Making A Strategic Equipment Investment
The purchase of capital equipment is a strategic investment. It can boost a company's performance and profit while building long-term customer value. But how can ceramic manufacturers ensure that the purchasing process is handled correctly?
An eight-step process developed by the Manufacturing Performance Institute can provide some guidance. The steps are:
• Assemble a cross-functional capital investment team
• Complete a strategic needs review
• Determine individual plant viability and life expectancy
• Perform an operations analysis
• Assess vendors
• Detail equipment specifications
• Compile and evaluate price, total cost and return on investment
• Negotiate and close the purchase
By following this process, manufacturers can help ensure that they are purchasing the right equipment from the right vendor under the right conditions to serve their company's needs today and for the future.
Assemble a Capital Investment TeamThe first step in making a strategic capital equipment purchase is to assemble a capital investment team (CIT) that combines the broad skills of purchasing and manufacturing, as well as the strategic input of senior executives. Customers and suppliers should also be consulted to ensure that the new equipment will create new value in both processes and the final product. In some cases, for example, customers and suppliers might be willing to renegotiate existing contracts or even to help finance the new equipment. The different members of the cross-functional CIT form an equipment-purchasing nucleus for the company and bring specific skills to the purchasing process (see CIT diagram).
Complete a Strategic Needs ReviewNext, the newly assembled CIT must develop a strategic needs review process that assesses capital equipment investments against a background of overall corporate strategy, focusing on the development of a prioritized list of capital investments. In a small company, this process can be quite simple (i.e., the CEO is the purchaser and manufacturing leader), while in large organizations this review might involve business units from around the globe.
A key component of the strategic needs review is understanding the compatibility of the purchase with the company's approach or methodology for operations improvement (e.g., Lean Manufacturing, Six Sigma, Total Quality Management, Toyota Production System, etc.) and technological development. A proposed capital equipment purchase must fit within the operations philosophy, particularly in discrete-production industries such as ceramic manufacturing, where capital equipment options range from highly automated machinery (e.g., robotic production lines) to low-cost, high-touch equipment (e.g., manual loading and unloading machines) to custom-built production lines. Lean advocates-as well as those backing other philosophies, such as Theory of Constraints-often cite the obstacle that "monuments," or large, inflexible and expensive pieces of equipment, can pose to streamlined production. A "lean" philosophy stresses the need for operations to gradually incorporate equipment selections that are flexible, portable and capable of handling small lots. Organizations focused on lean or TPS should think twice before investing in highly automated, large-batch-processing equipment that cannot be customized.
Even in capital-intensive, large-batch industries, a corporation's particular approach to technological development can significantly influence the selection of capital equipment. Some manufacturers have been able to capture new market share by aggressively seeking out and investing in new technologies, allowing them to surge ahead of companies hobbled by antiquated equipment. Other manufacturers have found a competitive advantage by customizing capital equipment in ways that develop proprietary processes.
Determine the Plant's Viability and Life ExpectancyA key factor in capital equipment investments is the viability and life expectancy of the plant requesting the investment. In larger firms, the roster of production facilities should always consist of plants with a variety of reasons for their existence, including:
• Performing at world-class levels
• Producing the majority share of the company's primary product
• Providing an example/pilot of technological advancement
• Offering best practices/training for managers
• Serving as a niche market producer
Manufacturers should periodically review their roster of plants regarding the strategic roles of each, and then use this analysis to reward plants that are fulfilling their purpose (with new capital equipment, new product introductions, etc.) or to wean plants from the corporation (downsizing, plant closings, outsourcing). Yet, as important as this information is to capital equipment investments, it is often unknown to purchasing or operations personnel-making the inclusion of senior executives on the CIT vital.
Companies that fail to assess and manage their plant roster, especially during the purchase of capital equipment, face the prospect of disastrous decisions down the road, such as sudden plant closings, consolidations and massive equipment sell-offs. The review process can also indicate whether relocation of equipment among plants is possible. Similarly, a key consideration for the CIT at this stage is to determine whether outsourcers, suppliers or even customers can alleviate the need for a particular piece of equipment. In some instances, such as when production is on-site at the customer's location, the equipment might be acquired by the customer and then leased back to the supplier.
Perform an Operations AnalysisAfter developing a strategic needs review process and an understanding of the current facility lineup, the CIT should develop an operations analysis of each capital equipment request that provides quantitative projections on how the new equipment will impact sales, profit, productivity, quality, deliverability, manufacturing costs, etc., as well as intangible benefits such as an improved working environment. This analysis should include a review of the required technical skills to install, operate and maintain the new equipment, as well as any additional training costs. In addition, the analysis should also review how well (or poorly) a facility has leveraged past equipment purchases, especially compared to sister plants also requesting equipment.
The analysis might also include consideration of asset management services from the equipment vendor or a third party. In many industries, particularly those that use heavy industrial machinery, the complexity, costs and skills necessary to maintain equipment can be prohibitive. Many OEM equipment vendors offer maintenance and predictive planning capabilities that can guarantee machine availability at cost-effective prices. One note of caution regarding operations analysis is that equipment purchases are too often approved or rejected based solely on whether a company can afford the investment "this year." Additionally, manufacturers should understand that health, safety and regulatory concerns override all other purchase considerations; if Occupational Safety and Health Administration (OSHA) or Environmental Protection Agency (EPA) standards can only be met by acquiring equipment, the real question becomes: "Do we acquire equipment now-or do we shut down?"
