Sunday, September 23, 2007

First Costs vs. Life-Cycle Costs aka How to Buy Stuff

One finds himself organizing and reorganizing his life many times as his first child's birth approaches. There is a constant assessment of the "known-knowns, known-unknowns and unknown-unknowns," as Donald Rumsfeld would explain it. One of the fields in constant flux over the past few months has been finances, specifically how much a new baby will cost, how much we should buy beforehand and finally how much should be spent on certain items. My wife and I have had many great debates on these issues and found at the end of it all a philosophy of money and spending that both of us have come to agree on (for the most part). The philosophy hinges on the difference between "first costs" and "life-cycle costs."

A good example of this difference is found in Thomas Stanley's book, "The Millionaire Mind." He gives the example of deciding whether to pay a professional plumber $150 to come install a new water heater or buy the supplies and install it yourself. Ask this question to a group of people and chances are you would get a good spilt between the DIY crowd and the "pay the professional" crowd.

Stanley writes, "Milliionaires and those who are likely to become wealthy someday are not 'first-cost' sensitive; they are life-cycle-cost sensitive. 'First cost' refers to the dollar cost savings if you install the water heater instead of using a skilled plumber. You may have saved $150 in the process, but the figure is very deceptive. You see, the plumber's quote included a high-efficiency water heater. You shopped and found a low-priced (first cost) water heater with the same gallon capacity as the high-efficiency one, but over the projected life of the heaters, the plumber's will save you more than the $150 in terms of operating costs. Also, the plumber's is estimated to last longer and heat water faster. Over the life of the heater you would install, there is no warranty on the installation. You could easily install it incorrectly and burn out the system..."

He goes on, "The other issue relates to trade-offs. You cannot install a water heater and at the same time carry out assignments that are part of your work. Of course the plumber still charges more per hour than you charge for an hour of your time, so you could save by doing it yourself. But you are not thinking of life-cycle differences...If you decide to install the water heater yourself, you have to shop for a unit, which takes time and energy. You could be using this time and energy to enhance your professional skills or study investments....Then you have to study water-heater installation techniques and acquire the proper tools. Whether you rent tools or buy them, it still takes time and money. Finally, how many other hot-water heaters will you be installing during the remainder of your working life? I bet you'll never want to install another one once you've stuffered through the first campain to save $150....After all this, ask yourself about the actual dollars you really saved. In terms of a life-cyle cost-benefit analysis, select option number two: Call the plumber!"

How does this relate to a baby you might ask? When deciding on what to spend money on and what to skimp on I have this philosophy of life-cycle costs in the back of my mind. Unless, this first baby scars us severely, Marelize and I plan on having a few children. So, when we look at the various cribs, car seats, or strollers (the must haves) we think more in terms of life-cyle costs (buying quality products that have good warranties and will last through several years and children) rather than being sensitive to "first cost" and trying to save through buying only the cheapest products. The baby industry is tricky though because the standards of safety and quality for products are high, owing to society's generally positive view of babies and the incredibly strict expectations and requirements of zealous parents. So, it's hard to find large variance in the quality of the industry's products. The practice of the life-cycle cost philosophy in this arena then becomes much more complex leading to choice anxiety for many parents. It seems the best a parent can do is pick off the outliers (aka Bugaboo strollers for $800...ridiculous) and find something in the middle.

Now, this entire philosophy hangs on two big assumptions: 1) you have the money to pay the up-front costs associated with "quality" 2) the extra money spent on an item or service actually equates to better quality or a longer service life. There is a large risk of looking and feeling like a fool when you spend top dollar for an item only to find that the quality is equal or even less superior to an item of lesser cost. As I go through this baby process I'm sure I will experience this feeling once or twice and will be sure to share it with all of you.

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