Great smart manufacturing initiatives deserve great funding
Calculating financial benefits and proving the return on investment (ROI) is critical when developing a smart manufacturing project.
- Calculating return on investment (ROI) is critical for a smart manufacturing project.
- Benefits include increased revenue, reduced risk and more.
- Cost sources include staff support, planning and project development.
After a long search, you have the project that will turn the company around. The technology is the right fit for the process, employees have been asking for a solution to this problem, it aligns with the company’s strategic goals, it can scale across the enterprise and an implementation team is ready to deliver. There is only one problem: No funding for the project.
It is rare to find a technical manager or engineer who is eager to write up a financial justification for a new project or initiative, but a proper business case is a critical component of project planning and necessary to get access to the business’ limited pool of resources and funds. Intuition and knowledge of manufacturing operations are great for finding improvement opportunities, but to get funding, it’s necessary to present hard-numbers and demonstrate the business will see a compelling financial return on the investment.
The exercise of building the business case is an important early step for any large and transformative initiative. In addition to getting an approved and funded project, financial justifications can unveil benefits and costs that were not previously considered, establish how to measure success and envision a strategy for long-term scalability.
Companies need to take a closer look at how to establish a financial justification and calculate the return on investment (ROI) for smart manufacturing projects.
Smart manufacturing: Fundamental principles of ROI
ROI is one of the most popular measures for understanding the financial feasibility of a project or initiative. ROI represents the efficiency of an investment: How effectively the benefits of an investment cover the cost of that investment. It is calculated by dividing the expected returns of an investment (the benefits minus the costs) by the total cost, is often represented as a percentage, and higher ROIs represent more promising investments. ROI is commonly used to compare multiple potential projects against each other to select the projects most likely to have the best financial impacts on the business.
ROI is popular because it is easy to understand and quick to calculate but discovering and quantifying the benefits and costs that make-up an ROI calculation can be an endeavor that takes time, money, and a little bit of educated guesswork. In the following sections, we will try to simplify this process of identification and quantification by examining some common costs and benefits associated with smart manufacturing projects specifically.
Five ROI benefits for manufacturers
It is important to understand the differences between hard and soft benefits and how they will be considered by a business. Hard benefits represent direct cash coming into the business through improvements like decreasing energy costs or increasing throughput and revenues. Soft benefits refer to intangible gains from an initiative like increasing customer confidence, avoiding high-value workers doing low-value work, or increasing operator satisfaction and retention. They can be more difficult to quantify, and procurement teams may not even be willing to consider them unless they can be represented as a hard benefit that hits the bottom-line. Soft benefits are still an important consideration for any smart manufacturing initiative, especially given modern technology’s promises around enabling knowledge-workers. When considering soft benefits, companies should consider ways how an intangible gain can be represented as a dollar value. Work with the finance team to understand the best way to represent these values in the business case.
Identifying potential benefits is all about solving critical manufacturing issues: finding the pain points in the process and operations and then finding the value of solving those pains. The value of these solutions often can be represented by one of the following categories:
- Increased revenue: The most obvious financial benefit is one that brings more revenue into the business. A project that increases the throughput of a bottleneck means more product per minute of runtime, which creates more to sell. The same goes for every minute of prevented downtime. Revenue also can increase through improving the ability to introduce and manufacture new products. Reducing the time for new product development (NPD) and new product introduction (NPI) can lead to a customer business before the competition, which leads to more direct revenues.
- Reduced costs: Similar to increasing revenue, every dollar saved in the manufacturing process goes directly to the business’ bottom-line. Smart manufacturing projects often reduce costs by reducing raw material costs, reducing labor costs, reducing the cost-per-unit of production, and reducing energy and utility costs. While most of these are hard benefits, there are potential soft benefits in this category as well. Reducing labor costs may improve operator satisfaction and retention. Reducing energy costs could be realized through green initiatives that increase public perception of the business.
- Cost avoidance: Avoiding costs eliminates the need to reduce a cost! Examples include increasing throughput to meet increasing demand, therefore avoiding the cost of adding new manufacturing assets; or avoiding overtime and extra shifts for the operations team.
- Reduced risk: Smart manufacturing projects can provide value by avoiding the “what ifs” that can disrupt business and cost the company money. They can replace manual systems that are prone to human error, therefore reducing the risk of a regulatory compliance issue. Smart manufacturing solutions also could detect quality issues before products leave the plant, reducing the risk of recalls; and provide increased traceability to reduce the impact of a recall or quality issue.
- Qualitative benefits: There may be other soft benefits that are difficult, if not impossible, to quantify but are still valuable to the company and can improve the business case for a project. Some examples of qualitative benefits include increasing the speed of intelligent decision making, increasing customer satisfaction, and capturing knowledge from an aging and retiring workforce.
Once the project benefits have been identified, they need to be quantified. This process includes some educated guesswork and assumptions, and it is important to document logic applied during the exercise. This also may require working with the finance team and other stakeholders to understand how to translate a 2% savings of material costs or a 14% reduction in downtime into dollars.
Identifying three cost sources for a smart manufacturing initiative
To calculate ROI and make a business case, the costs of an initiative must be documented and understood. Costs should include direct project costs and potential changes to the business’ operation costs. For a smart manufacturing initiative, be sure to consider these three cost sources:
1. Planning, preparation and feasibility: The work that goes into the business case and planning a successful implementation are important considerations for the overall solution ROI. This could include paid feasibility studies and consulting, establishing the current state-of-affairs and how to measure change, searching for qualified technology vendors and integrators, and documenting requirements.
2. Project development: These are the costs to the business to deploy the prescribed solution. Project development costs should consider hardware, software, internal efforts, contracted services and consulting, and risk management activities. Estimating these costs often starts with an internal assessment, then by soliciting proposals from qualified vendors. These costs also should consider required infrastructure upgrades, application retirement costs, and training costs.
3. Support: Smart manufacturing projects almost always will need some ongoing services or maintenance costs to keep the system running, secure, and up to date. Support costs should be considered for each project development cost over some planning horizon.
Smart manufacturing: Presenting the business case
Once there’s an assessment of the benefits and costs for the smart manufacturing initiative, this information can be included as part of the business case. Present the most important, high-level numbers that make a compelling case for the initiative but have the detail to back those numbers up when needed to.
Also, consider other financial metrics beyond ROI that could help make a more compelling business case. For example, net present value (NPV) incorporates time and the weighted average cost of capital (WACC) into the financial assessment, making it a very popular assessment metric that uses much of the same raw data as ROI.
Finally, the business case may be most compelling when considering how the solution will scale. Smart manufacturing projects often require some initial pilot phase to experiment and make sure the technology can deliver on its promises. These pilots often have higher costs than rollout projects and may not be financially compelling without considering their returns at-scale.
Constructing a business case for smart manufacturing projects is a challenging but necessary step to get buy-in and sponsorship from stakeholders across the organization. A proper business case with ROI can not only get the smart manufacturing initiative approved; it will also help develop an implementation strategy, reduce risk of surprise-costs and establish expectations and metrics for success.
Keywords: smart manufacturing, return on investment (ROI)
What return on investment (ROI) metrics are most important for your smart manufacturing projects?