EAM Enables Higher Shareholder Value. Asset Performance Management. Conservation of cash and margin improvement

Transcription

1 ARC BRIEF APRIL 7, 2010 EAM Enables Higher Shareholder Value By Ralph Rio Summary Today, nearly all industrial businesses are asset intensive. To be cost competitive on a global basis, high levels of automation are needed to drive the required productivity and yield along with flexibility for meeting changes in customer demand. High asset performance is needed for excellent financial performance in the Unfortunately, many executives focus on reducing P&L statement and balance sheet. Good the costs associated with maintaining these assets maintenance management enables higher ROA and the associated and neglect to consider the impact on the business' improvement in shareholder value. overall financial performance. Proper maintenance of the assets has a positive effect on the P&L statement, balance sheet, and shareholder value. To insure proper maintenance, a company needs a modern Enterprise Asset Management (EAM) system. Asset Performance Management Senior executives have significant fiduciary pressures with associated governance to insure compliance - particularly during the recent difficult economic times. These pressures can take several forms: Conservation of cash and margin improvement Financial ratios that indicate risk and drive stockholder value Safety and regulatory compliance Companies in asset intensive industries spend a significant portion of their revenues on asset maintenance. For some industries, as much as 5 to 10% of revenues are the norm - a tempting target for cost reduction. However, just cutting maintenance expenses will often have a negative impact on the fiduciary responsibilities of the C-suite with a corresponding negative effect on shareholder value. A recent ARC survey on enterprise asset management (EAM) had 65 participants whose responses represent input from 1,300+ plants with 463,000 employees. One question focused on the primary drivers for maintenance VISION, EXPERIENCE, ANSWERS FOR INDUSTRY

2 ARC Insights, Page 2 which shown in the chart. These drivers also link to the P&L statement, balance sheet, and shareholder value. Impact on P&L Statement Optimizing maintenance has a direct impact on the P&L statement. Analysis of the failure history provides an opportunity to optimize and plan maintenance activities. Maintenance teams become more proactive with a shift from run to failure with excessive unplanned downtime. This preventative maintenance reduces emergency repairs. Let s use an automotive analogy to help me describe the consequences. Improve Uptime & Downtime Cost Control for Labor & Parts Extend Asset Longevity Safety and Risk Management Reduce Energy Costs Sharing Best Practices Corporate Social Responsibility Calibration for Quality or Yield Knowledge Transfer 20% 18% 15% 35% 29% 60% 58% 58% 82% 0% 20% 40% 60% 80% 100% Primary Drivers for Maintenance Management Our example is oil for your engine. With run-to-failure, the oil level declines until the bearings have no lubrication, the metal melts, and the engine freezes solid (seizes-up). On the average car, the oil level would become too low in about 25,000 miles (individual results will vary). The failure causes about $5,000 in repair costs including materials ($2,500), technician labor ($2,000), towing ($150), and car rental ($350) for an average, mid-sized car. Also, there is at least a week of painful interruption of service (cars always fail when you need them, because failure occurs during use). All cars consume engine oil and, without maintenance, failure is assured. Source: ARC Trends Survey Feb The alternative is preventative maintenance. Oil and filter replacement costs about $50 every 5,000 miles which, for the 25,000 miles, is $250 (5*$50). Also, interruption of service is scheduled when you are available. Being proactive is a 20 to 1 financial benefit without the risk of missing commitments due to the interruption of service. We understand this tradeoff and have our engine oil maintained regularly.

3 ARC Insights, Page 3 From the ARC survey, the top four drivers for maintenance are very similar to the reasons you maintain your car. Shifting from reactive to planned maintenance provides similar benefits for your business. The performance improvements provided with good maintenance include: Improved uptime for production scheduling: Without maintenance, the equipment fails while it is in use and needed. First, this interrupts production which causes losses in direct labor and, often, work-inprocess (WIP) materials. Second, in today s tight scheduling with minimal inventory, interruption will cause missed shipment dates, customer satisfaction issues, and reduced revenue. Cost control for maintenance labor and materials: First, during the emergency equipment repair, acquiring replacement parts is expensive. To buy time, there are additional costs for materials, expedited shipping, and overtime. Second, failure of a component (inexpensive oil in the car analogy) cascades into damaging other components and systems (an expensive engine). The repair costs escalate dramatically. Extend asset longevity: For most cars currently in service, a $4,500 estimate for engine replacement would drive a decision to replace the car even if the replacement cost is significantly higher that the estimate. In business, the lack of maintenance causes excessive wear and tear which drives earlier replacement. Without maintenance, capital expenditures are higher. Safety and risk management: Catastrophic failure of equipment can put people in its vicinity in danger. And, failure of a major system can cascade into other systems representing a significant business risk. Governance including Sarbanes-Oxley necessitates maintenance. To summarize, the first two items listed above brings focus to impact of poor maintenance of critical assets on the P&L statement. They contain direct labor and material losses, emergency repair and equipment replacement costs, and some lost revenue. Costs go up, revenue declines, and operating margins are squeezed not good for the P&L statement and executive metrics.

