3 Tips for Getting More Out of Your CapEx Budgeting Process
Let’s face it, capital equipment procurement hasn’t really changed since the Industrial Revolution. The end-user gives the OEM money, the OEM gives the end-user a machine, and that’s it…unless there’s a problem. In no way is this transaction tied to performance and the end-user holds all the risk.
When it comes to making capital budgeting decisions, here’s the scenario that seems to play out too often:
Your company has a long list of projects competing for funding. Only the ones with the highest internal rate of return (IRR) will get picked.
Once the projects for that year are selected, it’s time to evaluate the vendors for that process. This requires a lot of front-end work and hidden costs, from the time and resources required to vet suppliers, to the risk of selecting the vendor that promises the best solution, cheapest price, or something in between.
After that, the capital dollars are exchanged, the projects get implemented, but the performance falls short. If the machine doesn’t meet the output levels that were promised, it makes it even more difficult to reach the anticipated ROI. After all, those anticipated returns could have been inflated since your teams knew they were competing for funding.
Next year, it happens all over again, only this time with even more audacious project justification requirements.
Or, maybe it’s time to reimagine your capital budgeting process.
Having lived through this capital budgeting process ourselves, here are 3 tips for getting more projects - and more output - out of your CapEx budgeting process:
1) Ask your OEMs about outcome-based payment programs
When we talk about Industry 4.0, we’re talking about the Fourth Industrial Revolution. If technology has changed so much since the 18th century, why are we still talking about procurement models from the First Industrial Revolution?
With outcome-based procurement models like Machine-as-a-Service, you can pay for equipment based on its usage and output rather than a fixed, upfront capital cost. This derisks and accelerates the process of selecting a vendor because they only get paid if you’re successfully producing a product.
2) Make sure you have the bench strength to keep your assets running
The skilled labor gap continues to be a headwind for manufacturers. Do you have the team you need to keep your equipment running at optimal production levels?
Machine performance is tied as much to the people operating and servicing the machine as it is to its production capabilities and capacity. Whether you have the staff in-house or not, partnering with top-tier equipment builders with strong service organizations is a great way to supplement your existing teams.
Getting the equipment is just the first investment. Select your partners for long-term results, not just installation and commissioning.
3) Stop creating unattainable IRR requirements
If you have trouble getting the anticipated returns on your capital investments, look beyond your vendors and at your internal budgeting processes as well. When an IRR of 30% is required for a project to get the “thumbs up,” is it the project or the process that’s causing results to fall short?
With usage-based payment models, you no longer need to select the top 1 or 2 projects that hit your IRR threshold. If you’re paying for performance rather than upfront capital, it’s feasible that you could do 3 or more projects that all yield healthy returns. This eliminates overzealous estimates of individual projects and gets you strong returns across-the-board.
Industry 4.0 and the Fourth Industrial Revolution have yielded technologies that allow you to monetize your production data and pay for output, not assets. It’s time to start paying for the results that your OEM partners are promising you.