Overall asset contribution: Tapping the hidden power of the asset base in process industries
A series of recent interviews conducted by Strategy& with operations leaders in process industries revealed that while companies focused on optimizing manufacturing and the asset cost base, they overlooked significant real opportunities for long term value enhancements. The main reason: Companies' manufacturing and business strategies are generally not sufficiently aligned. To support improving that alignnment, Strategy& has developed the overall asset contribution (OAC) methodology, which gives insights on how well manufacturing assets are performing and how much real value they contribute.
Management Tool Kit
Kaj Grichnik Sven Uwe Vallerien Matthias Bäumler Caroline Thiedig
Overall Asset Contribution Tapping the Hidden Power of the Asset Base in Process Industries
This report was originally published before March 31, 2014, when Booz & Company became Strategy&, part of the PwC network of firms. For more information visit www.strategyand.pwc.com.
Contact Information Berlin Matthias Bäumler Principal +49-30-88705-852 [email protected] Caroline Thiedig Senior Associate +49-30-88705-862 [email protected] Düsseldorf Sven Uwe Vallerien Partner +49-211-3890-260 [email protected] Frankfurt Dr. Marcus Morawietz Partner +49-69-97167-467 [email protected] Munich Kaj Grichnik Partner +49 89-54525-553 [email protected]
Dr. Marcus Morawietz also contributed to this Management Tool Kit.
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In tough market environments, companies tend to turn first— and often only—to operational cost cutting for stabilizing and improving profitability. However, such “restructuring” programs often fail to deliver expected or sustainable improvements in a company’s competitive position; instead they are frequently followed by yet another round of expense paring a few years later—all the more likely in this crisis. Indeed, a series of recent interviews conducted by Booz & Company with operations leaders in process industries revealed that while companies focused on optimizing manufacturing and the asset cost base, significant real opportunities for longterm value enhancements were overlooked. The main reason: Companies’ manufacturing and business strategies are generally not sufficiently aligned. There is no easy way to alleviate this constructive tension between manufacturing and business, but manufacturing leaders nonetheless should address this issue more proactively in order for production to deliver the full measure of its value to the organization. To support this activity, Booz & Company has developed the overall asset contribution (OAC) methodology, which gives insights on how well manufacturing assets are performing and how much real value they contribute. The rigorous application of this methodology will not only help companies make restructuring efforts more sustainable but also allow process industries leaders to make better strategic decisions on investing in new manufacturing assets as well as the company’s product and technology portfolio. Especially in times of crisis, and to thrive in the wake of an economic upturn, process industries companies should unleash the hidden power of their asset base.
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As global competition increased, so did the pressure on earnings of Western companies in process industries, including the mining, chemicals, steel, and pulp and paper sectors. Decreasing freight costs and reduced duties have only exacerbated this trend, as the barriers to entry for new companies dropped precipitously. These new competitors from Asia, India, and the Middle East sped up industry dynamics with their significant production cost advantages, access to leadingedge technology, and bold mergers and acquisitions, such as the parade of deals signed by SABIC (Saudi Basic Industries Corporation) or the Indian steel giant Tata. Often, Western companies have responded to this challenge by conducting comprehensive restructuring programs to aggressively cut variable and fixed costs. These restructurings, and typically a second round of similar restructurings, failed to deliver anticipated savings, primarily because too often they were isolated events, narrowly focused on nothing but short-term cost cuts. Improving productivity was paramount, an effort often associated with significant head count reduction. But adding value by upgrading manufacturing systems and support and elevating the efficiency of business functions, which are frequently slow and difficult
transformations, was neglected. In addition, legacy structures—such as suboptimal plant layouts and inefficient, aging sites or logistics infrastructure—were not addressed rigorously enough, leaving companies burdened with inadequate and old manufacturing assets. As market requirements change, so does the optimal manufacturing setup, making optimization a constant challenge that is difficult to manage. In Booz & Company’s interviews with executives at leading global process industries companies, three major obstacles to manufacturing transformation were raised. First, the payback from structural changes to manufacturing assets is deemed to be too low to warrant implementation, often because product-pruning opportunities are not approached simultaneously or with the same rigor. Second, the effectiveness of setting targets is often undermined by unclear business decisions or using the wrong kind of performance indicators, making it difficult to run an efficient production unit. Third, the shop floor is constantly being pushed to the next level of operations excellence, whereas the processes that drive other parts of the business—such as marketing and the supply chain—are not upgraded commensurately.
