The different perspectives in Capex procurement

This article follows on from my previous blog “What is Capex Procurement”.

Let’s look through the lenses of different departments in a Capex project by considering what’s important to them, along with their key priorities to see if we can find any overlap.

Finance perspective

•      Capex acquisition is a long-term, high-cost activity that benefits the company beyond one year and is directly linked to the company’s strategy.

•      The value is depreciated over a long period (an accounting convention to help smooth the impact of a high-cost purchase).

•      The value of the acquisition is added to the balance sheet as an asset.

•      The same value is shown on the cash flow statement (as an outflow).

•      The depreciation value is deducted from the income statement (“P&L”) for each year of the useful life of the asset (a typical useful life would be 15 years for production machinery, 5 years for IT equipment).

•      Operational expense (“opex”), the costs of the day to day running of the business are reflected in the P&L account.

•      The priorities of Finance in a Capex project are:

•      Ensuring that the return on investment as described in the business case is met on-time and in-full, due to:

•      The project being on budget.

•      Start-up being on-time – so revenue can be generated as planned.

•      Ongoing operating output, costs and sales revenues are in line with the business case forecast.

•      Note for Procurement people: the financial benefit of a project being delivered on-time, with the company being able to bring in revenue from selling the products from the newly acquired machine, will usually dwarf any machine cost savings. Bear this in mind during your negotiations.

Procurement perspective

•      The supply market is often dominated by few players (due to high technical and cost barriers to entry) so commercial leverage maybe limited.

•      Sourcing is often led by technical functions looking solely through a technical lens (at the expense of commercial considerations, so there is lots of opportunity for Procurement to add value!)

•      A Capex project entails managing a multitude of risks, with an entirely different set of risks to manage compared to Opex.

•      The Capex purchase price is unlikely to be the main cost component over the lifetime of the asset. Other costs will be incurred prior to start-up (eg installation & commissioning) and also throughout the life of the asset (eg maintenance, spare parts, energy).

•      The company has to live with the asset for years – so a more strategic “big picture” sourcing approach is more appropriate than short-term, tactical Procurement.

•      Supplier management emphasis is more likely to be on managing long-term relationships, securing capacity, service and access to new technology.

•      Machinery suppliers (so-called Original Equipment Manufacturers, or “OEM’s”) may also sell OEM spare parts and they’ll feature on the Opex side for the lifetime of the asset, too. This means that “divorce” from the supplier is difficult, so you have to make the supplier relationship work. Think about this carefully during the supplier selection phase.

•      As the Capex acquisition cost is reflected on the cash flow statement (and not P&L account) any savings made on the machine price are benefits to cash, not P&L. Procurement has to think more broadly on how it can report the value it’s delivered.

•      The priorities of Procurement in a Capex project should be:

•      Risk management – especially the risk of supplier-generated project delay

•      Securing sources of value beyond price

•      Always focus on the total cost of ownership over the lifetime of the asset, rather than purchase price alone.

Engineering perspective

•      The main factors that drive Capex acquisition decisions from an Engineering perspective are:

•      Compliance with all safety and environmental regulations

•      Well-designed and capable of operating as per the user requirements specification with the minimum of intervention

•      Compatibility with existing installed equipment eg established standards, maintenance requirements, spare parts and operator training.

•      Uses reliable, proven technology

•      Designed with ease of future modification, upgrade or refurbishment in mind.

The priorities of Engineering in a Capex project are:

·         Specifically meet the business case requirements

·         Minimise overall “cost of capacity” through equipment commonality by using current, proven suppliers

·         Minimise project risk – supplier, technical and impact on operations risk

Manufacturing perspective

The Manufacturing team are after an “easy life” (I don’t mean this in a derogatory way) and will expect the machine to run as expected, giving few problems and with minimum intervention. They prize:

·         High levels of Overall Equipment Effectiveness or “OEE”, comprising:

o   machine availability (up-time)

o   machine performance (produce as fast as possible)

o   low levels of waste

·         Low unit cost of production (waste, consumption of energy, materials, labour, consumables and spare parts)

·         Straightforward maintenance and servicing regime

·         Ease of operator use – low complexity

·         Responsive maintenance and servicing from the supplier

The priorities of Manufacturing in a Capex project are:

·         Ensure machinery performance meets business needs, always (output).

·         Minimise cost of ownership (machinery depreciation is a huge cost and is often reflected in the finances of the operating unit)

·         Negligible disruption to operations during installation and commissioning of the new asset.

From reading this article, you should see that the objectives of each relevant department within the Capex procurement process do not overlap precisely, but they are all (or should be) aligned to the success of the company in meeting its strategic objectives.

In a machinery acquisition project it’s vital that each department does not lose sight of the bigger picture and instead pursues the “greater good” of the corporate goals rather than individual siloed objectives.

Meanwhile, if you think I could help your team understand how to successfully navigate capex procurement and how to generate maximum value from this category, please get in touch.

PS. I’m very grateful to have received some fantastic insights from some former colleagues in Executive Engineering / Manufacturing positions for global CPG companies in writing this article.

The best days lie ahead

Martin