To get around the shortcomings of simple payback and comparative NPV presentations, I have developed a third way of positioning conservation projects that has met with considerable success. For lack of a better name, we can call it the "argument of avoided production", because it evaluates conservation projects relative to revenue. Here's how it works:
Let's assume I could reduce my annual utility costs by $100,000 after spending $300,000 on energy-efficient capital upgrades (lighting upgrades, a green data centre, and so forth) This project delivers a three-year simple payback (three years is typical for conservation projects). Do I do the work?
Well, many companies would dismiss a three-year payback out of hand (or would look very hard at competing capital requests first). But consider the project and savings in a different light. A typical commercial enterprise might recognize a profit margin of 10 percent. Saving $100,000 in energy costs means that my profitability can be maintained with $1,000,000 less in annual revenue. Or, more desirably, my revenue can be maintained and my margin increased.
For the example above, the reasoning for our capital request now becomes rather simple: We don't have to do this $300,000 project, but we need to sell $1,000,000 worth of widgets every year to offset the "missed" savings we would get if we did the $300,000 project. In this light, a three-year payback doesn't look so bad.
Also observe that when utility rates increase — as they inevitably do — this method really shines. It is easy to see how expected cost increases would need to be translated into production or revenue increases just to stay financially even. Using the example above, if my operating costs rise by $100,000 strictly because of rate increases, I must generate another $1,000,000 in revenue to break even. Can you increase revenue at will? That makes the conservation alternative strategically very attractive.
Finally, notice that for facilities running at 100 percent capacity, conservation may be the only practical way to offset utility rate increases. Once you cannot physically produce more, either you conserve, you take the hit on the bottom line or you are forced to invest substantial capital to let you produce more. Particularly here, conservation can be a big winner.
Turner is the utility manager for Brigham and Women's Hospital in Boston
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