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Modularisation – pros and cons

Positing the view that modularisation makes investing in District Energy and data centre facilities…

| | Mar 10, 2015 | 2:53 pm
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Modularisation – pros and cons
Positing the view that modularisation makes investing in District Energy and data centre facilities more attractive, Mohammad Abusaa demonstrates how a modular approach allows for scalable investment, while offering a future expansion option.

Traditional District Energy systems (such as a centralised cooling/heating plant in a university campus) are similar to legacy or enterprise data centres (such as a stock exchange data centre), in that they are more often than not built to deliver a service to specific single or multiple users, where the Capital Expenditure (CAPEX) and Operational Expenditure (OPEX) of these systems are considered “cost of doing business”.
As private investors have become more involved in the development of District Energy systems and data centre colocation facilities, either through public-private-partnerships (PPP or P3) or other ownership structures, the obvious priority has become generating profit from these installations. While CAPEX and OPEX are still utilised in evaluating a system or a solution, Return on Investment (ROI), Total Cost of Ownership (TCO), Break Even Point (BEP) and Internal Rate of Return (IRR) are other financial indicators that are becoming more prevalent in the District Energy and data centre sectors. Not only that, traditional owners/operators of District Energy systems and data centre facilities are now, sometime for the first time, being challenged by their CFOs and CEOs to prove the feasibility or the value of having these systems in-house, as against outsourcing.
All this has created a more competitive marketplace in these sectors, which demanded creativity and innovation in design, construction and operation of these facilities. Modularisation is considered one of the design and construction approaches that add value to these sectors.
In 2008, a committee within the National Research Council (NRC) was tasked to provide advice for advancing the competitiveness and productivity of the US construction industry. The committee defined efficiency improvements as “ways to cut waste in time, costs, materials, energy, skills, and labour”. It identified five interrelated activities that could lead to breakthrough improvements in construction efficiency and productivity in two to 10 years as follows:

  1. Widespread deployment and use of Building Information Modelling (BIM) applications
  2. Improved job-site efficiency through more effective interfacing of people, processes, materials, equipment, and information
  3. Greater use of prefabrication, preassembly, modularisation and off-site fabrication techniques and processes
  4. Innovative, widespread use of demonstration installations
  5. Effective performance measurement to drive efficiency and support innovation

Defining “modular”
In my experience in the Engineering, Procurement and Construction (EPC) and design and build of District Energy systems, which saw me working on some of the world’s largest modular and stick-built chilled water plants, and experience in the engineering of data centre facilities with exposure to key modular data centre projects, I have come across several definitions of the term “modular” in both industries. Therefore, it is important to ensure that all parties in a discussion are on the same level of understanding of the term before initiating a conversation about the concept in order to avoid misunderstanding, especially when it comes to contractual matters and setting client expectations.
Some believe that modularity is the complete pre-assembly of materials offsite, while others believe it is only partial pre-assembly. There are also those who think it is the traditional on-site stick-built construction built in phases; hence, the importance of clarity in such discussions.
In essence, my definition of a module is that different materials and equipment are pre-assembled/pre-fabricated offsite, typically in a controlled environment in the prefabrication facility to form a pre-assembled unit. Only when the unit is designed to produce a product, such as cooling in the case of chilled water plants, or provide a service, such as storing data in the case of data centres, when connected to basic resources, such as power and water, would it be considered a module. This could also be in conjunction with other modules forming a larger system.
The approach to a project becomes “modular” in nature when several of these “modules” are combined together on-site. This is a “modular” approach in contrast with pre-fabricating a component offsite to be used in a traditional stick-built construction project.