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One common element of all three dilemmas is that manufacturing alone cannot solve the problem. Asset footprint and effectiveness are ultimately dependent on business strategy; the implementation of structural changes to the asset base requires the cooperation of sales; and a misalignment of incentives between operations and businesses or regions leads to suboptimal solutions and companies failing to meet their targets. Without a deep level of cooperation between the business and manufacturing teams, true restructuring with long-term change is impossible. Therefore, an integrated and iterative approach is required to solve the challenges faced by Western process industries. Booz & Company has developed an analytical methodology, called overall asset contribution (OAC),
which measures manufacturing asset contribution by focusing on four criteria: utilization, or actual run time; throughput, or actual output per hour; acceptance, or quality of produced items; and the contribution of technology (see Exhibit 1). OAC is critical to long-term, sustainable restructuring because it can identify hidden efficiency potential that goes beyond merely optimizing lead time and asset effectiveness. Considered in a wider, more strategic context, OAC can help companies make better decisions with regard to, for example, whether to make or buy a new technology strategy. Moreover, manufacturing leaders can use this framework to illustrate for their sales counterparts the drivers of complexity and costs in operations. At its core, this methodology combines asset effectiveness and value creation and defines the actual vs. the potential value added by a plant, assuming that the best product mix could be sold to the market. Thus, OAC significantly enhances the widely
used overall asset/equipment effectiveness (OAE/OEE) method, introduced by Booz & Company (formerly Booz Allen Hamilton) in the early 1990s. OAE is lacking in one important way: It does not sufficiently capture the value creation of a site and its underlying technology. For example, the OAE of a plant may be low because small production campaigns and batch sizes result in poor throughput levels, but that ignores the fact that the manufactured products may be highly profitable. Alternatively, a plant’s high OAE may be due to filling its capacity with low-value products or investing in new capacity before exploring portfolio-pruning opportunities. By including value as a measure of contribution, OAC mitigates these shortcomings and emerges as a comprehensive indicator useful for capturing performance and setting targets in both manufacturing and business operations.
Exhibit 1 Definition of Overall Asset Contribution (OAC)
Utilization Actual run time Total time
Throughput Actual output Best demonstrated output
Acceptance Qualitiy of product Total production
Contribution Share Actual contribution Possible contribution within technology
OAC in %
Note: All indicators are related back to production hours. Source: Booz & Company
Booz & Company
In general, an OAC that is low compared with industry averages indicates that the plant’s capacity is not used to its full value potential due to operational losses, such as those caused by quality or throughput issues, or perhaps because technology setup and business strategy are misaligned— utilization and contribution are not leveraged in a sufficiently robust way (see Exhibit 2). Typically, the further downstream in the value chain, the lower the OAC target, as downstream operations must manage the challenge of greater product portfolio complexity, leading to higher throughput and utilization losses. Consistently applied, the OAC diagnostic pinpoints sources of performance losses in this way (see Exhibit 3, page 5):
• When utilization is low, insufficient scaling of the technology across the manufacturing network is often the key driver, which should raise strategic questions regarding the optimal manufacturing footprint or leveraging make-or-buy opportunities. Utilization losses while assets are operational are usually the result of lagging maintenance procedures or an inefficient supply chain and sales and operations process. • Low throughput and acceptance often indicate insufficient implementation of operating procedures and manufacturing excellence tools; best practices are built around individual know-how and not institutionalized well enough to reward the entire organization. Variability in takt time, or the maximum hours consigned
to making a product, is particularly glaring in multipurpose setups where carrying over knowledge from one job to the next is more difficult to achieve due to product portfolio complexity and the high number of changeovers. • Low contribution share comes about when installed technology is not aligned well enough with the profitability of the production portfolio. This indicates that the portfolio contains too many “fillers”—i.e., low-margin products that are sold to soak up idle plant capacity—or that the business strategy is not aligned with the asset base. A typical reason is that, as products move through their life cycle, the cost of running the plant does not fall in line with the drooping value of the product.
