KILN CONNECTION: On Investing
December 1, 2010
My colleagues in the ceramic industry are always trying to get funds approved in order to improve their firing systems, accuracy and temperature uniformity; add human-machine interface (HMI) systems; or reduce energy costs. As a kiln specialist, I am frequently asked to participate in these projects, and I often assist with the design specifications, predicted performance, and, of course, the cost estimates.
The first step is the most basic: define what you are trying to accomplish, then develop the concepts that will be used to achieve your goal(s). During the design development phase, we weigh the options of pulse firing, proportional firing, potential for heat recuperation, etc. Next, we determine the design schematics, select all of the components necessary, and obtain price quotations for the materials and installation. Controls costs are added to the equation, and we arrive at a total investment cost number. A contingency is then added to this amount to arrive at a comfortable final cost.
Understanding SavingsSavings can be associated with many areas: labor, energy, yield improvement, and time. Here's where things get a little dicey. Improving systems for reduced labor are fairly straightforward. If an automated product handling system eliminates a few labor positions, those savings are definable.
Energy is a little more demanding. We can estimate with confidence the amount of energy reduction, but assigning a price to the BTU or Kcal is tricky. Fuel prices are volatile, and natural gas is currently at a low point. This will change in the future, though; fuel prices are likely to continue to rise. Assigning a low value to the fuel understates the savings, yet I usually find that the current price for fuel is the benchmark (vs. the average over, say, three years), so the volatility ends up being over-weighted in either direction.
Improvements to yield offer high dollar savings, but many planners overrate them. Quite often, a yield improvement of "x" percent is attributable to a project. Unfortunately, the true yield is not increased by "x" because most products have more than one defect per piece; eliminating one defect does not necessarily improve the quantity of pieces shipped to the desired degree.
All managers would agree that time has value, but accountants often do not properly value time. For example, in some plants with numerous problems, managers spend most of their time running down defects that should never have occurred. When those defects are eliminated, however, the managers' salaries continue; from that perspective, there is no savings. But savings are achieved when people don't have to waste their time solving those continuous defect problems and are able to apply their skills to innovative progress.
As a simple example, I work in many facilities where the managers laboriously use handwritten data to plot kiln firing curves. The data is written by kiln technicians hour by hour, every day. Admittedly, this is an essential task, but it takes time. When HMI systems are employed and eliminate these manual tasks, time is freed up to do more important work. If a company values progress, innovation and the time to generate those valuable attributes, this time savings can offer real value.
Getting ApprovalWe finally arrive at the cost savings vs. capital costs, and here's where most projects usually stall. Many companies use some version of the internal rate of return calculation to arrive at an index that measures the project's improvement. They often simply require that the cost savings have to exceed the project cost within 18 months. Unfortunately, most projects stop at this point because that expectation isn't always practical.
I don't understand this short-term outlook. Think of it this way: A broker comes to you and says that if you invest $50,000, you will be paid $50,000 every 18 months for the rest of your life. That's the equivalent of more than 50% interest annually-a good deal by anyone's measurement. What kind of return are you getting these days?