Profit Driven Reliability
EP Editorial Staff | March 1, 2000
A six-step work process to increase profitability with reliability improvements.
A Fortune 500 specialty chemical company has doubled its profitability over the past five years, improving it from 7 percent to 14 percent as measured by return on net assets (RONA), after-tax operating profit divided by total net assets. To put this in perspective, a 7 percent RONA is typical for many large companies that consider themselves successful. Reliability’s contribution to cycle time improvements was a key enabler of this profitability improvement. Specifically, reliability improvements increased capacity and facilitated reduction of both inventory and order lead time policy.
Two distinct technical abilities are required to ensure that reliability improvements will result in profitability gains. First is the ability to identify high-impact reliability improvements. This requires identifying which financial variables produce the largest profitability improvement. Second is the ability to connect these financial terms to reliability. Connecting reliability to profitability typically requires computer simulation tools to link specific reliability improvements to competitive advantages that can deliver profitability gains.
Profit Driven Reliability*
Profit Driven Reliability (PDR) is a six-step work process using reliability modeling tools that harnesses reliability’s competitive advantage.
The first step in PDR is identifying the financial variables (such as sales, costs, expenses, or assets) that have the largest impact on profitability. These high-impact variables are known as PDR candidates. If PDR candidates have not already been identified by financial analysts, they can be identified using information from a financial statement. The easiest approach is to calculate the change in each financial variable needed to produce a specified gain in profitability. Since the proposed reliability initiative will seek to improve the PDR candidate, each PDR candidate should be screened for alignment with business strategy and feasibility. Completion of the first step is crucial to selecting a reliability improvement that will maximize profitability impact.
The second step is to enroll management by requesting their support in identifying a specific reliability improvement opportunity that will provide competitive advantages to improve the PDR candidate. A PDR candidate defines the business deliverable that the reliability initiative should provide. It does not define a specific reliability improvement, nor does it enroll management in the support of a reliability initiative directed at improving that variable. A specific reliability opportunity can be defined without approaching management; but a valuable opportunity to develop management support will be missed. Requesting management support will begin to enroll management in using reliability initiatives to increase profitability.
The third step is to define the specific reliability improvement that will deliver the desired competitive advantage (such as increased available capacity). Typically, reliability improvements provide competitive advantages that must be converted into profitability. Successful completion of the third step is an essential ingredient to ensuring that the reliability initiative will deliver the promised business benefit. This step requires an understanding of how reliability delivers competitive advantages and may require computer simulation tools.
The fourth step is to link reliability’s competitive advantages to profitability by formalizing the metrics and identifying the mechanisms to accomplish this. Reliability improvements may offer competitive advantages with high profitability potential but deliver little profitability gain if others fail to act on these competitive advantages. Converting reliability’s competitive advantages into profitability requires effectively communicating the improvement to individuals who are capable of acting on this knowledge by:
- Communicating the reliability improvement in meaningful terms by developing both reliability and profitability metrics. Rather than reporting an elimination of downtime, more effective metrics might include the associated increases in sold and unsold capacity.
- Verifying that everyone understands and is prepared to perform his role in harnessing the reliability improvement. Increasing profitability by improving reliability frequently requires the cooperation of others outside the reliability community. Unless these outsiders act on a reliability improvement, the improvement may fall short of its profitability potential.
The outcome of steps three and four is a PDR project. A PDR project is the reliability improvement project plus any actions required to convert the reliability improvement into increased profitability.
The fifth step is integrating the desired reliability improvement. For completeness, PDR includes a step to achieve the reliability improvement; however, PDR offers no tools or techniques to accomplish this. It is assumed that the necessary skills and tools to accomplish a reliability improvement are available.
The sixth step is feeding back results of the PDR project to the organization. This step is crucial in sustaining a culture of improving profitability with reliability. The sixth step is simply a brief report that contrasts final results with the initial state using metrics developed in step four. Any deviations from promised outcomes are briefly explained. The feedback occurs upon project completion as well as each time management support is requested for other initiatives.
A success story
Starting in the late 1980s, profit margins for the largest business unit of a Fortune 500 company began to shrink. Capital investment continued despite shrinking margins. The net effect was a rapid decline in business profitability over the next five years, as shown in Fig. 1. This decline began to strangle the company since this business supplied the bulk of the cash flow for other corporate investments.
Financial analysis of the 1993 financial statement by the Profit Driven Reliability financial analysis tool is shown in Table 1. Improving asset productivity through reliability looked very promising. The highest leveraged approach to improving profitability was to increase asset productivity (saleable capacity) of the existing assets. This approach was consistent with the long-term business plan for sales and capital expansion.
The business leaders were introduced to the concept of acquiring incremental capacity by increasing productive capacity of existing assets. Based on the potential profitability gain associated with improving reliability, the business leaders commissioned a pilot project. The pilot object was to quantify the incremental capacity resulting from reliability improvements within the plant gates, not to develop a specific reliability strategy.