Assess VendorsNext, the CIT should assess potential vendors against both standard supplier criteria and requirements unique to capital equipment vendors. Standard supplier criteria include:
• Past performance regarding delivery to promised date
• Timely follow up and service
• Willingness to offer aid and assistance
Criteria specific to equipment vendors will include:
• Ability to customize equipment or integrate in-house equipment designs with turnkey solutions
• On-site training
• Leasing, vendor financing and asset-management options
• Availability of used or rebuilt equipment
Unless vendor proximity is important, national and international providers should join the potential vendor list, whether through traditional or Internet-based trading mechanisms. The challenge is to create dossiers on remote firms comparable to those regarding known vendors. Pay particular attention to vendor viability and reputation when making acquisitions via an online market. Along with comparing standard evaluation criteria, the CIT should interview potential vendors for their opinions on equipment trends, industry outlook, and the types of support and services available for equipment. Vendors should be willing to share as much information as is available to them and their engineers; reluctance to do so warns of trouble during the post-purchase relationship.
Detail Equipment SpecificationsThe CIT should then assemble a detailed report of precise equipment specifications. This list should be exhaustive and include all appropriate parameters (e.g., throughput, capacity, footprint, potential changeover times, ergonomics, loading/unloading, tolerances, control systems and calibration requirements). The CIT should also require a report regarding unique factors beyond specifications, such as the equipment's ability to withstand the demands placed upon it within a particular manufacturing environment (e.g., continuous operations, wet or abrasive conditions and high/low temperatures).
During this process, manufacturers should require potential vendors to offer product histories and, if possible, references within similar industries and under similar operating conditions. Manufacturers should also ask whether the capital equipment under consideration is the latest model or a product that's being phased out. Older models aren't necessarily bad-unless users report poor performance, safety or environmental records-and could provide functionality at a lower price. Timing the review of equipment and vendors around a trade exhibition can significantly speed the purchasing process.
Evaluate Price vs. Return on InvestmentOne of the most important roles of the CIT is to evaluate costs and benefits in an appropriate financial framework. Purchase price is merely one factor in determining the total cost of capital equipment and ultimate return on investment (ROI). Instead, manufacturers should use the total cost of ownership (TCO) and potential ROI to evaluate the effectiveness of various capital equipment investments.
TCO can be tracked in various ways, but most methodologies aggregate direct costs, including capital investment and freight charges, as well as indirect costs, including maintenance, utilities and operating labor for the life of the equipment. TCO then builds to an ROI projection that captures potential cost savings and revenue increases through scenarios such as greater productivity, increased product volume and new process capabilities.
ROI is significantly impacted by equipment maintenance costs. While the rule of thumb is that maintenance costs should not exceed 5% of an asset's value, benchmark performances in some sectors have achieved maintenance costs of 2% or less. Even in a small company with just $1 million in asset values, that difference (2% vs. 5%) in maintenance needs can add up over 20 years to more than $2.16 million (accumulated value of 20-year maintenance opportunity cost at weighted average cost of capital).1
Operating equipment efficiency (OEE)-a factor of machine availability, quality yield and production rate-is also critical in estimating ROI for new equipment. For example, at a firm with annual sales of $10 million and an OEE of 70%, an increase in OEE to just 73% can add as much as $430,000 annually to the bottom line (about $143,000 per point of OEE). However, while individual equipment OEE should be considered, the primary emphasis must be on the purchase's effect on the overall efficiency of production in a particular plant. (Some define OEE as "overall equipment effectiveness.")
Be familiar, too, with overall market trends in pricing. A starting point is the producer price index-a family of indices that measure change over time in the selling prices received by domestic producers of goods and services-tracked by the U.S. Bureau of Labor Statistics. For example, "machinery, except electrical" experienced a 1% drop from December 2001 to December 2002.2 Why pay 5% more for such equipment in 2003 than in 2001?
Negotiate and Close the PurchaseAs the purchasing process enters the stage of soliciting quotes, purchasing members of the CIT should coordinate negotiations with equipment vendors to develop optimum packages. In fact, a good purchasing staff can substantially lower the cost of capital through negotiation without jeopardizing the vendor relationship. Key factors to consider at this stage are financing and lease and rental options, along with the ramifications of each (e.g., taxes, warranties, asset management, ROI, etc.). Operations members of the CIT should also continue to monitor specifications as changes in the package develop.
The CIT's overall focus will be to emphasize TCO and ROI, which starts by ensuring the optimum window for delivery and acceptance of equipment. For example, when presented with a turnkey equipment proposal, the CIT's response must be: How quickly can the machinery produce to our quality yields? The last thing any company can afford is to damage relationships with customers by unnecessarily compromising a line's performance during an equipment installation.
Finally, the CIT will make a consensus decision on the equipment from the pool of vendors and equipment options, and then close the purchase.
While this process may seem exhausting-especially for a small organization focused on a one-time buy-once a CIT and its procedures are established, the capital equipment investment process will become second nature to the organization. More importantly, the results of the CIT process will rarely be second-guessed as ROI-and profits-take flight.
References1. "The Cost of Maintenance Destroys Your Capital Investment Returns," Mike Sondalini, www.maintenanceresources.com.
2. Producer Price Index, Bureau of Labor Statistics, Jan. 15, 2003.