Asset Management as an Enterprise Strategy For Profitability-A Methodical Approach

A methodical systematic approach for  measuring a company’s current reliability performance and establishing  “Asset Management Opportunity” in terms of dollars is very much necessary for  long term sustenance of an Enterprise or an Organization.

In the context of fast growing global competitions, major manufacturing companies in many industries
(including process industries) have started to realize the importance of  Enterprise Asset Management (EAM) as an enterprise strategy, if  correctly implemented, will definetely improve financial performance. Typical results of an effective EAM Strategy include a 20% - 50% reduction in repair and maintenance expenses accompanied by a 5% - 10% increase in real production volume, with no significant investment in production equipment.
Profitability is the return on an investment. Measurements of return include cash flow and net income while measurements of investment include operating assets, total assets and equity. Typical measures that affect Senior Management  premium are Return on Net Assets (RONA), Economic Value Add (EVA), and Earnings Per Share (EPS), etc. Each of these can be directly correlated to Asset Utilization, the effective measure of a Strategic Asset Management Program.

CATEGORIES OF OPPORTUNITY FOR POTENTIAL RETURN ON INVESTMENT
There are mainly four categories that offer significant potential return from an Asset Management Program:
1. Fixed Cost Expense Reduction
2. Increased Product Throughput
3. Capital Spending Avoidance
4. Reduction of Inventory Investment

The easiest of these to achieve is the reduction of fixed costs in terms of maintenance expense, a waste elimination mechanism. It is critical to identify the inefficient business processes and infrastructures that create the waste and to replace them with well designed processes and structures. This mechanism is employed by reducing the amount of unplanned equipment outage or down time and becoming more effective in managing the resource allocation function.
Increasing product throughput by developing a more reliable operation, while more challenging, has a double impact on financial performance. It significantly reduces the unit cost of the product while reducing the level of maintenance repair required on the equipment. This is a particularly effective mechanism in industries where fixed costs represent a significant per cent of the total cost of making product as all additional units produced are made at a total cost equal to the variable cost of production, yielding the highest profit.
In an industry where product demand is high and Capital Investment is needed to increase plant capacity, a strong Asset Management Program can often achieve the required additional throughput, avoiding the requirement for capital spending. This mechanism often provides the greatest thrill in terms of financial improvement as it prevents the cost of borrowed money for investment in facilities as well as the increase of asset values on the company’s books. (Remember that profitability is a measure of return on assets employed.)
Raw material, finished product, and spares parts  inventories are held to account for unreliability in the manufacturing process. In a Lean Manufacturing environment where inventories of raw materials and finished product are minimized, it is critical that the company establish and maintain an effective Asset Management Strategy. As the manufacturing process and associated assets become more reliable, inventories of both of these as well as spares parts supplies can be significantly reduced with little risk.
FIXED COST EXPENSE REDUCTION
According to A.T. Kearney, Maintenance Cost to Equipment Replacement Value Ratio (ERV) in the early 80’s were used as determining  a benchmarking during survey for DuPont. It is calculated as:

ERV ratio = Maintenance Cost/Equipment (Asset) Replacement Value

-expressed as a per cent. Industry experience has shown that maintenance expenses can be considered to be genuinely justified if it is lower than  1.5% - 2.5% of ERV depending on the industry type and complexity of manufacturing process.

INCREASED PRODUCT THROUGHPUT
It is generally believed that shareholder return is a result of three factors:
• Asset Growth: Compounded Asset Growth Rate
• Cash Flow Margin: Ratio of Cash Flow to Sales
• Asset Productivity: Ratio of Sales to Asset
The most effective way to increase Fixed Asset Productivity is to maximize asset utilization by increasing the Reliability of the Assets through an effective Asset Management Program.
To calculate  current level of Fixed Asset Productivity (FAP) or Asset Utilization (AU) one can use the following formula:
FAP = Sales Volume x Selling Price/Net Fixed Assets
 Sales Volume= Max Daily Rate x Asset Utilization x 365 days

Where utilization is calculated as:
AU = Actual Annual Production / Max Daily Rate X 365 days
Max Daily Rate = Demonstrated Capacity

A company can look for opportunity for improvement up to the difference between current AU and AU = 100%.

CAPITAL SPENDING AVOIDANCE
When demand for a product of a manufacturing unit is strong, there is often a significant motivation to raise Capex for expanding capacity of the facility.Thus a proposal is put up before Top Management for seeking approval for enhancing capacity with justified capital investment.It has been experienced that if  current AU is less than 70%, the generally accepted strong probability is that one can achieve the desired enhanced capacity by implementing an Asset Management Program that raises AU to the 90% range.

REDUCTION OF INVENTORY INVESTMENT
Various manufacturing industries hold raw material and finished product inventories as insurance against manufacturing delays and unexpected demand. They maintain large spares parts Inventories (parts and maintenance supplies) for similar reasons. These inventories can amount to a significant portion of the Asset Value carried on Corporate Balance sheets, negatively impacting profitability. The objective of Lean Manufacturing concepts is the reduction or total elimination of these inventories. Poor reliability resulting from ineffective Asset Management will destroy any Lean Manufacturing benefits.
The Opportunity in this case is the total value of Raw Material and Finished Product Inventory that is maintained to account for unplanned manufacturing outage as well as a significant piece of the spares parts Inventory.
CHANGING THE PROCESS
Once opportunity is defined, one must be able to address the question of how one can achieve all or part of this opportunity. This means changing the existing business processes. The first step is to evaluate the current state; the second is to identify the process changes that will yield the expected financial benefits. Remember, without change in processes, one cannot achieve the future state that will deliver the benefits.