Fleet replacement and whole-life cost
A district council must replace 120 diesel vans. Two compliant bids are received for a five-year contract. Bid A has a capital cost of £2.1m, fuel consumption of 8.5 litres per 100 km, maintenance of £0.04 per km, and an expected residual value of 18%. Bid B has a capital cost of £2.35m, fuel consumption of 6.8 litres per 100 km, maintenance of £0.03 per km, and a residual value of 28%. Each van will cover 25,000 km a year. Diesel costs £1.45 per litre. The finance director wants to award to Bid A because it fits the £2.2m capital budget; procurement argues that whole-life cost should decide. The evaluation model gives 40% to price and 60% to quality, but the price score is based on capital cost only.
1. Calculate the five-year whole-life cost difference between the two bids and advise which offers better value for money.
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Annual distance: 120 × 25,000 = 3,000,000 km.
Bid A. Fuel = 3,000,000 × 8.5/100 = 255,000 litres × £1.45 = £369,750. Maintenance = 3,000,000 × £0.04 = £120,000. Annual operating cost = £489,750; five years = £2,448,750. Capital = £2,100,000. Residual = 18% × £2.1m = £378,000. Whole-life cost = £2,100,000 + £2,448,750 − £378,000 = £4,170,750.
Bid B. Fuel = 3,000,000 × 6.8/100 = 204,000 litres × £1.45 = £295,800. Maintenance = 3,000,000 × £0.03 = £90,000. Annual operating cost = £385,800; five years = £1,929,000. Capital = £2,350,000. Residual = 28% × £2.35m = £658,000. Whole-life cost = £2,350,000 + £1,929,000 − £658,000 = £3,621,000.
The difference is £549,750 in favour of Bid B before discounting. Bid B offers better value for money on these assumptions; Bid A is cheaper only on capital cost.
2. Explain how the evaluation model should be adjusted and how the budget constraint should be handled.
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The model is mis-specified because it scores capital cost, not whole-life cost. Price should be based on the discounted whole-life cost of each bid, including fuel, maintenance, residual value and any infrastructure or training costs. Quality should include delivery, reliability, environmental performance, warranty and residual-value risk. If the authority keeps 40/60, the price score for Bid A will be artificially high. Revise the tender clarification before award if the rules allow; if not, record the limitation and use a whole-life sensitivity as a commercial check.
The £2.2m capital budget is a cash constraint, not a value-for-money test. Bid B needs £150,000 more capital but saves £549,750 over five years. Finance can consider leasing, prudential borrowing, a phased replacement, or using the operating budget; the business case should show the payback. Do not simply choose the lowest capital bid. Ensure the decision is approved at the right level and that the budget treatment is transparent.
3. Identify risks in the whole-life cost assumptions and how to test them.
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Whole-life cost is an estimate, so test the assumptions. Fuel price: £1.45/litre may change; run scenarios at ±20%. Mileage: 25,000 km per van may be too low or high; test 20,000 and 30,000. Maintenance: Bid B's lower rate may depend on a service contract or driving style; check warranty terms and exclusions. Residual value: 18% and 28% are forecasts; obtain independent residual-value evidence and consider guaranteed buy-back. Capital cost: confirm whether delivery, conversion, charging or training are included. Discount rate: the calculation above is undiscounted; apply the authority's discount rate and compare net present values.
Also assess non-financial risk: vehicle availability, supplier financial stability and environmental compliance. If Bid B's residual value falls, the gap narrows; calculate the break-even residual value. Use sensitivity analysis in the business case and require contract mechanisms, such as service credits, warranties and residual-value guarantees, to protect the authority.