Quick analysis of existing operations showed substantial lost production, apparently resulting from variation in product-specific batch cycle times. These variations were the consequence of process or mechanical failures. To quantify the incremental capacity associated with failure elimination, a reliability model was developed. The reliability model used existing batch card data (cycle time data for every batch and every processing step). The batch card data did not explicitly capture lost production time or attribute specific lost production time to a symptom. For example, batch card data for the first batch of product A might show that the second processing step took 13 hours. The reliability model predicted lost capacity given data defining current and optimum batch cycle times. Validation by comparing actual production to simulation output showed that the model matched reality.
The next step in the pilot was to use the model to quantify the capacity gains associated with improving reliability to the level achieved by other sites. The predicted capacity gains were sufficient to defer capital investment. The business elected to hold the plant accountable for bringing its facility performance up to the level of its more reliable sister plants, rather than purchase incremental capacity with capital dollars.
In response to the request of the business leaders, site management was persuaded to develop a reliability strategy that could deliver the needed improvement. The reliability strategy was developed and implemented. The predicted capacity increase was achieved. Analysis of the pilot project established that reliability improvements were a cost-effective source of incremental capacity. For this business, incremental capacity purchased by reliability projects costs approximately 10 percent of capacity purchased by capital projects. A work process was developed to guarantee that the business would use capital dollars only as the last resort to purchase incremental capacity. To sustain commitment to the reliability purchased capacity, widely published metrics were instituted. Two key metrics were asset productivity and incremental capacity cost.
A simple work process was developed to ensure that reliability would be the preferred mechanism for increasing capacity. The work process consisted of one rule: there was no approval for capital expenditures more than $100,000 if reliability could deliver the incremental capacity. To support the new capital deployment process, a reliability model tool kit was developed and rolled out to every site. The reliability model tool kit allowed site personnel to develop a reliability model to simulate their site operations. All capital requests required justification provided by the reliability model.
Today the business reaps the rewards of its commitment to acquiring incremental capacity from the most cost-effective source. Fig. 2 shows the increase in profitability and the simultaneous decline in capital spending.
Suggestions for implementation
Harnessing reliability’s competitive advantages requires a tight alliance with the business throughout the reliability improvement process. A work process and tools similar to those provided in PDR are needed to form and sustain this alliance. To implement a similar process, it should contain these key elements:
Start with a business need. Without this up-front connection to the business, outstanding reliability improvements may have minimal impact on profitability. Connecting to the business can be accomplished by defining the profitability leverage of key financial variables and mapping these terms to business strategy.
Develop management support for the concept before the specific project. Generally, it is a mistake to introduce a specific reliability initiative first. Introducing a specific initiative at this point can imply that there is an idea searching for justification. A more effective approach is to establish how reliability can satisfy business needs prior to the introduction of any reliability initiative.
Select reliability improvements based on their ability to deliver quantifiable business benefits. Quantifying business benefits may require computer models. Ironically, more value was discovered in less complex, high-level models than in more complex, detailed models. This is not a reflection on the relative value of the two types of models; rather, it is the result of the resources and culture. Today, the resources to support widespread use of detailed models are not available. In addition, high-level models were quickly used early in a project when decisions had profound consequences on project profitability. Early in a project, there is usually insufficient data to support the use of more complex models. Finally, the high-level models were user-friendly with a short learning curve, so their use became wide spread.
Define strategy, work process, and metrics that will ensure profitability impact of reliability initiative. The profitability impact of a reliability project can be dramatically increased when it is leveraged through the business by changing fundamental business processes. In the case study, the dramatic results were possible because reliability contributions were considered in the capacity planning and capital deployment processes. Integration of reliability into other processes requires the development of common metrics for inter-process communication.
Sustain momentum by widely publishing metrics. Management commitment is sustained by its belief that an approach is more effective than its alternatives. This belief must be nurtured by publication of the business and reliability outcomes of a project.
Reliability is a powerful tool for providing competitive advantages that can increase profitability. Harnessing this tool requires the assistance of others outside of the reliability community. Ultimately, it is the support of the business leaders that will harness reliability’s competitive advantages, moving reliability from the plant floor to the boardroom.
An article next month will define the foundation concepts and tools needed to link a high-impact financial term to a reliability opportunity. Application of these tools and concepts will allow a user to predict the business benefits associated with specific reliability improvements. MT
This article is based on a paper presented at Process Plant Reliability 99, October 1999, Houston, TX.
*Profit Driven Reliability is a service mark of RonaMax, LLC, Yardley, PA.
Carol Vesier, Ph.D., is principal at RonaMax, LLC, Yardley, PA 19067; telephone (215) 736-2315; e-mail firstname.lastname@example.org; Internet www.ronamax.com
Change needed to increase RONA from 4.6 percent to 5.6 percent
|Fixed assets¹||Zero capital investment for one year²|
Eliminate 69 percent of receivables²
Eliminate 87 percent of inventory²
|Cost of goods sold||
Cut cost of goods sold by 2 percent
|Maintenance cost||Cut maintenance cost by 20 percent|
Increase facility uptime by 6 days if capital
Increase facility uptime by 2.5 days with
1 Fixed assets are primarily the manufacturing equipment.
2 Any money released by reducing total assets (fixed assets, inventory, and receivables) must be either returned to the stockholders or re-invested at a higher rate of return.
3 Asset productivity is the percent of maximum production that a facility is capable of delivering. To impact profitability, any gains in asset productivity must be sold or used to reduce the asset base.