Exhibit 2 Booz & Company Overall Asset Contribution (OAC) Ranges by Process Industry
OVERALL ASSET CONTRIBUTION (OAC) RANGE OF 1ST TO 2ND QUARTILE ACROSS PROCESS INDUSTRIES 80% 72% 68%
43% 43% 29% Basic Specialty Chemicals Note: All indicators are related back to production hours. Source: Booz & Company Fine Steel Processing Paper Processing Glass Conditioning 39%
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Once the root causes of value losses in operations are understood, sustainable improvement measures can be defined and OAC can serve as a critical performance indicator to continually assess the value of the targeted improvements. Going beyond pure productivity improvements, such as introducing lean/Six Sigma principles to improve throughput, OAC can help identify production network restructuring opportunities by highlighting the utilization and contribution of each technology within a site network. For instance, if an OAC analysis discovers that hydrogenation is a significant contributor to output in a chemical plant but the factory’s overall utilization is still low, investigating
ways to better consolidate activities in the plant could be a valuable step. After plotting the various technologies used in the network, it’s then possible to size up the contribution of each. Hence, in our analysis, we found that multipurpose Europe combined with sulfonation make up roughly 40 percent of the total contribution (for this and other examples, see Exhibit 4, page 6). In this context, OAC should be seen as a first way to develop efficiency hypotheses and identify levers for change. However, when opportunities for production network restructuring are being defined, more issues need to be addressed, including the optimal trade-off between utilization and contribution for an asset and the minimum
utilization required to run a continuous or semi-continuous asset economically. OAC can also protect against restructuring measures that are essentially the optimization of one element at the expense of another. For example, increasing the production speed to improve throughput will most likely reduce utilization (if there is no additional demand) or lead to lower acceptance rates. Optimizing working capital may produce a reduction in capital costs due to lower inventories, but such a strategy will likely neglect to factor in the cost of complexity and rescheduling because of suboptimal production runs—and that will result in lower throughput. Clearly, to be
Exhibit 3 OAC Assessment of a Western Specialty Chemicals Company
OVERALL ASSET CONTRIBUTION (OAC)
Utilization Key Sources of Losses • Overcapacities in manufacturing network • Fragmented product-reactor allocation • No make-or-buy strategy in place • Ineffective maintenance (planned & unplanned)
Throughput • Inadequate supply chain policies • Short-term demand plan adjustments • High tact time variability in individual process steps • Lacking standards in SOPs and shop floor organization
Acceptance • Lacking standards in SOPs and shop floor organization • Limited built-in quality control
Contribution Share • High share of low-margin products • Inadequate use of multipurpose technologies
Source: Booz & Company
Booz & Company
effective, results of an OAC assessment and the measures that emerge from these results must be understood and applied by both manufacturing and business leaders. Often, the greatest obstacle to bringing about real change during a restructuring is the constructive tension between manufacturing and sales in making strategic decisions—in particular, in resolving questions regarding product portfolio alignments and investment priorities. For example,
introduction of new products that are essentially commodities with low margins will certainly increase utilization, but unless they are produced with dedicated technologies, they will decrease the contribution share of the site. Assets for these new products may improve the performance of the plant in the very short term, but they will certainly increase operational complexity and reduce competitiveness in the long term. OAC can help determine which technologies at a site are fully leveraged, in terms of
both utilization and contribution, and can safeguard against investing in dedicated or special technologies that are not needed from an operations point of view and may not have sufficient market potential. In short, understanding the value contribution of assets can help companies navigate good and bad times; in periods when there is ample spare capacity, OAC can identify the products and assets to prune or reallocate so that the best ramp-up and growth is possible when the economy revives.