4 ARC Insights, Page 4 Impact on Balance Sheet Now, let s focus on the extends asset longevity driver from the ARC survey. Maintenance improves the longevity of assets, Maintaining assets extends their thus delaying the need for major capital projects longevity and avoids replacement. Conserving cash improves a common for replacement or refurbishment. Also, the increased uptime provides additional production financial metrics like the quick ratio. capacity and avoids procurement of additional Quick Ratio = (Cash + Marketable Securities) / equipment as the business grows. By delaying major capital expenditures, significant cash is Current Liabilities conserved. Cash conservation improves the financial ratios used to evaluate a company s financial risk. An example of a common financial metric is the quick ratio (or acid test): Quick Ratio = (cash + marketable securities) / current liabilities. Improving the quick ratio occurs when adding cash to the numerator, or by using cash to reduce liabilities in the denominator. Either approach improves this basic measure of financial risk. It makes the investment more attractive which raises the value of the stock and overall stockholder value. Also, these ratios are used to evaluate risk and affects interest rates on debt. Return on assets (ROA) is a key driver for your company s stock price. Business managers tend to focus on the numerator with revenue and costs i.e., the P&L. The denominator also needs attention. The longer an asset is in service, the lower its asset valuation after depreciation. The smaller denominator boosts ROA. This lower depreciated value of plant and facility assets depends on the extension of asset life. Another opportunity for cash conservation is WIP inventory. The purpose of inventory is to overcome uncertainty. Materials are queued between operations to buffer interruptions including equipment failures. Economic Order Quantity (EOQ) calculations include factors for this uncertainty. With preventative maintenance and higher equipment uptime, uncertainty and inventory is reduced. Again, the added cash improves commonly used financial evaluation metrics like quick ratio and ROA. To summarize, maintenance frees-up cash by delaying capital projects and reducing WIP inventory. The added cash improves financial measures, stock value, and executive metrics.

5 ARC Insights, Page 5 EAM the CFO s Quiet Savior Managing maintenance for your car is relatively easy. The car manual contains a printed maintenance schedule and check-off list. You just need to monitor mileage and take it in for service at the recommended intervals. But, this manual methodology of managing maintenance for one individual asset will not scale-up for a plant or facility with Asset Information Management Work Order Management MRO Materials Management Labor Management Service Contract Management Reporting & Analytics Mobility (docking station and wireless) EAM Functional Groupings thousands of assets. Your business has many complex and critical pieces of equipment. How does a maintenance manager know what is the most important item to work on next? With manual methods, the tendency is to degrade to a run-to-failure approach and assign technicians to the person who yells the loudest. An Enterprise Asset Management (EAM) system is used to manage maintenance including labor, inventory, service contracts and reports. It is required to successfully implement preventative maintenance with an improved P&L statement and balance sheet. Particularly for asset intensive industries, a modern EAM system makes the Chief Financial Officer (CFO) look good. Final Word High asset performance enables excellent financial performance in the P&L statement and balance sheet. Good maintenance management improves many of the financial measures of a business with reductions in costs for production and maintenance, and assets for inventory and equipment. One of the primary goals of all senior executives is to improve shareholder value. If you agree that metrics like Quick Ratio and ROA affect shareholder value, then you should also agree that your maintenance department needs a modern EAM system. This paper was written by ARC Advisory Group on behalf of IBM. The opinions and observations stated in the paper are ARC's. For further information or to provide feedback on this paper, please contact the author at rrio@arcweb.com.