Cxo Eam Arc Brief

8/3/2019 Cxo Eam Arc Brief

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VISION,EXPERIENCE,ANSWERS FOR INDUSTRY

ARC BRIEF

High asset performance is needed for

excellent financial performance in the

P&L statement and balance sheet. Good

maintenance management enables

higher ROA and the associated

improvement in shareholder value.

APRIL 7, 2010

EAM Enables Higher Shareholder Value

By Ralph Rio

Summary

Today, nearly all industrial businesses are asset intensive. To be cost com-

petitive on a global basis, high levels of automation are needed to drive the

required productivity and yield along with flexibil-

ity for meeting changes in customer demand.

Unfortunately, many executives focus on reducing

the costs associated with maintaining these assets

and neglect to consider the impact on the business'

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 go-

vernance 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 complianceCompanies 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 negativeeffect on shareholder value.

A recent ARC survey on enterprise asset management (EAM) had 65 partic-

ipants whose responses represent input from 1,300+ plants with 463,000

employees. One question focused on the primary drivers for maintenance


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ARC Insights, Page 2

2010 ARC 3 Allied Drive Dedham, MA 02026 USA 781-471-1000 ARCweb.com

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. Analy-

sis 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 pre-

ventative maintenance reduces emergency repairs. Lets use an automotive

analogy to help me describe the consequences.

Our example is oil for your engine.

With run-to-failure, the oil level de-

clines until the bearings have no

lubrication, the metal melts, and the

engine freezes solid (seizes-up). Onthe 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 in-

terruption of service (cars always fail

when you need them, because failure

occurs during use). All cars con-

sume engine oil and, without

maintenance, failure is assured.

The alternative is preventative main-

tenance. 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 trade-

off and have our engine oil maintained regularly.

15%

18%

20%

29%

35%

58%

58%

60%

82%

0% 20% 40% 60% 80% 100%

KnowledgeTransfer

Calibration forQuality or Yield

Corporate SocialResponsibility

Sharing BestPractices

Reduce EnergyCosts

Safety and RiskManagement

Extend AssetLongevity

Cost Control forLabor & Parts

Improve Uptime &Downtime

Primary Drivers for Maintenance Management

Source: ARC Trends Survey Feb. 2010


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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-in-

process (WIP) materials. Second, in todays tight scheduling with mi-

nimal inventory, interruption will cause missed shipment dates,

customer satisfaction issues, and reduced revenue.

Cost control for maintenance labor and materials: First, during theemergency equipment repair, acquiring replacement parts is expensive.

To buy time, there are additional costs for materials, expedited ship-

ping, 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 es-timate 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 ex-

penditures are higher.

Safety and risk management: Catastrophic failure of equipment canput people in its vicinity in danger. And, failure of a major system can

cascade into other systems representing a significant business risk. Go-

vernance 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 di-

rect 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.


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Maintaining assets extends their

longevity and avoids replacement.

Conserving cash improves a common

financial metrics like the quick ratio.

Quick Ratio =

(Cash + Marketable Securities) /

Current Liabilities

Impact on Balance Sheet

Now, lets focus on the extends asset longevity driver from the ARC sur-

vey. Maintenance improves the longevity of assets,

thus delaying the need for major capital projects

for replacement or refurbishment. Also, the in-creased uptime provides additional production

capacity and avoids procurement of additional

equipment as the business grows. By delaying ma-

jor capital expenditures, significant cash is

conserved.

Cash conservation improves the financial ratios used to evaluate a compa-

nys 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 im-

proves 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 companys 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 de-

nominator 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 op-

erations to buffer interruptions including equipment failures. Economic

Order Quantity (EOQ) calculations include factors for this uncertainty.

With preventative maintenance and higher equipment uptime, uncertaintyand 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.


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EAM the CFOs Quiet Savior

Managing maintenance for your car is relatively easy. The car manual con-

tains 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

thousands of assets.

Your business has many complex and critical piec-

es of equipment. How does a maintenance

manager know what is the most important item to

work on next? With manual methods, the tenden-

cy 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. Particu-

larly 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&Lstatement 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 sharehold-

er 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 pro-

vide feedback on this paper, please contact the author at [email protected].

Asset Information Management

Work Order Management

MRO Materials Management

Labor Management

Service Contract Management

Reporting & Analytics

Mobility (docking station and wireless)

EAM Functional Groupings

Cxo Eam Arc Brief

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