The final in a series of three papers on using a KPI Model to improve asset Productivity.
Some strategic decisions involve a fundamental shift in the use of business capital.
Make or buy decisions are one class of decision that can have important strategic consequences. If make or buy decisions are made simply on cost criteria, without assessment of the flow on implications, commonly ignoring evaluation of the effect on asset utilization they are likely to be unsound.
It is difficult to expose this factor without a KPI model, so a careful search for the potential unintended consequences is called for.
Changes in the risk profile of the Asset Mix need to be considered. This example from my casebook will explain the problem and the solution.
We often see businesses sell property assets moving to leased premises.
They usually argue that they can put the capital to better use.
Failure to consider the change in the risk profile of the change in asset allocation can lead to unrealized expectations. This example will illustrate the principle.
Family feud averted by a good strategic decision.
A long established and profitable manufacturing business had been conservatively managed. A family trust owned the factory in a location that had seen its industrial origins overtaken by fashionable retail and residential development.
The business managers, two brothers, wanted to invest in the latest and best CAD/CAM (computer aided design and integrated manufacturing) equipment to boost productivity and had nowhere to put the new machines in the old factory.
They wanted to sell the old factory and lease new premises, using the funds to invest in the very latest technology. The trustees were reluctant to sell the property. The business case did not persuade them. The managers saw an exciting future; the trustees took their custodial role seriously and were risk averse.
We created a KPI Model to evaluate both scenarios.
We factored in the rent that should have been charged for the old factory, and replaced that with the new rent for leased premises.
The key to the decision facing the business was the recognition that owning real estate was a low risk business and a typical commercial return was around 10%.
Investing the same funds into new plant and equipment changed the risk profile of the business. We asked “what level of return do we need for a pure manufacturing business?” and agreed on a minimum 36%. We used the model to evaluate what level of utilization we needed to achieve from the new plant, as well as assessing the margins available with the new production cost structure. We factored in the new capacity, the prospects of increasing sales, and pricing for improved levels of service.
The business case was re-presented to the trustees, and the logic was clear. They agreed to the change in strategy. Then the highly skilled workforce was canvassed to assess the impact of moving their workplace about 10 km.
A year later, the move had been made to new premises, the staff was happy and the new plant was working superbly. New customers had flocked in enjoying improved service levels and happy to pay for reduced lead times. The profit budget had been exceeded, and they were under pressure to order more new plant.
The trustees were happy because in the first year the ROFE target had been met.
Five years later the business reported 25% year on year growth and had acquired a synergistic business.
Strategic asset decisions can involve betting the company
If you get it wrong you become a target for the asset stripper. Getting it right often demands that you ask the question “What business are we in?”
When that is answered, the right asset mix becomes much easier to find.
In fact this is one of the few areas where there is plenty of industry data and benchmarking the Asset Turns KPI is easy and really worthwhile.
Your accountant will be able to assist you with access to industry databases.
These decisions are the ones with the largest return from the use of a KPI Model. You can start with a simple “What if?” model from realkpis.com and adapt it to your own business. You can also get this full series completed with diagrams as a paper from the same source.