Why modularisation?
It is important to qualify that modularisation is not a solution for every project. From a technical perspective, some of the benefits of off-site prefabrication and modularisation are higher quality of workmanship, shorter delivery schedules, an efficient and competitive supply chain system for the module components, cost competitiveness in some situations and less emissions that can harm the environment.
From a business perspective, the key benefit of modularisation is that it provides an opportunity to better manage a project cash flow. This is something that investors look at closely when evaluating any business opportunity. Building in “phases” or in “sections” using a modularisation approach allows for the spread of capital investment over longer periods and lowers the risk of building larger infrastructure prior to securing users or customers who are the source of revenues for the business.

Is it cheaper?
Not necessarily; it depends. We live in a global marketplace and need to put things in perspective before putting forward a blanket statement about the modular concept as “cheaper” or “more efficient” than the stick-built approach. Location, labour conditions, project requirements and client preferences, among other factors will define if a modular approach is preferable, feasible and/or cost competitive. It is also important to look at the different financial indicators of a modular project and not only the CAPEX. Similarly, it is important to understand the perspective of the entity incurring the cost of the project. There are situations, for example, where contractors prefer a  stick-built approach, as it gives them more control in implementing design changes or variations during construction in markets where this is the norm. Going modular would then “increase their risk cost” even though it might be lower in capital cost.
There are also sectors and markets where clients will pay a premium for a modular solution, at least from a CAPEX point of view. This typically happens when clients are seeking to ensure quality of workmanship, run parallel construction schedules (on site and offsite) to shorten project duration, control the security and confidentiality of the constructed system by fabricating offsite in a more controlled environment and to mitigate political, social and/or environmental issues that might hinder the efficient constructability of a typical stick-built project on site. All in all, it is about putting things in perspective.

District Energy and data centre colocation service providers – business model simplified
In simple words, District Energy systems consume resources to produce cooling and/or heating. This product is sold to end-users who pay a tariff based on their consumption of the cooling and heating product. Similarly, data centre facilities, colocation facilities in particular for example, consume resources to store or process data. This service is also provided for a fee or, say, a “tariff” that the users pay. In a non-competitive or monopolised marketplace, such tariffs are more or less mandated, either by the government or the private sector, and clients have no choice but to pay to get the service. In a competitive marketplace, which we are seeing more of nowadays in these sectors, District Energy service providers and data centre colocation providers will mainly compete on tariff.
While some might have exclusivity over a certain geographical area or client base, the fact that they are in competition with other providers to secure the business in the first place creates this competitiveness in tariff structures.
Typically, a service provider’s revenue will only come from tariffs. Therefore, the calculation of which is key to the District Energy and data centre colocation service providers’ business.

Key similarities in the District Energy and data centre colocation service providers’ business model:

District Energy service provider

 

Data centre colocation service provider

 

Revenue stream sources from users Consumption costs, connection costs, monthly fixed costs, annual fixed costs, etc.
Typical Capital Expenditure CAPEXTypically spent over an 18-30 months period depending on the size of the project. Real estate, legal/commercial fees, different professional fees, engineering, construction, commissioning, project management, employees and offices during project planning, construction and initial operation phase, sales and marketing, etc.
Typical Operational Expenditure OPEX  Operation & maintenance, utilities, administration (accounts, billing, customer service, sales and marketing, engineering, management, etc.), upgrades, depreciation, taxes and other costs.
Key performance parameters that directly affect profit margins KW/TR “kW of power consumed per tonne refrigeration produced” or COP “Coefficient of Performance”. Both are ratios between energy consumed in a facility and heating/cooling provided.Higher COP or lower kW/TR = lower operating cost or “more efficient system” PUE “Power Usage Effectiveness” Ratio between energy consumed in a facility (excluding IT load) and IT equipment load.Lower PUE = lower operating cost or “more efficient system”

The revenue stream
It is important to understand that when a customer agrees to pay, say, USD 1 for every unit of consumption, he/she will pay the USD 1 regardless of how much energy the service provider consumes to produce the unit. Therefore, reducing energy consumption per produced unit increases the margin for the service provider; hence the importance of efficiency in such systems to business, technical and investment groups, as it forms the basis of income and profit for the business.
It is worth noting that, typically, any increase in utility costs on the service provider is transferred directly to the customer via an agreed formula. This also applies to inflation, etc.