Exhibit 4 Evaluation of Technology Setup (specialty chemicals example)
EVALUATION OF PRODUCTION NETWORK BY TECHNOLOGY Contribution Share 100% Recommendation: Investigate opportunities for asset consolidation 90% 80% 70% 60% 50% Recommendation: Consider both pruning and asset consolidation or whether to make or buy; reduce working capital 40% 30% 20% 10% 0% 0% Source: Booz & Company 10% ~10% of total contribution 20% 30% 40% 50% 60% ~40% of total contribution 70% 80% 90% 100% Utilization Size of absolute contribution of an asset Multipurpose Asia Multipurpose Europe Recommendation: Investigate pruning opportunities or exiting of product groups; assess potential asset consolidation Ethoxylation Methylation Sulfonation ~30% of total contribution Hydrogenation ~20% of total contribution Recommendation: Focus on asset effectiveness through better management of interfaces (supply chain, manufacturing support) and rigorous introduction of lean principles; leverage opportunities to rededicate product groups within technology network
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OAC in Practice A specialty chemicals company was facing severe profitability issues as the competitiveness of the asset base had eroded over the years. Specifically, production was burdened by a legacy plant network and fragmented site footprint. Recent expansions had worsened the problem because they tended to focus on improving output to single customer segments without reflecting ongoing commoditization of entire product groups. As a result, some plants had utilization rates of 20 percent or less. Other assets appeared to be fully utilized but, on closer investigation, were found to be suffering from wasteful inefficiencies and low labor productivity. It was little surprise that OAC revealed this company’s production network to be less than stellar: Its results ranged from 15 to 80 percent, with an average of 50 percent. Indeed, the OAC at the company’s leading production site was only around 37 percent, which broke down in this way: • Utilization was mixed, ranging from 50 to 85 percent. Many assets were inefficiently dedicated, with unnecessary overlaps and complexity, and interfaces with manufacturing support functions and supply chain were inefficient, which led to frequent rescheduling and long periods of maintenance. • Throughput was unsatisfactory, about 65 percent or less. The shop floor was not organized in a lean way, leading to a clear lack of standardization and performance indicators. • Acceptance was high, between 95 and 99 percent. Quality control and engineering and process know-how were excellent, the result of a long-time focus due to the high share of raw material costs. • Contribution was middling, ranging from 65 to 90 percent. The variety of products manufactured at a plant increased over time as commodities were not consistently pruned or outsourced to free up time for more profitable products. Based on these findings and similar ones at other sites, a corporation-wide restructuring program was developed, which reduced fixed costs by 16 percent and increased OAC by 12 percentage points on average within two years. The main elements of this improvement concept were the following: • Optimization of the asset network, leading to plant shutdowns and outsourcing, after a review of the product portfolio by the business side, and the concomitant development of a long-term plan to align technology needs with the business plan to increase both utilization and contribution • Introduction of lean management principles, with a reorganization of the shop floor and a closer integration of manufacturing support functions to improve throughput while reducing lead time • Pruning of selected products • Dedication of plants in line with an implementation of supply chain principles (e.g., revision of lead times, stock levels, and order policies) Finally, OAC was introduced as a key performance indicator in the target-setting process for senior managers in operations, sales and marketing, and business units, helping them to align goals and make the envisioned improvements sustainable.
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Current restructuring efforts are often characterized by a “silo mentality” in which functional leaders lose sight of the importance of integrating the supply chain with business processes. This is worsened by target-setting practices that establish performance goals for individual functions, which are misleading as they tend to motivate sales and marketing to optimize at the expense of manufacturing, and vice versa. This results in short-term and tactical optimizations, limiting the appetite for sustainable and structural measures. In turn, long-term competitiveness is reduced. And while many companies are handcuffed by organizational legacies, we believe that an integrated OAC approach, which combines asset and business considerations in a single key performance indicator, can help
in achieving substantial operational benefits. OAC can be used as a starting point to bridge the gap between manufacturing and business targets by measuring improvement opportunities against benchmarks, by making the business side as well as the manufacturing function responsible for improving OAC, by triggering business and portfolio decisions in an integrated way, and by measuring the true value of investment and restructuring. Thus, OAC can help process industries increase their value creation by reaching the next level of operational excellence, as well as increase the value delivered by their asset base with improvements that are significantly greater than those gained from regular restructuring efforts—and certainly more sustainable. Given the scope of today’s global economic crisis, this is more important than ever.
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About the Authors Kaj Grichnik is a partner with Booz & Company in Munich. He specializes in manufacturing and lean operations for process and discrete manufacturing industries. Sven Vallerien is a partner with Booz & Company in Düsseldorf. He specializes in manufacturing and supply chain management for the chemical and pharmaceutical industry. Matthias Bäumler is a principal with Booz & Company in Berlin. He specializes in manufacturing and restructuring for the chemical and pharmaceutical industry. Caroline Thiedig is a senior associate with Booz & Company in Berlin. She specializes in manufacturing and supply chain management for the chemical and pharmaceutical industry.
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