Many electrical contractors (ECs) view the energy services market as mature with little potential for repeat business. This is especially true for energy conservation and efficiency projects that involve either a particular system component upgrade or an entire system replacement. Many of these projects are referred to as the “low-hanging fruit” because they are simple and require relatively little risk to secure a good return on investment (ROI). These projects can involve one or more system component replacement(s) to an entire building system replacement. However, once a building system is updated or replaced, most customers expect that system to operate satisfactorily for the remaining life of the building or until building use changes. ECs must employ effective marketing strategies to convert the energy services market into an ongoing partnership with its customers that involves repeat business.
Upgrade or replace?
A customer’s production systems include any components or systems that result in the actual product or service for sale. Most of the EC’s customers have a good idea when their production systems should be upgraded or replaced. The efficient and reliable operation of these production systems are key to their performance in the marketplace and must be kept up-to-date, so they can remain competitive.
Seldom will a customer wait until an important production system reaches the end of its useful life to replace it. Normally, the customer will begin planning to upgrade or replace important production systems when a more efficient system becomes commercially available, the existing system is no longer reliable, or the existing system cannot be economically repaired.
On the other hand, unlike customer production system upgrades and replacements, most customers view building improvements as good for their entire useful life. In other words, once a building system has been upgraded or replaced, this investment should be good for as long as the building system is operational or can be maintained for a reasonable amount of money.
It is unfortunate that many customers want to postpone any upgrade or replacement of building components or systems until the end of their useful life because advances in building technology are happening almost daily. These advances improve the operation of building components and systems and increase manufacturing efficiency, and they reduce system and component costs. Advances in building technology can often result in a higher ROI with less risk than the customer may obtain by making a similar investment in upgrading or replacing production equipment or systems. As a result, the EC loses not only the opportunity to help its customer improve the efficiency of its facility, but also the opportunity to build an ongoing profitable relationship with its customers.
Replacement analysis is an effective means for the EC to market building system and component upgrades or replacements to customers where financial ROI is an important part of the decision process. For the customer’s capital budgeting process, replacement analysis can provide the basis for comparing the ROI of building system additions and upgrades with other potential business investments, such as new production equipment, marketing programs or other business initiatives. Replacement analysis also can represent a key argument for overcoming the objections of the customer when the building system or component was replaced just a short time ago by demonstrating the financial advantages of replacing an existing building system or component with a new, more efficient and capable system.
Replacement analysis compares the ROI associated with the existing system or component often referred to as the “defender” or “incumbent” to the ROI’s of possible replacement systems and components typically referred to as the “challengers.” The ROI of the existing system or component as well as the ROIs of the challenging technologies or products are all expressed as a discounted present, annual or future worth or annual effective percent ROI using the customer’s minimum attractive rate of return (MARR). The customer’s MARR is closely related to its cost of capital adjusted for risk. With a replacement analysis, the existing system or component has an advantage over the challenging systems and components because the defender’s investment and cash flow to the time of analysis are treated as sunk costs. Based solely on the replacement analysis, the preferred alternative would be the one with the lowest discounted cash flow or highest ROI.
Next month’s column will provide an example of replacement analysis to illustrate how it can be used to effectively market energy service projects.