Planning, planning and planning
There is a significant and huge burden on project ownership and management groups to properly plan for the initial capacity of any system, its operational efficiency and growth plan as more customers come online. One of the main challenges service providers face is that typically high efficiency is achieved at full load or full capacity (depending on the design, of course), which is not the case a majority of the time.
Proper sizing of equipment, sequencing, phasing and having a solid control system will certainly contribute to managing the system efficiency as desired. Yet, such technical aspects are based on load assumptions that are usually provided by those who are in contact with the customers (typically principals and sales team), who have an important responsibility of understanding the customers “real” demands and requirements by working closely with them and by having enough experience to evaluate the expected real load versus contracted load. Thus, it is clear that both business and technical leadership groups within the service provider’s team are expected to work closely together to develop the phased growth plan of a project and demonstrate how such growth will be achieved. They are ultimately expected to provide a “promise” to investors based on their findings and assumptions. In a phased growth plan, modularisation will certainly help soften the initial CAPEX requirements, spread future re-investment and provide a reasonable revenue-to-CAPEX ratio.
For example, presenting a business case that requires USD 10 million in capital investment with 200 users connected at the initial phase and a plan to re-invest an additional USD 10 million in three years, when and if the client base reaches 500, sounds more attractive than presenting a business case to invest USD 20 million in capital today, with 200 users connected at the initial phase, with a forecast to secure 300 more users in three years. Of course, it all depends on the investors, cost of capital at the point of investment, risk appetite and many other factors, but certainly USD 10 million CAPEX would sound more attractive than USD 20 million CAPEX knowing that only 200 out of the forecasted 500 users are confirmed at the initial phase of the project.
Modularisation, therefore, will make sense when coupled with prior planning from the service provider’s side, and if implemented properly, will certainly contribute positively to the financial health of the business. On the other hand, improper planning from the service provider’s side will always affect the business negatively, regardless of the construction methodology.

Is a module a product or a solution?
When suppliers and/or contractors offer a true modular solution to a service provider, they are actually offering a “system” and not a “product”. That system is expected to deliver a certain output under certain conditions. Therefore, it is important to understand how risk is being managed in a modular project.
I have seen a number of companies that are transitioning from a typical product supplier background to a modular solution systems provider. The main challenge they face, at least internally, is the new contractual liabilities that they have to accept as part of offering a complete system, as against what they are used to, of offering a product within a system.
The risks, performance guarantees and penalties and the length of commitment to a project are only few commercial issues that need to be addressed by the modular system supplier. Therefore, District Energy and data centre colocation providers have to clearly identify who is taking the performance liability of the “packaged” or “pre-assembled” system that arrives on the site. It is typically expected that the modular system supplier is the entity that takes full responsibility of the system performance.

Conclusion
The concept of modularity for District Energy and data centre facilities has been presented and implemented over several years now. I will not indulge in comparing efficiencies, footprint and quality between modular and stick-built designs. I believe designers can excel in both approaches and deliver a great solution, with each having its own pros and cons.
The purpose here was to elaborate on why a modular approach might be attractive from a financial perspective. It boils down to a very simple analogy: Would it be reasonable for a university student to take out a loan to buy a minivan today in anticipation of having a family in 10 years or buy a smaller car which he/she can easily afford today and save money for the future upgrade to a minivan? It is not about complicated financial models or investment analysis. It is very simple and straight forward. Modularisation allows for scalable investment, starting with the minimum possible infrastructure required to serve current clients with the capability to expand in the future. In addition, especially in the ICT sector, modularisation allows for the incorporation of newer technologies and advancements in every new phase that is added to the system.

Mohammad Abusaa is Business Development Manager at H.H. Angus & Associates Limited, Consulting Engineers, Toronto, Ontario, Canada. He can be contacted at mgabusaa@gmail.com


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