Clients continue to ask the question “When and how will I know if it is time to expand?”.
To answer the “When” question: When, no pun intended, an ingredient or a service is a unique, high value, non-commodity, the answer becomes sooner than later. Depending upon how unique a firm’s need is will depend on the pay back of a capital project. Presumably, the charge for that ingredient or service is tied to a value and is charged to the firm. The opportunity becomes greater when the margin is higher and the volume becomes less significant than when considering a commodity.
Quantity and volume is the second component to the “When” question. If the volume is steady or the volume is large, justifying the need becomes easier because the size of the capital expansion will be priced accordingly. If however, the volume is intermittent, or comes in large spikes for example, the capital justification becomes difficult because the cost to outsource is temporary. The entrance costs to manufacturing can overwhelm the justification of a project .
Like the micro-economics theory, profitability being a function of margin and volume, so is capital justification expansion. Analyzing these dynamics will allow for an optimal decision to occur. Delta-Driver LLC has justified such projects even to the extent of writing the internal Capital Requisition for such a project.
Often writing the Capital Requisition by a manager can deter the entire process. The bureaucracy, the time and research required, the exposure to the individual writing it, and the process of change can limit whether a profitable project is considered.
When writing a Capital Requisition, five general components allow for an effective proposal to be seriously considered:
- 1. The problem statement: What problem is being solved through the proposed project? Problem statements can be about competitiveness in the marketplace, technological trends and innovation, regulatory requirements, efficiency opportunities, quality and reliability needs, infrastructure replacement, or other necessary updates in a plant.
30% of the capital requirements should meet an Internal Rate of Return or payback threshold, 30% should address infrastructure maintenance and 40% should address regulatory, R&D or other marketplace opportunity.
- 2. The solution statement: What solution is recommended and why that solution. In the detail of the Capital Requisition alternative solutions need to be considered, including doing nothing. This will give strength to the position of the Capital Requisition because alternatives are considered and show due diligence in the process. It may inadvertently answer questions that the decision makers may make as they approve or disapprove the proposal.
- 3. The cost analysis of each alternative solution: A side-by-side cost solution validates the final recommendation and the cheapest is not always the best. Side-by-side comparisons allow the decision makers justification to choose or not to choose one solution over the other.
- 4. The scope statement of the project: The scope should be on the executive summary of the Capital Request close to verbatim of what the vendor group is offering in their proposals. The scope statement, sometimes itemized, protects the project from “scope-creep” during implementation. It also protects the project manager from expectations of stakeholders who may assume more to the project than the project is expected to deliver. This statement of scope is likely one of the most important statements during implementation when new things are discovered as being “needed” but not included in the original proposal.
- 5. The Sensitivity analysis: This statement is generally in the detail of the Capital Requisition but is useful in predicting the reliability of the data and research in the project. This gives the stakeholders a risk assessment of the project. Because it is change, even though this change may fix the problem in the Problem Statement, it may also create a new problem in other areas of the process. A thorough, cross-functional sign-off on the perceived and preferably documented risks, can give the decision-makers a relative confidence of what they are agreeing to.
Once the project is approved there are as many different models of implementation as there are vendors offering these models. One such model that Delta-Driver LLC uses is the following:
- 1. Master planning phase: A conceptual Study that considers the current state with the future state and makes proportional recommendations on size, on space, on costs, on product flow and other principles in industrial engineering that will make the solution statement most effective.
- 2. Preliminary Design: a definition of major assets with capacities, layout drawing, utility matrix and an itemized but high-level budget for the project.
The Master planning phase and the Preliminary Design is often a project in and of itself and is used in the justification of the Final Design and the remainder of the project. In this case, one project defines the substance of the next phase of a larger project.
- 3. Final Design and Construction phase: This provides the detailed engineering, actual quotes of equipment, materials and services and a contingency when things go unexpected to plan.
Capital expansion is a difficult discipline in a company that is growing. Yet it is often the life blood of the future for most young companies entering the middle market. Having a system and a model to objectively guide a company into a future will support their mission and future profitability.