Optimizing Indirect Production Cost to Improve Overall Plant Performance
By Brad Cunic
(This article was first published on November 14, 2008 in Metal
Producing & Processing and is republished here courtesy of the
author. To read the original version, please click here.)
Indirect production costs — that is, the cost of using, sourcing, and purchasing all the materials, parts, supplies, labor, and services required to support or sustain operation of a plant or equipment, but is not directly included in the product — are receiving increased attention from senior managers in almost all industries, especially metals. Rising raw materials and power costs are forcing metal producers and processors to find new ways to reduce cost, improve performance, and increase profitability.
But, most companies attack indirect cost without realizing the total impact of specific reductions. Deferring maintenance, for example, or cutting costs on standard operating procedures can expedite a much larger capital expenditure by increasing equipment and/or performance degradation and /or premature failure. The cost to rebuild a carbon baking furnace for an aluminum smelter can be as much as $50 million, not counting the increased cost of purchasing carbon while the furnace is out of commission. Implementing proper maintenance and operating practices can extend the furnace life by as much as five years. Managers must determine the value of deferring $50 million for five years versus the value of deferring routine maintenance.
Most indirect costs are interrelated. A reduction in one cost may increase another one, or reduce performance in other areas. Recently, a steelmaker decided to use a less expensive lubricant on a hot-strip mill, saving just a few cents/pound. The lubricant did not have the right properties and was constantly being washed out. In addition the lubricant was not compatible with the other lubricants used in the mill. The steelmaker’s purchasing department was credited with the savings, but the total increase in the hot mill’s lifecycle cost was more than $500,000/year — which does not include the cost of handling and disposing of 37,000 lb/year of grease.
In some operations, indirect production cost can be 30-40% of total purchases. In contrast, many purchasing organizations will spend as much as 80% of their time sourcing, purchasing, and tracking direct materials. Often the effort to reduce indirect costs is focused on purchase price, not on lifecycle cost reduction principles.
To reduce or optimize indirect cost, the management team must understand that most indirect cost activities/ functions are interdependent with each other and in the way they impact production processes and total cost. Recognizing these dynamics in your operation will allow you to optimize and reduce indirect costs — and to reduce manufacturing risks and cost while increasing production throughput and profitability.
The first step in optimizing indirect costs is to determine the deficiencies in the current practices. A simple but effective opportunity assessment can define and quantify these factors.
Numeric scores are calculated using quantitative data from the current operation. Once the scores are calculated for each area of assessment, they are entered into the “dashboard tool.” The dashboard contains best-practice performance quartiles that provide immediate feedback on current performance compared to industry best practices. At the same time, a cost analysis is performed to determine the baseline for indirect service cost.
Next, the performance benchmark data and cost baselines are integrated with production performance cost and losses to calculate an economic gap analysis. The gap analysis will be a road map to determine the value of improved indirect cost optimization for each category of cost and prioritize optimization efforts.
Once the gaps have been identified, a root-cause analysis must be performed to identify the reasons for the poor performance. For example, if labor costs are high for maintenance personnel, a labor activity analysis can determine the craft productivity. Most people attribute excessive labor cost to a lazy or inefficient workforce. In most cases, it is just the opposite. We find that management work processes dictate a majority of the excess labor costs. Once a proper root-cause analysis has been performed on all major performance gaps, an improvement plan can be put in place to increase overall performance and optimize indirect costs.
This is an actual scorecard from a steelmaker’s opportunity assessment. Numeric scores are based on quantitative data, which is presented in a “dashboard” so that current performance information can be compared immediately to industry best practices.
After the plan is in place, a systematic process should be used to implement the step-change improvements using cross-functional teams. Each team should be trained to evaluate alternative work processes and solutions based on the lifecycle value before any changes are implemented.
Once any change has been properly evaluated, approved, and implemented, a “management of change” process must be implemented to ensure any new changes or modifications maintain the integrity of the process and do not degrade lifecycle cost.
The idea is for the team to include stakeholders or representatives from each area of the plant to be affected. For the hot-strip mill noted above, purchasing cannot decide to change lubricants solely because of price. Using the proper management of change process, purchasing would make a recommendation to the crossfunctional team. Then, the team would evaluate the benefits of lower purchase cost to the lifecycle cost and performance impacts with all stakeholders to determine the true value of making a change. A change should only be made if the total lifecycle value of the alternative is justified.
Once changes are justified, teams should follow a rigorous process to deliver improved performance, quickly. Lower cost delivers more profit per ton, and also positions owners for the sale of more tons. Integrating lower cost with reliability and asset effectiveness provides step changes in performance improvement and will result in compounded economic value to the owner.
Brad Cunic is the executive director of Sales for Fluor Enterprises Inc. Contact him at firstname.lastname@example.org