section 3.1.5 of the IIMM at pages 3/30, 3/31 and 3/32 for further detail on this aspect.

Reading 8.8 Refer to the IIMM at Section 3.1.8 on Pages 3/28 & 3/29 for a summary of other decision considerations and particularly the financial analysis information that should be considered.

Activities Activity 8.1 Select an appropriate infrastructure that you are familiar with and list out a

number of possible options that you feel could be likely interventions that might apply to prolong the life of the asset or restore its service potential. Consider then how you might go about performing an MCA to test those options and list out the various factors that you would address in such including weightings you might assign to reflect their importance.

  • Preview
    • Learning Objectives
  • Introduction
    • Optimised Decision Making for Asset Management
  • Which Assets to Evaluate?
  • What Options to Consider?
  • Decision Techniques and Which to Use?
  • Benefit Cost Analysis (BCA)
  • Economic Analysis DCF and NPV
    • Reference rates for discount rates
  • Multi Criteria Analysis (MCA)
  • Risk Based Decision Making
  • Cross Activity Optimisation
  • Some Other Decision Making Considerations
  • Summary
  • Review Questions
  • Review Questions and Sample Answer Summary
  • References
    • Readings
    • Activities