What's the Real Cost?

What's the Real Cost?

Analysis of overlooked costs

By Bill de Decker

June 1999

Costs are not always what they seem. When all factors are considered, sometimes the alternative that seems to cost the least is very expensive. And sometimes, the expensive alternative is the most cost effective. We seldom start with the intent of buying the more expensive service, part, or piece of equipment. But, when we make decisions, we all have a tendency to focus on the obvious, most visible costs, while overlooking the hidden costs. However, part of a manager's job is to select the most cost-effective solutions and that means ferreting out all the costs prior to making the selection.

Analyzing the following four often overlooked costs: implicit cost, impact of productivity, cost of operation, and impact of lost revenue; in addition to the obvious initial cost, will determine the total cost of an item or a service.

The first type of overlooked cost is implicit cost. Included here are taxes, shipping, training, licensing fees, insurance, and all the other expenses that are automatically incurred (sometimes on a recurring basis), when the item or service is acquired. Sometimes these are small and sometimes they are not. For example, payroll taxes, health insurance and other benefits for a full time employee are typically 25 to 35 percent of the total salary.

A second overlooked cost is the impact of productivity. For example, the latest, computerized test equipment is expensive to buy, but if it allows troubleshooting time to be cut by two-thirds, the savings in labor will quickly pay for the higher initial cost.

The third overlooked cost is the cost of operation and includes fuel, maintenance, number and qualifications of operators, etc. The differences here can be very large, particularly if one piece of equipment uses old technology and another uses new technology.

The last overlooked cost is the impact of lost revenue. Revenue lost when flights have to be canceled very quickly negates any savings that may have been gained by a maintenance choice with lower cost but greater down time. Let's look at some specific examples.

Implicit costs and productivity
Initially, one might think that contract labor at twice the hourly cost of a full-time employee is simply not cost-effective. But look at the details. According to some recent surveys, a typical maintenance technician makes between $15 and $20 per hour. However, that does not include the implicit costs of social security, Medicare, health insurance, life insurance, a 401K plan, a uniform allowance, and all the other benefits full-time employees get. These benefits add anywhere from 25 to 35 percent to the base hourly rate. Then there is the cost of training, which can add from $2000 to $4000, depending on the length and location of the training. And lastly there may well be some overtime, which adds perhaps another $2500 for the year. What this all adds up to for a total annual cost is as follows:

Translating this to an hourly cost poses the next problem. Basically, all full-time employee salaries are based on 2,080 hours per year (8 hours per day, 5 days per week, and 52 weeks per year), but nobody works that many hours. Between vacation (2 to 4 weeks depending on years of service), sick days (average is about 5 per year), national holidays (10 per year), and training, the best anyone can do is about 1,800 hours. And, that assumes each person is fully productive. But much aircraft maintenance cannot be scheduled and that means that there will be times there is no productive work to be done. In fact, a busy, well-scheduled maintenance department can get perhaps 1,500 productive hours per technician per year. A less busy, less well-scheduled department may go as low as 1,000 productive hours per year.

Dividing the total annual cost by the actual productive hours shows that the real cost per productive hour for maintenance technicians is somewhere between $35 and $53 — more than twice the nominal cost per hour shown in the surveys! It's also the reason that contract or part-time maintenance technicians can be very cost-effective.

Lost revenues
Maintenance problems cost money to fix. But often, the cost of the repair is small compared to the lost revenues. Consider the following example:

A charter operator with a mid-size jet needs to have a component overhauled for the aircraft. The choice is between sending the component out for overhaul at an estimated cost of $12,000 and two weeks down time, or pay $20,000 to get the component on an exchange program that involves no down time. At first glance, the $8,000 premium for the exchange program is stiff. However, if the aircraft flies typically 15 hours per week at an average revenue of $2,000 per hour, the lost revenues inherent in sending the component out for overhaul is $60,000. At the same time, the only extra costs incurred by being able to fly revenue flights during those two weeks is the cost of fuel, maintenance, and reserves. For a typical mid-size jet, those costs are about $750 per hour. This gives a total cost of $22,500. And, adding all the numbers shows the following:

In short, sending the component out for overhaul is a clear case of "penny wise and pound foolish."

Often, the differences in cost are not nearly as clear cut as these examples. However, when there is a choice, the smart manager looks beyond the price tag to focus on the real costs in order to select the most cost-effective alternative.